Bankruptcy, which is provided for in respect of merchants who have become unable to meet their commercial debts, is a special route in which the assets belonging to the debtor are subjected to liquidation not one by one but as a whole, and in which the proceeds obtained are distributed among the creditors according to the order laid down by law. Because the institution produces severe consequences both for the party unable to pay its debts and for the party seeking to collect its claim, it has been given a detailed and strict regulation within the Turkish Commercial Code No. 6102 and the Enforcement and Bankruptcy Act No. 2004.
The process may begin through three separate doors: the debtor requesting its own bankruptcy from the court, the creditor turning directly to the commercial court, or the creditor first instituting bankruptcy proceedings. What follows are the stages of filing claims with the estate, identifying the assets belonging to the debtor, converting those assets into money and, finally, distribution. From the moment the judgment is given the debtor loses the power to deal with its assets, individual enforcement proceedings cease to operate and all assets begin to be administered under the roof of the “bankruptcy estate”.
In this briefing note we examine, in systematic fashion, the legal framework of bankruptcy, who is subject to this route, how the application procedures differ from one another and the order of proceedings followed by the court.
The Definition and Legal Nature of Bankruptcy
Bankruptcy is a method of collective enforcement that arises only in the cases permitted by law and is reserved for merchants and for persons held liable as if they were merchants. Its purpose is to subject all the assets in the debtor’s hands to a single liquidation and to distribute the proceeds among those entitled in accordance with the order of priority determined by law.
In Turkish law this institution has been constructed as a judicial regime of liquidation in which the possibility of individual enforcement is closed off, in which the body of creditors is considered as a whole, and which takes effect only by a judgment of the court. It is therefore misleading to read bankruptcy as no more than a picture of economic failure; the institution is a technical mechanism resting on strict rules of procedure.
The Statutory Basis of Bankruptcy
The Enforcement and Bankruptcy Act No. 2004 does not meet bankruptcy with a single defining provision. Nevertheless, the two provisions that set out the nature of the institution most clearly are Art. 184 and Art. 193 of that Act. These articles draw the basic framework determining the scope and the logic of the liquidation.
Enforcement and Bankruptcy Act No. 2004, Art. 184 – The Bankruptcy Estate
“At the time the bankruptcy is opened, all attachable property of the bankrupt, wherever it may be situated, forms an estate and is allocated to the payment of the claims. Property that passes to the bankrupt until the closure of the bankruptcy enters the estate.”
The provision sets out the principles that the common interest of the creditors is to be protected and that the assets are to be administered as a whole.
Enforcement and Bankruptcy Act No. 2004, Art. 193 – The Stay and the Lapse of Enforcement Proceedings
“(1) The opening of the bankruptcy stays proceedings brought against the debtor by way of attachment and proceedings concerning the provision of security.
(2) Upon the bankruptcy judgment becoming final, those proceedings lapse.
(3) For the duration of the liquidation of the bankruptcy, none of the proceedings referred to in the first paragraph may be brought against the bankrupt.”
This provision, for its part, shows the practical counterpart of the collective liquidation approach and demonstrates that the debtor’s power of disposal is entirely removed.
Concepts Decisive for an Understanding of the Process
Bankruptcy law has a terminology of its own. Without a knowledge of the following concepts it becomes difficult to follow the operation of the process.
- Liquidation describes the whole of the stages by which the assets entering the estate are converted into money, the claims due to the debtor are collected and the resulting sum is distributed according to the statutory order of priority.
- The bankruptcy estate is the pool in which, once the judgment has been given, the debtor’s property, rights and claims are gathered; all transactions relating to the liquidation are conducted through that pool.
- The bankrupt is the name given to the debtor against whom bankruptcy has been adjudicated. That person loses the power to deal with its assets, and transactions are conducted by the bankruptcy administration.
- The bankruptcy administration is a three-member organ determined by the court from among the candidates put forward at the meeting of creditors; it sells the property of the estate, collects the claims and prepares the schedule of ranking.
- The filing of a claim is the notification of a claim to the estate so that it may be taken into account in the liquidation; claims not notified within the time limit are disregarded.
- The schedule of ranking is the official document drawn up by the bankruptcy administration showing which creditor is to receive payment in which rank and in what amount. In that document claims are grouped as privileged, secured by pledge and ordinary.
Persons and Entities Subject to Bankruptcy
When difficulty in paying debts arises in commercial life, one of the first questions asked is which persons are subject to this route. The rule is clear: in Turkish law the bankruptcy regime is provided for merchants. While the status of merchant affords certain opportunities, it also gives rise to onerous obligations.
Those Holding the Status of Merchant
The Turkish Commercial Code No. 6102 addresses merchants under two headings, natural persons and legal persons.
As regards merchants who are natural persons, the following are subject to bankruptcy: those who operate a commercial enterprise in their own name; those who announce to the public that they have established an enterprise or who have it entered in the trade registry; those who, although not in fact regarded as merchants, act towards third parties in good faith as if they were merchants; and those who operate a commercial enterprise in breach of prohibitions arising from the law, from a court judgment or from their profession, or without holding the necessary permits and approvals.
As regards legal persons, commercial companies consisting of joint-stock, limited liability, general partnership and limited partnership companies; associations and foundations that operate a commercial enterprise; and certain public bodies carrying on activity on commercial principles (state economic enterprises being the typical example) are regarded as merchants and are, as a rule, subject to bankruptcy.
By contrast, structures that possess public legal personality directly, such as the State, municipalities and the Social Security Institution (SGK), fall outside this regime.
Persons Made Subject to This Regime Although Not Regarded as Merchants
Some persons, although not regarded as merchants, may be pursued by way of bankruptcy by reason of special provisions.
Former merchants who have ceased their commercial activity come first among them; for one year from the date on which the deletion is announced in the trade registry they continue to be subject to bankruptcy in respect of their former commercial debts. The second group comprises the partners of general partnerships and the unlimited partners of limited partnerships; because they are liable for the debts of the company with their personal assets and without limitation, a judgment of personal bankruptcy may be given against them where the conditions are met. Thirdly, the Banking Act No. 5411 makes it possible for a judgment of personal bankruptcy to be given against directors and auditors who have brought about the collapse of a bank by their unlawful acts and decisions.
Persons Entitled to Request Bankruptcy
The Enforcement and Bankruptcy Act No. 2004 has enumerated the power to request bankruptcy exhaustively and has conferred it only on certain persons and authorities.
The Debtor Requesting Its Own Bankruptcy
A debtor that has fallen into difficulty in paying its debts, or that considers its existing assets insufficient to meet them, may request the court to adjudicate its own bankruptcy. In practice this route is taken with the aims of having the state of over-indebtedness formally established, of ensuring that the organs of the company discharge their statutory obligations in good time, and of preventing the burden of debt from growing without control.
In capital companies in particular, the debtor’s request for its own bankruptcy, or the making without delay of the notifications and applications provided for by law, is of decisive importance in preventing fault from being attributed to the members of the board of directors and to the managers and in preventing their liability from being aggravated.
The Request for Bankruptcy Made by the Creditor
The creditor may proceed along two different routes. The first is to proceed by way of enforcement proceedings; the second is, where one of the cases enumerated in Art. 177 exists, to turn directly to the court without instituting any proceedings.
In order to institute proceedings by the general bankruptcy route the creditor need not hold any particular document. It is, however, generally required that the claim relate to a debt of money, that it have fallen due, that is to say become payable, and that the opposing party hold the status of a merchant subject to bankruptcy. Where those conditions are met the route of enforcement is open, and once bankruptcy has been adjudicated the creditors acquire the opportunity to take part in the collective liquidation to be conducted over the whole of the debtor’s assets.
The cases in which the creditor may apply directly to the commercial court are enumerated exhaustively in the Act; we address those cases separately below.
Powers Arising from Special Legislation
There are exceptional situations in which persons and institutions other than the debtor and the creditor may also set the process in motion, and those powers arise from special legislation.
The court may adjudicate bankruptcy of its own motion in cases such as the establishment of over-indebtedness or the failure of composition proceedings. Trustees and auditors may set the process in motion where they report that the financial structure of the company is not sustainable. The Banking Regulation and Supervision Agency (BRSA) may, for its part, initiate liquidation and bankruptcy processes in respect of banks and financial institutions by virtue of the power conferred on it by special legislation.
The Procedures for Applying for Bankruptcy
Within the framework of the Enforcement and Bankruptcy Act No. 2004 the application may be made by two principal procedures: bankruptcy by way of enforcement proceedings and bankruptcy without proceedings, that is to say direct bankruptcy.
Bankruptcy by Way of Enforcement Proceedings
Under this procedure the creditor first institutes proceedings with a view to collecting its claim; upon those proceedings producing no result, the bankruptcy of the debtor is requested. The Act has regulated this route in two separate forms.
Proceedings by the general bankruptcy route (Art. 155-166)
The creditor has a payment order served on the debtor through the enforcement office. Where the debtor has not lodged an objection within the seven-day period, where an objection has been lodged but has been removed at the instance of the creditor, or where the debt has not been paid within the same period, the creditor may turn to the Commercial Court of First Instance and request both the removal of the objection and the adjudication of bankruptcy.
Where the court concludes that the debtor has not lodged an objection or that its objection is not well founded, it grants the debtor a peremptory period of seven days for payment. If payment is not made within that period and no ground preventing bankruptcy is put forward, bankruptcy may be adjudicated. The same procedure applies where no objection at all has been lodged against the payment order and the proceedings have become final; if payment is not made at the end of the peremptory period, a bankruptcy judgment is given.
Proceedings by the bankruptcy route specific to negotiable instruments (Art. 167-176/b)
Where the claim arises from a negotiable instrument such as a cheque, a promissory note or a bill of exchange, this special procedure comes into play. The periods for objection and for payment here have been kept shorter and are five days.
If the debtor does not make payment or lodge an objection within that period, the creditor turns to the court by a procedure similar to that in the general bankruptcy route and requests bankruptcy.
Direct (Proceedings-Free) Bankruptcy
Direct bankruptcy denotes an application to the court, without the need for any prior enforcement proceedings, where one of the exceptional situations enumerated in the Act exists.
Direct Bankruptcy on the Application of the Creditor (Art. 177)
Where the following cases exist, the creditor may bring a bankruptcy action without instituting proceedings:
- The debtor’s failure to pay its debt despite a final court judgment,
- Its declaring that it has suspended its payments,
- Its entering into fraudulent transactions intended to prejudice the creditors,
- Its concealing or removing its assets,
- The debtor having absconded.
Direct Bankruptcy on the Debtor’s Own Application (Art. 178)
The debtor may request its own bankruptcy by declaring that it has become unable to meet its debts. In that event it must submit to the court a declaration setting out its assets and its debts in detail.
There is one situation under this heading to which particular attention must be paid. Where one of the creditors has taken the route of attachment against a debtor subject to bankruptcy and the debtor has, by reason of that attachment, lost half of its assets, and where the remaining assets do not meet the debts that have fallen due or that will fall due within one year, the debtor is obliged to request its bankruptcy without delay. That obligation is not merely a statutory requirement; it is also the natural consequence of the principle that equality among the creditors is to be secured.
Bankruptcy in the Event of Over-Indebtedness (Art. 179)
Where the total debts of a capital company or of a cooperative exceed the probable sale value of the assets in its hands, that entity is regarded as over-indebted.
That state of affairs may be brought before the court by the managers or representatives of the company, in entities undergoing liquidation by the liquidators, or by one of the creditors, by means of an interim balance sheet prepared on the basis of the probable sale values of the assets.
If the court accepts the state of over-indebtedness, it may give a direct bankruptcy judgment without the need for the creditors to institute separate proceedings.
In conclusion, irrespective of the procedure by which the application is made, all requests for bankruptcy pass through the scrutiny of the Commercial Court of First Instance with jurisdiction. At the moment the judgment is given, the debtor’s assets are transferred to the bankruptcy estate and the liquidation begins to run.
Bringing the Bankruptcy Action and the Conduct of the Proceedings
By virtue of its legal nature, bankruptcy is an institution that can produce its effects only by a judgment of the court. The decisive link in the process is therefore the bringing of the action and the examination by the court of the debtor’s financial position throughout the proceedings.
Bringing the Action
The action is heard before the Commercial Court of First Instance with jurisdiction. Depending on who the claimant is, the process begins in two different ways.
The bankruptcy action brought by the creditor. Where the debt is not performed in time and as it should be, or where one of the grounds for direct bankruptcy enumerated in the Act has materialised, the creditor may request that the bankruptcy of the debtor be adjudicated.
The bankruptcy action brought by the debtor. The debtor may request its own bankruptcy by asserting that it is in a state of inability to pay or that it has become over-indebted. In capital companies this route carries a particular importance as regards the discharge by the managers of their statutory duties.
The statement of claim must set out, in concrete, clear and verifiable form, the legal basis of the debt or debts, the facts relied on as the ground for bankruptcy and any enforcement proceedings previously instituted.
At the first stage the court examines the compliance of the application in point of procedure and form; if no deficiency is found, the proceedings move forward.
The Stages of the Proceedings
Because bankruptcy proceedings concern public order, they are proceedings that must be concluded swiftly. The court examines both the debtor’s financial statements and, extensively, whether the grounds for bankruptcy relied on have materialised in the particular case. In general the process consists of the following links.
The hearing of the parties. The defence of the debtor and the assertions of the creditor are taken and the boundaries of the dispute are determined.
The collection and examination of the evidence. At this stage tax returns, financial statements, commercial books and records, information obtained from banks and other financial institutions, existing enforcement files and, where required, reports of court-appointed experts are added to the file and assessed.
The examination of over-indebtedness. Whether the debtor is in a state of over-indebtedness may be investigated by means of a financial examination conducted by specialist court-appointed experts.
Interim measures of legal protection. While the proceedings are pending the court may order interim measures with a view to preserving the debtor’s assets; within that framework the power of disposal may be restricted.
Oral proceedings and judgment. After the final submissions of the parties have been taken, the proceedings are concluded and judgment is given. Pursuant to the principle of ex officio investigation, the court may examine of its own motion any point it considers necessary.
The Bankruptcy Judgment
After assessing the evidence in the file as a whole, the court decides whether the grounds for bankruptcy have materialised.
Where bankruptcy is adjudicated, the following consequences arise: the debtor acquires the status of bankrupt; its power of disposal over its assets is removed; all assets belonging to the debtor are transferred to the bankruptcy estate; from the moment the bankruptcy is opened individual enforcement proceedings against the debtor are stayed (proceedings for the realisation of a pledge fall outside this rule); and the judgment is notified to the bankruptcy office, whereupon the liquidation is commenced.
Where the request is dismissed, the outcome differs: the creditor’s request for bankruptcy is without result; if it is established that the request was made in bad faith, damages may be awarded; and the debtor continues its commercial activity without interruption.
In short, the bankruptcy action is proceedings of grave consequence, affecting directly both the debtor’s financial structure and the rights of the creditors. Until it reaches the stage of judgment the court examines the debtor’s ability to pay in detail; with the bankruptcy judgment the whole of the debtor’s assets enters liquidation and the subsequent transactions are conducted by the bankruptcy administration.
Independent Legal Assessment
In bankruptcy files the element that determines the outcome is often not the argument on the merits but the procedure by which, and the timing with which, the process was set in motion. The choice between bankruptcy by way of enforcement proceedings and direct bankruptcy shapes from the outset the defences available to the debtor and the time the creditor will have to bear. In the same way, delay in notifying over-indebtedness in capital companies may reach beyond the legal personality of the company and raise the personal liability of the members of the management organ.
When the option of bankruptcy is being considered in commercial disputes, it is appropriate for the following heads to be analysed in advance:
- Verification, through the trade registry records, of whether the opposing party genuinely holds a status that is subject to bankruptcy
- Examination of the claim as regards its character as a debt of money and its having fallen due, and, where it rests on a negotiable instrument, determination of whether the shorter special procedure is to be preferred
- Assessment of whether the grounds for direct bankruptcy within the scope of Art. 177 can be supported by concrete evidence
- In an allegation of over-indebtedness, review of the technical adequacy of the interim balance sheet prepared on the basis of the probable sale value of the assets
- Identification of delays capable of giving rise to the liability of the managers and discharge of the duty of notification in good time
- Diarising the period prescribed for the filing of the claim with the estate and taking into account from the outset the possibility of an objection to the schedule of ranking
Independent Legal advises and represents creditors and debtors alike throughout the process, from the preparation of the request for bankruptcy to the completion of the liquidation.