Prohibition of Joint Stock Companies’ Subscription for their own Shares

December 2018 Ecem Çetinyılmaz
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Introduction

Pursuant to Article 388 of Turkish Commercial Code No. 6102[1] (“TCC”), amongst the provisions governing joint stock companies, a company cannot subscribe for its own shares. Subscription for the company’s shares by a third party, or a subsidiary in its own name, but on the company’s account, is also considered as subscription by the company for its own shares. Although not explicitly regulated, this rule was also adopted as a principle under the abrogated Turkish Commercial Code No. 6762 (“Previous TCC”). Through the TCC, the rule and the scope were both clarified, and the sanctions applicable to violation thereof were regulated, as well. This Newsletter examines the legal grounds, scope of application, and consequences concerning the prohibition of subscription by a company for its own shares.

Legal Grounds of the Prohibition and the Reference Legislation

Article 388 of the TCC is mainly based on Second Council Directive 77/91/EEC dated 13 December 1976 of the European Union, and Article 56 of the German Stock Corporation Act. Even though the expression of “prohibition of subscription for its own shares” was first used in the TCC, the preamble of Article 388 of the TCC states that the term “free from any collusion” under Article 285/1 of the Previous TCC also included this rule[2]. Therefore, although Article 388 of the TCC is a newly introduced provision, the main rule existed in the Previous TCC.

The prohibition of subscription for its own shares is a requisite of the principle of actual payment of capital and is an absolute prohibition[3]. A situation to the contrary would mean investing the assets owned by the company again in its assets, as capital; in other words, using the same capital twice[4], which would also violate the principle of equal treatment through the establishment of a company without capital, or allocation of the risk in the amount of the increased capital to the company, by taking the risk from all or certain of the shareholders[5].

Scope and Field of Application of the Prohibition

As per the preamble of the said Article, the provision aims to include all circumstances of original acquisition of shares, such as subscription for the shares to be issued at the incorporation and capital increase, subscription through taking over the preemptive right in principal and registered capital systems, and the exercise of the rights of exchange and purchase in conditional capital increases[6]. On the other hand, in the event of a capital increase through internal resources (by way of conversion into capital of the substitutes, reassessment fund, immovables or subsidiary sales earnings, or the profits decided to be distributed), it is argued that the prohibition of subscription for its own shares is not applicable, as it is not possible to violate the principles of actual payment and protection of capital, since there is no new external contribution to increase the company’s assets through this type of capital increase[7].

Whilst Article 388/1 of the TCC states, as a general principle, that a company cannot subscribe for its own shares, the second paragraph of the Article extends the scope of prohibition by regulating that a third party or a subsidiary subscribing for the shares in its own name, but on the company’s account, would also be considered as subscription for its own shares. Although one can think that at the incorporation stage, a joint stock company cannot subscribe for its own shares as it does not yet exist, in fact, a subsidiary subscribing for the company’s shares in its name, but on the company’s account, means that the company subscribes for its own shares even at the incorporation stage. Pursuant to the last paragraph of the Article, the first paragraph shall apply by way of analogy to the subsidiary company, which subscribes for the parent company’s shares.

The reason for explicitly regulating that a third party or a subsidiary subscribing for the shares in its own name, but on the company’s account, is included within the scope of the prohibition, is explained in the preamble of the Article, as follows: “The purpose of the provision is to prevent the prohibition under the first paragraph from being disabled by collusive transactions. If this provision had not been regulated under the draft, maybe the same result could have been reached based on the provisions relating to evasion of law, and (partially) based on the third paragraph. However, any hesitations that might appear in one’s mind, different approaches and interpretations might have eliminated the benefit anticipated from the prohibition regulated under the first paragraph. The reason for explicitly stating “subsidiary company” is the concern that it might not be considered as a third party through certain assumptions. In incorporation and capital increases, in the event that a third party or a subsidiary subscribes for the shares of a joint stock company in its own name, but on the joint stock company’s account, which exists or is being established, the aforesaid shares would be considered subscribed for on account of the above-mentioned joint stock company, and such situation would be included within the scope of the prohibition regulated under the first paragraph. The third party may be a real person, a legal entity, or a single proprietorship. The subsidiary company is defined pursuant to Article 195. The provision also applies where the subsidiary company is a single proprietorship. Subscription on account may be any kind of commission, proxy or performance contract, or have the characteristics of a mixed contract. For the application of the second paragraph, it is sufficient that the company carries the risk. The principal capital and registered capital systems as well as conditional capital increases, are within the scope of the provision.[8]

Since share buybacks, or establishments of pledges over a company’s own shares, in other words, acquisitions through transfers, are subject to Article 379 and the following Articles of the TCC, such acquisitions are not included within the scope of Article 388 of the TCC[9] [10].

Violation of the Prohibition and Consequences thereof

Pursuant to Article 388/3 of the TCC, in the event of violation of the prohibition of subscription for its own shares, founders and the members of the board of directors are deemed to have subscribed for such shares at the incorporation, and at the capital increase, respectively, and are liable for the share prices. From the standpoint of the company, subscription is invalid due to unlawfulness, and does not result in any legal consequences; the fact that these shares are deemed to have been subscribed for by the founders and members of the board of directors does not affect the invalidity against the company[11].

The same paragraph also regulates that the founders and the members of the board of directors, in capital increases, who evidence that they bear no fault in an unlawful subscription, shall be relieved of liability. Therefore, the TCC accepts a presumption of fault, and allows the said persons to be relieved of liability through evidencing faultlessness. The founders and the members of the board of directors, apart from those whom have evidenced that they bear no fault, are not relieved of their liability. The liability for unpaid prices is several[12].

The preamble of the provision states that the Article is based on the assumption that the subscription was made by the founders at the incorporation and by the board of directors in capital increases, and explains the structure of the Article, based on the presumption of fault, as follows: “If the founders or the members of the board of directors are not at fault, the subscription not only has no consequences (as it is invalid), but it also is not replaced by another subscription through an assumption. If the founders or the members of the board of directors are at fault, the invalid subscription is replaced by their subscription through a statutory assumption. In order to eliminate any ambiguities, fault is emphasized.[13]

In accordance with Article 388/4 of the TCC, the third paragraph that regulates the consequences of violation of the prohibition shall also apply by way of analogy to the subsidiaries subscribing for the shares of the parent company, and such shares shall be deemed to have been subscribed for by the members of the board of directors of the subsidiary. The members are liable for the share prices. This paragraph emphasizes that the liable parties are the members of the board of directors of the subsidiary, and the liability of the founders of the subsidiary is not explicitly regulated as it is a very exceptional case; however, such wording that is preferred in the Article does not prevent assigning the liability of the founders of the subsidiary[14].

Conclusion

As a requirement of the principle of actual payment of capital, companies are prohibited from subscribing for their own shares under the TCC. Even though the expression of “prohibition of subscription for its own shares” was first used in the TCC, the term “free from any collusion” under Article 285/1 of the Previous TCC also included this rule. Subscription for the company’s shares by a third party or a subsidiary in its own name, but on the company’s account, is also considered as subscription by the company for its own shares. In the event of violation of the prohibition, subscription does not give rise to any consequences for the company. Founders and the members of the boards of directors are deemed to have subscribed for such shares, at the incorporation and in capital increases, respectively, and become liable for the share prices, unless they prove that they bear no fault.

[1] TCC (Official Gazette, 14.02.2011, No. 27846) entered into force on 01.07.2012.

[2] Preamble of Article 388 of the TCC.

[3] Preamble of Article 388 of the TCC.

[4] Nilsson, Gül Okutan: Türk Ticaret Kanunu Tasarısı’na Göre Şirketler Topluluğu Hukuku, İstanbul 2009, p. 209; Çapa, Mehmet Sadık: Anonim ve Limited Şirketlerin Kendi Paylarını İktisap Etmesi, İstanbul 2013, p. 138.

[5] Pulaşlı, Hasan: 6102 Sayılı Türk Ticaret Kanuna Göre Şirketler Hukuku Şerhi, Cilt II, Ankara 2011, p. 1243; Çapa, p. 139

[6] Preamble of Article 388 of the TCC.

[7] Pulaşlı, p. 1243 and the authors mentioned therein.

[8] Preamble of Article 388 of the TCC.

[9] Preamble of Article 388 of the TCC.

[10] See Leyla Orak Çelikboya, Share Buyback of Companies pursuant to the New TCC for information on share buyback of companies.

[11] Preamble of Article 388 of the TCC.

[12] Preamble of Article 388 of the TCC.

[13] Preamble of Article 388 of the TCC.

[14] Preamble of Article 388 of the TCC.

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