M&A: Avoiding the pitfalls

Author: | Published: 1 Jul 2011
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Turkey has been a centre of interest to foreign investors since 2004. With the government's programme to ease, incentivise and develop foreign investment in the country, which was embedded in the Foreign Direct Investments Law of 2003, the chains surrounding foreign investment were broken and the Turkish market has seen an enormous increase in both volume and deal size in respect of mergers and acquisitions.

A glittering era (2004-2008)

Between 2004 and 2008, almost all of the prominent Turkish banks were acquired by foreign investors from overseas.

Privatisation of strategic government investments, such as ports, steel and cement factories and telecoms companies, also paved the way for the foreign investor into Turkey. Each foreign investor dragged another to this attractive market and there was a significant evolution in almost all sectors, from oil and energy to foods and beverages.

Boosted by the privatisations in important sectors, and transactions concerning the largest players of the Turkish market, such as banks and other conglomerates, this upward trend continued until the third quarter of 2008 when the credit crunch hit the worldwide markets.

Pause and downfall (2008-2009)

2008 started well and Turkey witnessed a noteworthy deal volume. However, as in the other large markets, the financial crisis started to hit the Turkish economy and Turkish M&A activity suddenly dropped with the start of the third quarter.

Mostly because of the experience Turkey had gained from its domestic financial crisis in 2001 and also due to the strong legal and financial system created afterwards, the global financial crisis did not affect the financial markets in Turkey as it did in the rest of the world. Nevertheless, Turkey, which was once an investors' heaven with its economic and political stability, as well as charming growth rates, had a hard time attracting foreign investors in 2009. M&A activity was practically insensible due to the financial crisis, which spread rapidly, knocking global markets off balance. Certain multinational companies divested their businesses in Turkey in order to focus on their core markets. As a result, 2009 was the most quiet of the last seven years.

Markets recovering (2010-2011)

After a silent period for M&A in 2009, the M&A buzz of 2010 was redolent of the good old times. Consequently, 2010 was a year of gradual recovery in the financial markets. Energy, privatisation, healthcare and consumer products were the most M&A-active sectors.

This gradual recovery is progressing in 2011, which is marked by the elections. Privatisation is, as usual, on top of the trending topics whereas healthcare investments are still hot. The privatisations of Istanbul City Ferries and electricity generation assets tagged the first quarter, and Istanbul Natural Gas Distribution (IGDAS), National Lottery (Milli Piyango), Galata Cruise Port (Galataport) privatisations are in the pipeline.

While the Turkish market got used to M&A activity over the last seven years and learnt how to deal with foreign investment, the Turkish parliament also decided to overhaul its laws to enable a harmony between Turkish rules and those applied in the United States and Europe.

In light of this effort, the new Turkish Commercial Code and the Code of Obligations were enacted at the beginning of 2011 to enter into force by July 2012, together with the Civil Procedure Code which will enter into force by October 2011. All these three laws will have great impact on M&A transactions.

Dos and don'ts in Turkish M&A

Due to the lack of specific legislation regulating M&A transactions as in many jurisdictions, investments are governed by agreements which are comprehensively negotiated by the parties. Since M&A deals in Turkey are generally realised by acquiring the target company's shareholding, and such acquisition is carried out through participating into a capital increase and/or a sale of shares; the main instrument that is used for such acquisitions are share purchase agreements and share subscription agreements.

The second important instrument used in M&A deals is shareholders' agreements. This particular agreement becomes a must when it comes to an acquisition where the investor does not end up as the one and only shareholder of the target. Standard provisions of a shareholders' agreement such as transfer restrictions, board compositions and veto rights are common features in Turkey.

Furthermore, as private equity investors stay with the company for a short period of time and then get out, exit mechanisms such as tag-along, drag-along rights or initiation of a public offering, which can be the big deal breaker issues, are also encountered.

A third instrument that is often used in these deals is employment agreements. Most private equity investors enter into solid agreements with successful senior management and/or former shareholders of the target to keep the business going upwards.

Although negotiated from a commercial perspective for hundreds of hours, it can be that these agreements are not given enough thought from a legal point of view and this is the main reason why certain legal necessities are sometimes omitted or overlooked. Such insufficient care from legal counsel is causing more and more disputes and other difficulties which pop up within a couple of years from closing. Some common failures and omissions are described below.


The purpose of negotiation is to identify and understand the attitude of the counterparty and prepare security nets for transaction. Attitudes during the negotiation can clue one party in as to how its counterparty will act after the signatures are in place and if the investment will prove to be reliable.

Based on the impression during the negotiations, one can first build up appropriate security nets for possible future disputes depending on the insight that is gained from attitudes during the negotiations. One can even walk away from the deal if it is obvious that the counterparty does not win its confidence even with the security net.

Governing law

Turkish law allows the parties to freely choose the governing law (save for provisions against Turkish public policy) when there is a foreign element involved.

Although local parties prefer Turkish law, many foreign investors tend to have the laws of their jurisdiction governing the agreement. This may be very problematic when a dispute arises in connection with either the target itself or its shares. As the dispute is around the target, it is most probably handled in Turkey. Application of foreign laws by a Turkish court is cost and time inefficient.

Furthermore, aside from the liberty of choosing governing law for contractual obligations, Turkish law sets forth that rights in rem are subject to the laws of the jurisdiction where the concerned property is located. This is eventually Turkish law in respect of disputes arising in relation to ownership rights on shares that are in Turkey. This particular rule is important in asset deals which concern transfer of ownership of movable and/or immovable assets. Even if the asset transfer agreement is governed by laws of a foreign jurisdiction, the transfer of the ownership of the assets transferred thereunder, as well as all disputes arising in connection with such transfer, would be subject to Turkish law if the assets in question are located in Turkey at the time of transfer.

Turkish law also imposes different governing law options when it comes to intellectual property-related agreements and employment agreements. Therefore, governing law should be defined taking into account all aspects of the transaction and possible future disputes.


Articles of association and shareholders' agreement are, in some cases, two brothers raised by different nannies, with articles of association being subject to Turkish law and Turkish jurisdiction and shareholders' agreement being, in some cases, subject to foreign law and arbitration.

Since articles of association cannot be subject to foreign laws and disputes arising in connection therewith cannot be arbitrated, parties must be careful when structuring the relationship between these two legal instruments and avoid having the same matters regulated in both documents. Otherwise, one can end up with two different judgments ruled by the court and the arbitral tribunal on the very same issue. In case a Turkish court decision is rendered on the basis of articles of association before the arbitral award, the arbitral award will be deprived of its ability to be enforced in Turkey.

On the other hand, even if the arbitral award has been rendered before the court ruling or it does not relate to a matter regulated under the articles of association, it will not be enforced or recognised in Turkey to the extent it is against Turkish public policy.

Penalty clauses

Almost all share purchase agreements contain penalty (cezai sart) provisions that trigger in the event of the seller's breach of any of its obligations, representations and warranties. These provisions are drafted as if they provide for an independent obligation. To the contrary, the obligation of the seller imposed under a penalty is dependent on the seller's main obligation it is covering under the agreement. In other words, if the seller's main obligation becomes null and void, the penalty becomes null and void automatically.

Another misconception regarding penalty clauses is the belief that the penalty is free from fault. Pursuant to Article 161 of the Turkish Code of Obligations, unless the agreement otherwise stipulates, the penalty cannot be exercised in case the seller breaches its obligation without fault. Therefore, if the intention is that the penalty triggers even in case of force majeure events, this should be explicitly provided for in the agreement.

Representations and warranties

Representations and warranties of the seller are as important as its obligation to sell and transfer the shares. Under Turkish Law, a share transfer is considered as a sale of shares exclusively and is not considered as the sale and transfer of the enterprise in general. Therefore, the liability of the seller is limited to the qualifications of the shares and cannot be extended to the qualifications of the enterprise automatically. In order to extend this liability, representation and warranty provisions are used in agreements.

However, it is not the representation and warranty items themselves that provide this extension. In order to have a sound protection, the representations and warranties of the seller should be shaped as main obligations.

The seller should explicitly represent and warrant that (i) these are its main obligations; (ii) a breach of the representation and warranty triggers its liability of the if damages have occurred; and (iii) its liability is independent from its fault. The agreement should contain an undertaking of the seller that, if a breach of representation and warranty occurs, the seller will be liable for the losses and damages under Article 96 of the Turkish Code of Obligations even if it has no fault with regards to being aware of such breach.

Furthermore, certain representations and warranties should be structured as independent guarantees of the seller. These representations and warranties are those relating to the target's or third parties' acts.

Lack of dispute experience

Another established tradition of Turkish practice is to draft very good-looking agreements without any dispute insight. Drawn up by lawyers who have never been to a court or arbitral tribunal, share purchase and shareholders' agreements look perfect in theory but do not work in practice.

The very well-known example of this failure is the inexistence of specific performance in respect of undertakings to perform an act (yapma edimi) under Turkish law. In other words, unless a party willingly performs the act, such as voting in the agreed manner, it cannot be forced to do so. The only option in such a case would be indemnification for damages arising from breach of undertaking.

Many share purchase and shareholders' agreements contain wonderful undertakings that, if complied with, would make the counterparty's day. However, the agreement should also say what would happen if these undertakings are not complied with. There should be mechanisms that offer alternatives which have similar benefits capable of replacing the specific performance.

For instance, voting arrangements are nothing without a significant penalty. As the one who undertook to vote in a certain way would not be forced to do so unless it willingly votes so, the undertaking itself would not mean anything to the beneficiary. In case of these arrangements, the beneficiary should receive a significant penalty which might practically (and psychologically) force the specific performance. Similarly, put and call options may be used as instruments that trigger in case of breach and to practically force the specific performance.

Another very well-known example is the non-corporate provisions of shareholders' agreements. These agreements involve both corporate provisions and non-corporate provisions. Corporate provisions relate to the relationship between the target and its shareholders, for example composition of the board of directors, super-majority resolutions, veto rights at the general assembly level, and so on. On the other hand, non-corporate provisions are those relating specifically to the relationship among the shareholders, such as drag-alongs, tag-alongs, or put and call options.

Although the non-corporate provisions can be placed in the articles of association of the target, there is no benefit in doing so as Turkish scholars and court precedents argue that these provisions do not become corporate provisions, even if they are placed in the articles of association, and thus are not enforceable against the target or third parties. These provisions remain as purely contractual provisions and are, therefore, subject to the principle of relativity of contracts. Nevertheless, much of the time spent for closing preparations is wasted for negotiations on how much of the shareholders' agreement must be transported into the articles of association, which is unnecessarily spending the client's money and time.

However, keeping the non-corporate provisions in the shareholders' agreement is advantageous as shareholders' agreement could be brought to arbitration whereas the disputes arising out of the articles of association will be settled before the competent commercial courts.

It is hoped that the New Commercial Code will be the cure to this disease of Turkish practice as it exhaustively enumerates the items that can be included in the articles of association.

Crowded agreements

Many lawyers tend to have shareholders' agreements involving a set of parties including the target itself. These agreements should be structured with utmost diligence. In case of dispute, the court answers the following question: who can claim what from whom and on what legal basis? Therefore, it is crucial to determine which party is responsible against whom.

If the responsible party is not accurately identified, the whole agreement would turn into a piece of paper with all the glamorous "joint and several" undertakings and obligations it has, as the client would not have a specific counterparty it would address.

Lex commissoria

Turkish law recognises lex commissoria, which means that agreements allowing the seizure of the pledged asset by the pledgee before a default occurs and in consideration of its receivables are invalid. This famous restriction of the Roman law orders that the pledgee can only gain ownership of the pledged asset under a separate agreement that is concluded following the occurrence of the default.

Although respected in most of the cases, one can see that certain agreements have special mechanisms that are used to discount the value of the pledged asset from the due receivables. This is, of course, not legally enforceable.

Parallel debt

The other common mistake regarding collaterals is parallel debt. Existence of receivables is the prerequisite of the existence of collateral under Turkish law. This is the renowned principle that "collateral follows the receivables". In other terms, no party can hold an asset as collateral unless it has receivables secured by such asset. In certain acquisition finance deals, the security agent is not among the lenders and therefore does not have any receivables to be secured.

However, all the collaterals are delivered to the security agent to be held in the name of the lenders, and to circumvent the said requirement of Turkish law the security documents include a parallel debt wording. This wording sets forth that the borrower shall pay to the security agent, as creditor in its own rights and not as representative of the lenders, a sum equal to and in the currency of each amount payable by the borrower to the lender as and when that amount falls due for payment under the facility agreement.

Any amount due and payable by the borrower to the security agent is decreased to the extent that the lenders have received payment in full of the corresponding amount under the facility agreement and any amount payable by the borrower to the lenders is decreased to the extent that the security agent has received (and is able to retain) payment in full.

This is obviously a circumvention of the aforementioned requirement of Turkish law by creating a debt which actually never existed, and to the best of the author's knowledge, has not yet been tested before Turkish courts. There is a significant risk that a competent Turkish court will invalidate the parallel debt structure which would jeopardise all the security packages established based on parallel debt.

Assignment of security interest

Another reflection of the principle that "collateral follows the receivables" is that the security interest is automatically assigned together with the assignment of the secured receivables.

To put this another way, the security interest cannot be assigned or transferred independently from the secured receivables. This is not legally possible. However, certain Turkish lawyers have, in the past, had special assignment clauses in security documents and negotiated for hours to keep the beneficiary's right to assign its security interest. This, again, seems to be an unnecessary expenditure of the client's money and time.

Joint and several liability

Pursuant to Turkish law, a liability can be either joint or several. There is no such concept of joint and several liability. However, almost all agreements containing multiple debtors set forth that their liability is joint and several. What is meant here is that the liability is joint and the creditor may request any of the debtors to perform the whole obligation.

The Turkish word that covers this situation is müteselsil and this should not be used together with müsterek which means that (i) the creditor is not entitled to request any of the debtors to perform the whole obligation and (ii) the creditor can only request from such debtor to perform its own share. The ambiguity caused by the mixed use of these two different terms may endanger this particular joint character of the liability.


Escrow is necessary when part of the shares or the consideration needs to be set aside for some time. The escrow mechanism should be drawn in accordance with the qualifications of Turkish law. Escrow is the representative of the parties which holds these assets on their behalf. It is not the security agent acting as a pledgee. But in certain cases, the authorities attributed to the escrow elevate it to the level of a pledgee.

This is very dangerous as a valid and enforceable security interest requires the existence of receivables to be secured. However, the escrow does not hold the said assets to secure any of its receivables. Therefore, structuring escrow as a pledgee may result in the invalidation of the whole structure. In those cases where the escrow mechanism serves to the purpose of pledging certain assets, such structure should be clearly reflected in both the agreement that is the legal basis of the obligation and the pledge agreement supported by the escrow mechanism.

Employment agreements

Turkish law puts a strong emphasis on the protection of the employee with respect to the employer. Many provisions that would be perfectly enforceable if they were in a regular agreement, become unenforceable against the employee when they are positioned in employment agreements.

For instance clauses providing for serious penalties that trigger in case of the employee's termination are not capable of being enforced against the employee. This legal fact is generally omitted when drafting employment agreement as part of closing deliverables.

On the other hand, if the senior management to be locked in is at the same time the seller, it is advisable that the terms and conditions of the employment of the senior management be kept in the shareholders' agreement and not transported into a separate employment agreement. In doing so, the risk that the relationship between the target and the management is interpreted to be an employment may be mitigated to a certain extent.

About the author
Dr Ismail G Esin, partner
Esin Law Firm

Following his graduation from the Istanbul University Law School in 1990, Dr Ismail G Esin completed his LLM at the Tubingen University Law School and wrote his thesis on "The Abuse of Cancellation Lawsuit in Turkish and German Joint Stock Companies Law" in 1991. He completed his PhD with his dissertation on The Liability of the Seller in Mergers and Acquisitions in 1997. He lectured between 1992 and 2004 at the Marmara University Law School and gave graduate lectures at Galatasaray, Bilgi and Bahcesehir Universities.

In addition to his substantive experience in M&A, real estate and corporate law, Esin is also recognised as a leading commercial arbitration and litigation expert, advising multinational clients and Turkish companies. Aside from being a member of international arbitration committees, Esin is also a member of the International Bar Association, AHK German-Turkish Chamber of Commerce and ABFT American Business Forum in Turkey.

Esin has published several books and articles on arbitration, M&A, private equity and dispute resolution in locally and internationally recognised legal journals. He co-authored the book Mergers and Acquisitions under Turkish Law which has been published in both Turkish and English.