I. INTRODUCTION
Capital increase from internal resources is a restructuring transaction of company’s assets. The purpose of such transaction is to convert certain elements present in company’s assets into capital. Therefore, shareholders shall not undertake a new financial burden by capital increase from internal resources unlike capital increase through capital subscription. There can be several reasons for capital increase from internal resources such as organizing the financial structure of the company, increasing assurance of company’s creditors and hence increasing the credibility, with capital increase through capital subscription from external resources.
This transaction is regulated in Article 462 of the Turkish Commercial Code (“TCC”) and as follows: “(i) The reserve funds reserved as per the articles of association and the Board of Directors resolution and is not allotted for a certain purpose, as well as disposable portion of the statutory reserves and funds which are allowed to be converted into capital under the applicable legislation to be added into capital, may be converted into capital to create the internal resources required for capital increase. (ii) The availability of the amount that is met from internal resources in company for capital increase shall be clearly verified in annual financial statement and also confirmed in writing by the Board of Directors dealing with capital increase. In case six months are passed as of the date of the last financial statement, a new financial statement and approval of such financial statement by board of directors are required. (iii) If funds are allotted in the financial statement, capital increase through capital subscription may not be implemented unless these funds are converted to capital. Capital can be increased through conversion of these funds into capital and through capital subscription at the same time and with the same ratio. Capital increase shall be finalized upon registration of the amended form of the relevant provisions of articles of association and resolution of the General Assembly or the Board of Directors. By registration, the existing shareholders spontaneously shall be entitled to acquire the gratuitous shares in portion of their shares to capital. The rights on gratuitous shares shall neither be abated nor be limited; also, these rights shall not be renounced.”
Although it has been criticized that capital increase is just regulated in one Article, as a reply to such criticism as per the Justification of Turkish Commercial Code (“Justification”), it is regulated in one Article for the purpose of avoiding confusion and is clarified that there is also tax legislation regulating the subject.
II. THE PURPOSE AND THE NATURE OF THE PROVISION
Capital increase from internal resources was not regulated in former Turkish Commercial Code numbered 6762 and so that in practice, it was used against junior shareholders. Certain companies, even though internal resources are sufficient, prefer to increase the capital through capital subscription and thus, such transaction causes decrease in shares of junior partners not participating to capital increase through capital subscription due to economic reasons. That circumstance, expressed as “dilution of shares”, caused negative results, for that reason it is criticized and Supreme Court had jurisprudence in order to avoid such circumstances. Along with the TCC, a fair regulation is performed regarding the prohibition of capital increase through capital subscription without using internal resources in order to prevent such negative results.
As also expressed explicitly in Justification, due to mandatory characteristic of the provision, transactions contrary to this provision shall be deemed null and void. However, at this point Circular Letter numbered 548 and dated January 23, 2013 of Ministry of Customs and Trade (“Circular”) is to be evaluated. As per the provisions of the Circular, despite the presence of the funds which are allowed to be added to the capital in company’s assets, the company is not required to exhaust the internal funds before capital increase through capital subscription in case that all of the shareholders of the company vote in general assembly that capital increase through capital subscription without transferring such funds to capital, capital increase through capital subscription can be performed without exhausting such mentioned funds. Even though it could be thought that the purpose of protection of junior shareholders in case of the acceptance of all shareholders is not affected, it is still complicated whether Circular will be accepted by the jurisdiction against mandatory qualification of the provision.
III. INTERNAL RESOURCES
As per Article 462 of the TCC, in the event that funds which are allowed to be converted into capital under the applicable legislation are present in the financial statement, capital increase through capital subscription may not be implemented unless these funds are converted to capital according to the articles of association and resolution of the Board of Directors. In this provision, it is clarified which resources may be used for capital increase from internal resources.
Companies may reserve some part of their company’s assets as reserve funds in accordance with articles of association or with the resolution of general assembly. Reserve funds can be kept in company’s assets for allocating for a certain purpose as an aid fund in favor of the personnel and employees as stated in the Article 522 of TCC or without allocating for any purpose. Undistributed dividends are generally interpreted within this scope. As expressed in the provision, such reserve funds which are not allocated for a certain purpose, can be subject to capital increase from internal resources.
General statutory reserve funds are regulated in Article 519 of TCC. Accordingly, five (%5) percent of the annual profit shall be allocated as general statutory reserve until it reaches to twenty percent of the capital. After the limit is exceeded, the remaining portion after issuance of shares, deduction of expenses and portion not used for premiums (amounts exceeding nominal value), disposal of shares and aids, the portion remaining after deduction of the payments effected against the share certificates written off by way of invalidation and portion remaining after deduction of the issuance expenses of the new shares substituting the former shares, ten (%10) percent of the amount to be distributed to the persons receiving share from profit shall be allotted as general statutory reserve fund after payment of dividend at the rate of five (%5) percent to the shareholders. If allotted amounts exceed half of the capital, exceeded part can be used freely. The part permitted to be used freely can be subject of capital increase which will be done from internal resources as per article 462 of the TCC.
As per the Article 462 of TCC, the internal resources to be used for capital increase are accepted as funds which are allowed to be converted into capital under the applicable legislation. In the provision, the wording of “the laws” is chosen on purpose and it is purposed to include the funds within the scope of the relevant provision of TCC. This purpose is also explicitly expressed in Justification. In the light of the explained reasons, financial regulations shall be taken into consideration for the funds to be converted to capital.
IV. THE RULE OF CONSUMPTION OF INTERNAL RESOURCES
The most debated regulation of the Article 462 of TCC is placed in the 3rd paragraph of the Article. While the reserve funds allocated for a special purpose specified in the first paragraph are separately accepted as internal funds to be used for capital increase, general statutory reserves and funds which are allowed to be converted into capital under the applicable legislation to be added to the capital, only the conversion necessity of the funds which are allowed to be converted into capital under the applicable legislation to be added to the capital is remarked in the 3rd paragraph that prohibits capital increase through capital subscription without using totally internal resources. Revaluation, affiliate and real estate revenue and inflation funds are shown as the examples of these funds in Justification. As per the opinion in doctrine, even though only the funds which are allowed to be converted into capital under the applicable legislation are specified in the provision, reserve funds not allotted for a certain purpose and as well as disposable portion of the statutory reserves are also in the scope of these funds.
However, pursuant to another opinion, it is supported that the difference between first and 3rd paragraph is a conscious regulation and exhaustion of the funds which are allowed to be converted into capital under the applicable legislation is sufficient for making capital increase through capital subscription. We are of the opinion that second opinion is more conformable when taking into consideration of the letter of law for such mentioned paragraph.
Another controversial issue is how much of the present internal resources should be converted for capital increase through capital subscription. There are two different opinions in doctrine regarding this issue. Pursuant to first opinion, second sentence of 3rd paragraph softens the rule of exhaustion regarding the internal resources in first sentence. The sentence “Capital can be increased through a conversion of the funds into capital and capital subscription at the same time and with the same ratio.” is interpreted as capital can be increased through capital subscription by using some parts of internal resource “at the same time” and “the same ratio” of the amount of used internal resources.
On the other side, the other opinion clarifies that in case of the existence of the funds which are allowed to be converted into capital under the applicable legislation in financial statement, capital shall not be increased through capital subscription and in order for capital to be increased the capital needs to be exhausted.
As per the letter of law, the first sentence of third paragraph of Justification has no exception and is regulated as a mandatory rule which can be eliminated in no circumstance and resulted with absolute nullity of transactions in case of its breach. For that reason, exhaustion of all available internal resources in company for capital increase through capital subscription is become an acceptable interpretation. Moreover, this rule is also expressed by Circular as “Joint stock companies that have funds which are allowed to be converted into capital under the applicable legislation in balance sheet and non-public company or have not applied to the Capital Market Board for public offer, the funds in the amount of the capital should also be converted to capital at the same time.”
It should be noted that the necessity of exhaustion of the internal resources shall be discussed in case of capital increase through capital subscription. If capital increase through internal resources is desired, the capital can be also increased by using a part of internal resources.
Another issue regarding the exhaustion of internal resources that should be expressed is that as per 6th paragraph of the Article 12 of the Capital Market Law numbered 6362 “Article 346 and third paragraph of Article 462 of the Law numbered 6102 shall not be applied to corporations which are publicly-held or have applied to the Board for public offer”. Accordingly, corporations which are publicly-held or have applied to the Capital Market Board for public offer are not bound by the rule of exhaustion of internal resources for capital increase through capital subscription.
V. ADDITIONAL INFORMATIONS
Article 457 of TCC regulates the Board of Directors declaration to be prepared regarding the type of capital increase. This declaration shall be prepared in accordance with the principle of clear, perfect, accurate and honest information. As per subparagraph (b) of 2nd paragraph of Article 457, in case of capital increase from internal resources, the declaration is also required to include the internal funds which the capital increase was sourced from, actuality of such funds and guarantee on their existence within the assets of the company. Similarly, as per the Article 462/2 regarding capital increase from internal resources, the respect that the increased part is fully subscribed in terms of capital in cash and the amount required to be paid under the articles of association is paid. Within the scope of this issue, furthermore, the report issued by certified public accountant or by independent accountant or by auditor for audited companies regarding company’s capital is protected in net assets and increased part is fully subscribed in terms of capital in cash and registration of capital increase through internal resources is considered necessary.
Additionally, another issue that has to be taken into consideration, in case of capital increase from internal resources the company is required to prepare interim financial statement. In case six months are passed as of the date of the last financial statement which will be used for capital increase from internal resources, a new financial statement and approval of such financial statement by board of directors are required.
