ABSTRACT
Within the scope of the article, the consequences of the breach of the representations and warranties regarding the share purchase agreements regarding the transfer of shares related to the company and the liability of the seller arising from these defects are analyzed.
I. INTRODUCTION
Share purchase agreements are agreements between the shareholder who transfers their shares (the “Seller”) and the shareholder who acquires the shares (the “Buyer”) that focus on the transfer of the shares held by the Seller in the company to the Buyer. In share purchase agreements, since the value subject to the sale is “shares”, in addition to the responsibilities of the Seller arising from the share purchase agreement, the Seller also has a liability of warranty against defects in the event that the shares sold are defective. Furthermore, although the value subject to sale in share purchase agreements is the “share”, the matters declared and warranted are sometimes directly related to the “share”, while sometimes the declarations, undertakes and warranties under the agreement are not limited to the qualifications of the shares, but may also include information regarding the status of the target company. The representations and warranties promised under the agreement may include information regarding the management decisions, activities and general condition of the company. This means that the Seller’s liabilities may vary depending on the characteristics of the representations and warranties.
II. SHARE PURCHASE AGREEMENTS IN GENERAL
The Turkish Code of Obligations No. 6098 (the “TCO”) extensively regulates the liability arising from the defects of the goods sold and the effect of such liability on the sales agreement. On the other hand, there is no special regulation on liability for representations and warranties in the context of share purchase agreements, which are mainly subject to the Turkish Commercial Code No. 6102 (the “TCC”).
Notwithstanding the fact that the basis of the share purchase agreements is the transferred share of the company, the purpose of the Buyer in the share purchase agreement may be the acquisition of not only the share, but also the activities of the company belonging to the share. In this context, in addition to the characteristics of the share, the characteristics that are extremely important for the Buyer include elements that may significantly affect the activities of the company. Therefore, the representations and warranties contained in the agreement may not only be limited to the characteristics of the shares but may also include information regarding the status of the target company.
III. REPRESENTATIONS AND WARRANTIES
Especially in share purchase agreements, the accuracy of the Seller’s representations and warranties hold paramount significance for the future performance and value of the company whose shares the Buyer will acquire. Such agreements are usually detailed and comprehensive and are accompanied by a process in which many factors such as the target company’s financial status, legal obligations, and position in the sector in which it operates are examined.
A. Liability for Representations and Warranties in Sales Agreements
In sales agreements, the TCO comprehensively regulates the liabilities that may arise from the defects of the goods sold and the projection of these liabilities in the agreement. However, in principle, there is no special provision in the TCC with respect to share purchase agreements. The representations and warranties in share purchase agreements determine the liability of the seller1. In the event that the representations and warranties regarding the accuracy and completeness of the circumstances declared by the Seller with the provision to be included in the agreement are not true or the conditions undertaken are not fulfilled, the liability of the Seller will arise. In this case, the Buyer may have the right to claim indemnification for material damages and/ or terminate the agreement with the regulations introduced in favor of the Buyer as outlined in the agreement.
Pursuant to Article 219 of the TCO, the Seller may be held liable in the event that the qualities specified to the Buyer in the sales agreement are not present in the sold goods, as well as in the presence of material, legal or economic defects that contradict the quality or quantity affecting the quality, that eliminate the value in terms of intended use and the benefits that the Buyer expects to provide or that significantly reduce these benefits2. In this case, the warranty liability under the agreement of sale is divided into statutory (legal) and contractual warranties3. Statutory warranty is the liability arising from the absence of the characteristics that should normally be present in the goods subject to sale or the existence of certain defects that reduce the value of the goods. In order for the Seller to be held liable for such defects, the Seller does not need to make a separate undertaking, and the liability arises directly from the provision of the law4. Contractual warranty, on the other hand, is the liability of the Seller for the features that the Seller has declared to be present in the goods subject to sale. The Seller’s undertaking may be express or implied5.
B. Statements of Qualification and Warranties in Share Purchase Agreements
The seller may make certain commitments that are not only valid when the contract is executed, but also during the period between the execution of the contract and the closing, at the time of the closing, and thereafter6. These commitments are characterized as qualification statements for a specific period of time, such as whether the company possesses certain characteristics at the time of transfer.
In the doctrine, a distinction is made between “statements of qualification” (representations) and “warranties”. With a statement of qualification, the Seller undertakes that the company subject to the transfer has certain positive qualities or does not have certain negative qualities at the time the share purchase agreement is concluded.
In the concrete case, the issue of whether a declaration of qualifications or a guarantee is in question is important since the declaration of qualifications is subject to the provisions regarding the liability of warranty against defects, whereas the guarantees give rise to an independent obligation. In case of breach of the guarantee commitment, the general provisions regarding breach of obligation are applied instead of the provisions of the liability of warranty against defects, and the claims arising therefrom are subject to the general limitation period of 10 (ten) years instead of the 2 (two) year limitation period for defects7. In cases where there is a notice of quality, an independent cause of liability does not arise, the provisions of the law on the liability of warranty against defects are extended or amended in favor of the Buyer, and in other cases, the provisions of the law are applied8.
C. Optional Rights of the Buyer when the Seller is Responsible for the Defect
Article 227 of the TCO regulates the optional rights of the Buyer in cases where the Seller is liable for defects, and pursuant to the provision of this article; the Seller has the right to withdraw from the agreement, to retain the goods or value and to request a discount in the sale price in proportion to the defect, to request the repair of the sold goods at the Seller’s expense unless it requires an excessive expense, and if possible, to request the replacement of the sold goods with a similar one without defects9.
In share purchase agreements, since the value sold is basically the shares, the main liability of the Seller arises within the scope of the defects related to the shares. As mentioned above, there is no special provision in the TCC regarding the declarations and undertakings under the share purchase agreement, and the relevant liability is subject to the general provisions explained above. In this context, the Seller first undertakes that the shares sold have been properly issued by the target company, that the share certificates, if any, have been duly issued, and similar matters regarding the shares.
a. Regulations on the Prevention of Problems that may arise in Share Purchase Agreements
In share purchase agreements, the parties aim to prevent problems that may arise after the execution of the agreement regarding declarations and warranties by regulating them through detailed examination procedures under headings such as the proper establishment of the company subject to the transfer, the subject matter of the transfer and the transfer price, closing conditions, arrangements regarding guarantees, the fact that the transferred company has the necessary permits to operate, that it performs its activities properly, that taxes are duly declared, and that the necessary reserves are set aside10. The provisions relating to these matters are the most intensively consulted and negotiated provisions during the conclusion of the agreement11.
Amendments in the processes between the period the agreement is concluded, and the completion stage of the agreement may lead to disputes between the parties. Differences in valuation processes can lead to disputes, particularly between the predicted value and the realized value.
IV. COMMON CHALLENGES IN SHARE PURCHASE AGREEMENTS
We have already mentioned above that amendments in the processes between the period the agreement is concluded, and the completion stage of the agreement may lead to disputes between the parties. Differences in valuation processes may lead to disputes, especially between the predicted value and the realized value.
Since the definition and regulations of the Seller’s liability for defects in share transfer transactions are not clearly regulated in the law, there are different opinions in the doctrine on the definition and the ways to be followed in practice.
In the event that the representations and warranties regulated in the agreement are directed not only to the shares, but also to the company; since the shares constitute the main subject matter of the share purchase agreements, there is no consensus in the doctrine regarding the special quality of the goods sold notified to the Buyer pursuant to Article 219/1 of the TCO, i.e. “the matter mentioned and promised”. In this context, Tekinalp emphasizes that in the event of the transfer of the majority of the shares of the target company, the transferor is liable for material and legal defects and deficiencies in the assets12.
In support of Tekinalp, Buz argues that the transfer of the shares of a corporation is, as a rule, not the sale of goods, but the transfer of rights, and that only in the case of the transfer of all or almost all of the shares of the corporation, a situation economically similar to the transfer of a business will be in question13. In this case, Buz assesses that the defects related to the business can be characterized as defects related to the shares and the liability of the Seller will arise. Ayoğlu, on the other hand, argues that the representations and warranties regarding the company cannot be considered within the scope of the special quality notified to the Buyer regarding the sale within the meaning of Article 219/1 of the TCO14.
In a share purchase agreement, the issue of whether or not the company shares are bound to negotiable instruments is not addressed separately in the positive regulations. Therefore, it is important to take into account the doctrinal differences of opinion on share purchase agreements when making regulations regarding the consequences of such representations and warranties. In this context, it should be emphasized that the breach of the relevant representations and warranties is an important issue in terms of reaching the true will of the parties. The issues regarding the representations and warranties set forth in the agreement may vary depending on the legal, economic, tax and other various scopes of the Buyer’s examination of the target company and the shares sold.
V. CASES IN WHICH THE TRANSFEREE CLAIMS DEFICIENCIES IN THE ASSETS OF THE TARGET COMPANY IN THE TRANSFER OF SHARES OF A JOINT STOCK COMPANY
The transaction involving the transfer of shares in a joint stock company may be related to the value of the company’s assets or the nature of the company’s shares. Particularly in block purchases, the Buyer’s objective is to obtain control of the business through ownership of the company’s shares.
In each of these transactions, the economic results and benefits obtained by the Buyer are almost identical; however, the legal processes used to achieve this result are completely different. Therefore, in competition law, from an economic perspective, share acquisitions, mergers and acquisitions are broadly considered as mergers or concentrations. These transactions are evaluated in accordance with Article 7 of the No. 4054 Law on the Protection of Competition.
When evaluating the transfer of shares in a joint stock company, the validity of the transferee’s share certificate and the establishment of share ownership through registration in the share ledger are critical factors to consider from a commercial and legal standpoint. When the transfer of shares of a joint stock company is considered in terms of commercial and law of obligations, it is important that the share certificate of the transferee is valid, and the share ownership is established by being registered in the share ledger. However, if it is considered that only the share is transferred, this may mean that the transferor is released from liability. However, when the transfer of shares is considered not only as an asset value but also as a means of control, it may not be sufficient for the transferor to be released from liability. In particular, in cases where the transferor has a dominant position in the management of the company, the transfer of shares may not only mean the transfer of shares but may also be perceived as the transfer of control power. The acceptance of control as a separate asset value arises from the fact that it provides the owner with direct or indirect economic power over the assets of the company15.Therefore, the link between the value of the shares and the assets of the company should be considered.
Although this contradicts the fact that the legal personality and assets of the company are not affected by the transfer of shares, it means that the value of the shares is not independent from the assets of the company and any legal or material deficiencies resulting from the transfer of shares should be included in the liability of the transferor. Although this contradicts the theory of legal personality and the principle of separation, it shows that the legal order should not ignore this economic reality and should take into account the relationship between the value of the shares and the assets of the company.
In the event of a transfer of a right attached to a negotiable instrument, in terms of the tangible asset subject to the transfer, this is not a transfer of “instrument”, but a transfer of a share, which is essentially the right itself, and it expresses a transfer of a right within the scope of intangible property16. In the doctrine, it is generally argued that the provisions of the liability of warranty against defects are only applicable to the sale of tangible assets and therefore, if the subject matter of the agreement is considered to be only partnership shares, the provisions of the liability of warranty against defects cannot be applied17. According to this view, in cases where the share certificate is materially defective, the provisions of the warranty against defect are applicable only if the share certificate is attached to the share certificate. However, in the event that the share is attached to both the share as a right and the share certificate as a negotiable instrument in accordance with its nature, it may be possible to raise the issue of liability for defects in terms of the share certificate, which is a tangible asset. Material defects in the share certificate include scratches, tears or, in the case of attachments such as talons or coupons attached to the share certificate, the lack of these attachments, and the lack of these elements may be considered among the situations that may lead to liability for defect.
In the case of the transfer of control of the company or special undertakings related to the assets of the company, a situation is mentioned where it may almost qualify as a business transfer. In this case, the defect provisions in the sale of securities in the transfer of shares may need to be applied in a similar manner. Here, even if there is no sale of securities, in the event of significant deficiencies or negativities in the assets of the company that may affect the valuation, the liability of the transferor or the Seller may arise within the framework of the defect provisions.
In the case of transfer of control of the company or special commitments regarding the assets of the company, the transfer of shares may become a business transfer. In this case, the defect provisions in the sale of movable property may need to be applied in a similar manner in the transfer of shares. Even if there is no sale of securities, in the event of significant deficiencies or negativities in the assets of the company that may affect the valuation, the liability of the transferor or the Seller may arise within the framework of the defect provisions.
In particular, the difficulty of the direct application of the provisions on the sale of securities should be taken into consideration when the company shares subject to the sale are not initially a “value”. However, even in this case, it may be necessary to allow the application of the provisions of the sale of securities in a similar manner in the sale of “rights”. In such a case, it would be fair to authorize the transferee to exercise the optional rights granted to the buyer in sales agreements under Article 227 of the TCO. In this case, the powers of rescission or reduction of consideration are particularly prominent, but the powers of modification or repair may be very difficult to enforce in large company acquisitions. Provided that it does not constitute an obstacle to the application of special undertakings and general indemnity liability, the defect liability assumed by the transferor may stand out as one of the most topical issues in corporate takeovers.
The Court of Cassation, evaluating the relationship between such block share transfers and business transfers, recognizes the special defect liability of the transferor in relation to the assets of the company18.
In another decision of the Court of Cassation numbered 2012-17579/6683, the Court of Cassation explains the relationship between company assets and share transfer and the liability of the transferor in a share transfer transaction, with the case law that the risk arising from the potential insurance indemnity of the target company’s subsidiary company should be evaluated in the termination of the agreement lawsuit filed due to the transferor’s misleading information about the economic situation.
VI. CONCLUSION
Share purchase agreements have a critical structure that requires due diligence in commercial relations. The difficulties encountered in drafting the agreements and the balance between the parties’ representations form the basis of the agreement. Inaccuracies in the Seller’s representations may give rise to the Buyer’s right to protect its rights, which may lead to a claim of indemnity for damages or termination of the agreement. Therefore, it is vital for both parties that the flow of accurate information, the scrupulous fulfillment of legal commitments, and the clauses in the agreement reflect the concrete facts.
However, as explained, the Buyer’s objective with the share purchase agreement is to take over the activities of the company to which the shares belong. In this context, the characteristics of the company and its activities are also important for the Buyer. For this reason, share purchase agreements do not contain a list of the qualifications that the Seller guarantees or warrants. The scope of such warranties and guarantees varies according to the interests of the parties and the agreement reached. In this framework, the share purchase agreements include representations and warranties regarding the qualifications such as that the company subject to transfer is duly established, has the necessary permits and licenses to carry out its activities, has the right to use the assets necessary to carry out its activities in accordance with the law, and carries out its activities in accordance with the legislation. However, liability of the Seller is not restricted to representations and warranties. Legally, the Seller may also be liable for defects.
Moreover, if not only the shares but also the transferred company is defective, the Seller may be held liable. In such a case, liability may arise as a result of deficiencies or defects in the target company’s operations that are unrelated to the terms agreed upon by the Seller. In such cases, beyond the representations and warranties contained in the agreement, legal proceedings often come into play and various legal steps may be taken to protect the rights of the parties.
Consequently, the main subject matter of share purchase agreements is shares. Generally, however, share purchase agreements aim to enable the Buyer to take over the activities of the company to which the shares belong. Therefore, the characteristics of the company are as important as the characteristics of the shares. Although the laws do not specifically regulate share purchase agreements, the parties usually make detailed arrangements in the agreement. The problems that may be encountered in share purchase agreements in the context of points of disagreement and legal problems and the solution of these problems require intensive analysis, the aim of bringing a fair solution for the parties and ultimately consensus. Maintaining the balance between the parties will contribute to the healthy conduct of commercial relations.
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FOOTNOTE
1 Nurşen Ayan, Taşınır Satımında Satıcının Kanundan Doğan Ayıba Karşı Tekeffül Borcu, DergiPark, z. 14.
2 Turkish Code of Obligations No. 6098 (TCO).
3 Hande Deniz Çakmaklı, Türk Medeni Hukukunda Komisyon Sözleşmesi, Marmara Üniversitesi, 2021.
4 Ayan, Taşınır Satımında Satıcının Kanundan Doğan Ayıba Karşı Tekeffül Borcu, DergiPark, z. 14.
5 This matter has been particularly emphasized in the preamble of Article 227 of the Turkish Draft Civil Code.
6 Vedat Buz, Ortaklık Paylarının Devrinde Ayıba Karşı Tekeffül Hükümlerinin Uygulanabilirliği Sorunu, Banka ve Ticaret Hukuku Dergisi. 35th volume, p. 3, While the agreements regarding the transfer of shares have the characteristics of an obligatory transaction, the transfer of shares for the purpose of performance of the transaction in question is expressed by the concept of “closing”.
7 Eren, F.: Borçlar Hukuku, Özel Hükümler, 4th volume, Ankara 2017, p. 109; Gümüş, M. A.: Borçlar Hukuku, Özel Hükümler, İstanbul 2012, p. 97; Kapancı, K. B.: 6098 Sayılı Türk Borçlar Kanunu Açısından Satış Hukukunda Ayıptan Doğan Sorumluluk ve Sözleşmesel Garanti Türleri, İstanbul 2012, p. 117.
8 Cited in; Buz, Ortaklık Paylarının Devrinde Ayıba Karşı Tekeffül Hükümlerinin Uygulanabilirliği Sorunu, Banka ve Ticaret Hukuku Dergisi. 35th volume, p. 3, 2019; Staudinger/ Beckmann, § 453 BGB, Rn. 108; BeckOGK-BGB/Wilhelmi, § 453, Rn.720; Huber, Acp 202 (2002), p. 205
9 Turkish Code of Obligations No. 6098 (TCO).
10 Ferna İpekel Kayalı, Türk Ticaret Kanunu’na Göre Birleşmeler, İstanbul, 2014, p. 138.
11 Buz, Ortaklık Paylarının Devrinde Ayıba Karşı Tekeffül Hükümlerinin Uygulanabilirliği Sorunu, Banka ve Ticaret Hukuku Dergisi. 35th volume, p. 3, 2019’dan naklen Tschäni, p. 145; Tschäni, R./ Wolf, W.: Vertragliche Gewährleistung und Garantien - Typische Vertragsklauseln, Mergers & Acquisitions VIII, Zürich 2006, p. 94; Grossmann, K./Mönnich, U.: Warranty&Indemnity Insurance, Die Versicherbarkeit von Garantierisiken aus Unternehmenskaufverträgen, NZG 2003, p. 708.
12 Poroy/ Tekinalp/ Çamoğlu, Ortaklıklar Hukuku I, Rewritten 14. Edition, p. 626-627.
13 Buz, Ortaklık Paylarının Devrinde Ayıba Karşı Tekeffül Hükümlerinin Uygulanabilirliği Sorunu Banka ve Ticaret Hukuku Dergisi. 35th volume, p. 3, 2019, p. 70.
14 T. Ayoğlu, Sermaye Şirketleri Özelinde Şirketler Hukuku Uyuşmazlıklarının Çözümünde Tahkim. On İki Levha Yayıncılık, İstanbul (2018, p. 25.) See for the contrary opinion in the article: İsmail G. Esin/ S. Tunç Lokmanhekim, “M&A Transactions Under Turkish Law” p. 39-40.
15 Ali Paslı, Anonim Ortaklığın Devralınması, İstanbul, 2009, p. 215.
16 Haluk Nami Nomer/ Baki İlkay Engin, Türk Borçlar Kanunu Şerhi Özel Borç İlişkileri, Ankara, 2018, p. 54.
17 Fikret Eren, Borçlar Hukuku Özel Hükümler, 10th Edition, İstanbul, 2022, p. 103.
18 11th Civil Chamber of the Court of Cassation, D: 27.03.2014, 2012/19104.
