To Restructure or Not To Restructure?

The concept of “financial restructuring” was introduced in Turkey following the country’s currency crisis in the summer of 2018. Financial restructuring, defined as revising a debtor’s financial structure and redetermining its financial strategy, became the major agenda item for Turkish financial institutions. Regulators intervened immediately and began working to create a legal framework for restructuring. The aptly named “Framework Agreement” that entered into force as a result of the joint efforts of the Banking Regulatory and Supervisory Authority (the “ BRSA ”) and the Banks Association of Turkey (the “ BAT ”) was of particular importance. Nevertheless, we observe that restructurings commenced pursuant to the Framework Agreement have been progressing very slowly and in most cases have reached an impasse. While analysing the reasons behind that slow progress, we compared the concepts behind the Framework Agreement with those in some well-known international restructuring regimes such as Chapter 11 (US) and Administration and Scheme of Arrangement (UK), in order to identify the obstacles to effective financial restructuring in Turkey.

We would like to share with you our opinions on how to address the issues.

• Lawmaking: Following the entry into force of the Financial Restructuring Regulation (the “ Regulation “) which provided for the legal infrastructure for financial restructuring , Turkey quickly enacted the Framework Agreement; however, both the Regulation and the Framework Agreement required amendment shortly after upon criticism from international and Turkish financial institutions. These criticisms first led to the preparation of a draft law proposing various amendments to the Banking Law, then to the preparation of a separate draft law focused on financial restructuring. Both of these draft laws are still being discussed in government and other circles. Albeit not following the usual or ideally coordinated approach to lawmaking, having different initiatives aimed essentially at the same problem is understandable given the necessity to respond quickly to the significant impact of the fluctuations in the Turkish currency. However, considering that the currency crisis is, under control and financial restructurings will take place over the longer term, there may be an opportunity for better holistic consideration of the proposed legislation , taking into account all stakeholders’ opinions.
• Embezzlement concern: While embezzlement, as defined under Article 160 of the Turkish Banking Law, hangs over bankers like the sword of Damocles, it is hard to expect them to undertake restructurings in practical terms. We observe that a number of restructuring tools, such as write-downs, debt to equity swaps, super-senior DIP financing, and takeover of the debtor’s management and operations are frequently used around the world. Nevertheless, Article 160 leaves open the question as to whether the use of such tools as regards sums owed to Turkish financial institutions might result in such methods can invoke criminal liability, as it states, “[an officer’s] damaging [of a] credit institution by any means whatsoever by using the credit institution’s resources to his or others’ benefit is deemed embezzlement”. As such, given the risk of liability, there is often perceived to be no restructuring tool left for our banks except for amending and extending loan terms. The crucial issue here is to clarify that restructuring tools commonly used elsewhere, such as those referred to above, do not constitute embezzlement and to assure bankers that they will not be subject to personal liability in this respect.
• NPL issue: Banks must maintain their capital adequacy while restructuring their receivables. A method for this is to expeditiously remove NPLs (non-performing loans) from their balance sheets by selling them to third parties. There are various licensed “asset management companies” established and operating in Turkey. However, it would be unfair to expect those Turkish asset management companies, whose job is to buy and collect NPLs, to undertake the major NPL burden alone given the likely extent of NPLs. At this point, an option may be to attract investment in NPLs from international funds focused on them and their work-out. That being said, various tax exemptions granted to authorised asset management companies for NPL purchases are not available to international funds’ purchases which increases the costs of funds and renders the option of shifting the NPL burden to these international funds unfeasible. In light of these considerations, in order to convert the international interest in Turkish NPLs into investment, Turkish tax and NPL laws must be amended to enable the above transactions.
• Tax costs: One of the critical objectives of well-designed restructuring regimes is to facilitate the provision of additional funds to the debtor in default, which will likely be experiencing a shortage of working capital. Naturally, it would be unfair to expect Turkish banks that cannot collect their receivables to undertake the additional financing burden alone. However, the funding gap could be closed with the help of the international funds that provide specialized funding (mezzanine, distressed, DIP finance etc.). However, since most of international funds are not considered to be a “financial institution” under our tax laws, loans utilized from these funds are subject to additional taxes. To overcome these obstacles, relevant tax exemptions should be granted in relation to to loans provided by international funds to financially distressed companies.
• Cramdown: Benchmark international restructuring regimes (such as Schemes of Arrangement and Chapter 11) allow for the write-down or other restructuring of debt (including secured debt, albeit respecting the value of security rights provided), and in some cases debt for equity swaps, without minority creditor or shareholder consent, but simply with the consent of majorities of (sometimes relevant classes) of creditors. The Framework Agreement does not go that far as write-down specifically requires the unanimous consent of creditors, and it is unclear whether secured debt can be restructured at all. Additionally, it does not contemplate debt-for-equity swaps without shareholder consent. Where a debtor balance sheet requires to be right-sized, then the absence of those tools gives rise to a material issue as the key thing or things that might normally be anticipated as being available to cure the problem will simply not be available. Of course, it could still be expected that, in many instances, those foreign procedures, such as Schemes of Arrangement and Chapter 11, will also be available to the creditors and debtors (though some preparatory steps may be necessary). However, there will be circumstances where it is simply not practicable to go abroad. The Framework Agreement should be updated to provide for these tools.
• Provision of debtor information: The Framework Agreement, which can only be initiated by the debtor, requires it, at the time of application, to submit very full financial information in relation to itself and associates including shareholders. Whilst there are material disclosure obligations under the alternative international restructuring regimes, they do not require all such information to be provided at the outset. It would seem that this requirement is a material deterrent for Turkish debtors who might otherwise wish to invoke the regime and the protection (and flexibility) which it affords. The Framework Agreement should be adjusted to ensure debtors which need protection can apply for it in a relatively straightforward way. Otherwise, in situations of emergency, there will be value loss which could be entirely avoidable.
• Contractual rather than universal effect: As should be appreciated from its name, the “Framework Agreement” is ‘just an agreement’; it is not a properly “collective” insolvency procedure. Properly collective procedures operate vis-à-vis the world at large, including all creditors. The only parties who are bound by the Framework Agreement, however, are those who have signed it. As such, many parties who commonly operate in the credit markets in Turkey will work outside the Framework Agreement, and compromises struck by and between the parties to the Framework Agreement will not bind non-signatories. The situation begs that a restructuring regime be instituted which would have collective effect. Even where a regime does have collective effect, there are of course limits. The effects of a local insolvency procedure in one jurisdiction (for example to write off claims) may not be effective in another. However, it is impossible to legislate locally to avoid that issue (that is the job of international treaties). That does not by any means defeat the purpose of introducing collective procedures for restructuring, though.
• Enforcement procedures: Creditors ability to enforce rights, including security rights are very important in terms of tidying up overstretched financial markets. Where it is desirable that outside parties relieve incumbent holders of distressed debt, potential purchasers will wish to know that the path to enforcement is as smooth and efficient as possible, and that proper recourse can be had against debtors and their assets (where secured). For that, it is necessary that the enforcement regimes are as quick as they can practically be whilst ensuring that value is obtained. There are examples under the international regimes where independent valuations by properly qualified valuers of assets (which can be obtained without any undue delay) can serve to ensure that value is achieved, without holding up enforcement and realisation. The cleaner the enforcement processes, the greater the attraction of local loans will be to international investors, the quicker they will enter the market to acquire them, and the quicker any local banks’ balance sheet issues will be resolved.

Two heads are better than one. We believe that the most viable approach is to hold a convention composed of financial institutions, restructuring lawyers, financial advisors and the international funds under the leadership of the BAT. The purpose of this convention would be for the participants to agree on the necessary legislative changes and implement an agreed plan in the quickest way possible. In this manner, it will be possible to establish a system in accordance with international standards, which considers all stakeholders’ interests, a necessity given that financial restructuring will be a key part of the financial landscape in upcoming years.

*This article was first published in Forbes Turkey in July 2019.