Technical Bankruptcy Under The Turkish Commercial Code

I. Introduction

The deterioration of a company’s (namely joint stock companies, limited liability companies and partnerships limited by shares are subject to this provision) financial standing and its legal consequences are governed by Article 376 of the Turkish Commercial Code numbered 6102 (published in the Official Gazette dated February 14, 2011 and numbered 27846 (“TCC”) and the Communiqué on the Procedures and Principles regarding the Implementation of Article 376 of the TCC published in the Official Gazette dated September 15, 2018 and numbered 30536 (“Communiqué”). When a company incurs losses that impair its capital and legal reserves (if any), or becomes insolvent (a condition commonly referred to as “technical bankruptcy”) the board of directors (“BoD”) and the general assembly of shareholders are legally obligated to take remedial measures to restore the company’s equity in accordance with Article 376 of TCC.

The legal obligations arising from financial deterioration, and the corresponding responsibilities of the BoD and the general assembly, vary depending on the severity of the financial distress. These obligations can be categorized into three principal scenarios; (i) losses have depleted half of the company’s paid-in capital and legal reserves (if any), (ii) losses have depleted two-thirds of the company’s paid-in capital and legal reserves (if any) and (iii) the company is technically bankrupt or excessively indebted.

In accordance with Article 5(1) of the Communiqué, if it is determined from the latest annual balance sheet that at least half or two-thirds of the capital and legal reserves have been depleted due to losses, the management body must immediately convene the general assembly, and this fact must be explicitly stated among the agenda items. However, pursuant to Article 5(2) of the Communiqué, applicable to both the first and second scenarios, the financial situation must be addressed at the general assembly, even if convened under a different agenda. Accordingly, the general assembly must deliberate on the company’s financial distress at its earliest meeting without delay.

Below is a detailed analysis of each scenario (stated above) and the associated legal remedies.

II. Scenarios Based on the Degree of Capital Depletion

i) Depletion of Half of the Paid-in Capital and Legal Reserves

Under Article 376(1) of the TCC, if the latest annual balance sheet reveals that at least half of the company’s paid-in capital and legal reserves (if any) have been depleted, the BoD is required to convene the general assembly and propose appropriate remedial measures. The BoD must present the balance sheet in a clear and comprehensible manner, ensuring that all shareholders are adequately informed of the company’s financial position. A supplementary report may also be submitted.

The BoD is expected to propose and explain alternative remedial strategies, which may include capital replenishment or increase, downsizing or closure of certain operational units, divestiture of subsidiaries and revisions to the marketing strategy.

The general assembly may adopt the proposed measures, amend them, or opt for alternative solutions.

ii) Depletion of Two-Thirds of the Paid-in Capital and Legal Reserves

According to Article 376(2) of the TCC, if the latest annual balance sheet indicates that at least two-thirds of the company’s paid-in capital and legal reserves (if any) have been depleted, the BoD must convene the general assembly, which must resolve either to:

1. Reduce the capital to one-third (based on Articles 473 and 475 of the TCC): This may involve reducing the capital to the statutory minimum of TRY 250,000, provided that at least half of the total capital and legal reserves remain within the company’s equity.
2. Increase the capital: Shareholders may be required to contribute additional capital pro rata to their shareholding, either through cash injection or by waiving receivables. A simultaneous capital decrease and increase may also be resolved, whereby the reduced capital offsets the company’s losses.
3. Replenish the capital: This involves injecting a capital replenishment fund by all or some of the shareholders without issuing new shares or treating the contribution as a loan. The fund is solely used to offset accumulated losses. This obligation does not constitute a capital contribution or a loan and is made without consideration. Furthermore, the payments made are not to be regarded as an advance against a future capital increase. Importantly, such decision requires all shareholders’ consent.

If the general assembly fails to adopt any of the above remedies, the company is deemed dissolved and enters liquidation. Pursuant to Article 11 of the Communiqué, the liquidation procedures of a company that has dissolved in this manner are carried out in accordance with Article 536 and subsequent provisions of the TCC.

iii) Technical Bankruptcy / Excessive Indebtedness

Where there are indications that give rise to reasonable doubt as to the company’s solvency or suggesting material indebtedness, the BoD is obliged to prepare a balance sheet predicated upon both the going concern principle and the potential sales value of the company’s assets. If it is determined that the company’s assets are insufficient to cover its liabilities, and no remedial measures (that explained above; capital reduction, increase, or replenishment) are initiated, the BoD is obligated to notify the commercial court of first instance at the company’s registered address and file for bankruptcy. Indicators of insolvency may be derived from annual or interim financial statements and the BoD’s assessments. Failure to act in accordance with these obligations may expose the BoD to legal liability.

 iv) Mergers Involving Capital Loss or Insolvency (Article 14)

A company with capital loss or insolvent may merge with another company that has freely disposable equity sufficient to cover the losses. This must be confirmed by a certified public accountant or sworn financial adviser's report, verifying either that the solvent company holds adequate freely disposable equity to cover the capital loss or insolvency, or that no such adverse condition exists. Where the transferee company is subject to audit, the report may alternatively be prepared by its statutory auditor.

In practice, the merger mechanism is commonly utilised by group companies that include a subsidiary or affiliate in a state of technical insolvency. Rather than pursuing formal restructuring or liquidation proceedings, group structures frequently resolve the technical insolvency of an ailing entity by merging it into a financially sound group company that holds sufficient freely disposable equity to absorb the losses.

III. Balance Sheets

A company's capital loss or insolvency status is determined on the basis of financial statements prepared in accordance with Article 88 of the TCC.

Until 1 January 2027, when calculating capital loss or insolvency under Article 376 of the TCC, companies may disregard: (i) the entirety of foreign exchange losses arising from outstanding foreign currency obligations, and (ii) half of the total leasing expenses, depreciation charges, and personnel costs accrued in 2020 and 2021. Calculations must be made without double-counting. These adjustments are not recorded in the financial statements prepared under Article 13 but must be disclosed in the notes as supplementary information.

IV. BoD Liability

The non-transferable duties and powers of the BoD expressly include notifying the court in case of insolvency. Founders, board members, managers, and liquidators are liable to the company, shareholders, and creditors for damages arising from negligent breaches of their statutory obligations in line with Article 553 of the TCC.

Under Article 345/a of the Enforcement and Bankruptcy Law, if persons authorized to manage or represent the company, or liquidators, fail to file for bankruptcy despite the company’s assets being insufficient to cover its debts, they may face imprisonment from 10 days to 3 months upon a creditor’s complaint. This is the key criminal provision triggered by a failure to notify the court of insolvency.

Also, pursuant to Article 333/a, if those with legal or de facto management authority in a commercial company intentionally harm creditors by failing to pay debts (in whole or in part), they may be sentenced to 6 months to 2 years’ imprisonment and a judicial fine of up to 5,000 days, unless the act constitutes another offense. If committed negligently, a judicial fine of up to 2,000 days applies. This provision typically arises where the board knowingly continues operations despite technical insolvency, breaches payment priority, or favors certain creditors over others.

V. Conclusion

In conclusion, Article 376 of the TCC and the Communiqué establish a comprehensive legal framework for addressing financial distress in companies. The obligations imposed on the BoD and the general assembly vary depending on the extent of financial loss, ensuring timely and appropriate intervention. Effective compliance with these provisions is essential for safeguarding corporate continuity and creditor interests within the Turkish legal system.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.