Capital Loss and Indebtedness of Joint-Stock Companies: Article 376 of Turkish Commercial Code (“TCC”)
By Gözde Esen Sakar
The current economic state has made it even more pertinent to discuss the measures to take if the healthy financial condition of a company is disrupted. Article 376 of the Turkish Commercial Code (“TCC”) sets out the steps required for joint-stock companies.
The extent of the measures stipulated depends on the extent of the disruption of the financial condition, and Article 376 gradually regulates under three separate paragraphs:
Paragraph One regulates a situation in which half of the sum of the share capital and legal reserves, as shown in the last annual balance sheet, become not covered due to losses. Under this provision the board of directors is obliged to call a general assembly meeting to submit the remedial measures that the board considers appropriate.
Paragraph Two regulates a situation in which two-thirds of the sum of the share capital and legal reserves, as shown in the last annual balance sheet, become not covered due to losses. Under this provision the board of directors is obliged to call a general assembly meeting to resolve whether to continue company activities with one-third of the share capital or whether to make up the loss of the share capital. If either of these are not decided upon, the company will automatically dissolve.
Paragraph Three regulates a situation in which indicators are present that the company is fully in-debt. In this case, the board of directors must prepare an interim balance sheet based on assets using a going concern concept and the contingent sale prices. If it is evident from the interim balance sheet that the assets do not cover the receivables of the company’s creditors, the board of directors must notify the situation to commercial court of first instance for the location of the company headquarters, and request bankruptcy of the company.
A request for bankruptcy shall not be necessary, however, if creditors with debts owed (that equate to at least cover the company’s financial deficit) agree that all other creditors shall be prioritised before their receivables. These agreements or declarations must be made in writing, prior to the court rendering any decision on bankruptcy, and must be verified by the experts appointed by the court.
Solutions for exclusion from Paragraph Two of Article 376
There are solutions that allow for exclusion from the second paragraph of Article 376. The choice of which and how to implement will be a commercial decision for the company.
- Making up / completion of the loss of share capital: Decreasing the capital loss to an amount under the two-thirds ratio stated in Article 376, via a shareholder of the company injecting cash or in kind value gratuitously.
- Simultaneous share capital increase and decrease: Share capital may be decreased for the purpose of recovering the losses in the balance sheet and the share capital may be increased simultaneously.
In the event that the share capital is decreased simultaneously with a share capital increase for the purpose of recovering losses shown in the balance sheet, the payment of rights of the creditors of the company or securing such rights shall not be required, since the purpose of the share capital decrease is to recover the adverse balance as a result of losses.
However, if the share capital decrease will be at an amount greater than the losses shown in the balance sheet, it must be proven that the rights of the creditors of the company will not be at risk due to the share capital decrease. In order to prove this, in principle, assets sufficient to cover the rights of the creditors of the company must exist within the company. If this level of assets does not exist in the company, share capital may be decreased by an amount exceeding the losses shown in the balance sheet on condition that no payment to the shareholders is made due to this share capital decrease.
Solutions for exclusion from Paragraph One of Article 376
Even if the company is excluded from the second paragraph of Article 376, at a further stage the company board of directors may be obliged to take necessary measures within the scope of the first paragraph of the article. Such measures are not numerus clauses (not limited) as they are in the second paragraph of Article 376; any and all measures considered appropriate by the board of directors and resolved by the general assembly for recovering the capital loss may be implemented. In other words, if the company falls within the scope of the first paragraph of Article 376, the board of directors at its discretion is obliged to recover the company with measures to be implemented. Some examples of measures that are seen to this end are share capital increase, closing or down-sizing production units or departments, alteration of the marketing system and/or reducing costs.
Liability of the Members of the Board of Directors Arising from the Necessary Measures under the First and Second Paragraphs of Article 376
Pursuant to Article 553 of TCC, in the event that members of the board of directors, through fault, violate their obligations arising from the law and the articles of association, board members are liable against the company, the shareholders and the creditors of the company for their losses.
In case of capital loss, members of the board of directors are obliged to call a general assembly meeting for the purpose of taking necessary measures. Otherwise, members of the board of directors will be in violation of their legal liabilities. In such a case, if a loss occurs, members of the board of directors shall be jointly liable pursuant to Article 553 and subsequent articles of the TCC.
If members of the board of directors fail to call a general assembly meeting to discuss measures to be implemented, theoretically the shareholders and creditors of the company are entitled to file a lawsuit for liability against the members of the board of directors.