Turkey: Conditional Capital Increase In Joint-Stock Companies

Conditional capital increase is a type of an increase to the share capital that is regulated under the Turkish Commercial Code numbered 6102 ("TCC"). This type of capital increase is "conditional" due to the uncertainty of the amount of the increase and when the increase will take place. In addition, the increase is conditional upon the right holders (i.e. creditors and employees of the company) to exercise their conversion rights or call options.

Conditional capital increase is regulated in Article 463 of the TCC as follows: "the general assembly may, due to newly issued bonds or similar debt instruments, decide upon a conditional increase of share capital by providing the right to acquire new shares to employees or creditors of the company or the group companies through exercising conversion rights or call options under the articles of association. Share capital increases automatically as and when the conversion right or call option is exercised and capital debt is settled through exchange or payment.". "

As per the common rules for capital increases in principal capital and authorized capital systems, the capital increase is realized with the decision of the general assembly of shareholders and board of directors respectively. However, in the conditional capital increase system, the organs of the company do not decide on the actual increase of share capital but rather third parties' discretion plays an essential role.

The increase in the share capital shall realize when the right holders exercise their call option or conversion rights. Unless the creditors or the employees use their right to acquire shares from the company, the share capital of the company will not increase even though there is a general assembly resolution on the conditional capital increase. Therefore, right holders are empowered with the discretion to decide on the capital increase rather than company organs.

Once the company decides on a conditional capital increase by granting the right to acquire new shares by exercising conversion right or call option and registers the amendment of articles of association before trade registry, it losses all its influence over the capital increase.

The share capital gradually and continuously increases through the exercise of conversion right and call option. The right holders can exercise these rights at different times and the company issues share certificates as per the need. The issuance of share certificates according to the need is one of the main features of conditional capital increase. The board of directors of the company may determine the period for exercising the call option and conversion right. If the capital needs to be increased within a short period of time, it may keep this period short.

In addition, spreading the capital increase over time is contrary to the principle of capital rigidity and openness which are two of the essential principles of joint-stock companies. Pursuant to the principle of rigidity, the capital must be predetermined. However, in the case of conditional capital increase, it is not possible to determine the share capital since it depends on the exercise of the relevant rights. Principle of publicity is not applicable in the conditional capital increase system either as the capital increases as a result of exercise of call option or conversion right and not registered before trade registry each time. Therefore, the publicly available information on the share capital of the company will not be up-to-date until the board of directors registers the actual share capital of the company with the trade registry following the closing of an accounting period.

As per Article 461(1) of the TCC, each shareholder has a right to purchase newly issued shares according to the ratio of their existing shares to the share capital of the company (i.e. pre-emptive right). That said, as the pre-emptive right provides its holder to acquire the shares of the company in case of a capital increase, it will create an obstacle to the creditors and employees acquiring shares from the company through exercising the conversion right or call option. Therefore, in order to implement conditional capital increase, pre-emptive right of the shareholders of the company must be removed and this should be stated in the articles of association of the company.

On the other hand, since pre-emptive rights of the shareholders will be removed, shareholding ratios of the current shareholders will decrease upon the use of conversion rights or call option by the right holders. To prevent such a decrease, the TCC foresees a new shareholder's right in Article 466 as the right of first refusal ("önerilmeye muhatap olma hakkı"). Accordingly, if a bond or similar debt instrument is issued, it will be first offered to the shareholders of the company.

According to Article 464 of the TCC, conditional capital increase is subject to certain restrictions. For instance, the nominal value of the share capital that may be increased conditionally cannot exceed half of the current share capital.

It is compulsory for the general assembly to amend the articles of association of the company to enable a conditional capital increase system in the company. In addition, a detailed report indicating the reasons for the conditional capital increase and the purpose to be achieved is prepared by the board of directors and submitted to the shareholders two weeks before the general assembly meeting. Following this process, the general assembly decides on the amendment of the articles of association that will enable the conditional capital increase, and this is registered with the trade registry.

Pursuant to Article 465 of the TCC, in the amendment of the articles of association regarding conditional capital increase, the following shall be included in the new provision:

1. The nominal value of the conditional capital increase,
2. Number and the type of the shares,
3. The groups that can benefit from call-option and conversion right,
4. The removal of the pre-emptive right of the current shareholders and the quantity of that,
5. The privileges that will be given to specific groups,
6. New restrictions on the share transfer of registered shares.

Once the use of call option or conversion rights are finalized, pursuant to Article 472 of the TCC, board of directors removes the provision regarding the conditional capital increase from the articles of association and this resolution is registered with the trade registry which is deemed explanatory.

Conditional capital increase, a relatively new concept under Turkish Law, is a system that grants the right to the creditors of the company or group companies through issued bonds and similar debt instruments and employees of the company by call option to acquire new shares of the company. The increase in the capital is conditioned upon the use of conversion right or call option by the related third parties. The capital increases automatically as a result of the exercise of these rights.

Since only third parties are granted with the right to acquire shares in the company through the conditional capital increase system, a new shareholding right has been introduced in the context of Turkish Law to protect shareholding rights of the existing shareholders of the company (i.e. right of first refusal for newly issued bonds or similar debt instruments). This enables maintaining the balance between the interests of the current shareholders and potential shareholders (namely, creditors and employees) of the company.

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.