Legal Remedies For Corporate Bondholders in The Event Of Default
Those following the Turkish economy in the past months have observed hot debates that are ensuing on the correlation between interest and inflation. In the midst of the ongoing deliberations between President Erdoğan and the Central Bank Governor, Mr. Başçı, the Turkish Lira has been devalued 27% against the USD since April 2014. While some dispute that excess TL devaluation to the tune of approximately 10% as compared to other emerging market currencies is the result of the uncertainty due to the upcoming June 7 general elections, the economists emphasize that the Turkish economy, undoubtedly, entered a period of stagflation where growth has been muted between 2-3% per year while inflation remains high at 6-7%. In capital markets, we watch the effects of the liquidity crunch, as well, both in debt, and in equity products. Thus, CDS rates are increasing compared to previous years.[1] Although these figures may not be indicative of corporate bond defaults, we see that the legal remedies that are available under Turkish law and the current regulatory trends may be of practical importance for investors.
Nature of Corporate Bonds and Rights of Bondholders
A bond is a negotiable instrument that indicates a monetary right of a creditor to be issued only by following a special procedure[2]. Despite the special issuance procedure, there is no exceptional remedy available through which investors may be protected by the credit or default risk of the issuer.
As per Article 206/4 of the Law on Enforcement and Bankruptcy numbered 2004, if the issuer goes bankrupt, unlike the covered bond and sukuk holders[3], the bondholders’ rank is subordinated to privileged creditors, such as employees, the state, and other creditors determined under the law. Therefore, unless the issuer, the controlling shareholder of the issuer, or the underwriter (if any) provides an extra guarantee or security to the bondholder, the chances are less likely that bondholders will be able to recover their unpaid coupons and the principal.
Bondholders are characterized as mere creditors of the company so they may only benefit from those provisions under Commercial Code numbered 6102, as with any other creditor.[4] The Capital Markets Law numbered 6362 does not provide any special rights to bondholders other than those available for misrepresentations in the prospectus. Unlike the former Commercial Code that granted bondholders the right to convene general assemblies in certain matters, the new Commercial Code does not include such opportunity.[5] Therefore, in the event of bankruptcy, bondholders will claim their investments, either individually or collectively as there is no provision hindering them to act as a group.[6] However, such lawsuit is not a class action, as it is only introduced for legal entities, such as associations provided in Article 113 of Code of Civil Procedure numbered 6100.
Current Regulatory Trends
As per Article 4/7 of Communiqué Regarding Debt Securities numbered II-31.1 (“Communiqué”), the Capital Markets Board (“CMB”) is entitled to request from the issuer a guarantee for payment obligations given by a local bank or third party, or limit the sale to the qualified investors, only. Despite such broad power, the CMB has exercised such authority in seven applications thus far since the entry into force of the Communiqué, the first one starting with the bond offering of Fenerbahçe FC, raising funds to eliminate the effects of the controversial match-fixing investigation.
The latter approvals of the CMB introduced other conditions that were not present in the Communiqué. The clearance for issuance is given, provided that the sale is structured as a private placement, or backed by a bank guarantee, if made to qualified investors.[7] Although the Communiqué prescribes that the CMB is entitled to request either a guarantee or limit the sale to the qualified investors, it went beyond its powers and requested both by requiring a bank guarantee in a bond sale to qualified investors. In response to another application, the CMB requested a bank guarantee regardless of the sale structured as a private placement or being directed to qualified investors.[8] Lately, the CMB even restricts sales to collective investment institutions and pension investment funds.[9] We believe that the regulatory aim in the last approach is to prevent the investors of the aforementioned institutions from investing in non-guaranteed bonds.
Above all, the standards applied by the CMB through this catch-all provision seem to be exercised beyond power. Thus, since the reasoning of the CMB approval is not transparent, it causes uncertainty for the issuers as it is not clear when such guarantee will be requested. Additionally, investors may be misled by such approvals because the CMB in some applications, requests the issuer to obtain a bank guarantee while not in the others. Consequently, not exercising such power to request a guarantee from the issuer may create a mind of protection for an investor despite the fact that the CMB has a disclaimer in offering documents indicating that its approval does not qualify as a representation and warranty of the financial condition of the issuer. It is noteworthy to mention that after such decisions, except for Fenerbahçe, none of the issuers were able to launch the bond offering.
Will G.Ç.S. Issuance Become a Milestone in Corporate Bond Offerings?
Approximately four months after the approval of the CMB of the sale of 35 million TL bill to 17 qualified investors, G.Ç.S. Metal Çatı İzolasyon Taahhüt Ticaret ve Sanayi A.Ş. announced that it obtained from the court a bankruptcy postponement decision.[10] This news has raised many questions with the market participants as to how the CMB permitted such issuance, when the issuer was on the verge of bankruptcy. The bonds mature on July 15th. In a scenario of non-payment, the liability of the CMB will also be under scrutiny.
Conclusion
In reaction to the unsuccessful equity IPO boom in the former CMB president’s period that resulted in many investors’ loss, the newly formed CMB promulgated many regulations to the benefit of the investors, while stringent rules have slowed down the IPOs. We now see a similar approach in the CMB’s approval on debt issuances and, in light of the above, one may expect more regulation and even changes in the law to come with exceptional guarantees and expedited enforcement procedures for the sake of investors.
[1] http://www.bloomberght.com/piyasa/TURKEY%20CDS%20USD%20SR%205Y%20CORP.
[2] Domanic, Hayri p. 313; Corporate Bonds, Banking and Commercial Law Journal December 1973 Volume VII/2.
[3] As per Article 59/3 and 61/3 of the Capital Markets Law, if the issuer goes bankrupt, the collateral for covered bonds and sukuk holders, respectively, is not included in the bankruptcy estate, and the bondholders have the privilege to benefit from the sale proceeds of the collateral.
[4] The following articles of the Turkish Commercial Code will be relevant for the creditors: 202/1/c, 395/2, 474, 513/1, 530, 541/1, 549/1, 550, 551, 553, 554, 556, 557/1.
[5] Erdem, Ercument; Jouissance Shares For The Founders In The Turkish Commercial Code available at http://www.erdem-erdem.com/fr/articles/jouissance-shares-for-the-founders-in-the-turkish-commercial-code-2/.
[6] Pulasli, Hasan p. 1732; Commentary on Company Law, 2nd Edition 2014.
[7] CMB Bulletins numbered no. 2014/28 and 2014/35.
[8] CMB Bulletin numbered no. 2014/35.
[9] CMB Bulletins numbered no. 2014/35 and 2015/10.
[10] For further information regarding this type of decision, please visit: http://www.erdem-erdem.com/en/articles/postponement-of-bankruptcy/.
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