Turkey’s attractiveness to investors over the past two decades has naturally resulted in an increase in M&A transactions. The types of contracts used in transactions are complex. Due diligence reports, long-term business plans containing the target company’s minutiae, and trade secrets are exchanged during and after the transaction.
Mergers and Acquisitions (M&A) and Due Diligence (DD) activities in Turkey started to increase again once the national lockdown was lifted. Currently, the market generally favours buyers, especially in private company acquisitions. In Turkey, small M&A transactions are generally not debt-financed, but bigger transactions may use debt financing (usually bank financing).
In Turkey, the most common way to structure a private M&A transaction is a share sale. Share sales can be more advantageous in terms of tax and require fewer procedural steps compared to asset sales. Asset sales may also be used, depending on the nature of the investment and the parties’ needs.
Memorandum of understanding
A typical private M&A transaction process in Turkey usually follows customary international practices. The potential buyer and the seller negotiate and execute a term sheet/memorandum of understanding, which outlines the major terms to be included in the final transaction documents. The potential buyer and its advisers conduct due diligence on the target company. While due diligence is conducted, the main transaction documents and any ancillary documents are negotiated, and are normally finalised following completion of due diligence. The transaction documents are executed. Any clearances, consents, and approvals are obtained. Closing occurs.
The principal transaction document is typically a share purchase agreement or asset purchase agreement. If the entire company or business is not being acquired, a shareholders’ agreement is also normally executed. In deals involving non-Turkish party(ies), the language of negotiations and transaction documents is most commonly English, and the share purchase agreement and/or the shareholders agreement are generally modelled after UK and US precedents in style and content. International arbitration is usually the preferred dispute resolution method, although the jurisdiction of Turkish courts is sometimes seen. It is also not uncommon for transaction documents to be governed by the law of a foreign jurisdiction. Since the object of the transaction is in Turkey, Turkish law is increasingly the norm. If there are multiple potential buyers, an auction process similar to that commonly conducted in jurisdictions like the UK and the US may be undertaken.
Foreign companies who want to invest in Turkey or establishing a new business in Turkey or enter into a deal with Turkish parties, always need to know about their counterparty and their economic background and their legal basis and whole company’s validity. Our Lawyers are prepared to help them through launching really strong due diligence and prepare a comprehensive report in this regard; and it is notable that we have been cooperating with some of leading companies in the world in this field.
In practice and in private acquisitions, the main companies used are joint stock companies (JSCs) and limited liability companies (LLCs). In a JSC and an LLC, the liability of the shareholders is limited to their subscribed capital contribution, except that liability for the governmental debts in an LLC is reserved. In a JSC, the company is liable for its debts up to its assets and the shareholders are liable to the company up to their subscribed capital contribution. The shareholders are not responsible for the JSC’s debts in terms of their personal assets. The shareholders are not responsible for the JSC’s governmental debts (such as tax or social security debts the JSC owes to the government), unless they are also a board member. In an LLC, the shareholders are liable for the LLC’s governmental debts with their personal assets according to their shareholding ratio in the company’s capital (Article 35, Law on Collection Procedure of Assets No.6183). Therefore, a sole shareholder is 100% liable if a governmental debt cannot be collected from the LLC.
Foreign Ownership Restrictions
National policy on foreign investment was liberalised following amendments to the Foreign Direct Investment Law, which is the main foreign investment legislation in Turkey. In principle, there are no foreign ownership restrictions and foreign investors, regardless of their identity or citizenship, can invest in Turkey without any approval or permission. Legal entities established with foreign capital under Turkish law, regardless of their shareholding structure and percentage of foreign investors, are treated as domestic companies.
Having said that, foreign investments in sectors such as civil aviation, insurance, banking, radio and TV broadcasting, financial advisory, and mining are subject to certain restrictions. Restrictions mainly involve establishing a local investment vehicle in Turkey that is controlled by Turkish nationals.
Due diligence (DD) is an integral part of Mergers and Acquisitions (M&A). Due diligence is conducted by the buyer to confirm the accuracy of the seller’s claims. A potential M&A deal involves several types of due diligence. In M&A deals in Turkey, financial due diligence, tax due diligence, and legal due diligence are usually carried out. When conducting the DD process, an acquirer enjoys the opportunity to verify the accuracy of the information provided by the seller, examine the target entity’s legacy and corporate structure, and evaluate its businesses, capabilities, assets, and financial performance as a whole.
Due Diligence investigations conducted by our team help the clients to mitigate risk, make the best well informed decisions, and take client business to the next level. From starting, growing, to selling the company, clieents let us empower their business to success.
Companies can minimize the risks of doing business with a new or unknown customer or partner in Turkey by benefiting the BH Turkey’s International Company Profile (ICP) service. An ICP provides up-to-date information on potential partners, including bank and trade references, names of principals, key officers and managers, product lines, number of employees, financial data, sales volume, reputation and market outlook, all at a reasonable price. The BH makes every reasonable effort to ensure the accuracy and completeness of the information.
During legal DD, our lawyers pay attention to the assessment of corporate and commercial agreements, insurance agreements, employment contracts, and loan agreements. With DD, an acquiring entity protects itself from potential financial, commercial, and legal problems before finalizing a deal. A DD report puts an acquiring company in a position to accurately assess the advantageousness of its investment decision. In this regard, a DD report contributes to the negotiations on the determination of transaction value and the necessary representations and warranties that should be obtained from the seller.
M&A transactions bring along a wide range of risks from a predecessor company’s business and assets. Because a successor company acquires all of a predecessor company’s liabilities, any unforeseen liabilities not only have the potential to result in an unprofitable deal, they could also expose a purchaser to administrative, criminal, and reputational damage. Therefore, M&A transactions require proper DD including risk and compliance matters, both prior to and following a transaction.
The results of DD may create the need for the re-evaluation of a target’s value, taking more protective measures and ensuring post-closing liabilities are provided to mitigate identified risks, or even the re-consideration of the transaction itself, depending on the risk level. M&A compliance enables an acquiring entity to identify, analyze and assess a target company’s compliance risk profile to reveal red-flags that may give rise to successor liability.
Main areas of M&A compliance services
Among other legal compliance liabilities detected under legal DD, the main areas of M&A compliance services cover:
- anticorruption and anti-bribery,
- money laundering,
- conflicts of interest,
- government relationships,
- export controls and trade sanctions,
- labor and employment,
- data protection,
- privacy, and cyber security,
- workplace health and safety,
- human rights,
and other binding regulations and high-risk areas associated with a target company according to its industry and geography.
Potential purchasers must be aware of the fact that the accurate value of a target can only be determined when compliance risks are considered and priced into the deal. Contrary to what is often believed, M&A compliance does not only consist of legal DD. In fact, beyond identifying the regulatory obligations, liabilities, and risks of a targeted company, M&A compliance also examines whether, and to what extent a company complies with and manages such risks. Unlike legal DD, M&A compliance is an ongoing process that continues post-transaction.
We advise that even though the comprehensiveness of the steps may differ depending on the industries and the size of the companies involved in a transaction, involving compliance in transactions is highly recommended to all companies to ensure that they identify and mitigate their transactional risks and prevent unforeseen successor liabilities.
Conducting Pre-M&A DD
We examine the matters below to draw a compliance risk map of a target company:
- the ownership/representation structure of a target company, whether government officials are involved, or any individuals have been placed on international blacklists or have been previously convicted of misconduct, the reputational background of these individuals and potential conflicts of interest,
- the target company, and its subsidiaries’ operational and contractual relationships with local and foreign government officials and organizations,
- any kind of third-party relationships, including agents, distributors, consultants, etc.
- the target company’s financial records, statements, and accounting books, including any government and third-party payments,
- the existence and implementation of a compliance program, codes of conduct, internal policies and procedures, training programs and internal controls, and the monitoring and audit mechanisms of a target company, or the lack of thereof
- clarification of the red flags identified by operational, financial, and legal DD; the target company’s demonstration of compliance through necessary permits, certifications and audits, and reasonable explanations for identified non-compliance,
- assessment of investigations, lawsuits, and enforcements initiated against the target company and previous convictions, history of corruption, and exposure to administrative fines, if any,
- geopolitical specific risks, and the cultural business environment and their reflection on business operations,
- examination of compliance with the previously mentioned areas such as export controls, sanctions, antitrust, data protection, etc.
A transaction is evaluated, valued, and structured according to the results of the pre- M&A DD process. The transactional risks is represented in the deal documents, such as in the terms and conditions of the contract, the design of representations and warranties, and the allocation of liabilities.
DD Circumstances may dictate that comprehensive DD cannot be conducted prior to a transaction, or there may be obstacles limiting access to information and the scope of the DD process. Therefore, the risk assessment process may have to be left until after a transaction is completed. In these circumstances, an acquiring entity is advised to guarantee the necessary protections through post-transaction clauses and to conduct immediate post-transaction DD.
The DOJ and SEC also recognize a timely and thoroughly conducted post-transaction DD as an effort by acquiring companies to integrate compliance. Acquiring companies must monitor and remediate the risks identified during the DD process. New legal requirements and risks associated with new third-party relationships, and activities involving potential violations must be duly reflected in a successor company’s compliance policies, procedures, and internal control mechanisms. The authorites look for an acquiring company to conduct post-transaction audits to track and remediate the misconduct or misconduct risks identified in the DD process, and to implement their compliance policies responding to these risks.
The authorities expect acquiring companies to integrate compliance functions both during and after the transaction. Immediate integration of compliance and control mechanisms for identified risks must not be overlooked due to the fact that a transaction period creates control gaps during the integration of different businesses, operations, and company cultures that may be exploited by employees.
The post-transaction period is also an opportunity to assess and improve the existing compliance programs. Companies should not insist on keeping their existing compliance program or policies and procedures, instead, they should decide on what best suits the successor company’s needs: maintaining separate compliance programs tailored to particular needs, especially in transactions where only the shareholding structure is changed but businesses and operations remain separate, merging two compliance programs and tailoring the new program according to the successor company’s structure, compliance requirements, and potential risks, keeping the acquiring company’s compliance program and improving it according to the new compliance requirements and potential risks of the successor company.
Integrating compliance and procuring acceptance for new policies, procedures and a new company culture is likely to face resistance. By considering possible resistance against change and the potential risks that may arise during this process, companies must act promptly while updating policies, procedures, and internal control mechanisms.
Extra-Territorial Anti-Corruption Compliance
Due diligence specific to the Foreign Corrupt Practices Act (“FCPA”) is deemed necessary when a target company has previously been subject to the FCPA, and also in situations when, following a transaction, the target becomes subject to the FCPA for the first time. The authorities do not find FCPA compliance efforts honest and adequate in the cases where compliance concerns have only been reflected in contract drafts that allocate risks through representations and warranties.
The FCPA Resource Guide, recommends that companies in M&A transactions:
- conduct thorough risk-based FCPA DD,
- ensure the compliance environment regarding the FCPA applies as quickly as is practicable to the successor company,
- give FCPA and other required compliance training to the new directors, officers, and employees, and when necessary, agents, subcontractors, business partners,
- conduct an FCPA-specific audit as quickly as practicable,
- disclose any corrupt payments discovered as part of its DD of newly acquired entities or merged entities.
Depending on their efforts to integrate compliance and to identify and prevent violations, as well as prompt action to disclose misconduct, and efforts for remediation and cooperation, the DoJ and SEC may decline to initiate prosecution against a successor company, and instead, take enforcement action against its predecessor.
The UK Bribery Act also mentions M&A compliance in its guidance under the principle of “DD”,
Avoiding criminal and civil successor liability
Acquiring companies must take M&A compliance as seriously as financial and operational DD. Regardless of the scope of an M&A transaction, unforeseen compliance risks may give rise to criminal and civil successor liability and may not only turn the whole deal into a gross fault but may also result in a considerable loss for the acquiring company; both financial and reputational.
The parties to a potential transaction must invoke the compliance expertise of our law firms from the first step. Early involvement of compliance and pre-M&A compliance DD enable companies to accurately value a target company, identify their new compliance risks, prevent potential violations, and detect non-compliance in a timely manner.
Involvement of compliance functions in the pre and post-transaction process is required to reflect the compliance risks to both transaction documents and the successor company’s compliance environment. M&A risks may vary depending on the scope, structure, and industries of the companies involved; hence, the main focus points of M&A compliance may change according to compliance requirements.
While the compliance itself cannot remove all risks, the parties can manage these risks and mitigate the negative results and heavy successor liabilities as long as our compliance expertise is involved.
The types of contracts used in transactions are complex. The main transactional documents are sale and purchase agreements (SPAs) (these may include share subscription instead of or in addition to share purchase, or may be designed as asset transfer agreements instead of share sales) and shareholders’ agreements (SHAs).
To be more specific, representations and warranties are one of the most important terms in SPAs. Their purpose is to define the target company’s condition and guarantee its past and current (representations) and future (warranties) performance. They map out the sellers’ boundaries of liability for the target company. The representations generally included in SPAs are to ascertain the accuracy of the information the sellers provide about a target company’s financial, legal and operational status as at the closing date.
In principle, Turkish law allows agreements with a foreign element (for example, a foreign party) to include a choice of foreign law. There is no general rule that the acquisition of shares or assets in a company or a business is governed by Turkish law. While the parties are free to choose a foreign law and agree on arbitration, certain Turkish law provisions always bind the parties and the target company, for example, formalities for share transfers, statutory minority rights, and corporate governance.
Under the International Private and Civil Procedure Law No. 5718, directly applicable rules of Turkish law will always apply in relation to: Public order and public interest. The social, political, or economic structure of Turkey, for example competition law, intellectual property law, and employment law.
The article 7 of the Law on Protection of Competition No. 4054, dated 13 December 1994 (the Competition Law) governs mergers and acquisitions in Turkey. Recently, Law No. 7246 on the Amendment to Law No. 4054 on the Protection of Competition was published in the Official Gazette and entered into force on 24 June 2020 (the Amendment Law).
The article 7 authorises the Turkish Competition Board (the Board or the Competition Board), which is a legal entity with administrative and financial autonomy, to regulate that mergers and acquisitions should be notified to the Board to gain validity. Communiqué No. 2010/4 on Mergers and Acquisitions Requiring the Approval of the Competition Board (Communiqué No. 2010/4) was published on 7 October 2010, replaced Communiqué No. 1997/1 on Mergers and Acquisitions Requiring the Approval of the Competition Board (Communiqué No. 1997/1) as of 1 January 2011. The Communiqué No. 2010/4 is now the primary instrument for assessing merger cases in Turkey and sets forth the types of mergers and acquisitions that are subject to the Board’s review and approval, bringing about some significant changes to the Turkish merger control regime.
As the investment climate in Turkey strengthened, M&A transactions increased, outnumbering transaction-related disputes.
The common types of disputes arising from SPAs concern breach of representations and warranties terms, particularly based on failure to disclose or misrepresentation by sellers and disagreements on post-closing price adjustments. The most common SHA disputes arise out of the exercise of corporate governance and share option rights. Finally, fraud is another recurring reason for dispute; however, proving it is very difficult under Turkish law.
Disputes arise when representations turn out to be inaccurate, leading the target company and buyer to suffer losses. In this case, the buyer claims for damages.
The majority of warranties disputes arise as a result of the vague wording of representation and warranty terms. Parties frequently agree on purchase price adjustments to track changes in the target company’s valuation in the period between a given commencement date (such as the signing date or last accounts date as at the end of the year immediately prior to the signing date) and an end-date (such as the closing date, immediately prior to the closing date or the post-closing date). These mechanisms are prone to disputes because of the complexity of agreeing on the definition of the relevant balance sheet positions and performance characteristics, and agreeing on the standards and methods applicable for valuation and later adjustments.
Fraud and failure to disclose
In general, the seller is expected to disclose everything it knows to the buyer. Under Turkish law, the seller cannot evade liability (unless the liability is contractually limited to the extent allowed by law) based on the argument that it was unaware of certain information, or does not possess certain documents with respect to the target company, as its shares are at stake. The only party that possesses such detailed information is the seller. In this context, it is necessary for the seller to know everything about the target company that is crucial to the deal and to disclose it to the buyer.
To avoid the omission of crucial information and a blind sale, buyers should conduct extensive due diligence. In the due diligence process, our professional team examines all of the target company’s documents for anything missing from the target company’s history and prepares a report wherein it inspects the target company’s existing condition.
Moreover, in the context of Turkish M&A, parties tend to attach either a list of due diligence documents, the documents themselves, or a CD containing the documents uploaded to virtual data room to indicate which documents were submitted for the buyers’ review. This aims to limit the sellers’ liability that may arise out of the documents or events disclosed to the buyer during the due diligence process. However, depending on the negotiations and the parties’ bargaining powers, buyers can request to hold the sellers liable even if the buyer conducted proper due diligence and can include this provision in the transaction documents. Alternatively, though rarely, sellers can limit their liabilities irrespective of the due diligence exercise and disclosed information.
Apart from the above, if the sellers do not disclose information willingly (that is, commit fraud), and this leads to a loss for the target company or the buyers, the limitation of liability clauses are invalid.
One should note that a due diligence report cannot realistically reflect the target company’s position with complete accuracy, and the best option is to prepare a disclosure letter.
Foreign investors meant M&A transactions became international; investors requested an independent forum for disputes, the answer to which was mediation and arbitration. Consequently, mediation and arbitration practice developed concurrently with M&A practice. Over the past 20 years, M&A contracts have tended to include mediation and arbitration clauses and all related disputes are resolved through mediation or arbitration.
The mandatory mediation process was introduced for commercial litigation in 2019, compelling parties to a commercial dispute to first undergo the mandatory mediation process and to proceed with arbitration and court litigation if the dispute is unresolved in mandatory mediation. In other words, the parties cannot proceed with court litigation unless the mandatory mediation process is exhausted.
A decade ago, commercial arbitration tended only to relate to construction, distributorship, sale of goods or provision of services, etc. For some time, the arbitration arena has greatly expanded to include M&A transaction disputes.
The enforcement of foreign arbitral awards is a difficulty. Unfortunately, because enforcement proceedings are heard before the Turkish courts, the procedure takes longer than necessary and can last up to three years, including the higher court review. Even though the examination of the courts is limited to the reasons given under the New York Convention and the Turkish International Private and Procedure Law, judges take an excessive amount of time to consider whether the enforcement conditions are lawful or to examine the substance of the case, although it may be beyond their authority.
Additionally, one of the most difficult conditions for the enforcement of the award is not to be against public policy. Because the term ‘public policy’ is vague and a judge can interpret it in many ways, it can lead a judge to render an incorrect decision. Consequently, this leads the claimant to apply for an appeal and extends the process.
After observing parties’ interest in and the success of mandatory mediation, the prominent local arbitration centre, ISTAC, introduced mediation-arbitration rules (the Med-Arb Rules) at the end of 2019.
The Med-Arb Rules provide users with a two-tier dispute settlement mechanism in the same proceeding. In this model, the parties attempt to resolve their disputes through mediation; if mediation fails, the parties resort to arbitration. If the parties give their explicit and written consent, the mediator can also act as an arbitrator.
The model enables the parties to reach a settlement by either mediation or binding arbitration. Combining these methods may save time and costs. ISTAC states that it established the world’s first written rules to regulate mediation-arbitration. Thanks to this two-tier system, parties have the opportunity to resolve their disputes without resorting to the courts as well as to utilise the mediation mechanism.
Because of their overwhelming caseload, local courts in Turkey may not always be efficient or expedient enough in dispute resolution, which may jeopardise companies’ operations, especially when disputes are among shareholders.
Burden of proof
The burden of proof is a procedural issue and the general rule is the party that makes a claim must prove the facts supporting its claim. A claimant must prove (1) the respondent’s breach of contract; (2) the loss the claimant suffered; and (3) the causal link between the claimant’s loss and the breach of contract.
The respondent must prove it did not cause the breach of contract. However, there are certain situations where the burden of proof is swapped. For instance, if a seller claims the price of a product sold or service provided was not paid, and the buyer claims it paid the agreed amount, the buyer must prove this. If the buyer can show that it made a payment, the burden of proof would be incumbent on the seller to prove the payment was not received.
Another example can be the burden of proof rules for penalty clauses. Under Turkish law, if an agreement contains penalty clauses (such as penalty clauses to secure the seller’s non-compete or non-solicitation covenants), the claimant does not have to prove the amount of its losses but can directly claim the penalty amount. However, if the claimant’s losses are higher than the penalty amount, the claimant must prove its losses exceeding the penalty amount established under the agreement, and that the losses were caused by the counterparty.
Apart from the above, parties are free to enter into burden of proof agreements under which they can eliminate one of the elements of liability: the party’s fault. For instance, the buyers and the sellers can be held liable for their breach of the SPA, and representations and warranties terms, respectively. Moreover, parties commonly enter into agreements or include a clause in SPAs where a buyer’s prior knowledge of the target company will not prevent it from making demands under the SPA (pro-sandbagging) or that will prevent it from making any demands (anti-sandbagging).