March 5, 2012 10:43 pm

Turkey’s new commercial code to have broad impact on M&A

This article is provided to FT.com readers by mergermarket—a news service focused on providing actionable, origination intelligence to M&A professionals. www.mergermarket.com
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Turkey’s new commercial code, which comes into force on 1 July 2012, is set to revolutionize Turkish business life and change the dynamics of M&A in the country.

The law will radically boost auditing standards and transparency, eventually increasing the number of investment and acquisition targets in a market in which, historically, private equity funds have found themselves chasing a limited field of targets. Compliance with the new law, as well as trends in renegotiations, buyouts, consolidation, and stock market activism, is expected to open business opportunities for auditors, investment bankers, and lawyers.

Need for a new law

The new commercial code is “not just a change of the law, it is a change of mentality, understanding, and approach,” Prof. Dr. Unal Tekinalp, Emeritus Professor of Law at Istanbul University and president of the commission that wrote the new code told mergermarket. “The [commercial] mentality of Turkey must change, because the mentality of the world has changed,” Dr. Tekinalp, noting that the current law has seen no major amendments since it came into effect in 1956. “The [current] Turkish Commercial Code was a good code, but in the 1950s,” he said.

Turkey’s negotiations for a full-membership in the European Union (EU) have also required its laws to be harmonized with those of the EU; and World Trade Organization membership obligations required better regulation of competition, Dr. Tekinalp said. The new code also reflects the impact of the internet, requiring companies to keep websites and including provisions for e-commerce, online general assemblies and online board meetings, among others.

Dr. Tekinalp especially emphasizes that the new law will require Turkish commerce “to speak the language of the international market,” a language he says consists primarily of “true and fair financial statements” and “real auditing”.

The new code will require all companies to have independent and qualified auditors—a requirement lacking until now—and all joint stock and limited liability companies to abide by the International Financial Reporting Standards (IFRS); small and medium-sized enterprises (SMEs) will follow a simplified version of the IFRS. “Now all enterprises [in Turkey] will audit according to the same philosophy, the same logic and the same mentality,” Dr. Tekinalp said.

Mergers and acquisitions

Company mergers, divisions (spin-offs, etc.), and conversions are all to be regulated in accordance with EU law, which will benefit investors, Dr. Tekinalp said.

A number of provisions in the new law will promote M&A in more specific ways, said Tolga Ismen, senior partner at Ismen law firm and a lecturer at Sabanci University in Istanbul.

All joint ventures (JVs) will have to adapt their articles of association and shareholders’ agreements to the new regime within 18 months. “For 50% of JVs this will be rubber-stamp work, but once you open the Pandora’s box of renegotiation, there will be new deals,” he said. “For example, in a deal cut five years ago where the partners are not [presently] very happy—they will use this requirement as grounds for renegotiation,” said Ismen. “This could progress to stock swaps, exits, etc. We could see private equity fund A taking over for private equity fund B. And the clock will be ticking”.

The law may also lead to an increase in the use of off-shore special-purpose vehicles (SPVs) and limited liability companies as acquisition vehicles, Ismen said.

The position of minority shareholders will also change drastically. Each shareholder in a company will have inspection rights for major transactions such as mergers and securities issuance; they will have the right to use outside experts to evaluate a company’s legal and financial information; and, each shareholder will have the right to request the general assembly appoint a special independent auditor, Dr. Tekinalp said.

These new rights, coupled with a provision allowing those owning 90% of a company’s shares to squeeze out minority shareholders, are likely to lead to increased buyouts and fewer minority deals, as investors try to reduce the “governance risk” posed by empowered minority shareholders, Ismen said.

Waiting for decisions

However, it will take between three and five years for the real impact of the law to be seen, Ismen said. During this period, court decisions interpreting the law are expected to clarify what are at present ambiguities, he said.

Examples of these include a provision that any board or general assembly decision contrary to “the general principles” of joint stock companies will be null and void. “Nobody knows what ‘general principles’ are—we have an idea, but without a body of case law, it’s difficult to give a clear definition,” Ismen said.

Another is a provision that any agreement that grants control over another company must be registered and announced with the Trade Registry in order to be effective.

According to Ismen, this may cause a problem in that shareholders agreements—the documents that govern relationships between and among shareholders and the company—fit the definition of such “control agreements,” and it will surely be argued a shareholders’ agreement not registered and announced is not valid under the law.

“We’ll have to wait and see whether the courts will accept [that argument]…At least some will not and it will take five to ten years to solve the problem [through case law],” he said.

The critics

There is a significant lobby in Turkey against the new law, and many are calling for a delay in its enactment, both Ismen and Dr. Tekinalp said.

“I feel like I’m being crucified,” Tekinalp added, laughing.

The new law restricts a shareholder’s ability to become indebted to his or her company, Dr. Tekinalp said. Under the current law, shareholders can easily take money out of their company and routinely postpone repayment, Dr. Tekinalp said. “They can’t understand there is a difference between a shareholder’s private assets and the company’s assets…But a company’s assets are securities of the company’s creditors as well,” Dr. Tekinalp said.

The independent auditing provided for by the new law will combat practices such as disguising bribes paid out as shareholder debt, and recording cash income without invoices as shareholder credit, Dr. Tekinalp said.

Comprehensive transparency is a hallmark of the new law. All data relevant to the company and stakeholders, that is, all financial reports, including audit and valuation reports, documents relating to general assemblies, mergers, and spin-offs, will have to be published on the company’s website.

Such transparency will eventually increase the number of targets for inbound M&A, however it will take time. “Most companies don’t have sufficient accounting personnel to handle full-fledged audited IFRS accounting. There’s no way within the next five to ten years we’ll have that transparency available,” Ismen said.

The burden of complying with the new law will likely trigger a wave of consolidation among Turkish SMEs, Ismen said.

“The cost of compliance for any company [has been estimated to start] between TRY 50,000 and 100,000 [USD 30K-60K]…therefore SMEs will have to get bigger and have meaningful margins with that cost,” said Ismen.

Boom time for auditors, lawyers, and investment bankers

The law will provide a large market for corporate service providers. “There will be huge niche merger activity going on among SMEs,” said Ismen. “Boutique services, for example, a lawyer, accountant, and adviser, can get together and create a good structure for integrating four or five SMEs into one management system—there will be huge business in this,” he said.

And larger corporate finance houses “need a totally new way of thinking to capture all the benefits of this new law,” said Ismen. “We’ll have squeeze outs and dissolution lawsuits. Stock market activism will move into a new era,” he said.

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