Summary: Leveraged buy-out mechanism is analysed within scope of the financial aid prohibition for joint stock companies brought under Articles 379 and 380 of the new Turkish Commercial Code No. 6102.
“Leveraged buy-out” is one of the most preferred methods in company acquisitions, especially by acquiring companies, due to its various financial advantages.
- The buyer should acquire company shares in a manner that would enable it to take control over the relevant company,
- A considerable amount of the purchase price should be financed by third party loans and
- Full amount or a considerable amount of the relevant loans should be secured by the target company’s assets.
The term “leveraged buy-out” actually reflects the financial aspects of this method. If, according to this method, loan money is put in the company instead of capital, revenues as well as profitability of the company will increase and the less money is spent from the capital and lower is the interest rate, the profitability of the company will increase again. This effect is called as the “leverage effect” in finance literature. Leveraged buy-out may be referred to as “acquisition by way of indebtedness” from a legal point of view. In fact, the company acquires another company, as mentioned above, by using the money it has obtained through a loan.
This acquisition method was freely applied in Turkey without any legal restriction until 1 July 2012, which is the entry into force of the Turkish Commercial Code No. 6102 (“TCC”). However, an important change may be considered to have occurred at this point with the entry into force of the TCC.
Article 379 of the TCC stipulates that a company cannot acquire or accept as pledge its own shares in an onerous manner, in an amount exceeding, or which will exceed at the end of a transaction, one tenth of the principal or issued capital of the company. In order to prevent the circumvention of the prohibition for the companies to acquire their own shares, Article 380 of the TCC (entitled “Fraud against the law”) stipulates that “legal transactions involving advance payments, provision of loans or security, which are carried out by a company with another person for the purpose of acquisition of the company’s shares, shall be null and void”. The main purpose of this article is to prevent Article 379 from being ineffective and being circumvented by invalidating the legal transactions in which a joint stock company assists or supports a third party by providing financing, loan or security or by other means for the acquisition of its shares by such third party. In fact, such support is considered as indirect acquisition by a joint stock company of its own shares under the mentioned Article.
There are two exceptions to the financial aid prohibition: (a) transactions falling within the scope of business of credit and financial institutions and (b) legal transactions with respect to advance payments, provision of loans or security to the company’s or its affiliates’ employees for the purpose of acquisition of the company’s shares.
However, under any circumstances, such transactions shall be invalid in the event that they result in a decrease in the amount of legal reserves, which the company is obliged to set aside according to the law and its article of association, or are in breach of the rules set forth in Article 519 in relation to disbursements relating to the legal reserves and prevent the company from setting aside legal reserves provided for in Article 520.
Leveraged buy-out procedure may also be considered within the scope of the financial aid prohibition provided for in Article 380 of the TCC.
Let’s assume that company A is the target company and a share purchase agreement (SPA) will be signed between the shareholder B of company and the buyer C. Within the framework of the leveraged buy-out, the buyer C may prefer to pay the purchase price by way of a loan obtained by a bank, instead of financing it from its own capital. In such case, the bank will of course demand security in consideration of the loan and the buyer C may prefer to provide security from the target company A’s assets (mortgage, assignment of receivables, etc.), instead of providing security from its own assets.
This financiang method, which was quite common before the entry into force of the TCC, may be considered as subject to the prohibition of financial aid provided for in Article 380 of the TCC. In fact, the main aim of this regulation is to protect the relevant company’s capital (in our case, the capital of target company A), as is the case with prohibition of a company’s acquisition of its own shares (TCC Art. 379). In our example, target company A provides security from its own assets without receiving any benefits.
Penalty for non-compliance with the mentioned financial aid prohibition is the relevant agreement’s becoming null and void. In our case, the security arrangements carried out through the assets of company A may be considered as null and void. Since the relevant articles of the TCC have not yet been tested in practice, it is not totally clear which effects they may have. There are opinions in legal doctrine stating that if a loan agreement is deemed as combined with a security agreement, then the relevant loan agreement shall also be null and void, which may even apply for a share transfer agreement. However, it is still not clear how this will be interpreted and applied in practice.
Having said that, it is stated in the rationale of Article 380 that the prohibition should be interpreted broadly and the transactions mentioned in the relevant article are not numerus clausus. Thus, for instance, the costs and expenses of a due diligence carried out by the buyer C for acquisition of the target company A being paid by the target company A could even be considered to fall within scope of the relevant prohibition.
The financial aid prohibition, which is now being abandoned in the European Union, is subject to significant criticism, especially in respect of its effects on the leveraged buy-out mechanism, which is a preferred acquisition method in practice. It is still not possible to state that there are specific solutions that may apply to the explained matter, nevertheless creative ideas are expected to emerge in practice in order to circumvent this prohibition of circumvention.