Composition with creditors, which is designed to allow companies in financial difficulty to restructure their debts and continue trading, is an institution that seeks to strike a balance between the interests of creditor and debtor. Reshaped by the legislative amendments of 2018, the system has become a frequently preferred solution in practice for averting bankruptcy and preserving commercial activity.
The effects of a composition are not, however, confined to commercial creditors; it also directly affects the legal position of the employees who stand in an employment relationship with the employer. Employees hold claims arising from the employment contract — severance pay, notice pay, wages, annual leave and overtime — and these items call for separate consideration, both because of their legal character and because of the social protection function they carry.
In this briefing note we examine how composition proceedings operate and the consequences they produce for employee claims, under the principal legal headings.
Key Concepts and Legal Framework
What Is Composition with Creditors?
Composition is a restructuring route aimed at averting bankruptcy, which enables debtor companies to pay their debts under a defined plan with the approval of their creditors and the confirmation of the court. Governed by Arts. 285-309 of the Enforcement and Bankruptcy Act No. 2004, the institution allows the debtor to continue its commercial activity while also enabling creditors to recover within a defined ratio and order of priority.
The institution takes three forms in practice:
- Ordinary composition: The most frequently used form; it provides for the debtor to pay its debts over an extended term or at a specified reduction.
- Composition by assignment of assets: This rests on the principle that the whole of the debtor’s assets is surrendered to the creditors.
- Composition within bankruptcy: This operates as the exit of a debtor already adjudged bankrupt from the bankruptcy estate by agreement with its creditors.
Once the court grants a provisional and subsequently a definitive moratorium, the process begins to produce a range of legal consequences: the debtor’s assets are placed under protection, individual enforcement proceedings by creditors are stayed, and a payment plan is prepared and submitted for the court’s confirmation. For detailed information on the process as a whole, our study entitled What Is Composition with Creditors? may be consulted.
Scope of Employee Claims
The monetary rights arising from the employment contract that an employee may claim from the employer in return for their labour are grouped under the heading of employee claims. The items most frequently encountered in practice are the following:
- Wage claim: The basic wage the employee has earned in return for their work, together with ancillary payments.
- Severance pay: The compensation paid to an employee with at least one year of service where the contract ends for one of the reasons enumerated in the legislation.
- Notice pay: This arises on terminations effected without observing the notice periods.
- Overtime pay: The additional remuneration payable in return for work exceeding 45 hours per week.
- Annual leave pay: The monetary claim for untaken leave upon termination of the contract.
Under the principle of "protection of the weaker party" that governs labour law, these items are in certain circumstances treated as priority or preferential claims and are subject to a special regime in composition and bankruptcy proceedings.
Effect of Composition and Bankruptcy on Employee Rights
While composition affords certain safeguards for employee claims, the employer’s financial position may delay recovery or render it partly impossible. For as long as the moratorium continues, enforcement proceedings in respect of employee claims are stayed, which narrows the employee’s ability to recover the claim individually.
By contrast, Art. 206 of the Enforcement and Bankruptcy Act No. 2004 accords first-rank preferential status to certain employee claims in bankruptcy and composition. Wages together with severance and notice pay fall within this scope, and enforcement by way of attachment may be pursued in respect of such preferential claims. In addition, the Wage Guarantee Fund established under the Unemployment Insurance Act No. 4447 may be engaged in order to secure the employee’s wages.
The difference between the two institutions becomes apparent at this point: whereas employment contracts are deemed terminated upon the making of a bankruptcy order, in a composition whether employment relationships continue depends on the orders made by the court and on whether the employer carries on its activity. This is also the source of the particular significance that composition carries for working life and for employee claims.
Legal Position of Employee Claims in Composition Proceedings
Character of the Claims and Their Preferential Status
Where an employer applies for composition, employee claims acquire a special status. The legal character of these claims and their position under the legislation are decisive both for securing employees’ economic safety and for the equitable conduct of the process.
The legal character of these items
An employee’s severance and notice pay, wages, overtime remuneration and annual leave claim are among the monetary rights arising from the employment contract. These rights are secured by the Labour Act No. 4857 above all, and also by instruments such as the Turkish Code of Obligations No. 6098 and the Social Insurance and Universal Health Insurance Act No. 5510.
The common features of these claims are as follows: they constitute a pecuniary debt, they follow directly from the employer’s obligation, and they are mandatory rights of a social character in that they enable the employee to make a living.
For this reason, the priority of payment accorded to these items in a composition is not merely a commercial choice but has been laid down as a social necessity.
Art. 206 of the Enforcement and Bankruptcy Act No. 2004 and the order of priority
Art. 206 of the Enforcement and Bankruptcy Act No. 2004 regulates the order in which claims are to be paid in bankruptcy and composition, and accords a special preference to employee claims:
Art. 206 of the Enforcement and Bankruptcy Act
"Employees’ claims based on the employment relationship and accrued within the year preceding the opening of the bankruptcy, including notice and severance pay, together with the notice and severance pay they have become entitled to upon the termination of the employment relationship by reason of the bankruptcy"
are enumerated in the provision among the first-rank preferential claims.
The practical consequences of this provision are as follows:
- Severance and notice pay, wages, overtime and annual leave claims are treated as first-rank preferential claims.
- The preference, however, covers only claims that arose within the one-year period preceding the opening of the bankruptcy.
- In a composition this preference is taken into account in framing the payment plan; but if the plan is confirmed and the employee is also included in it, not the whole of the claim but the portion determined under the plan is paid.
Act No. 4447 and the Wage Guarantee Fund
Where an employer applies for composition or falls into difficulty in meeting its payments, the Wage Guarantee Fund may be engaged in order to reduce the employee’s hardship. The provision is contained in Supplementary Article 1 of the Unemployment Insurance Act No. 4447:
Supplementary Art. 1 of the Unemployment Insurance Act No. 4447
"A separate Wage Guarantee Fund shall be established within the Unemployment Insurance Fund for the purpose of meeting employees’ unpaid wage claims for three months arising from the employment relationship, applicable in cases where the employer who employs persons deemed insured under this Act under a service contract falls into difficulty in meeting its payments by reason of applying for composition, the issue of a certificate of insolvency against the employer, bankruptcy or the postponement of bankruptcy. In the payments to be made under this article, payment shall be made over the basic wage on the basis of the condition that the employee has worked at the same workplace within the last year preceding the employer’s falling into difficulty in meeting its payments. These payments may not exceed the upper earnings limit determined pursuant to Article 78 of the Social Insurance Act No. 506.
The Wage Guarantee Fund shall amount to one per cent of the annual total of the payments made by employers as unemployment insurance premiums. The procedures and principles concerning the establishment and application of the Wage Guarantee Fund shall be determined by regulation."
Payment from the Fund is subject to three conditions: the employee must be working under a service contract; the employer must be in difficulty in meeting its payments, as evidenced by bankruptcy, composition or a certificate of insolvency; and the claim in question must relate to the last 3 months.
This mechanism constitutes an important social security safeguard directed at meeting the employee’s basic subsistence needs during the composition.
Stages of the Process and Their Impact on Employee Claims
A composition materially affects the legal position not only of the debtor but also of the employees standing in an employment relationship with it. Each stage, from the application to confirmation, produces different consequences for the recovery of the claim, the fate of the employment contract and recourse to the courts.
The Application Stage
The process opens with the debtor’s application to the court for composition. If, on its initial examination, the court finds the debtor’s position to be genuine, it grants a provisional moratorium and, by appointing a composition commissioner, brings the company’s financial position under supervision.
At this stage the legal position of the employees does not yet change directly; the indications that the process has begun are, however, the first sign that rights and claims may come under risk.
Consequences of the Moratorium Orders
Throughout the provisional moratorium and the definitive moratorium that follows it, no enforcement proceedings may be brought against the debtor (Art. 294 of the Enforcement and Bankruptcy Act No. 2004). Within this framework:
- Save for the preferential claims falling within Art. 206 of the Enforcement and Bankruptcy Act No. 2004, it is prohibited to commence enforcement proceedings in respect of employees’ claims.
- Proceedings already commenced are stayed and no new attachment may be effected.
- The employer’s assets are placed under a "protective shield".
The moratorium does not extinguish the employee’s accrued claim where the employment contract ends or is terminated for just cause; it merely restricts, on a temporary basis, the possibility of recovery through enforcement.
The List of Creditors and Confirmation
Employee claims are also entered on the list of creditors drawn up by the commissioner. It is critical that the employee be shown on this list correctly and in full, since claims omitted from the list may find no provision in the composition plan, while items left outside the plan or notified incompletely may later become the subject of an objection or an action.
At the creditors’ meeting employees may vote on the plan just like any other creditor. Once the requisite majority is obtained and the plan is confirmed, payment of employee claims is likewise subject to the terms of that plan.
The Enforcement Stay During the Moratorium
Pursuant to Art. 294 of the Enforcement and Bankruptcy Act No. 2004, throughout the composition moratorium no new proceedings may be commenced in respect of employee claims, save for preferential claims falling within Art. 206 of the Enforcement and Bankruptcy Act No. 2004; pending enforcement proceedings are stayed; and claims not secured by pledge cannot be recovered.
This prohibition narrows the employee’s individual means of pursuing their rights. The employee may nonetheless bring an action for performance before the labour court in order not to leave the claim in a state of uncertainty. Even where the existence of the debt is established by the court, execution of the judgment will remain dependent on the completion of the process.
Continuing Contracts and the Employee’s Right to Terminate
Even where a composition has begun, employment contracts remain in force for as long as the debtor’s activity continues. The continuation of work is generally maintained with the knowledge and under the supervision of the composition commissioner.
By contrast, where wages are not paid, where the workplace becomes in fact incapable of operating, or where the debtor is unable to perform its obligations under the employment contract, the employee may exercise the right of immediate termination for just cause (Art. 24 of the Labour Act No. 4857). On such a termination the employee becomes entitled to severance pay and may claim the entitlements arising from the termination by notifying them in the composition proceedings.
Moreover, if the employer wishes to carry out a collective dismissal during the process, it must comply with the statutory procedure governing that matter.
The Fate of Claims After Confirmation
The process ends with the court’s confirmation of the plan. On confirmation the debtor comes under an obligation to make payment in accordance with the plan, and the creditors participating in the composition likewise become bound by it. So far as employee claims are concerned, this is the stage at which the question of whether the claim will be paid, and on what terms it will be recovered, is answered.
Inclusion of Claims in the Plan
As a rule the plan covers all creditors, and employee claims may also fall within its scope. In framing the plan, the character of the claim — the distinction between wages and severance pay, for example — the period to which it relates and whether it is treated as preferential become decisive.
Where employee claims are included in the plan, payment is made not of the whole claim but of a portion determined in accordance with the terms of the composition and within the payment timetable laid down. That outcome is binding even where it has come about without the employee’s consent, because the plan has been confirmed (Art. 309 of the Enforcement and Bankruptcy Act No. 2004).
The Position of Non-Priority Claims
Wage claims arising within the one-year period falling within Art. 206 of the Enforcement and Bankruptcy Act No. 2004, together with severance and notice pay, may be dealt with on a preferential basis within the plan. In respect of such claims, payment must be made ahead of other creditors even where there is no security by way of pledge.
By contrast, employee claims falling outside the scope of priority — such as overtime and annual leave pay relating to earlier periods, or payments that have accumulated over a long time — are treated in the plan in the same way as ordinary claims. This means greater uncertainty and risk as regards recovery.
Difficulties Encountered in Practice
Even where the plan covers the whole of the employee’s claims, the following difficulties are frequently experienced in practice:
- Failure to implement the plan: Notwithstanding the confirmation order, the debtor company may fail to make the payments it has undertaken.
- Deficiency in the notification: The employee’s claim may not appear on the list at all, or may be shown incorrectly.
- Inadequate supervision: Insufficient monitoring of the implementation of the plan by the commissioner or the court may produce outcomes adverse to the employee.
- Terminations after confirmation: Where the employment contract has ended after the confirmation order, the claims arising from that termination may fall outside the plan and become the subject of separate legal proceedings.
Notwithstanding these risks, once the plan has been confirmed the employee may recover the claim only within the ratio and timetable provided for in the plan. Should the employee attempt to recover outside the plan, they will encounter the enforcement stay or an obstacle to execution.
Protection of the Employee and Available Legal Remedies
Although a composition makes recovery of the claim more difficult, Turkish law provides a series of priorities, protections and remedies in the employee’s favour. Below we examine the statutory instruments available to the employee both during and after the process.
Order of Priority and the Question of Security
Art. 206 of the Enforcement and Bankruptcy Act No. 2004 accords first-rank preferential status to employee claims. Among unsecured claims, priority belongs to severance and notice pay arising from the employment contract, to pay for untaken annual leave, and to wage claims that arose within the last year.
The purpose of the preference is to prevent all claims in a composition from being subjected to a reduction on equal terms. That protection is not, however, unlimited: even where the claim carries priority, the framework of payment is once again determined by the plan, and unless a pledge has additionally been created to secure payment, the employee too must abide by the plan.
Where the pledges over the employer’s assets belong not to the employee but to other creditors, the employee’s priority is of significance only as regards the unsecured portion to be liquidated.
Application to the Labour Court and Procedure
Even though the employee cannot recover through enforcement during the process, they may apply to the labour court in order to have the existence of the claim determined by judgment.
Such an application has three practical benefits: it provides legal proof should the employer deny the debt; it strengthens the prospect of appearing on the list of creditors before the commissioner and the court; and it creates scope for objection and annotation as regards claims left outside the plan.
As a matter of procedure, the Labour Courts Act No. 7036 provides for the following sequence: mandatory mediation is conducted before an action is brought; if no settlement is reached, an application may be made to the labour court; and even where a judgment is obtained from the court, its execution remains limited while the composition continues.
Limitation and Time Limits to Be Observed
The general statute of limitations for employee claims is 5 years.
Composition proceedings do not interrupt the limitation period. For that reason, in order that the period does not expire, the claim must be interrupted by a written notice, an action or an application for mediation, and the period for objecting to the list of creditors must not be missed.
Moreover, as regards employee claims not taken into the plan, a failure to apply to the general courts within 1 year following confirmation may result in the loss of rights.
Conditions for Applying to the Fund
The social security instrument of last resort is the Wage Guarantee Fund referred to above.
The conditions required:
- The employee must be working under an employment contract
- The employer’s actual difficulty in meeting its payments must be evidenced by a court order
- The claim must be submitted through the Turkish Employment Agency (İŞKUR)
Payment from the Fund reaches the employee directly; that payment does not, however, extinguish the employer’s debt. The Fund has a right of recourse against the employer for the amount it has paid.
A Roadmap for the Employee Facing an Employer’s Composition
An application for composition does not mean that the employment contract will come to an end of its own accord. The process does, however, require the employee to act in a planned manner as regards both their claims and the continuation of the employment relationship. The essential steps to be followed are set out below.
Monitoring and Documenting the Claims
The employee should keep track of whether items such as wages, overtime and compensation are being paid regularly. It is important to preserve evidence relating to unpaid items, such as bank receipts, payslips, witness statements and e-mail correspondence. Where payments are outstanding, their total amount, the months to which they relate and their content must be clearly established.
Following Announcements and Notifications in the Process
The composition application and the moratorium orders are made public by official announcement; there is no requirement that the employee be given separate notice. For that reason the process must be followed through ilan.gov.tr, UYAP or the enforcement court files, and the periods allowed for having the claim entered on the list must not be missed. Where necessary, an application should be made to the composition commissioner to have the claim entered on the list, and if the employee is left off the list, recourse should be had to objection.
Assessing Whether the Contract Continues
If the employer is carrying on its activity and work is actually being performed at the workplace, the contract remains valid.
By contrast, if wages are not being paid regularly or the employer is not performing its obligations, the employee acquires a right of termination for just cause (Art. 24 of the Labour Act No. 4857). An employee taking this course becomes entitled to severance pay, may claim all entitlements arising from the termination, and should notify the claim within the composition so as to be included in the payment plan.
Exploring the Wage Guarantee Fund Option
An employee with an unpaid wage claim relating to the last 3 months, where the composition application has become final, may apply to the Wage Guarantee Fund. The application is made through İŞKUR and serves a vital function in enabling the employee to maintain a minimum standard of living.
Observing Limitation and Preclusive Periods
Although the limitation period for employee claims is 5 years, a failure to bring an action within 1 year of confirmation of the composition plan may result in the loss of certain rights. For that reason a legal application must be made in time in respect of claims left outside the plan.
Independent Legal Assessment
For the employee, a composition most often creates a two-layered problem: even where the existence of the claim is beyond dispute, the ability to recover it is suspended for the duration of the moratorium and, after confirmation, is limited by the terms of the plan. The first-rank preference accorded by Art. 206 of the Enforcement and Bankruptcy Act No. 2004 improves this picture; but because the preference is confined to a one-year period, historic overtime and leave claims are for the most part treated as ordinary claims. What is decisive in practice is that the period to which the claim relates, and its character, are correctly identified from the outset.
The aspect of the process most frequently overlooked is the discipline of notification. Since there is no requirement that separate notice be served on the employee, a failure to appear on the list of creditors most often results not from neglect but from a failure to monitor the announcements. In a concrete case we recommend that priority be given to the following matters:
- Separating the items of claim by period and calculating the preferential and ordinary portions individually
- Monitoring composition announcements regularly and notifying the claim to the commissioner in good time
- Pursuing the route of objection in time in respect of claims omitted from the list altogether or entered incompletely
- Assessing, by comparing their consequences, the options of terminating for just cause and of continuing to work where wages are not paid
- Not neglecting an application to the Wage Guarantee Fund in respect of the last three months’ wage claim
- Diarising separately the five-year limitation period and the one-year period for applying after confirmation
Independent Legal provides advisory services and conducts litigation in composition proceedings, acting for both employers and creditors at every stage from the notification of claims through to objections to the plan and court proceedings.