Delving Into Financial Assistance Rules in Acquisition Financing Transactions

One of the most discussed topics under Turkish law, at the intersection of M&A and banking and finance transactions, is the financial assistance prohibition, which essentially aims to prevent companies from providing financial assistance to third parties to acquire their own shares, otherwise known as a leveraged buyout. In this article, we will review the source and purpose of this prohibition and discuss the current regime under the Turkish Commercial Code, as well as alternatives and consequences.

Financial Assistance: Definition

Article 380 of the Turkish Commercial Code numbered 6102 (“TCC”) [i] sets forth that a joint stock corporation, with the purpose of facilitating the acquisition of its own shares, cannot provide advance funding, a loan or a security interest to a third party. Otherwise, these transactions shall be deemed null and void. The legislative reasoning behind the TCC explains that the wording of “advance funding, loan or security” should be interpreted broadly in accordance with the legislative intent. This provision is titled “Circumvention of the Law” and aims to prevent parties from exploiting legal loopholes to circumvent the prohibition in acquisition financing transactions. The TCC sets forth a less strict regime compared to the abrogated Turkish Commercial Code which was numbered 6762.

Source and Purpose: Practice in Türkiye

A proper understanding of Article 380 of the TCC requires an examination of the preceding provision. Article 379 of the TCC provides that a joint stock corporation cannot acquire its own shares or accept them as a pledge for consideration exceeding one-tenth of its issued or paid-in capital, or in an amount that would cause this limit to be exceeded as a result of such acquisition. The first paragraph of Article 379 further states that this provision also applies to shares acquired by or pledged in favor of a third party in its own name but on behalf of the company. The term “financial assistance” refers to situations where a company provides financing to enable the acquisition of its own shares or shares of its subsidiary.

The financial assistance rule set forth in Article 380 of the TCC affects the structure of leveraged buyout transactions (“LBO”) in Türkiye. Typically, in an LBO transaction, the acquirer purchases the target using a loan that is funded and collateralized by the target’s own revenues and assets. By borrowing funds, parties reduce acquisition costs, creating the “leverage” effect.

Alternatives Observed in Market Practice

In Turkish practice, one of the alternatives used to mitigate the risks associated with the breach of financial assistance rules is merger. In this alternative, acquirers of the shares in a Turkish target company (“Target”) incorporate a new company (“NewCo”) in Türkiye and NewCo borrows the funds necessary for the acquisition. After the closing of the acquisition, the Target and NewCo merge with each other by way of a downstream merger (NewCo merging into Target) or an upstream merger (Target merging into NewCo). The prevailing scholarly opinion is that the financial assistance restriction should not apply to (especially upstream) mergers since the Target would dissolve and there would be no legal entity that could breach the financial assistance rule. Under the TCC, an indebted company may merge with another company, which indicates legislative intent to permit the acquiring company to benefit from the target’s assets and revenues in merger transactions. In a downstream merger scenario, the Target assumes NewCo’s loan repayment obligations, creating uncertainty regarding compliance with the financial assistance prohibition, as the downstream merger transfers the loan obligation to the Target and may therefore constitute financial assistance.

Another, less common alternative in practice is to convert the Target into a limited liability partnership before the acquisition. Some legal scholars argue that financial assistance rules regulated under Article 380 of the TCC are applicable to joint stock corporations but not to limited liability partnerships. However, conversion is often a time-consuming exercise, and there are concerns about increased tax liability and administrative burden on the transfer of shares in limited liability partnerships.

Consequences of Circumventing the Law

If Article 380 of the TCC is circumvented, any person with a legitimate interest may claim the absolute nullity of the underlying transaction. However, prevailing scholarly opinions suggest that creditors must first exhaust all available legal remedies against the company to collect their receivables before claiming absolute nullity.

There are various opinions regarding the application, enforceability, and scope of Article 380, and case law remains limited. Nevertheless, it is clear that a JSC must not provide financial assistance for the acquisition of its own shares. Since circumventing the financial assistance rules renders the underlying transaction null and void, all parties should adopt a prudent approach to ensure legal compliance and transaction certainty.

[i] Published in the Official Gazette dated 14 February 2011 and numbered 27846.