In periods when economic fluctuation becomes severe, a great many undertakings fall into payment difficulty and face the risk of losing their capacity to survive. Composition with creditors is an institution that comes into play precisely at that threshold; it affords temporary protection to undertakings on the brink of bankruptcy and allows their debts to be restructured within a statutory framework.
To define the institution briefly: it is a route to restructuring under which the debtor reaches agreement with its creditors on a particular plan, undertakes to pay on that basis, and the whole of the process is conducted under the supervision of the court. Through this mechanism, regulated in the Turkish Commercial Code No. 6102 and the Enforcement and Bankruptcy Act No. 2004, the debtor is protected from bankruptcy while the creditors, for their part, move away from the danger of losing their claims in full.
In this briefing note we address, in systematic fashion, the principal headings that make up the operation of composition with creditors.
The Concept of Composition with Creditors
Composition with creditors is a restructuring process conducted under judicial supervision by which the debtor, having obtained the consent of its creditors, spreads its debts over time or pays them by way of abatement. Regulated in Art. 285 et seq. of the Enforcement and Bankruptcy Act No. 2004, the institution affords legal protection so that the debtor may continue its activity without being driven into bankruptcy.
Legal Basis and Key Concepts
In Turkish law the institution is regulated in the Turkish Commercial Code No. 6102 and, principally, in Arts. 285–309/z of the Enforcement and Bankruptcy Act No. 2004 (EBA). Its axis is formed by the moratorium, the appointment of a commissioner, the debtor’s inability to pay, and the payment plan on which agreement is to be reached with the creditors.
The Purpose and Function of the Institution
The aim of composition with creditors is twofold: on the one hand to prevent the bankruptcy of an honest debtor and thereby enable it to continue its activity, and on the other to secure the satisfaction of the creditors at as high a rate as possible. In that respect the process protects the debtor while at the same time establishing a fair regime of collection for the creditors.
The Difference from Bankruptcy
Composition with creditors is a route to restructuring that is preventive and remedial in character; bankruptcy, by contrast, produces the liquidation of the undertaking.
Types of Composition
The institution may be applied in different forms according to the debtor’s intention to pay and the economic picture in which it finds itself. Three basic types are spoken of in practice.
Composition by Extension of Time
This is the type in which the debtor undertakes to pay the whole of its debts but wishes to do so by spreading them over a period of time within a new schedule of maturities. Here the amount of the debt does not change; only the time for payment is extended. It is generally preferred by debtors experiencing a temporary liquidity bottleneck who retain their capacity to pay in the long term.
Composition by Abatement (Reduction)
This is the type in which the debtor asks that part of its debts be given up, that is to say that an abatement be made. In that event the creditors waive a given percentage of their claims; the balance is for the most part paid by being tied to maturity dates. It offers a solution for undertakings whose burden of debt has risen above their capacity to pay.
Mixed Composition
This is the type in which the debtor seeks both a reduction and an extension of time. Through that combined structure the amount of the debt is reduced while the period for repayment is also extended, and a footing favourable to the debtor’s recovery is created. The form most frequently encountered in practice is generally the mixed composition.
Who May Apply?
The system is a special mechanism that affords the possibility of applying not only to debtors but, in certain circumstances, to creditors as well. The capacity to apply varies according to whether the person concerned carries on commercial activity and according to his legal status.
Conditions in respect of natural and legal persons
- Natural persons: Any natural person who has difficulty in paying his debts may make an application, regardless of whether he holds the status of merchant. For the composition to be accepted, however, the person must have income or assets capable of meeting his debts.
- Legal persons: Capital companies, partnerships and cooperatives may apply in order to be able to continue their activities. The application must rest on a decision of the competent organ of the company.
- Whether or not they are subject to bankruptcy, debtors who face the danger of being unable to pay their debts, or who have in fact fallen into payment difficulty, may seek a composition (Art. 285 of the EBA).
Conditions for Application
Being in financial difficulty is not of itself sufficient to make an application. Whether the application to the court can be accepted depends on the substantive and formal conditions laid down in the statute being satisfied together.
Payment Difficulty or Insolvency
Art. 285 of the EBA provides that the application may be made in two situations:
- Where the debtor has become unable to meet its existing debts as they fall due, that is to say has fallen into default
- Where the debtor carries a foreseeable risk of insolvency, in other words where its liabilities exceed its assets
The court requires that picture to be established on reasonable and concrete grounds.
Good Faith and a Workable Plan
Three things are expected of the debtor making the application: that it act in accordance with the rule of good faith, that it not act with the intention of causing loss to its creditors, and that it submit a realistic, workable and persuasive payment plan.
The plan submitted must rest on concrete economic data as to the method by which and the period within which the claims are to be paid, and as to how the financial structure of the company is to be put right.
Documents to Be Submitted
Under Art. 286 of the EBA the following documents must be attached to the application in full:
- The preliminary composition plan,
- Documents establishing the state of the debtor’s assets (the latest balance sheet, the profit and loss account, the cash flow statement, interim balance sheets and the information and documents on expenditure listed in the Act),
- A list showing the creditors, the amounts of their claims and the privileged status of the creditors,
- A table showing, by way of comparison, the amount the creditors are expected to receive under the preliminary plan and the probable amount they could receive were the debtor to be made bankrupt,
- The audit report providing reasonable assurance that the offer made in the preliminary plan will be realised, together with the material on which it is based,
- Any other documents and records that may be requested by the court or the commissioner in the course of the process.
Appointment of a Commissioner and Security
If the application is accepted, the court, together with the order granting a provisional moratorium, appoints one or more commissioners in order to supervise the debtor’s activity and to protect the interests of the creditors. So that the commissioner’s fee may be met, the court requires the applicant to deposit security.
The Cost of the Process
Composition with creditors brings with it a series of judicial and administrative costs: the court fee and the advance on costs, the security to be provided for the commissioners’ fees, any expert or audit costs that may arise where required, and the costs of conducting the proceedings are among them. For that reason it is important to carry out a cost analysis and to prepare a cash plan before making the application.
The Application Process
Composition with creditors proceeds under close judicial supervision. The stages running from the application to the court through to the confirmation order are subject to a particular sequence and to rules of form. Conducting the process correctly is decisive as regards the acceptance of the application.
The Court to Which the Application Is Made
The application is submitted to the Commercial Court of First Instance with subject-matter and territorial jurisdiction. Under Article 285 et seq. of the Enforcement and Bankruptcy Act No. 2004:
- Where the debtor is a merchant, the application is made to the Commercial Court of First Instance of the place where its head office is situated,
- Where the debtor does not hold the status of merchant, it is made to the Commercial Court of First Instance of the place of its domicile.
The application must comprise, alongside a duly drawn petition seeking the declaration of a composition, the full set of mandatory documents listed above — the balance sheet, the plan, the documents on financial position, the list of debts and the like. The advance on costs and the security required by the court must also be deposited.
Where all those conditions are satisfied, the court may accept the application and begin the provisional moratorium stage. Otherwise the application may be dismissed for want of documents or on procedural grounds.
Preparing the Petition and Its Annexes
The process is opened by the petition the debtor submits to the Commercial Court of First Instance with subject-matter jurisdiction. The following documents must be attached to the petition in a consistent and complete form (Art. 286 of the EBA):
- The preliminary composition plan,
- Documents establishing the state of the debtor’s assets (the profit and loss account, the latest balance sheet, interim balance sheets, the cash flow statement and the information and documents on expenditure listed in the Act),
- A list showing the creditors, the amounts of their claims and the privileged status of the creditors,
- A table showing, by way of comparison, the amount the creditors are expected to receive under the preliminary plan and the probable amount they could receive were the debtor to be made bankrupt,
- The audit report providing reasonable assurance that the offer made in the preliminary plan will be realised, together with the material on which it is based.
Where the documents are incomplete or inadequate, the court grants time for them to be completed; serious deficiencies may, however, result in the dismissal of the application.
The Provisional and the Definitive Moratorium
The provisional moratorium: If the court considers the application well founded, it grants at the first stage a provisional moratorium of 3 months and takes the debtor under protection from pressures such as attachment, bankruptcy and the running of interest. Where the need arises, that period may be extended by a further 2 months (Art. 287 of the EBA).
In that period a composition commissioner is appointed and keeps the debtor’s commercial activities under supervision. The debtor may not deal with its assets without the permission of the commissioner.
The definitive moratorium: At the end of the provisional moratorium the court, taking the commissioner’s reports and assessment as its basis, grants a definitive moratorium of at most 1 year. In exceptional cases a further 6 months may be added to that period. The definitive moratorium is the most critical phase of the process; the recovery plan takes its final shape at that stage and the views of the creditors are obtained.
The Commissioner’s Report, Creditor Approval and the Decision of the Court
Three matters follow one another throughout the definitive moratorium:
- The commissioner makes an assessment of the debtor’s financial structure and of the workability of the plan, and prepares a preliminary report and a final report.
- A creditors’ meeting is held and the plan is put to a vote by classes of creditor. For acceptance, the majorities required by the statute must be attained; those proportions are calculated both by reference to the amount of the claims and by reference to the number of creditors.
- Where the commissioner’s favourable report and the approval of the creditors come together, the court orders the confirmation of the plan.
At the confirmation stage the court does not content itself with the formal conditions alone; it also has regard to the balance between economic reality and the interests of the creditors.
The Rights and Obligations of the Parties
Composition with creditors is a mechanism of balance, operating under judicial supervision, that has regard to the rights and interests of the creditors as much as to those of the debtor. Various obligations and legal powers therefore arise in respect of both parties.
The Obligations of the Debtor
The debtor making the application comes under an obligation of transparency and honesty from the moment of application. Within that framework the debtor is obliged:
- To submit accurate, complete and up-to-date information and documents to the court and to the commissioner,
- To refrain from arbitrary dealings with its assets throughout the moratorium,
- Not to transfer or assign the assets of the company without the approval of the commissioner,
- To act with commercial diligence so as to sustain its activity,
- To keep clear of conduct liable to impair the interests of the creditors
Where those obligations are breached, the court may bring the process to an end or order bankruptcy.
The Creditors’ Objection and Approval Process
The creditors occupy a position that is both supervisory and approving in the process. At the definitive moratorium stage in particular, the creditors may object to the plan, submit a written objection concerning the amounts of the claims or the ranking of creditors, vote on the plan prepared by the commissioner on the basis of the amount of the claims and of numerical majority, and complain to the court if they form the view that the conditions of the composition are being abused.
For the composition to be regarded as accepted, one of the following two majorities must be attained (Art. 302 of the EBA):
- Half of the registered creditors and of the registered claims,
- Or a majority consisting of a quarter of the registered creditors together with more than two-thirds of the claims.
The Confirmation Order and Its Consequences
The successful completion of the process depends on the court confirming the plan. The confirmation order produces binding consequences for the debtor and the creditors alike.
The Legal Effects of the Order
When the plan accepted at the creditors’ meeting is confirmed by the court under Art. 305 of the Enforcement and Bankruptcy Act No. 2004, the composition formally takes effect and produces the following consequences:
- Binding force for all creditors: A confirmed composition is valid also in respect of creditors who did not take part in the vote or who voted against it. Creditors may no longer advance any claim beyond the amount and the period provided for in the plan.
- The fate of enforcement proceedings: Enforcement proceedings stayed during the moratorium are concluded in accordance with the plan once the confirmation order becomes final.
- The running of interest: Unless the confirmed plan contains a provision to the contrary, the running of interest ceases, as from the date on which the definitive moratorium was granted, in respect of all claims not secured by a pledge.
- Protection of the debtor: For as long as the debtor acts in accordance with the terms of the plan, it is protected from the threat of bankruptcy and from the pressure of enforcement.
Restructuring and the Payment Plan
Within the framework of the confirmed plan the debts may be abated at particular rates; it may have been agreed, for example, that 40% of the debt be written off. The remaining amount is paid on the dates fixed and by instalments. The measures undertaken in the plan for increasing income and reducing expenditure — the sale of immovable property, the narrowing of the field of activity, an increase in production and the like — are also put into effect.
For as long as the debtor keeps up the payments under the plan regularly, the composition retains its validity. Where, by contrast, the payment plan is not complied with or the interests of the creditors are seriously impaired, the confirmation order may be set aside and an order of bankruptcy made against the debtor (Art. 309 of the EBA).
Dismissal of the Application and Bankruptcy
Not every composition ends in confirmation. A court that forms the view that the plan is not apt to protect the interests of the creditors, or that establishes that the statutory conditions are not satisfied, dismisses the application. That outcome is frequently encountered in particular where the plan is not sufficient to put the debtor’s financial position right.
Grounds for Dismissal and Appeals
The grounds capable of leading the court to refuse confirmation of the plan are set out in Art. 308 of the EBA:
- That the required majority of creditors has not been duly attained,
- That it emerges that the debtor has not acted in good faith,
- That the plan is not found to be serious, workable and convincing,
- That one group of creditors is plainly caused loss as compared with the others,
- That the debtor has not complied with the conditions of the composition during the moratorium, by concealing its assets, for example, or by acting otherwise than honestly.
An appeal may be brought against an order of dismissal under Art. 308 of the EBA. Against the decision of the regional court of appeal, an appeal on points of law may be lodged within two weeks.
The Transition to Bankruptcy
Where the application is dismissed, the court may order the bankruptcy of the debtor of its own motion, depending on the presence of the following conditions:
- That the debtor is a natural or legal person subject to bankruptcy,
- That the financial picture calls for bankruptcy,
- That one of the creditors has expressly sought bankruptcy.
Where bankruptcy is ordered, the whole of the debtor’s assets enters the process of liquidation. Moreover, where the composition ends in bankruptcy, the court making the bankruptcy order decides whether the liquidation is to be conducted under the summary or the ordinary procedure; where required, it may order that the ordinary liquidation be carried out by the commissioners. In such a case the duties and powers of the bankruptcy administration are exercised by the commissioners.
For that reason the closure of the process in failure may mean, for the debtor, the end of its activity and severe loss of commercial standing.
For a detailed assessment of the effect of composition with creditors on employee claims, our note entitled The Effect of a Composition Order on Employee Claims may be consulted.
Independent Legal Assessment
In applications for a composition, the factor determining the outcome is more often than not the persuasiveness of the plan submitted rather than the financial picture in which the debtor finds itself. The court examines the preliminary plan not merely as a formal document but as an undertaking whose likelihood of realisation can be measured. The audit report providing reasonable assurance, and a comparison table showing the creditor a better outcome than bankruptcy, form the practical threshold of the confirmation stage.
The second critical dimension of the process is timing. Seeking the provisional moratorium too late both weakens the realism of the plan and removes the time needed for the company to recover during the moratorium period. In any given file we recommend that priority be given to the following headings:
- Planning the timing of the application before the cash flow deteriorates and before insolvency deepens
- Preparing the documents listed in Art. 286 of the EBA in full and consistently before the application
- Drawing up the list of creditors with care, so that privileged positions are also shown correctly
- Calculating the majority thresholds required in the vote at the outset and conducting communication with the creditors accordingly
- Tying transactions subject to the commissioner’s approval during the moratorium to an internal procedure and maintaining an orderly record
- Reflecting the total cost, including the court fee, the advance on costs and the commissioner’s security, in the cash plan in advance
Independent Legal provides advisory services and conducts proceedings throughout composition processes, from the preparation of the preliminary plan and the application file to the management of the moratorium period and, on the creditor side, to the stages of notifying the claim and objecting to the plan.