Insolvency and directors' duties in Turkey: overview
A Q&A guide to group insolvency and directors' duties in Turkey.
The Q&A global guide provides an overview of insolvency from the perspective of companies that are operating within a domestic and/or international group of companies, and considers the various complexities that this can introduce into insolvency procedures. It also has a significant concentration on duties, liabilities, insurance, litigation, and subsequent restrictions imposed on directors and officers of an insolvent company.
To compare answers across multiple jurisdictions, visit the International Insolvency: Group Insolvency and Directors’ Duties Country Q&A tool.
This Q&A is part of the International Insolvency: Group Insolvency and Directors’ Duties Global Guide. For a full list of contents, please visit www.practicallaw.com/internationalinsolvency-guide.
Corporate insolvency proceedings
The Turkish Execution and Bankruptcy Law (Law No. 5358, as amended) does not allow for out-of-court insolvency proceedings. Under the Law, insolvency proceedings can be initiated by either:
Debt collection procedures (takipli iflas), which, if frustrated, end up before the commercial court as a bankruptcy lawsuit.
Direct filing for bankruptcy (doğrudan iflas) with the competent Turkish commercial court, where a company lacks sufficient assets to cover its liabilities.
Regardless of the method used for commencement of the insolvency proceedings, liquidation of a company's assets requires a Turkish commercial court order in one of the following forms:
Approval of moratorium/debt restructuring by forfeiting assets (malvarlığının terki suretiyle konkordato).
Approval of reorganisation by consent (uzlaşma yoluyla yeniden yapılandırma).
The last two scenarios are considered rescue mechanisms rather than methods for initiating insolvency proceedings.
The Execution and Bankruptcy Law allows for three company rescue mechanisms:
Postponement of bankruptcy (iflas erteleme). This mechanism allows a period of one year (with possibility of renewal) to an insolvent company to rehabilitate its financial position in order to repay its debts. The board of directors of an insolvent company must report an insolvency situation to the commercial court and either file for a bankruptcy declaration or a postponement of bankruptcy order. In a postponement application, a reliable rehabilitation plan must be submitted for court approval. Creditor consent is not required. A postponement order suspends all public and private debt collection proceedings against the company for the duration of the order. The court can delegate the powers of the board of directors to an administrator (kayyum).
Moratorium/debt restructuring (konkordato). The Execution and Bankruptcy Law provides for two types of moratorium:
ordinary debt restructuring (adi konkordato). Unlike a postponement application, a debt restructuring application does not require demonstration of an insolvency situation. However, this mechanism involves a court-structured negotiation with the creditors in order to restructure the existing debt. In an ordinary debt restructuring moratorium, a restructuring project involving rescheduling of payments and/or partial write-offs is submitted to the court and to the creditors. The project must be approved by the majority of the creditors, with a represented vote of two-thirds of the outstanding debt. The court approves the restructuring project if it potentially secures a better distribution to the creditors than the liquidation proceeds of a bankruptcy. The court delegates powers of the board of directors to a commissary (konkordato komiseri) for the duration of the moratorium period;
debt restructuring by forfeiting assets (malvarlığının terki suretiyle konkordato). The effects of debt restructuring by forfeiting assets resemble a bankruptcy situation where the company, with the approval of its creditors and the court, transfers a part or all of its assets to the creditors. The court appoints an officer to liquidate the assets, subject to a moratorium period, and to distribute the proceeds to the creditors.
Reorganisation by consent (uzlaşma yoluyla yeniden yapılandırma). A reorganisation application does not require demonstration of an insolvency situation. Even an only potentially distressed company can choose to apply for a reorganisation order. Reorganisation aims to preserve the going-concern value of a business, and any form of reorganisation method can be applied. The procedure involves the debtor company:
preparing a reorganisation project;
negotiating with the creditors directly affected by the project to obtain their consent; and
getting a court approval for the project.
Compared to a moratorium, a reorganisation is less structured and flexible, in that the debtor can freely choose from the creditors who would be affected by the reorganisation project and then negotiate with that select group of creditors to obtain their consent without any court intervention. However, the Execution and Bankruptcy Law requires the consent of majority of the affected creditors representing two-thirds of the outstanding debt to be obtained. On approval of a reorganisation project, the court also appoints a project auditor for supervision and reporting purposes.
Debt collection procedures
In insolvency proceedings initiated by debt collection, the creditor initiates debt collection proceedings by filing an application with the execution office. The execution office issues a payment order and serves it to the debtor, notifying the debtor at the same time that failure to settle the debt without a justified objection will result in a declaration of bankruptcy. Two types of debt collection mechanisms can be used to initiate insolvency proceedings:
Ordinary debt collection procedures, where the debt is not yet liquid (such as a contentious damages claim arising under a contract or tort, or an outstanding cash receivable).
Collection procedures for a returned commercial paper or negotiable instruments (such as a cheque or a promissory note).
Both collection mechanisms are strictly structured under the Execution and Bankruptcy Law. The major difference is the debtor's response periods against the payment order, which is seven days in ordinary debt collection and five days for commercial paper. In the event of non-payment or an objection within these time limits, the creditor must file a bankruptcy lawsuit before the Turkish commercial court seated at the domicile of the debtor company.
Direct filing for bankruptcy
If the assets of a company are insufficient to cover its liabilities, the company is deemed insolvent (borca batıklık) under the Turkish Commercial Code. The board of directors of an insolvent company must:
Inform the commercial court seated at the domicile of the company of the insolvency situation.
File for bankruptcy or for the postponement of bankruptcy (see Question 2).
Following the filing of the bankruptcy lawsuit before the commercial court, the insolvency proceedings proceed as follows:
Bankruptcy lawsuit. The commercial court reviews the objection of the company in a debt collection proceeding and, if not satisfied, renders a bankruptcy declaratory judgment. In direct filings for bankruptcy, the court simply renders a bankruptcy declaratory judgment, as long as the insolvent company does not request a postponement or resort to any other rescue mechanisms.
Formation of the bankruptcy estate. On rendering of a bankruptcy declaratory judgment, all assets and liabilities of the company form the bankruptcy estate. The bankruptcy office (iflas dairesi) at the seat of the commercial court rendering the bankruptcy judgment becomes the supervising body for maintenance of the books of the bankruptcy estate. The bankruptcy office announces the type of liquidation process to be followed, which is either:
an expedited liquidation process that does not involve a bankruptcy administration or creditors' meeting, in cases where it is evident that the assets are insufficient to cover the liabilities.
The bankruptcy office delegates the power to administer the bankruptcy estate and finalise the liquidation of assets to the bankruptcy administration (iflas idaresi). It then announces the bankruptcy declaration and invites the creditors to file their claims with the bankruptcy estate. It also invites the creditors to the first creditors' meeting.
First creditors' meeting. The purpose of the first creditors' meeting is to decide whether the company should resume its operations or, in the case of a moratorium, to decide on approval of the restructuring plan.
Preparation and announcement of creditors list. The bankruptcy administration prepares a creditors list based on the creditors' filings and annotated claims in public registers. The creditors list also states rejected claims, with reasons for rejection. The creditors list is announced and notified to the creditors whose claims are rejected. The time limit for filing an objection to the creditors list is 15 days. Objections are filed with the commercial court with the same seat as the bankruptcy court.
Second creditors' meeting. On finalisation of the objections to creditors list, the bankruptcy administration invites approved creditors to a second creditors' meeting to decide on, among other things:
the liquidation procedure;
third party claims over the assets of the bankruptcy estate;
any pending moratorium requests.
Liquidation of assets. Unless there is a situation that necessitates an expedited sale, the general rule for liquidation of assets is a sale by public auction.
Distribution of proceeds. The bankruptcy administration distributes the proceeds of sale in accordance with the statutory rankings and privileges of creditors. Public receivables are privileged and satisfied first. Any remaining amount is distributed to the creditors in the following order:
first rank: labour claims, pension fund contributions, alimony and child support;
second rank: trust administrator and guardian claims;
third rank: privileged claims and receivables;
fourth rank: all other non-privileged debts.
Completion of insolvency proceedings. The bankruptcy administration prepares a final report and submits it to the bankruptcy court to declare the closing of the bankruptcy. The decision of the court officially concludes the insolvency proceedings.
Insolvency of corporate groups
Regardless of an insolvency situation, shareholders and creditors of a subsidiary company can file a derivative action against the parent company and its board of directors to compensate any loss resulting from transferring assets of a subsidiary to other members of the corporate group. The Turkish Commercial Code (Law No. 6102) prohibits controlling companies from giving instructions to subsidiaries that would jeopardise the financial standing of the subsidiary, or significantly depreciate its equity value. To avoid a derivative lawsuit, the parent company must adjust any negative balance caused by a detrimental transaction or allow for an equivalent adjustment claim to the subsidiary within the same operating year.
There is an exemption from liability for board members and officers of a wholly owned subsidiary following instructions from its parent company (see Question 21).
There is no subordination of intra-group debt or claims to those of third party creditors, if they are legitimate and properly accounted for in the corporate books. In a formal insolvency process, the court-appointed officer or administrator assesses each claim and categorises them in the creditors list by rank and any applicable privilege.
The Execution and Bankruptcy Law does not allow for joint insolvency proceedings. A creditor secured by a guarantee or lien by one member of a corporate group for the debt of another member of the corporate group that then becomes insolvent, can pursue the guarantee or lien for the entire amount of the outstanding debt. In the case of partial collection of the debt, the secured creditor and the guarantor (for his right of recourse) can both register the entire claim with the bankruptcy estate and are paid out their pro rata shares from the proceeds of liquidation. In addition, the Execution and Bankruptcy Law requires that a secured creditor with a lien must first seek to enforce the lien. The lien holder can then initiate or join insolvency proceedings against a debtor for the uncollected amount.
Insolvency proceedings for international corporate groups
The Execution and Bankruptcy Law does not allow for joint insolvency proceedings. To initiate insolvency proceedings against a company incorporated under a foreign jurisdiction in Turkey, the company must have its main place of business (muamele merkezi) in Turkey. Turkish insolvency law observes the universality principle in relation to the enforcement abroad of bankruptcy declarations obtained in Turkey. If an international company has its main place of business in Turkey, a bankruptcy declaration can be obtained from a commercial court seated at the place of business. The Turkish bankruptcy declaration then has effect abroad and covers assets located abroad.
If the foreign company does not have its main place of business in Turkey, but does have a branch established in Turkey, insolvency proceedings can only be initiated for the debts of the branch, and have effect only on the branch assets located in Turkey. Turkish insolvency law observes the territoriality principle in local branch of a foreign company cases, and liquidation proceeds are available to local creditors of the branch only.
If a foreign company does not have its place of business or a branch in Turkey, only ordinary debt collection procedures (enforcement of an attachment or a lien) can be pursued against the company's assets located in Turkey.
Turkish insolvency law observes the universality principle in relation to bankruptcy declarations obtained in Turkey. Turkish courts exercise jurisdiction over all the assets worldwide of a company with its main place of business in Turkey filing for insolvency in Turkey (see Question 15).
Foreign bankruptcy declarations are given effect in Turkey if either:
The foreign state where the bankruptcy declaration is issued has a bilateral treaty with Turkey for the enforcement of bankruptcy declarations obtained in both jurisdictions.
There is statutory or de facto reciprocity regarding enforcement of bankruptcy declarations obtained in both jurisdictions.
If one of these conditions is met, a foreign creditor can initiate an enforcement lawsuit before a Turkish commercial court to give effect to the foreign bankruptcy declaration in Turkey and to seize debtor assets located in Turkey.
The Turkish Commercial Code does not prohibit overlapping boards of directors for separate members of a corporate group, as long as the board members do not breach their duty to act in good faith or their non-compete obligations, and protect the interests of the company by acting as cautious executives in matters under their control.
In cases of full control, where a parent company directly or indirectly wholly owns the subsidiary, the Turkish Commercial Code allows controlling company board members to exercise de facto management over the subsidiary and to instruct the board members of the subsidiary to pass certain decisions. Board members, management and other persons related to the administration of the wholly owned subsidiary must follow the instructions of the parent and therefore are not held liable for any resulting loss towards the subsidiary company or its shareholders. Creditors can directly pursue the shareholders and board members of the parent company for compensation of losses.
The board of directors and officers owe the following general duties towards the company, its shareholders and creditors. These duties remain unchanged in an insolvency situation:
Duty of care and duty of loyalty. Board members and officers owe a duty of care and a duty of loyalty towards the company. They are under an obligation to protect the interests of the company. They must act in good faith and exercise cautious judgment in relation to matters under their control.
Non-compete. Board members are prohibited from engaging in the company's commercial activities for their own or a third party's benefit, unless they are expressly authorised to do so by a general assembly of shareholders' resolution.
No self-dealing. Board members are prohibited from dealing with the company, unless they are expressly authorised to do so by a general assembly of shareholders' resolution.
Duty of confidentiality. Board members must keep trade secrets of the company confidential.
Maintenance of corporate books and records. Board members are responsible for the accuracy and completeness of the corporate books and accounts.
Duty to report insolvency. Board members owe a duty to inform the commercial court of an insolvency situation and must file for a bankruptcy declaration or a postponement of bankruptcy order.
The following types of conduct would be in breach of the duties and responsibilities of directors and officers:
Failure to take reasonable steps to minimise losses to creditors.
Misappropriation of corporate assets.
Misleading declarations regarding payment of capital.
Failure to inform the commercial court of insolvency.
Continuing to trade when there is little prospect of being able to pay when debts are due.
Failure to maintain corporate books and records.
Preparing documents and declarations in contravention of the law.
Breaches of the duty of confidentiality.
Breaches of the duty of care and duty of loyalty.
Breaches of no-compete and no self-dealing obligations.
In an insolvency, creditors can file a derivative action against the board members to compensate the company for payments received by the board members for the previous three years, where those payments exceeded market rates and thus amounted to unjust enrichment.
Shareholders and creditors can file a derivative action for damages against board members to compensate for losses caused to the company by the board members negligently committing any of the following acts:
Misappropriation of corporate assets. This is punishable by between six and 24 months' imprisonment, and up to 5000 days' judicial fine.
Misleading declarations regarding payment of capital. This is punishable by between three months' and three years' imprisonment.
Failure to maintain corporate books and records. This is punishable by a minimum 300 days' judicial fine.
Preparing documents and declarations in contravention of the law. This is punishable by between one and three years' imprisonment, and a minimum 300 days' judicial fine.
Breach of the duty of confidentiality. This is punishable by between one and three years' imprisonment, and up to 5000 days' judicial fine.
Breach of the duty of care and duty of loyalty.
Breach of non-compete and no self-dealing obligations.
Failure to report insolvency to the commercial court. This is punishable by between ten days' and three months' imprisonment.
Board members and officers cannot by resigning from office avoid liability for losses caused by their negligent acts. The only exception to this general rule is the situation where the board members of a wholly owned subsidiary receives instructions from the parent company that they were obliged to follow and that they are therefore not held liable for. In that situation, creditors can pursue the shareholders and board members of the parent company to compensate the loss (see Question 21).
The creditors and shareholders of a company, as well as the bankruptcy administration, have standing to sue the board members and officers for violation of their duties. It is common practice to file these derivative actions against board members and management. Litigation is successful where negligence and causation can be demonstrated.
The liability of board members and officers is limited to matters under their control and losses caused by their negligent acts. Board members can delegate their management powers to third parties through an organisational directive that is publicly announced in the Turkish Trade Registry Gazette. If the board members can demonstrate that reasonable care is exercised in choosing the substitute representative for a certain task they can avoid liability for the substitute's acts. No liability attaches if the board members perform their duties as cautious executives who act in good faith and act to protect the company's interests over conflicting interests of other corporate group companies (with the exception of wholly owned subsidiaries, see Question 21).
In an insolvency, board members are under a statutory duty to inform the commercial court of the situation and to file for a bankruptcy declaration or a postponement order. The commercial court will approve a rehabilitation plan or a rescue mechanism (such as a request for a moratorium or reorganisation by consent) if it would secure a better distribution to the company creditors by preserving the going concern value of the company. Directors and officers can only be protected from liability if they obtain court approval for one of the rescue mechanisms (see Question 2) and an order of stay of insolvency proceedings.
A director or officer of an insolvent company is not legally restricted from acting as a director or officer in another company, or from receiving payment as a promoter of another company. The only exception to this rule is for board members and officers of banks and financial institutions, since insolvency of a bank or a financial institution can subject their board members and officers to personal bankruptcy under the legislation governing these institutions.
A personally insolvent director or officer is not restricted from continuing to act, since he is not considered to be a merchant under the Turkish Commercial Code, and management or administrative positions do not require solvency. However, a personally insolvent director or an officer is restricted from becoming or continuing to act as a board member or officer of a bank, a financial institution or an insurance company.
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Esra Bicen, Managing Partner
Professional qualifications. İstanbul Bar, Turkey; New York State Bar, US
Adjunct Professor of Law at John F Kennedy University, School of Law
Areas of practice. Regulatory compliance (corporate, commerce, finance); international contracts (EPC, FIDIC); investment projects, public tenders; international arbitration.
Non-professional qualifications. BA/MBA in Business Economics/Corporate Finance, Lorry I Lokey Graduate School of Business, CA, US
Languages. English, Turkish
Professional associations/memberships. Turkish Bars Association; Istanbul Bar Association, American Bar Association; New York State Bar Association; American Trial Lawyers Association; ILI-İstanbul International Law Association; TKYD-Corporate Governance Association of Turkey; CTC-Capital Turkish Connections