Pledging Dematerialized Shares Of Publicly Held Joint-Stock Companies

December 2009
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Pledging dematerialized shares of publicly held joint-stock companies as security for loans granted by domestic and foreign credit and finance institutions have recently become a widespread practice in Turkey.

In this article, the issues relating to the establishment procedures, the legal nature of, and the enforceability of pledges on the dematerialized shares of publicly held joint-stock companies which are listed on the stock exchange, will be analyzed in comparison with pledges of shares of closed joint-stock companies subject to the provisions of the Turkish Commercial Code and joint-stock companies which are considered as publicly held joint-stock companies under Article 11 of the Turkish Capital Market Law N°: 2499 as the number of their shareholders exceeds 250.

Under Turkish law, pledges on the shares of joint stock companies are regulated in various codes, including the Code of Obligations N°: 818, the Banking Law N°: 5411, Law N°: 1447 on Commercial Enterprise Pledge. However, in this article, pledges on the shares of joint stock companies will be analyzed within the frame of the provisions of the Turkish Civil Code N°: 4721 (“MK”), the Turkish Commercial Code N°: 6762 (“TTK”) and the Turkish Capital Market Law N°: 2499 (“Ser.PK”) and the Bankruptcy and Enforcement Law N°: 2004 (“IIK”) where the realization of the pledge is mainly stipulated.

Establishment of pledges on dematerialized shares of joint-stock companies

The establishment of pledges on the shares of closed joint-stock companies subject to the articles of TTK and of joint-stock companies having more than 250 shareholders and thus considered publicly held joint-stock companies according to Article 11 of Ser.PK, are subject to Article 956 of MK concerning the pledge of negotiable instruments. Pursuant to the first paragraph of this Article, a transfer of share certificates to a pledgee is deemed sufficient to establish a pledge of bearer shares. However, pursuant to the second paragraph of the same article, to establish a pledge on registered shares, the transfer of the share certificates must be accompanied by the issuance of a written statement of transfer or endorsement of the share certificates.

Regardless of whether the shares are registered or bearer shares, to establish pledge on dematerialized shares, it is compulsory to declare the pledge on the shares to the Central Registry Agency (“MKK”) via the relevant intermediary institution and to have it registered with the records of the MKK according to Article 19 of the “Communiqué on the Principles Regarding Book-entry Recording of Dematerialized Capital Market Instruments” (Serial: IV No: 28) issued by the Turkish Capital Markets Board (“SPK”).

According to Article 956 of MK, transfers of possession for the pledge of bearer shares and endorsement of the shares or a written pledge declaration for the pledge of the registered shares are constitutive and essential procedures. Since the shares traded on the stock exchange are not stored physically, but are instead recorded electronically pursuant to the provisions of Ser.PK, physical transfer of dematerialized shares is not possible. Moreover, according to Article 10/A of Ser.PK, for asserting the rights on the capital market instruments to the third parties the date of notification to the Central Registry Agency shall be taken as reference. In light of these facts, registrations of pledges on dematerialized shares in the records of the Central Registry Agency should be perceived as a constitutive procedure for the pledge of the dematerialized shares.

To establish a pledge on dematerialized shares, execution of a written pledge agreement is neither compulsory nor considered constitutive; however, it constitutes evidence of the pledge relationship between parties. Although execution of a written pledge agreement is not necessary to establish a pledge on dematerialized shares subject to Ser.PK, a written pledge agreement may help a pledgee to avoid any future loss of rights resulting from correction of a wrong registration or in case of future disputes regarding the pledge.

In order to procure the required announcement by the intermediary institution to the Central Registry Agency, first the parties or the pledgee must inform the intermediary institution about the establishment of the pledge on shares that are stored in the account operated by the intermediary institution. In practice, when informing intermediary institutions about a pledge, the intermediary institutions require submission of every kind of written document, including the written pledge agreement to avoid any future liability before the Central Registration Agency.

According to the fourth paragraph of Article 19 of the Communiqué mentioned above, upon announcement of a pledge on dematerialized shares by the relevant intermediary institution to the Central Registry Agency, the Central Registry Agency will register the share pledge in its electronic records and will transfer the pledged shares from the existing account of the pledgor to a sub-account of the pledgee. However, in practice the storage of the pledged shares under a sub-account of the pledgor is allowed by the Agency as well if the parties have mutually agreed to it.. If the pledged shares are stored in a sub-account of the pledgee, the identity information of the pledgor will also be maintained in connection with the sub-account.

Even if the pledge shares are stored in a sub-account of the pledgor, the pledgor is not entitled to dispose of the shares. Therefore, the issue of whether the pledged shares are stored in a sub-account of the pledgee or of the pledgor has no effect on establishing a pledge on the dematerialized shares.

If the pledged shares that are registered in the records of the Central Registry Agency are to be stored in the sub-account of the pledge,

1. monthly payments due for the annual storage fee, which are equal to %0.075 (seven point five of ten thousandth) of the nominal values of the pledged shares, are to be collected by the Central Registry Agency, and

2. if the parties to the pledge have so agreed and the pledgee is entitled to collect the dividends paid on the pledge shares, the distribution of dividend fee with an amount equal to %0.05 (five of ten thousandth) of the dividend collected from each distribution performed by the issuer joint-company

shall be paid by the pledgee which is the account owner.

The advantages of pledges on dematerialized shares compared to other share pledges

A pledge on the dematerialized shares of publicly held joint-stock companies, just like pledges on other negotiable instruments, is subject to the general provisions for realization of pledges on movable assets under the Bankruptcy and Enforcement Law. According to Article 45 of the Bankruptcy and Enforcement Law concerning the receivables that are secured by pledges, a pledge wishing to collect its receivables must first apply for and initiate enforcement proceedings.

The procedures to follow during the enforcement proceedings for the realization of the pledged dematerialized shares of a joint-stock company do not differ from other types of procedures of the enforcement proceedings initiated for realization of the ordinary shares or shares bound to a share certificate of the joint-stock companies until the phase where proceedings become definite against the pledgor and thus the pledgee is entitled to request the sale of the pledged shares.

When the proceedings become definite and the pledgee requests sale of the colleteral, the pledged dematerialized shares are to be auctioned by the relevant enforcement office without waiting for an appraisal of the pledged shares since the pledged shares are traded on the stock exchange. An appraisal usually adds one month to the sale process

Another regulation in favor of the pledgee at the point of selling the pledged dematerialized shares is Article 29 of the Istanbul Stock Exchange Shares Market Regulation. Pursuant to this article, since the pledged shares are traded on the stock exchange along with ordinary sale options, which are sale by way of auction or, sale by way of bargaining, it is also possible to sell the shares in an out of session auction or within the daily sessions of the Stock Exchange.

Even though Turkish Law calls for the sale of the pledged shares by the relevant enforcement office, if it is mutually agreed by the parties to the pledge that the pledgee is entitled to sell the pledged shares at a private auction or by bargaining, the pledgee may perform the sale of the pledged shares without applying to the relevant enforcement office. Therefore, the sale of pledged shares at the market value obviates the need for an appraisal and accelerates the process.

The establishment of a subsequent pledge on the pledged shares with the consent of the pledgee, which is allowed under the provisions of the Turkish Civil Code, is not possible due to the practice of the Central Registry Agency. Therefore, no right or other security which may compete with or prejudice the rights of the pledgee may be established on the pledged shares in favor of third parties under the provisions of the Ser.PK.

Under Turkish capital market legislation, there is no specific regulation addressing the issue of whether the inclusion of provisions in the articles of association of publicly held companies prohibiting or requiring consent to establish pledges on the shares of publicly held companies is allowed or not. In practice, it may be mutually agreed by the parties that the pledgee will be entitled to sell the pledged shares by private auction or private bargaining or that the pledgee will enjoy shareholder’s rights for the term of the pledge. In light of the corporate governance principles imposed on the publicly held joint-stock companies by Ser.PK, there should be no provisions hindering the circulation of shares traded on the stock exchange. We are of the opinion that if any provision which may impinge on shareholders’ rights is not allowed by the corporate governance principles adopted in the Turkish capital market environment, then there should also be no provision complicating the establishment or realization of pledges on shares which is commonly granted to pledgees with the right to enjoy the shareholder’s rights.

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