A new era in commercial transactions has begun for establishing pledges over a wide range of movable assets and receivables.
Updating the Movable Pledge Law
THE Turkish Grand National Assembly passed the new Code on Movable Pledges in Commercial Transactions (the “Movable Pledge Code”) on October 28, 2016, and it came into force on January 1, 2017. Many aspects of movable pledges have now changed substantially under the Movable Pledge Code, such as the establishment of movable pledges, the registration of movable pledges, and the enforcement of rights over movable pledges.
What led law-makers to pass the Movable Pledge Code? Its preamble addresses that question by referring to the enhancement of the national economy, in which small and medium sized enterprises have a major role. According to this preamble, only 4,927 commercial enterprise pledges have been established within the last 45 years. Therefore, it is anticipated that the Movable Pledge Code will assist small and medium sized enterprises by making it easier for such enterprises to secure financing and increase their power to compete in the market. This could ultimately contribute to Turkey’s stable and balanced economic growth, which is inherently one of the most desirable components for the domestic policy of any country.
How does the Movable Pledge Code envisage addressing such a financing need? Rather than change everything, the Movable Pledge Code allows commercial transactions to be secured more swiftly and flexibly by amending the current structure. Some of the most important changes include removing the burdensome requirement for perfection of a pledge by way of transfer of possession (zilyetliğin devri) of pledged movables, permitting the establishment of a pledge that would be over certain movables rather than only permitting pledges over an entire commercial enterprise, and providing breakthrough amendments to the enforcement process of pledges an the event of a default.
The Movable Pledge Code abolished the Commercial Enterprise Pledge Code (“CE Pledge Code”) on the day it entered into force, and all future movable pledges now fall within its scope. However, relevant provisions of the CE Code will continue to govern pledges on commercial enterprises that were established prior to January 1, 2017. In addition, the Movable Pledge Code will not apply to lawsuits and proceedings that were initiated prior to that date. To ensure a smooth transition to the new law, three implementation regulations were also promulgated for the Movable Pledge Code on December 31, 2016.
Scope of the Law
The Movable Pledge Code exhaustively lists the movable assets that may be subject to pledge transactions as security for obligations. In contrast with the CE Pledge Code, the Movable Pledge Code lists more and broader movable assets, but it specifically does not apply to (i) pledge agreements over financial agreements relating to capital market instruments and derivatives; (ii) bank account pledge agreements; and (iii) movables that may be registered in title deed registries. Other exemptions are listed in the implementation regulations for the Movable Pledge Code, which include agreements such as movable pledges established in accordance with the Civil Code (i.e., by way of transfer of possession of the concerned movable to the pledgee) and mortgages on ships established in accordance with the Turkish Commercial Code.
The list of movables in the Movable Pledge Code specifically includes “receivables.” In addition, the definition of “pledge right” refers to “the receivable right of an assignee in the assignment of receivables… to secure the payment or performance of a loan,” which recalls the commonly used “assignment of receivables for security purposes for fulfilment of secured obligations” in common banking practice. These provisions, among others, bring to mind the question of whether such an assignment of receivables would be considered within the scope of pledge rights, and thus become subject to the registration requirement. However, the language of the Movable Pledge Code and its implementation regulations do not provide further detail on the matter, leaving this question to sectoral preference (mostly the banking sector), the interpretation of the Ministry of Customs and Trade, and ultimately future jurisprudence. For the time being, the position of the Ministry of Customs and Trade is that while a pledge on receivables falls within the scope of the Moveable Pledge Code, an assignment of receivables does not. Likewise, notaries in Turkey interpret the Law in a limited manner, to exclude the assignment of receivables from the scope of Law and abstain from applying requirements (e.g. registration to TARES) arising from Movable Pledge Code on such agreements.
Establishment of the Pledge
Pledge agreements may be executed between the following parties: (i) financing institutions (defined under the Movable Pledge Code as banks and financial institutions operating under the Banking Code, financial institutions operating under the Financial Leasing, Factoring and Financing Companies Code, and public or private institutions providing loans and sureties), and (ii) merchants and/or tradesman.
Pledges on movable assets are established by registering the pledge agreement with the pledged movables registry (“Pledged Movables Registry (“Taşınır Rehni Sicili -TARES”)”) established by the Ministry of Customs and Trade. All transactions regarding pledges such as registering, deregistering, and amending will be carried out through the Pledged Movables Registry, the records of which will be publicly available but will exclude movables that are required to be registered with other specific registries, such as the vehicle registry, the heavy machine registry, etc. Pledges over movables assets will then be effective and binding upon third parties following the registration of the pledge agreement with the Pledged Movables Registry.
The CE Pledge Code previously required pledge agreements to be drawn up by a notary public located in the same region in which the respective commercial enterprise was registered. However, the Movable Pledge Code states that pledge agreements may be executed electronically or in written form. To register a pledge agreement that is signed electronically, the agreement must be approved through secured electronic signatures. Having provided such electronic simplicity however, for a written pledge agreement to be registered it must have either (i) the signatures of the parties as approved by a notary public, or (ii) the agreement executed directly before registry officers.
Characteristics of a Pledge Agreement
Besides identifying information of the parties, a pledge agreement must contain the following:
- the subject and amount of the underlying debt;
- the amount secured if the extent of the underlying debt is uncertain;
- the currency of the payment to be made;
- the upper limit of the pledge; and
- the list of the movables that are subject to pledge and its identifying features such as serial number, brand, production date, license plate, etc.
Under the CE Pledge Code, the upper limit of the pledge had to have been determined in Turkish Lira. Neither the Movable Pledge Code nor the implementation regulations refer to such a currency restriction, thus the upper limit of a pledge may be determined in either Turkish Lira or foreign currencies. This will most likely provide additional comfort to financing deals involving foreign investors and/or foreign financial institutions when providing financial assistance to commercial enterprises, since in most cases, commercial enterprises obtain such facilities and loans in foreign currency.
Another advantage introduced by the Movable Pledge Code is that the execution and registration of pledge agreements with the Pledged Movables Registry are exempt from any taxes, duties, fees, or other relevant charges.
Commercial Enterprise Pledges
The Movable Pledge Code ends the establishment of a pledge over entire commercial enterprises if their movables (as listed in the Movable Pledge Code) would be sufficient to secure a relevant debt. However, Article 17 of Regulation Concerning Establishment of Pledge on Commercial Transactions and Exercising Rights upon Occurrence of Event of Default limits this condition to apply only to debts that are certain. For context, the CE Pledge Code had provided parties with an opt-out right, where parties were required to establish a commercial pledge on commercial titles, company names, and movable assets of the commercial enterprises, but were also entitled to exclude certain assets or rights (i.e., licenses, trademarks etc.) from the scope of the commercial enterprise pledge. The new rule under the Movable Pledge Code must be interpreted along with the right of the parties to procure valuation of movable assets before the establishment of pledge rights.
Accordingly, valuations are to be performed by experts appointed by the competent court upon the request of pledgees. In the event that one of the parties objects to the valuation performed by a relevant expert, the court will request another expert to conduct a second valuation, and the second valuation will be binding on the parties. In any case, the Movable Pledge Code would have an effect on future pledge agreements from a financial aspect by causing the parties to incur an additional burden, as they will most likely require a prior valuation of the movable assets in order to determine if the movable assets are sufficient to secure the relevant debt. Therefore, it may be wise for parties to agree in advance under the pledge agreement about which party would incur such an additional valuation and court expenses.
Pledged Movables Registry and Ranking System
Prior to 2017, commercial enterprise pledges were registered with the relevant trade registry where the respective commercial enterprise was registered. The Movable Pledge Code however established the new Pledged Movables Registry, in order to ensure transparency in the registration of movable pledges so that these pledges would be enforceable against third parties, as well as making it possible to identify ranking among pledgees. Under the Movable Pledge Code, pledges are only enforceable against third parties if they are registered in the Pledged Movables Registry, and the pledgor is under an obligation to ensure that movable pledges are registered in the Pledged Movables Registry. In the event that the pledgor does not fulfill this obligation, a punitive fine in an amount not exceeding 50% of the secured obligation may be assessed, in addition to the fact that there will not have been a valid and effective security.
Similar to pledges over immovable properties, the Movable Pledge Code provides a degree system, whereby the security created in the pledge is limited to the pledge amount and degree shown in the registry, and different ranking pledges may be established over the same movable. If the pledge agreement does not stipulate the degree of the pledge, then priority among the pledgees (öncelik hakkı) would be determined as per the moment of registration of such pledge. However, if the parties of a pledge agreement indicate the relevant degree of the pledge, then such a degree would be taken into account. The parties may also stipulate the right to move to free degrees under the pledge agreement, just as in mortgages over immovable properties. In order for such a right to be valid, it must be agreed under the pledge agreement that is registered in the Pledged Movables Registry.
A groundbreaking aspect of the new law shifts away from the previous rule, where a pledgee would have to initiate foreclosure proceedings when a pledgor failed to fulfill their obligations. Now, under the Movable Pledge Code, the pledgee in the first rank will be entitled to petition the execution office to transfer the ownership rights over the pledged movable to it, provided that such action does not violate the rights of subsequent pledgees.
Introduction of such a right granted to pledgees is an exception to the lex commissoria principle under Turkish law, according to which, it would have been considered void and unenforceable to provide a pledgee with the right to request transfer of ownership rights over a secured asset upon the occurrence of an event of default. Now however, in the event that the pledgor does not transfer ownership rights, an administrative fine in an amount not exceeding 50% of the secured obligation may be imposed on the pledgor. As such, a pledgee may also assign its receivables to an asset management company operating pursuant to the Banking Code. In such cases, those asset management companies would have the same ranking as assigning pledgees.
The Movable Pledge Code introduces an additional right for pledgees to use rental or licensing rights with respect to secured assets that are not subject to transfer of possession. Such a right is to be terminated upon the income received to the degree that exercising such rights would be sufficient to discharge the relevant debt. However, it is not clear as to how these rights will be exercised by the pledgees upon occurrence of an event of default. Therefore, it would be advisable to stipulate the details of such rights in pledge agreements in advance.
Termination of Receivables
The Movable Pledge Code introduces a requirement on pledgees to apply to the Pledged Movables Registry to have the pledge deregistered within three (3) business days of the relevant debt having been satisfied. Such a requirement did not exist under the CE Pledge Code, where the pledgor was only entitled to request pledgees to deregister the respective pledge from the registry but without any time limit. Failure to comply with this requirement under the Movable Pledge Code by the pledgees may result in an administrative fine in the amount of 10% of the secured obligation being assessed on the pledgee.
The New Law in Practice
The Movable Pledge Code will substantially change common practices that have been adopted over many years in Turkish financing, in order to make it easier for commercial enterprises to obtain funding by encouraging the use of moveable pledges as securities without requiring delivery. However, it remains to be seen how the Movable Pledge Code, its secondary legislation, and implementation of the Movable Pledge Registry will be applied in practice and interpreted by courts. Since the Movable Pledge Code and its secondary legislation is relatively new, for any party who will execute a pledge agreement, it would be wise to seek out expert advice on the matter to mitigate the risks associated with any new law.