A judicial finding that a debtor has been unable to meet its obligations on time is no ordinary declaratory ruling. A bankruptcy judgment is a constitutive decision that, from the moment it is given, wholly alters the legal regime applicable to the debtor. After the judgment the debtor’s freedom over its assets comes to an end, all attachable assets are gathered under the roof of the bankruptcy estate, and the satisfaction of claims is conducted not through individual enforcement proceedings but according to the logic of collective liquidation.
The scope of this change is not confined to the debtor. The judgment causes enforcement files pending against the debtor to be stayed, pending actions concerning its assets to become dependent on the choice of the bankruptcy administration, and the legal transactions the debtor may enter into to be hemmed in by strict limits. Bankruptcy is therefore not merely a finding of payment difficulty; it marks the transition, within the law of compulsory enforcement, from a regime of individual proceedings to a collective liquidation regime founded on equality among creditors.
In this briefing note we examine, under separate headings, the legal consequences the process gives rise to — from the publication of the judgment to the formation of the estate, from the status of the bankrupt to the ranking of claims, and from the protection of third parties to the closure of the bankruptcy.
The Nature of the Bankruptcy Judgment and Its Immediate Effects
Publication of the Judgment and Registration in the Trade Registry
Once the court has adjudicated bankruptcy, publication of the judgment and its registration in the trade registry are compulsory by law. The function of publication is to ensure that the interested circles, above all the creditors, are made aware of the situation; the ability of creditors to notify their claims to the estate also depends on that announcement. Although publication is not an act that of itself gives rise to the state of bankruptcy, it is a complementary and indispensable stage for the sound conduct of the process.
With registration in the trade registry, the debtor’s state of bankruptcy also begins to take effect as against third parties.
The Automatic Formation of the Estate
At the moment the judgment is given, the debtor’s attachable assets, rights and claims pass, without any further act being required, into the legal whole known as the bankruptcy estate. The estate is a special body of assets dedicated to the purpose of satisfying claims, over which the debtor’s power of disposal has wholly come to an end.
Transactions carried out by the debtor in respect of these assets after the opening of the bankruptcy produce no effect as against the creditors. From that moment the power to preserve, administer and realise the assets forming part of the estate is taken from the debtor and left to the bankruptcy administration.
Consequences Arising for the Debtor
For the debtor the judgment is not merely a finding of payment difficulty; it produces direct and mandatory effects on its assets, its power of disposal and its legal position. With the opening of the bankruptcy the debtor enters a special regime drawn up in the Enforcement and Bankruptcy Act No. 2004. Under that regime freedom over the assets comes to an end and the liquidation is pursued with regard to the common interest of the creditors.
The Status of Bankrupt and Its Scope
With the judgment the debtor becomes in law a bankrupt. That status does not remove the person’s legal capacity to have rights or capacity to act. The bankrupt continues to be able to carry out transactions concerning rights strictly attached to the person and to retain the status of party in actions concerning their personal circumstances.
By contrast, the bankrupt’s power of disposal over the assets and rights included in the estate wholly ceases. The administration and representation of the estate is by law the task of the bankruptcy administration. Legal transactions entered into by the bankrupt in respect of assets forming part of the estate after the opening of the bankruptcy have no validity as regards the creditors.
Loss of the Power of Disposal and the Invalidity of Transactions
The opening of the bankruptcy, as a rule, wholly removes the bankrupt’s power over the elements of the assets falling within the estate. In this framework, transactions carried out after the judgment such as sale, gift, creation of a pledge, acknowledgement of debt or the giving of security bind neither the estate nor the creditors.
The purpose behind the provision is to preserve the integrity of the estate and to safeguard equality among the creditors. The removal of the power takes effect prospectively from the moment the bankruptcy is opened; the exceptions laid down by law are reserved as regards transactions entered into with third parties in good faith before publication and regarded as legally valid.
Termination of the Powers of the Organs of Capital Companies
If the debtor is a capital company, the adjudication of bankruptcy brings to an end the status of the organs holding the power to manage and represent the company. After the judgment the following restrictions apply to the members of the board of directors or the managers authorised to represent the company:
- They may not dispose of the company’s assets.
- They may not place the company under a new debt obligation.
- They may not enter into legal transactions binding on the estate.
From that moment the management and representation of the company passes by law to the bankruptcy administration. The task remaining to the organs consists in supporting the bankruptcy administration with information and documents and contributing to the conduct of the liquidation. The aim of the provision is the protection of the company’s assets and the completion of the liquidation in a manner consistent with the interests of the creditors.
Consequences Arising for the Creditors
The bankruptcy judgment does not merely change the debtor’s status; it also fundamentally transforms the manner in which creditors exercise their rights, initiating a liquidation founded on collective enforcement. From that stage onwards creditors may not resort to individual proceedings or to compulsory enforcement; claims may be asserted only through the bankruptcy estate and the bankruptcy administration.
In short, bankruptcy is a collective route of enforcement in which the individual room for manoeuvre of creditors is narrowed and claims are satisfied within the ranking and proportions laid down by law.
Claims Not Yet Due Falling Due
One of the most marked effects the judgment produces for creditors is that claims whose term has not yet expired fall due. Under Article 195 of the Enforcement and Bankruptcy Act No. 2004, upon the adjudication of the debtor’s bankruptcy claims become capable of being asserted against the estate without awaiting maturity. The situation falling outside this rule is that of claims secured by an immovable pledge; these do not fall due upon the opening of the bankruptcy.
The aim pursued by the provision is to ensure that the liquidation is conducted in a single operation covering all creditors, and to prevent differences in maturity from conferring an unfair advantage on some creditors.
The Regime for Interest and Enforcement Costs
Interest accrued up to the date the bankruptcy is opened, together with the enforcement costs, is recorded with the estate along with the principal claim. As regards interest and costs relating to the period after the date of bankruptcy, a different regime operates according to whether or not the claim is secured by pledge.
Interest on Unsecured Claims
As regards claims entering the estate, interest continues to run after the opening of the bankruptcy as well. Statutory interest is applied to claims not secured by pledge.
When the bankrupt’s assets are realised, first satisfied is the principal debt comprising the claims included in the estate under Art. 195 together with the interest accrued up to the date the bankruptcy was opened and the enforcement costs. If, after all the principal debts have been paid, a balance remains in the assets, payment of the interest running after the bankruptcy is then made under the final paragraph of Art. 196.
Interest on Claims Secured by Pledge
An exceptional interest regime has been adopted for claims secured by pledge. A secured creditor may, confined to the proceeds obtained from the realisation of the pledge, claim interest for the period after the date of bankruptcy as well, without being bound by the statutory interest limit. That claim may not, however, in any event exceed the value of the pledge.
If the value of the pledge does not cover the claim in full, the uncovered portion takes on the character of an unsecured claim and only statutory interest may run on that part.
Enforcement Costs and Litigation Expenses
For enforcement costs and litigation expenses too, the criterion is the date of bankruptcy. Accordingly, enforcement costs arising before the bankruptcy may be recorded with the estate. By contrast, individual enforcement measures taken after the date of bankruptcy are invalid by reason of the prohibition on individual proceedings; the costs arising from such measures cannot be charged to the estate.
Filing a Claim with the Estate: Procedure, Time Limit and the Consequence of Delay
With the opening of the bankruptcy it becomes compulsory for creditors to assert their claims not through individual enforcement instruments but by filing them with the estate. Filing is a condition required for a creditor to take part in the liquidation, to find a place in the schedule of ranking and to receive a share in the distribution.
Under Art. 219 et seq., the bankruptcy administration issues a call to creditors by way of publication. Creditors must notify their claims to the estate within one month following the date on which the announcement is published. That period is not preclusive in nature; it is a procedural period intended to ensure the orderly progress of the liquidation.
Notification where the period has elapsed
Even if the one-month period has been missed, the way to give notification is not closed. Two consequences arise, however, for claims notified late: such claims may be taken into the schedule of ranking, but they obtain no share in distributions already carried out.
The Schedule of Ranking and the Ranking of Claims
The schedule of ranking is the basic document showing which claim is to be satisfied in the liquidation, in what order and in what proportion. Prepared on the basis of the admitted claims, the schedule is published to the creditors and the distribution is conducted in accordance with that document.
Claims Secured by Pledge
Claims secured by pledge are kept outside the general ranking and are satisfied from the proceeds obtained from the realisation of the pledge. If the proceeds prove insufficient, the uncovered portion is entered in the schedule of ranking as an unsecured claim.
Privileged Claims
Article 206 of the Enforcement and Bankruptcy Act No. 2004 divides privileged claims into three ranks.
Those in the first rank are as follows:
- Employees’ wage claims for the last year preceding the opening of the bankruptcy,
- Severance and notice pay payable to employees,
- Maintenance claims arising from family law,
- The employer’s debts to assistance funds or similar social welfare bodies set up for employees.
The second rank covers two groups of claim:
- All claims arising from a relationship of guardianship or custody in respect of assets administered by the debtor,
- Funeral and treatment expenses together with certain claims of a social nature.
In the third rank are claims belonging to the public sector:
- Tax claims,
- Social Security Institution (SGK) premiums and other public claims of the same nature.
Ordinary Claims
All claims falling outside secured and privileged claims are regarded as ordinary claims and take fourth rank. Within this group the distribution is made on a proportional (pro rata) basis. Where no money remains in the estate to be distributed, ordinary creditors may receive no payment at all.
The Position of Public Claims
Tax offices, the Social Security Institution (SGK) and other public administrations must likewise notify their claims to the estate. There is no provision requiring public claims to be recorded with the estate automatically.
Public claims secured by pledge are subject to the regime for secured claims; public claims not supported by a pledge are treated as third-rank privileged claims. The privilege accorded to public claims therefore confers only a limited advantage as against secured claims and first- and second-rank privileged claims.
Effects as Regards Third Parties and Continuing Relationships
The field of effect of a bankruptcy judgment is not confined to the relationship between the debtor and the creditors; it also covers the debtor’s continuing contracts, the ties formed with third parties, negotiable instruments, pending enforcement files and pending proceedings. In this respect bankruptcy is a change of status producing multilateral and knock-on effects.
The provisions on the protection of third parties are framed by striking a balance between, on the one hand, securing the integrity of the estate and, on the other, preventing persons acting in good faith from losing their rights.
The Fate of Contracts
The opening of the bankruptcy does not automatically bring to an end all the contracts to which the debtor is a party. The decisive criterion is whether the contract involves a personal performance and whether performance has been completed. Three situations are distinguished in this framework:
- Contracts involving a personal performance — for example, mandate, service and certain types of works contract — as a rule terminate automatically upon the debtor’s bankruptcy.
- In contracts whose reciprocal performances have not been rendered at all or have been rendered only in part, the power to decide whether to continue or to terminate the contract belongs to the bankruptcy administration.
- If the bankruptcy administration chooses to continue the contract, the obligations arising from that contract acquire the character of an estate debt.
This structure makes it possible for contracts to be kept alive or brought to an end according to the interest of the estate.
Contracts that terminate automatically
Certain types of contract terminate automatically upon bankruptcy because they rest on the relationship of trust between the parties or are personal in nature. Ordinary partnership contracts, contracts of mandate, commission contracts and some insurance contracts are assessed within this scope. Since the debtor’s personal participation is an essential element in these relationships, bankruptcy extinguishes the contract.
Special Provisions on Negotiable Instruments and Commercial Paper
Since negotiable instruments and bills of exchange are built upon the principles of abstraction, transferability and confidence in the instrument, the repercussions of bankruptcy in this field are governed by special rules departing from the general regime. Indeed, these instruments concern not only the debt relationship between the parties but also, closely, the rights and the sense of confidence of third parties in commercial circulation.
For this reason Articles 188 to 192 of the Enforcement and Bankruptcy Act No. 2004 introduce exceptional provisions aimed on the one hand at protecting the integrity of the estate and equality among creditors and, on the other, at safeguarding the acquisitions of holders in good faith and the uninterrupted continuation of commercial life.
Recovery of instruments handed over for collection (Art. 188)
Third parties may claim the return of bills of exchange that they left with the bankrupt before the bankruptcy solely for the purpose of conferring authority to collect, or against a payment to be made in the future.
Sale of property belonging to another and the claim for the price (Art. 189)
Where the bankrupt has sold property of which it is not the owner and the price has not yet been collected, the right to that price belongs not to the estate but to the true owner of the property. The purpose of the provision is to prevent the third party’s right of ownership from being harmed by the bankruptcy, and it affords protection similar to that under the provisions on claims of title.
The seller’s right of recovery (Art. 190)
The seller may exercise a right of recovery in respect of goods whose price has not been paid at the time of the bankruptcy and which remain in the bankrupt’s hands in their original state. For this possibility to arise, the goods must be present in their original state, must not have been transferred to third parties and must not have entered the disposal of the bankruptcy administration. If these conditions are not met, the seller’s claim is converted into a bankruptcy claim.
Termination of the power of disposal and protection of the holder in good faith (Art. 191)
Even though the bankrupt’s power of disposal has come to an end with the opening of the bankruptcy, by virtue of the principles of abstraction and confidence governing bills of exchange the acquisitions of holders who acquired the instrument in good faith and without knowledge of the bankruptcy are protected. This exception is directed at maintaining the circulating force of bills of exchange and commercial security.
Validity of payments made to the bankrupt (Art. 192)
Payments made to the bankrupt before the publication of the bankruptcy by debtors who did not know that the bankruptcy had been opened are regarded as valid and extinguish the debt. By contrast, payments made to the bankrupt by those aware of the situation produce no effect; such persons are obliged to pay again to the estate. The provision is a natural reflection of the principle of the protection of good faith.
The Stay of Pending Enforcement Proceedings
With the opening of the bankruptcy, all individual enforcement proceedings directed against the debtor are stayed automatically. No separate decision by the enforcement office is required for this result to follow. After this stage, the only route by which creditors may assert their rights is to file their claims with the estate.
The Effect on Claims Secured by Pledge
The opening of the bankruptcy as a rule also stays proceedings commenced by way of realisation of a pledge. This result is the natural extension of the prohibition on individual proceedings and applies to secured creditors as well. That said, the secured creditor is not deprived of the priority of security in rem afforded by the right of pledge.
The secured creditor now asserts its claim not through individual proceedings but within the estate and confined to the proceeds to be obtained from the sale of the pledged property. Where the proceeds do not cover the claim in full, the uncovered part is converted into an unsecured claim and becomes subject to the general ranking regime.
Pending Actions and the Suspension of Time Limits
Under Article 194 of the Enforcement and Bankruptcy Act No. 2004, upon publication of the bankruptcy the civil actions to which the bankrupt is a party, whether as claimant or as respondent, are stayed. Those files may be resumed from the point at which they were left once 10 days have passed since the second meeting of creditors. Whether the dispute is to be pursued for the purposes of the liquidation depends on the will of the bankruptcy administration to continue the action or to abandon it.
While the liquidation continues, save in the cases expressly excepted by law, the statute of limitations and preclusive periods running in favour of or against the debtor are suspended. The aim is thus to prevent creditors or other interested parties from losing rights through the lapse of time while the liquidation is under way.
The Closure and the Lifting of the Bankruptcy
The Closure of the Bankruptcy
The liquidation is completed in practical terms with the final distribution of the monies in the estate and the issue of a certificate of insolvency to creditors who have not been able to collect their claims in full. For the bankruptcy to come to an end in law, however, the commercial court that adjudicated the bankruptcy must additionally give a decision of closure. If, on the basis of the report submitted by the bankruptcy administration, the court concludes that the proceedings have been conducted in accordance with the proper procedure, it rules that the bankruptcy be closed. An appeal may be lodged against the ruling on closure within two weeks of service; an appeal on points of law may likewise be brought against the decision of the Regional Court of Appeal within two weeks of the date of service.
Publication of the closure is carried out by the bankruptcy office. The consequences of closure may be summarised as follows: the state of bankruptcy comes to an end in law and the task of the bankruptcy administration ceases. That result does not, however, remove the person’s status as a bankrupt.
If, after the closure, it emerges that there is property that remained outside the liquidation, the bankruptcy office sells that property and distributes the proceeds, within their ranking, to the creditors who received less than their claims. The same course is followed as regards monies previously deposited with a bank that subsequently become available for disposal.
The Lifting of the Bankruptcy
The lifting of the bankruptcy is a separately regulated route under the law which causes the legal effects of the judgment against the debtor to be wholly removed while the liquidation has not yet been concluded. A decision to that effect may be given only if one of the following three conditions is met:
- All the creditors withdraw their claims,
- All the claims have been paid,
- The composition proposed by the debtor — that is, an agreement for the restructuring of the debts — is ratified by the court.
Once the decision lifting the bankruptcy becomes final, all the consequences that arose upon the opening of the bankruptcy lose their validity. The debtor’s status as a bankrupt falls away, the task of the bankruptcy administration ceases, and the debtor may return in full to legal and commercial life. Unlike closure, this route removes all the restrictions on the debtor’s standing and legal powers.
Offences Connected with Bankruptcy
In order to ensure that the process is conducted honestly and that creditors’ rights are protected, various bankruptcy offences are set out in the Turkish Penal Code No. 5237 and the Enforcement and Bankruptcy Act No. 2004. These provisions are intended to deter bad-faith conduct and to safeguard the fair operation of the liquidation:
- Negligent bankruptcy: where a trader fails to display the care required in commercial life or engages in conduct from which it should have refrained — for instance, causing its own bankruptcy through immoderate spending and irresponsible behaviour.
- Fraudulent bankruptcy: where the debtor resorts to fraudulent transactions, before or after its bankruptcy, with the intention of knowingly causing loss to its creditors.
- Failure to deliver up the bankrupt’s property or to declare debts: where third parties, despite the bankruptcy having been announced, fail to hand over to the bankruptcy administration property of the bankrupt in their hands, or fail to declare their debts to the bankrupt.
- Failure to request bankruptcy when required: where the managers of a capital company, although aware that the company is balance-sheet insolvent, fail to make the request for bankruptcy in due time.
The offences listed are serious sanctions laid down by law in order to secure transparency and fairness in the liquidation and the protection of creditors’ rights.
Misconceptions Frequently Encountered in Practice
There are certain beliefs about bankruptcy that are well established in society but do not correspond to the legal reality. These mistaken views can make it harder for individuals and businesses in financial difficulty to take the right decisions.
Bankruptcy means the end of everything
The idea that bankruptcy is the irreversible end of a person’s or a company’s commercial life is fairly widespread. Yet in Turkish law bankruptcy is not always an absolute end. Restructuring instruments such as composition in particular give businesses the opportunity to repair their financial position and continue their activities. The legal order leaves debtors acting in good faith the possibility, on certain conditions, of returning to commercial life. Once the liquidation has been completed and payments have been made to the creditors, the court rules that the bankruptcy be closed. For natural persons, the right to request “rehabilitation” arises upon the expiry of certain statutory periods. That mechanism is intended to allow a debtor who has fulfilled its obligations to rejoin society and commercial life.
Debts pass to family members
The belief that, because of a person’s debt, attachment may be levied on the property of their parents or other relatives is likewise an established misconception. In Turkish law the “principle of the personal nature of debt” is a fundamental tenet. Under that principle a person’s debt concerns that person alone and does not directly affect their family. It is not possible for creditors to seek collection from the debtor’s close relatives.
Someone who goes bankrupt can never do business again
The idea that a bankrupt trader cannot return to commercial life, cannot set up a new business or cannot practise certain professions is another frequently encountered error. Although a person who goes bankrupt acquires the status of bankrupt, they do not lose their capacity to have rights and to exercise them. While bankruptcy does bring certain professional prohibitions in the field of public law — for example, that ordinary bankrupts may not practise as lawyers or notaries or serve as bank directors — those prohibitions vary according to the type of bankruptcy and can generally be removed by way of “rehabilitation”.
With rehabilitation the status of bankrupt comes to an end and the prohibitions attached to it likewise fall away. A trader who has gone bankrupt may therefore return to commercial life and turn to new ventures once the legal processes have been completed and their standing restored.
These mistaken beliefs about bankruptcy may cause individuals and businesses to shy away from taking the right legal steps in the face of a financial crisis. Giving way to despair instead of considering alternatives such as composition leads the process to produce more serious consequences. Incorrect information distorts the legal and economic operation of bankruptcy and adversely affects crisis-management strategies; it also creates a social stigma that makes it harder for those in financial difficulty to obtain professional support. Bearing in mind, too, that bankruptcy can create a domino effect in periods of economic stagnation, it becomes clear that the spread of incorrect information can go beyond the individual level and produce macroeconomic consequences. Sharing accurate information through informative work therefore contributes both to preventing losses of rights and to economic recovery.
The Role of Legal Advice in the Bankruptcy Process
It is of great importance that every person and business faced with bankruptcy or serious financial difficulty obtain professional support from a legal team experienced in this field. Qualified legal guidance makes it possible for the process to be managed correctly, for legal rights to be fully protected and for potential losses to be kept to a minimum. It should not be forgotten that in sensitive processes such as bankruptcy even a small procedural error may lead to heavy financial losses and to consequences that are difficult to remedy. With accurate information and competent support these difficult stages can be completed far more effectively and equitably.
For readers wishing to grasp the whole of bankruptcy law, the following subject headings are also complementary: the opening of bankruptcy, the bankruptcy estate and the liquidation process; the definition of bankruptcy in Turkish law, the routes of application and the judicial process; which assets cannot be attached (Art. 82); enforcement proceedings by way of realisation of a mortgage; the sale of attached property through enforcement and the auction process; the schedule of ranking and objection to the schedule of ranking.
Independent Legal Assessment
In bankruptcy files the element that determines the outcome is often not the argument on the merits but timing and procedure. For a creditor, missing the one-month call for filing means that a claim notified late obtains no share in earlier distributions; for the managers of a bankrupt company, failing to submit the request for bankruptcy in due time may give rise to criminal liability. The parties must therefore clarify their positions swiftly once the judgment is published.
Secured creditors require particular attention. Where the value of the pledge does not cover the claim, the change of regime affecting the uncovered part also directly affects the scope of any claim for interest. In a concrete file the following headings should be assessed as a priority:
- Correctly determining, before filing, whether the claim is secured, privileged or merely ordinary in nature
- Recording the date of publication and the final day of the one-month notification period
- Calculating separately the interest and enforcement costs falling before and after the date of bankruptcy
- Monitoring whether an estate debt will arise under continuing contracts according to the choice of the bankruptcy administration
- Following the ten-day waiting period after the second meeting of creditors in pending actions
- Not overlooking the period prescribed for objecting to the schedule of ranking
Independent Legal provides advisory and litigation services at every stage of the liquidation process following a bankruptcy judgment, from the filing of claims to objections to the schedule of ranking, and from the management of estate debts to applications for the lifting of the bankruptcy.