In the first half of 2006, economic growth stayed strong in Turkey with growth rates keeping up with recent years' average of 7%. Emerging market equities have recovered since the fluctuations of May-June last year. This stabilization encouraged Istanbul Stock Exchange's movement into the 40,000s and 2006 witnessed an historic increase in foreign investment. Ernst & Young referred to the Turkish economy as a sleeping giant in a recent survey with Turkey ranked the second most attractive country in terms of perception and third in terms of foreign direct investment in the south-eastern European region. And Standard & Poor's raised Turkey's credit rating to positive from stable in 2006.

According to market research, 154 mergers and acquisitions were recorded in Turkey in 2006, at an aggregate amount of $18.3 billion; a striking $17.3 billion comes from foreign investment. The most attractive industry was banking and finance, the share of foreign banks in the system is increased by M&A.

Notable transactions in 2006 include the sale of 46% of Finansbank shares to National Bank of Greece; 75% of Denizbank shares to Dexia; and 57.42% of Yapi ve Kredi Bankasi shares to a Koçbank-Unicredito consortium. In addition, 91% of MNG Bank was sold to an Arap Bank-BankMed consortium while Merrill Lynch European Asset Holdings bought Tat Yatirim Bank, which also controls securities firm Tat Menkul Degerler.

In the entertainment sector, Ticketmaster bought ticket provider Biletix through Rigol Groupo. In energy, central European gas and oil group OMV purchased 34% of Petrol Ofisi from Dogan Group. OMV also announced in February that it had bought around TRY 23 million ($16.1 million) of additional Petrol Ofisi shares, increasing its stake to 35%. And Koç Group sold its 61% share of Izocam to French insulation company Saint-Gobain Isover and Kuwaiti company Alamana Industries for $171.3 million.

In privatization, controlling stakes in Tupras and Erdemir were transferred to Koç Holdings and Oyak respectively. Legal obstacles however proved too much for the privatization of Halk Bank and the deal fell through. And the privatization of electricity distribution companies in three districts Istanbul – Anadolu Yakasi, Baskent and Sakarya – has been postponed for political reasons.

Finally, on January 26 last year the Turkish Competition Authority approved the transfer of telecoms company Telsim to winning bidder Vodafone.

Governing legislation

M&A deals are not governed by a single piece of legislation. Instead, practitioners must look to the Turkish Commercial Code (TCC) and Turkish Code of Obligations as well as applicable banking, tax, securities and labour rules. Competition legislation and application requirements of the Turkish Competition Board must be also reviewed in M&A transactions.

Mergers

According to general provisions of the TCC, merger is only possible between companies of the same kind. For completion, companies need to reconcile the contemplated merger with the procedures and provisions for amendment of their articles of association. Merger under Turkish law is based on the principle of general succession (subrogation) in which the assets and liabilities of the predecessor are assumed by the successor in entirety. So all of the assets, rights, obligations and liabilities of the target company are assumed by the buyer on completion of merger procedures.

Mergers can occur in two ways under Turkish law:

• Merger by acquisition (buying company takes over a target company).
• Merger by establishment of a new company (two or more companies merge to form a new company).

Most cross-border M&A transactions in Turkey are being formed as acquisitions rather than mergers.

Acquisitions

Acquisitions in Turkey are mostly structured through contractual means – acquisition agreements for shares, business and asset transfers or tender offers. In contract law practice, the representations and warranties section in share or asset purchase agreements is among the most critical and highly negotiated section. It is also widespread practice for foreign investors in Turkey to buy controlling shareholdings of entities jointly with a local partner.

The aim of such joint shareholdings could be the investigation of a business environment before entering into bigger investments, or receiving support of a local partner for more successful business activities. In either case, the joint venture agreement provisions need to be negotiated carefully, including conditions for termination options, joint approval matters, share transfer restrictions, deadlock and penalty provisions. The key step following joint venture agreements is incorporation of the provisions into the articles of association of the target company – to the extent legally possible.

Articles of association govern a company's activities and the rights and obligations of its shareholders towards the company. Because articles of association are public, registration with the relevant trade registry and announcement to the third parties in the trade registry gazette need to be implemented. The TCC lists compulsory subjects to be included in the articles. But insertion of all the provisions of shareholder agreements into the company articles of association, especially with respect to shareholder relations, may not be possible.

Further, decisions of the Court of Appeals indicate that subjects of articles of association, other than those required by the TCC, are not binding against third parties. This could be an obstacle for shareholders, in particular concerning the provisions of deadlock, share transfer restrictions and put/buy options. We are observing improvement in recent practice, with trade registries allowing insertion of many shareholder agreement provisions into company articles of association, especially in Istanbul.

As to the asset transfers, it may be assumed by investors that transactions mean the acquisitions of the assets but not the liabilities of a target company. According to the Turkish Code of Obligations, a legal person who buys a target's assets will be liable for debts of the transferred assets jointly with the transferor. The transferor's liability in that case is for two years following the announcement of the transfer. Following this two-year term, the liability of transferee will continue under the Statue of Limitations while the transferor will not be liable after two years. In addition, in case all or a substantial portion of assets of a debtor are transferred by the debtor with the purpose of harming its creditors, the transferee is deemed to know the purpose of this transfer under Turkish rules of evidence. Such transactions can be cancelled – where the conditions of the Code of Execution and Bankruptcy are satisfied. Therefore, transfer of liabilities for the buyer may not be entirely eliminated under Turkish law.

Limitations on foreign investors

According to the Direct Foreign Investments Law, foreign investors are entitled to equal treatment with local investors. (The Foreign Investment Directorate General requires notification of acquisitions within one month of the deal, for "statistical purposes".)

The equal treatment principle is applied to areas where the provisions of other laws do not set out restrictions to the contrary. For instance, Article 2 of the Cabotage Law requires commercial activities at Turkish ports to be conducted by Turkish entities. (Ships putting up a Turkish flag could also fall outside the scope of the equal treatment principle.) In this context, the detail of the restriction must be carefully analyzed. Nevertheless, foreigners enjoy equal treatment in almost all business sectors in Turkey, thanks to amendments to various laws in recent years.

Legislative changes in 2006

A new regulation concerning banking mergers and acquisitions came into force on November 1 2006. The regulation covers the steps involved in obtaining general assembly approval, merger agreements, post-execution procedures and registration of the merger with trade registry. And provisions that could have an adverse effect on the rights of customers or third parties cannot be included in a merger agreement.

The Turkish equivalent of the US Securities and Exchange Commission, the Capital, Markets Board, also amended Communique Serial Number: I No 31 last year. The board governs the conduct of mergers where one of the parties is a public company. The amendment, to Article 5 of the Communique', emphasizes that the parties' financial information must be prepared according to the board's accounting standards, and include a private independent audit. Accordingly an amendment on independent auditing standards came into force in July 2006.

M&A auctions

Auctions are now increasingly common in private M&A in Turkey.

There are many reasons for a seller to have an auction to market its business or a part of it. A seller has more control over a number of factors including the extent of due diligence process, timing, drafting of purchase agreements and freedom to invite and review purchasers. Under ideal circumstances, auctions yield the best price for a seller due to increased competition. On the other hand, generally the entire auction process is slower than a negotiated bilateral process and requires careful management of the bidders involved. From the legal point of view, the crucial initial step is the preparation of confidentiality agreements – even the most successful auction process can fail.

Due diligence and electronic data rooms

Electronic data rooms have gained acceptance in Turkish M&A auctions. Electronic data rooms ease access to information on a timely and organized basis where there is more than one prospective purchaser. Electronic due diligence is particularly useful when vast amounts of information is available on different platforms and in different locations. It is not easy to choose between the different commercial providers of electronic data sites and the decision to selecting a provider must be based on likelihood of its having the speed and competence of digital tools to handle digital data.

A new tendency in due diligence reviews appears in the negotiation phase of share or asset purchase agreements. Legal advisers of sellers of shares want to insert information provided in due diligence exercise in representations and warranties in agreements. Thus, the index of documents provided in due diligence data rooms is required to be annexed to share purchase agreements. Sometimes, in addition to the index, a compact disk containing all the documents is also annexed to the agreements. With these mechanisms, sellers look to ensure the contents of the due diligence documents fall outside the extent of their liability to buyers. Since the documents are reviewed in electronic format, the context of each document and the preservation of it remain issues to be clarified. In order to prevent future differences of opinion, the parties understanding of the documents must be clearly drafted in agreements.

Collaboration with financial and technical teams

Exchange of ideas and close collaboration among legal, financial and technical teams in a project provide benefits in evaluating the critical issues in the early stages of due diligence. Most of the time, the buying company and/or its consultants organize information sharing among all the parties in a preliminary meeting. Following this initial meeting, which integrates and motivates the teams, weekly process meetings assist each team member in its specific aims and help avoid wasting time on insignificant matters. Therefore, it is correct to state that success in M&A comes from the method and execution of integration planning. Communication is critical throughout the process in achieving an optimal level of due diligence.

Cross-border M&A and other issues

In cross-border transactions, even in the planning phase of an M&A, legal prerequisites must be discussed with a local firm to identify issues and plan timing of each legal step in line with the overall timing of the transaction. Another concern might be the extension of certain local laws into other jurisdictions and conflicting legal requirements. In these circumstances, close contact with local regulatory authorities and government agencies and helping them to understand another jurisdictions' point of view is imperative for successful closing of transaction.

Certain issues in M&A practice have not been tested in Turkish courts. There exist only a few court precedents reviewing M&A issues, almost none of which concerns cross-border transactions. So contractual undertakings shape many acquisitions in the Turkish legal market. Unavoidable circumstances must always be kept in mind. Accordingly, material adverse change clauses provide a right to terminate an agreement before completion or open a door for renegotiations if one of the parties, generally the buyer, is subject to changes introduced by adverse business or economic developments occurring between signing phase and closing an acquisition deal. On the other hand, if one of the parties simply walks away from the transaction after the signing of agreement, the question might be whether the other party's right is limited to a contractual penalty clause in addition to statutory relief or whether specific performance may also be enforced in the courts. Certainly, signing creates a duly enforceable agreement between the parties, yet preventive clauses must be analytically used to allocate risks for both parties.

Competition

If the merger parties' turnover in a relevant product market exceeds TRY25 million or if this threshold is not exceeded but the total market share of the parties in a relevant product market exceeds 25% of market share, the transaction must be approved by the Competition Board. M&A transactions without this approval are not legally valid.

The Board needs to be notified preferably one month before the deal is closed because it must issue an opinion on the deal within one month. However, the one-month review period can be extended by a Board request for additional information or documents with respect to the parties or the transaction. The Board can stop the clock at its discretion. So only a fully completed and attentively drafted notification form must be submitted to the Board – unlike EU law, Turkish law does not recognise a short-form notification.

Global M&A transactions will need to be notified to the Board if the thresholds in the relevant product markets are exceeded, even if the parties do not have an establishment in Turkey but realize direct sales to the Turkish market, where they generate a turnover. The issue related to indirect sales into Turkish market is more complicated and was only recently resolved. The Board's intervention in global transactions is not just limited to the jurisdiction matter. In 2006 the Board received a number of notifications for global merger cases, and closely scrutinized the transaction agreements in terms of non-compete, confidentiality and non-solicitation clauses, intervening where it deemed necessary regarding the durations of these prohibitions and even granting conditional approvals provided the parties amended their global agreements in accordance with the decisions of the Board. The Board usually accepts these prohibitions for a term of three years if know-how is involved and for joint ventures for the duration of the joint controlling relationship.

Issues in labour law

With respect to acquisitions, the relevant labour law issues can be differentiated in terms of whether the acquisition is by share purchase or asset transfer.

According to the Turkish Labour Code, employment relationships are automatically transferred to the acquiring party by the employer during an asset transfer including all rights and obligations as of the transfer. The transferor and transferee are jointly liable for the rights and liabilities that arise from events occurring before the date of transfer for a period of two years, although certain exceptions are observed. The acquiring party has in principle to continue the employment contracts as they were agreed upon by the transferor and the employee.

As a rule, in a share sale, the legal personality of the employer remains the same and so the sale has no impact on the employer-employee relationship and employment contracts with the company are not unaffected. The employees may be affected by a change in the management control, but they have no right to be kept informed or to terminate their employment contracts solely on the basis of such a change. Also, a mere change in the shareholder structure or management of a company does not constitute a just cause for termination of the employment contract by the employee. If the employer intends to amend the working conditions of the employees in any substantial way, it must respect the procedure set out in the Labour Code.

Set for growth

In M&A, a thorough legal and financial due diligence exercise must always be the initial step, to prevent future issues and ease the integration process. In line with the relevant legislation, preventive measurements and solution mechanisms must be carefully thought, negotiated and implemented before execution of share/asset purchase, joint venture and shareholders agreements.

Financial market indicators clearly show that Turkey will continue to be an attractive investment market due to its strong and stable economic structure and strategically impressive location. The EU initiated membership negotiations with Turkey in 2005 and Turkey is fulfilling the acquis communautaire to a significant extent through its newly enacted laws and regulations. In 2007, Turkey will benefit more from being a marketing base for neighbouring countries in the region. It will also be the year for elections. After the election excitement dies down, the M&A environment in 2007-2008 is expected to be highly promising in Turkey.

Firm profile and author biographies

YükselKarkinKüçük Law Firm Yüksel Karkin Küçük was formed in early 2006 by an expert team of lawyers as an endeavour of unyielding integrity and dedication to legal services. Every partner is a recognized specialist in each one of the main practice areas of the firm. The firm's clients, within the firm's extensive international practice, enjoy the benefit of receiving this expertise in mergers and acquisitions, competition, energy, privatization, project finance, arbitration, corporate, banking and finance, labour, litigation, real estate and intellectual property law areas. Consequently, Yüksel Karkin Küçük is a law firm to provide not only the highest quality legal representation but also personalized business intelligence for each case or transaction. The firm has grown quickly since its formation and currently encompasses 16 lawyers. This legal team holds education and knowledge of both civil and common law legal systems, with lawyers admitted to practise law in Turkey and in New York. Cüneyt Yüksel YükselKarkinKüçük Cüneyt Yüksel is a partner in Yüksel Karkin Küçük Law Firm practising primarily in the areas of mergers and acquisitions, oil, pipeline and gas, energy and infrastructure, and arbitration. He is involved in large M&A deals and arbitration cases. Before founding Yüksel Karkin Küçük Law Firm, Yüksel was a partner in a leading law firm. Yüksel was also a lecturer at the Istanbul University School of Law International Law Department between 1996 and 1998. He is recognized as a leading lawyer in Turkey by Chambers Global in both its 2006 and 2007 editions. Yüksel received his LLM degree in European/trade law from the University of Leicester School of Law, England, 1996 after receiving his Law Diploma from the Istanbul University School of Law in 1994. Fulya Kazbay YükselKarkinKüçük Fulya Kazbay is a senior associate in Yüksel Karkin Küçük Law Firm experienced primarily in the areas of mergers and acquisitions, banking and project finance. She is admitted to practise law in Turkey and in New York. Kazbay has an LLM degree in banking corporate and finance law from Fordham University School of Law, New York, 1996, a Diploma in Bank Lending from New York University, 1994 and a Law Diploma from Dokuz Eylul University School of Law, 1990.