Change for the better: An overview of the current legal landscape

In keeping with the country’s growing social needs and the breakneck pace of technological advances that the world has seen since the turn of the century, the need to amend and improve major codes in the law has become indispensable as of late. The government has been very active in trying to keep the legal environment current, and has introduced major improvements to the existing legal framework in recent years. The year 2012 will see some of the most important of these newly enacted laws go into effect. In this overview, some of the most notable changes that will be brought about as a result of this modernisation effort will be discussed.

COMMERCIAL LAW: One of the most notable overhauls in Turkish law in recent memory is the introduction of the new Turkish Commercial Code (TCC), which will enter into force on July 1, 2012. The new TCC will update the commercial legal environment to bring it in line with modern trends, and introduce new concepts that were absent from the law in its previous incarnation. In this section we will address seven of the most significant changes that the new TCC will bring to the legal landscape.

GROUP OF COMPANIES: The new TCC will introduce the concept of a group of companies. Under the new TCC, a group of companies is composed of a parent company (dominant company) and subsidiary companies under its dominance. In other words, the existence of a group of companies will depend on the existence of dominance among the group members. The new TCC does not define “dominance”, and we can, therefore, assume that the law adopts the existing definition of the concept. Legal doctrine currently defines dominance as the power to determine and control decisions of a company concerning its finances and operations, and also influence decisions relating to its budget, investments and all other financial matters, dividend policy, production, marketing, sales and human resources. The new TCC lists the sources of dominant power as: (i) dominance through voting rights, (ii) dominance through agreements and (iii) dominance through other sources.

The new TCC also establishes certain rules obliging dominant companies not to inflict losses on their subsidiaries through the exercise of their dominance.

It enumerates two situations of dominance abuse: (i) abuse of dominance through transactions within the scope of authority of the board of directors and (ii) abuse of dominance through transactions within the scope of authority of the general assembly. In addition to these, the new TCC also addresses a third situation of abuse in Article 209, which prohibits (iii) the abuse of public trust in the goodwill of the group of companies.

SHARE BUYBACK: The purchase by a company of its own shares is generally referred to as a “share buyback.” Companies follow this process in order to reduce the number of their shares on the market.

The two main reasons that companies may elect to reduce their shares on the market are: (i) increasing the value of shares still available, and (ii) eliminating threats by shareholders who may be looking to gain a controlling stake. Although share buybacks have been allowed in many common law countries along with many European Union countries since the mid-1970s, share buybacks have generally been prohibited under Turkish law.

The new TCC will allow share buybacks by companies under certain conditions, essentially enacting into law the principles regulated under EU law. Under the new TCC, joint-stock corporations will be allowed to repurchase up to 10% of their own shares; this sort of a buyback will have to be carried out by the board of directors, pursuant to the authorisation of the general assembly. A repurchasing company will only be allowed to buy back shares that represent capital that has been fully paid-in. As for limited liability partnerships, the new TCC will allow the repurchase of 10% of shares as a matter of course, but in this form of association the repurchase ratio will be allowed to go up to as high as 20% in the event that a partner wants to leave the partnership and the company’s articles of association provide for a buyback of this scale in such an event.

LIABILITY OF BOARD MEMBERS: The new TCC will hold members of the board of directors up to the standard of the prudent executive and require them to protect the interest of the company under a duty of good faith. Directors will face liability if they breach the obligations entrusted upon them by the law or by the company’s articles, unless they can prove they have not acted negligently. In the event that managerial powers have been delegated, directors delegating authority may not be held liable for their delegates’ acts unless they are proven to have acted negligently in choosing their managers.

Under the scheme introduced by the new TCC, directors may not be held liable for illegal acts that have occurred outside of their control, and neither the obligation to supervise nor the duty of care may be used as grounds for holding them liable. The ultimate liability system of the current TCC will be reduced to a level that is within the scope of human control under the new TCC.

FINANCIAL ASSISTANCE RESTRICTIONS: According to the new TCC, it will not be permitted for shareholders to borrow from the company, except for share capital contribution undertakings, unless the debt arises from a transaction that is required by the company’s scope of activity or the business of the shareholder’s enterprise, and unless the debt is made on terms similar to those applicable in comparable cases conducted at arm’s length.

A joint-stock corporation cannot be a party to transactions with third parties made to advance funds, extend loans or provide security to have the company’s own shares acquired by a third party. Notably, this prohibition will not apply to transactions (i) executed with credit and finance institutions in the normal course of their business, and (ii) effected with a view to having the shares acquired by the company’s or its affiliates’ employees.

SQUEEZE-OUT: The new TCC grants a squeeze-out right to shareholders who control, directly or indirectly, at least 90% of the share capital and at least 90% of the voting rights in a joint stock corporation. Controlling shareholders are entitled to exercise this right if the minority shareholders act to obstruct the operations of the company, act in bad faith, create a perceptible disruption in the company or act in a manner that is deemed reckless.

The new TCC also provides an exception to the principle of “continuity of the shareholding of a shareholder” and allows for the squeeze-out of minority shareholders in the case of a merger. In a merger agreement, the entities involved in the merger may compel the shareholders of the dissolving company to sell their shares merely by providing compensation through payment (without the shareholders being offered a choice). In such a case, the minority shareholders will not be entitled to obtain shares in the surviving entity, but instead will only be paid “squeeze-out compensation”. However, the new TCC limits the scope of this squeeze-out procedure in that, if the minority shareholders of the merging entity are forced to exit and accept compensation payment, shareholders holding 90% of the voting rights of the dissolving entity will have to approve the merger agreement.

ENFORCEABILITY OF RIGHTS & OPTIONS: The new TCC adopts a different approach to the enforceability of put/call options and tag-along/drag-along rights as between joint-stock corporations and limited liability partnerships. According to the new TCC, option rights and other ancillary obligations for shareholders cannot be included in the articles of association of a joint-stock corporation, and these will not be binding on third parties.

However, the new TCC does not prohibit such mechanisms from being implemented under private contractual arrangements between the shareholders (i.e. under shareholders’ agreements). This approach unfortunately will invite enforceability concerns. Notably, the new TCC will allow limited liability partnerships to freely include such limitations in their articles of association.

SHARE TRANSFER RESTRICTIONS: The new TCC modifies the restrictions applicable to share transfers. Under the new TCC, registered shares that are not fully paid-in can only be transferred upon the approval of the company. The company may withhold such approval if it has doubts regarding the solvency of the purchaser and the purchaser refuses to provide the requested security to the company.

Moreover, a company’s articles of association may also require the firm’s approval for share transfers. With regards to non-listed registered shares, the company is permitted to refuse approval on the basis of material reasons laid out in its articles of association, or it may choose to make an offer to transfer the shares at their actual value. With respect to shares that are listed and registered, the company may only reject a transfer should such transfer exceed the acquisition threshold set by the articles of association in terms of the percentage of the share capital that is changing hands.

CONTRACTS LAW: A second pillar of the government’s efforts to modernise Turkish law will be the replacement of the current Turkish Code of Obligations (TCO) by the new TCO, which was enacted on January 11, 2011 and will go into effect on July 1, 2012.

The new TCO provides a new set of rules for “standard terms and conditions” (genel işlem şartları ), which went unaddressed by the old TCO. With these provisions, the law aims to protect individuals from abstract and one-sided agreements unilaterally drafted by companies specifically to not be negotiable. The new TCO provides a detailed definition for standard terms and conditions, and regulates the validity conditions of these agreements.

For parties who have not determined yearly contractual or default interest rates under their agreement, the new TCO establishes the application of the valid and relevant regulations for the accrual of interest.

The new TCO extends statutes of limitations for compensation in both torts and unjust enrichment claims. A one-year time limit for both claims under the old TCO is extended to two years under the new regime. The new TCO also provides certain new concepts regarding employment agreements:

• Sexual harassment/mobbing: The concepts of mobbing or sexual harassment do not exist in the old TCO or Labour Code. The legal gap, especially in case of mobbing, was filled by court rulings. The new TCO regulates both sexual harassment and mobbing through a specific article. Employers are now obliged to take all necessary actions to prevent employees from exposure to such acts and minimise the damage for those who are already exposed to such behaviour.

• Non-competition agreements: The old TCO did not have a specific provision on the time limit of non-competition agreements for employees following termination of employment, simply indicating that such agreements would be applied only if they were effective for an “appropriate period”. The new TCO provides an upper limit of two years for such agreements.

• Instructions: The new TCO also provides that employers may have general regulations that cover job performance, and may give special instructions to employees. Employees are obliged to follow such instructions to the extent that they are reasonable.

• Intermediation fees: There is also a new regulation regarding the payment of “intermediation fees” to employees. If the employer and employee agree, the employee will be entitled to an intermediation fee to assist in establishing a commercial relationship between the employer and a third person.

• Vehicle: If the employer and the employee agree that the employee may use his/her own vehicle for the performance of the employer’s commercial activities, the employer must pay the taxes, mandatory liability insurance premiums and an appropriate compensation for depreciation of the vehicle.

• Notice periods for indefinite-term employment agreements: The new TCO also amends the termination notice periods for employment agreements of indefinite duration based on the length of the employment period. With this amendment, the actual termination notice will be two weeks for employment of at least one year. For employment of one to five years, this will be four weeks, and for employment of more than five years, the termination notice period will be six weeks. This scheme is in line with the corresponding provision in the Labour Code. It is worth noting the provisions of the new TCO do not remove or repeal overlapping Labour Code provisions. The new regulations will only apply in circumstances where the new TCO governs employment.

Finally, in accordance with the Electronic Signature Law, the new TCO recognises an electronic signature as an original signature in written agreements. With this rule, an electronic signature will be sufficient to execute an agreement. Under the new law, documents that contain secure electronic signatures or documents that are sent via fax or other transmission methods with confirmation may also be considered authentic writings.

PROCEDURAL LAW: The old Civil Procedural Code, which was enacted in 1927 and contained outdated and archaic methods, was replaced in 2011 by a new code that introduced many fresh concepts and mechanisms to Turkish law. Most notably, the new law addresses the most problematic aspects of civil litigation in Turkey, namely the unacceptably slow pace of legal proceedings, through a number of means, the most notable of which are:

• Advance for costs: Under the old code, parties were able to avoid paying even the trivial court fees until specifically ordered by a judge at a hearing. This meant that one or two hearings would be wasted and resulted in a time-consuming procedure for payment of required costs. However, with the enactment of the new code, plaintiffs are now required to not only pay court fees but an estimated advance for costs as well.

• Submission of claims, counterclaims and defences: Under the old code, parties could also delay a case by waiting until the last minute to submit their full cause together with documentary evidence. They would wait until the judge set a final deadline for submission, and this would again delay the procedure. However, it is now mandatory to submit full claims, counterclaims and defences at the outset, together with all documentary evidence available. A trial cannot be set in motion until written pleadings are completed. Following the completion of this step, the judge schedules a preliminary examination hearing. Moreover, judges are specifically authorised to urge the parties to settle or resort to alternative dispute resolution mechanisms as early as the pre-trial stage. In addition, the new Civil Procedural Code addresses the use of experts in the Turkish legal system. Even though it was technically prohibited under the old code, judges, because of their heavy workload, usually assigned analysis of solely factual and legal issues to experts, and utilised these experts’ review of the case when delivering their judgements. The new code prohibits the use of these “legal experts” by restricting the use of experts to those listed in the expert list, posted by the Civil Law Justice Commissions. This means that judges will only be able to assign as experts persons that have technical and/or scientific expertise.

ENERGY SECTOR: The Law on the Utilisation of Renewable Energy Resources for Electricity Generation (RES Law), enacted in 2005, fell short of satisfying the needs of investors who have carried the burden of costly energy-sector investments. The initial form of the RES Law also had limited impact on the market due to its modest and uncompetitive feed-in tariff regime. To overcome the shortcomings of the RES Law, the government prepared a bill that included amendments to offer higher feed-in tariffs. These amendments were enacted on December 29, 2010, and they became effective on January 8, 2011. While the effects of the amendments in the marketplace are yet to be fully understood, they do introduce numerous investment and financial advantages that have long been awaited by investors. These include:

• Priority for system connection: Generation facilities that use renewable energy resources will have priority over other applications in the evaluation of the licence applications, with regards to the preparation of the system connection opinion.

• Renewable Energy Support Scheme: Generation licensees generating electricity from renewable energy resources are eligible to receive a renewable energy source certificate (RES certificate) from the Energy Market Regulatory Authority. Facilities holding a RES certificate are allowed to participate in the Renewable Energy Support Scheme according to the generation amount indicated on their RES certificate. Companies that supply electricity are obliged to financially participate in the support scheme pro rata to the electricity amounts that they have supplied. In other words, it is indirectly imposed upon these companies to purchase electricity that is generated from renewable resources. Generation licence holders have the right to receive these payments pro rata to the generation amounts indicated on their RES certificates. However, it is not mandatory, but optional, for generation facilities to enter into the support scheme. The support scheme is organised annually, and licensees that wish to benefit from it must apply by October 31 to be eligible for the following year. The highest rates under the support scheme are set for biomass and solar energy facilities, and facilities using domestically manufactured components are accorded comparatively higher feed-in rates.

• Electricity generation for self needs: Generation facilities using renewable energy resources with an established capacity lower than 500 KW are allowed to deliver the electricity that they generate beyond their own needs to the distribution system at the above-mentioned prices for 10 years. In this case, the relevant distribution company is obliged to purchase such electricity. The country’s national strategy documents are proof of its desire for growth in the renewable energy market. Accordingly, Turkey is expected to establish 10,000 MW wind and 300 MW geothermal energy generation capacity by 2014. In addition, according to the Ministry of Energy and Natural Resources, Turkey’s solar energy potential is estimated to stand at 380 TWh per year. With these figures as forecasted, Turkey hopes that the new legislative developments will serve its aim of becoming a major player in the renewable energy sector in the coming years.

CAPITAL MARKETS LAW: After obtaining comments from public authorities, the Capital Markets Board (CMB) announced the draft law on capital markets on March 9, 2012 and requested comments and recommendations on it from private parties. After the enactment of the new TCC, legislation of a new Capital Markets Law was expected, and such a draft was finally made public in March 2012.

The draft Capital Markets Law aims to update Turkish capital markets jurisprudence in line with European Union law and the design to be implemented by the new TCC. With this draft law, the CMB has aimed to integrate into a coherent whole various strands of existing CMB jurisprudence, which had been developed over time in discrete regulatory communiqués and so-called principle decisions. Another proclaimed goal of the CMB in this process has been to keep the superstructure of the law as flexible as possible so that any changes in the future can be easily accommodated.

The bill introduces many innovations, but the most remarkable of these concern the alignment of the Capital Markets Law with the new TCC. The draft Capital Markets Law formally introduces the concepts of the right to exit and the squeeze-out mechanism into capital markets law. The draft bill also introduces to Turkish capital markets jurisprudence the concept of the undertaking for collective investment in transferable securities. This gives collective investment funds recognisable legal personhood, and thereby allows them to take advantage of a greater variety of investment opportunities, most notably real estate.

In addition to the new draft law, the CMB has recently been very active in refining the principles of corporate governance that it will require public companies to follow. The CMB initially published its principles of corporate governance in 2003, but these were only advisory at the time. Since then the CMB has steadily worked a number of these principles into its regulations, albeit in piecemeal fashion. Finally, in October 2011 the parliament authorised the CMB to require companies under its watch that met certain thresholds regarding the dispersion of shares, the frequency of trading, etc. to abide by these principles in their entirety.

The CMB took a cautious first step in its initial communiqué implementing this directive, which it issued in October 2011. That communiqué’s mandatory language was addressed only to the top 30 companies listed on the Istanbul Stock Exchange, and the addressees were required to abide by only a limited set of the CMB’s principles. One of the principles that was made mandatory at this time was that at least one-third of the board of directors had to consist of independent directors. This initial communiqué was followed by another one issued in late December 2011, which expanded the mandate to follow the principles to all publicly traded companies.

The December communiqué also controversially installed the requirement that a majority of independent board members must approve certain acts fundamentally changing the nature of the corporation, such as acquiring, transferring or encumbering a significant portion of corporate assets or delisting with a stock exchange. Under this communiqué, there was no way to circumvent the independent board members: even submitting the measure to the consideration of the general assembly of shareholders required their approval.

This scheme generated a significant amount of backlash from the industry: to many, this design seemed to wrest control of corporations away from shareholders and give it to independent board members. As a result, in February 2012 the CMB issued yet a third communiqué reversing itself on this particular requirement. As it now stands, CMB regulations require acts that would fundamentally change the nature of the company to be approved by a majority of the independent directors on the board; failing that, the general assembly of shareholders may consider and approve the measure, but it must first take under advisement the stated reasons for the independent directors’ rejection of the measure.

In its February communiqué the CMB also had to walk back another aggressive move it had made regarding independent board members: In its December communiqué, the CMB had introduced a requirement that the board of directors of any publicly floated company must at a minimum contain enough independent directors to proportionally represent the shares being publicly held. This move was also seen by the industry as unnecessarily diluting management control over the company. As a result, the CMB softened its stance on this question in the last incarnation of its regulations, only requiring, as of now, that no less than one-third of the board be composed of independent directors, provided that there are no less than two independent directors in any event.