The following article will examine the financial assistance prohibition, the source of which is European Union company law, and the leveraged buyout models, the source of which is Anglo-American law.
- WHAT IS LEVERAGED BUYOUT?
Leveraged Buyout (Expressed as (LBO) in Anglo-American law) is a type of financing transaction used in company purchases. In leveraged buyout transactions, the financing to be used for the acquisition of the company in general is secured through registering the assets of the company to be taken over ("Target Company") as collateral. In other words, leveraged takeover transactions can also be described as purchasing a company by borrowing.
Leveraged Buyout transactions have three main legal aspects;
- The buyer / investor acquires controlling shares of the company;
- Financing the acquisition price largely through loan / credit transactions from third parties;
- The borrowings / loans used are ultimately either fully or largely secured by the Target Company's assets."1
Therefore; the main reason why leveraged buyout transactions are frequently used in financing; is the acquisition of the company with a low equity risk, and as a result achieving high total capital profitability.
In leveraged buyout transactions, in general, the company to take over the Target Company establishes a third company and realizes the borrowing/crediting through the third company ("SPV") to be established. Considering that this company is newly established and has no significant assets; The collaterals required for the borrowing transaction will generally be covered by the assets of the Target Company.
Finally, through the merger of the SPV and the Target Company, the leveraged buyout will be completed by merging the assets of the Target Company and the debts of the SPV under the same roof and providing the balance of the undertaken debt for the acquisition, from the operating profit of the Target Company.
The main principle in joint stock companies is the protection of capital. As stated above, for leveraged buyout models, the final source of collateral is the capital or assets of the Target Company. In this respect, different laws have forbidden this process, and in Turkish Law, a financing of this sort is considered null and void to the extent that it is associated with the financial assistance prohibition.
- FINANCIAL ASSISTANCE PROHIBITION AND ITS PROVISIONS IN TURKISH JURISDICTION
The source of the financial assistance prohibition is the European Union corporate law and Turkey has included to provision within its jurisdiction in line with the harmonization with EU legal framework. In Turkish Law, joint stock companies are prohibited from acquiring their own shares according to the Articles 379 and 380 of Turkish Commercial Code ("TCC"). In this respect, the financial assistance prohibition includes all share acquisitions from a target company regardless of the shares being controlling shares. In addition, whether the share acquisition is completed via original and/or sub-acquisition style does not differ according to the wording of the provision and both options are considered under the scope of financial assistance prohibition.
The company's prohibition on acquiring its own shares is due to the principle of capital protection in joint stock companies; with this rule, it is aimed to prevent the possibilities such as the actual reduction of the capital, which is stated as an assurance fund for the protection of creditors, and the company to enter into the liquidity problems..2
The fundamental provision prohibiting leveraged buyout models within the framework of the TCC, is the first paragraph of Article 380 that regulates the "Cheat Against Law". According to the related provision;
"The legal transactions of a company with another person, in order to enable the acquisition of its shares, the subject of which is advance, loan or collateral, are void. This clause does not apply to transactions within the business areas of credit and financial institutions, and to the legal procedures regarding the advances, loans and collaterals to the employees of the company or its affiliates so that they can acquire the company's shares. However, these exceptional transactions are void if the transaction reduces the reserves that the company has to allocate in accordance with the law and the articles of association or violate the rules regarding the spending of the reserves regulated in article 519 and does not allow the company to allocate the reserves stipulated in article 520."
the transactions of advance, loan or collateral made with third parties in order to acquire Target Company's own shares are regulated to be void. The notion of this prohibition is aimed to prevent the buyer, who wants to acquire the shares of the joint stock company, from receiving any financial assistance from the company. As a matter of fact, considering that the registering collaterals from the Target Company for the people who plans to acquire a small share is very rare in practice, the financial assistance prohibition is also referred to as leveraged buyout prohibition in the doctrine.
As clearly stated in the TCC, there are two exceptions to this provision, although the legal transactions that the company makes with another person for the purpose of acquiring its shares are subject to advance, loan or collateral. The first one is the transactions that are included in the businesses of credit and financial institutions. The second is the legal procedures regarding the advances, loans and collateral to the employees of the company or its affiliated companies so that they can acquire the shares of the company. In the presence of these two types of transactions, it is not possible to claim the invalidity of these transactions based on financial assistance prohibition.
As a final remark in this context; considering that leveraged buyouts improve the economic structure of the Target Company and to encourage and facilitate investments in the market; and therefore due to the overall improvement of national economies; some jurisdictions including the European Union has moderated the financial assistance prohibition; resulting leveraged buyouts to be permitted under certain conditions. Furthermore; this prohibition was never regulated in some countries including the United States.3
- SANCTIONS OF FINANCIAL ASSISTANCE PROHIBITION
When the letter of law regarding the financial assistance prohibition is examined; it is clearly understood that financial assistance transactions made without complying with this prohibition shall be void. However, it is not yet determined by law and / or judicial decisions if voidness of the financial transaction affects validness of shares acquired from the Target Company.
Since there is no explicit legislative provision on the subject and the relevant issue has not been subject to judicial decisions in practice; causes of the financing process being void on the share purchase agreement is not yet clarified; as a result, in the doctrine there are conflicting views if the promissory transaction (financing through collateral) and act of disposition (share transfer) compile a compound agreement or not. The importance of this distinction in practice is critical because according to this distinction; it will be determined whether the resulting share transfer is valid or not. However; since a dispute on the financial assistance prohibition has not been subject to the decisions of the high judicial authorities in practice, a uniform conclusion cannot be reached in this regard.
As a result; leveraged buyout system, which is often implemented in the United States; is a frequently used method in practice due to the direction of world investment law, the increase in project finance activities worldwide and the economic benefits of the system. Due to the fact that the legal benefit (protection of company capital) protected by the financial assistance prohibition is not higher than the economic return, the scope of the financial assistance prohibition is moderated and leveraged buyouts are permitted under certain conditions even in legal systems that has previously strictly enforced the prohibition.
As a general assessment, the financial assistance prohibition may have restrictive consequences in the economic context. Once this prohibition in doctrine is evaluated "The prohibition is considered to be
- preventing or limiting the value creation potential of leveraged buyouts,
- creating additional transaction costs due to uncertainty,
- reducing the effectiveness of venture capital investments,
- being eligible to be used as a tactical claim in disputes.
The prohibition restricts companies' financing opportunities for the aforementioned reasons, while increasing the cost of potential buyers on the financing of the acquisition. This can have a slowing effect on the acquisition market and may have consequences for real economic and social welfare" 4 . Therefore, criticizing the financial assistance prohibition.
When the criticism of the doctrine, the need to increase these transactions that create market efficiency by overcoming financing problems in merger transactions and the direction in which the world legislation is acting jointly, it is evaluated that it would be beneficial to moderate the financial aid ban, which is strictly regulated under Turkish Law, under certain conditions.
1 Veziroğlu, C. & Fatih Arıcı, M. (2018). Kaldıraçlı Devralma ve Anonim Şirketin Finansal Yardım Yasağı. İstanbul: On İki Levha Yayıncılık
2 Özdamar, M.: Anonim Ortaklıkların Kendi Paylarını İktisap Etmesi (TTK md. 329), Ankara 2005. s.75-79
3 Lowry, J.: "The Prohibition Against Financial Assistance: Constructing a Rationale Response", Ed. by D.Prentice and A.Reisberg, Corporate Finance Law in the UK and EU, Oxford, 2011. s.22
4 Veziroğlu & Arıcı s.134
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.