Inclusion of Shareholder Debt in Capital in Joint Stock Companies

Entrance

In joint-stock companies, capital is a decisive factor not only during the establishment phase but throughout the company's entire existence. This is because capital represents the shareholders' stake in the company, while also serving as the most important tool providing security to creditors against the company's debts. Therefore, the Turkish Commercial Code ("TCC") regulates capital not only as an accounting item but also as a legal security institution .

In this context, one of the most debated issues in joint-stock companies is whether the company's existing debts to shareholders can be converted into capital. This situation, frequently encountered in practice, is a method often used to strengthen the company's financial structure, particularly through capital increases. Including shareholder debt in capital both challenges the limits of the capital protection principle and raises the question of whether creditors' rights are secured.

The Concept of Capital in Joint Stock Companies

In joint-stock companies, the concept of capital is regulated in Article 127 of the Turkish Commercial Code. According to this provision, "money, receivables, securities, intellectual property rights, movable and immovable assets, and all kinds of transferable and cash-valued assets" can be contributed as capital. Thus, the legislator has interpreted the concept of capital very broadly, allowing any element that represents economic value to be accepted as capital.

However, it is important to note that the element to be contributed as capital real, existing, transferable, and convertible into cash . Therefore, fictitious rights, rights that may arise in the future, or rights that cannot be legally transferred cannot be accepted as capital.

Capital has three main functions in joint-stock companies:

Security function: It protects the rights of creditors.
Participation function: Determines the percentage of ownership shareholders have in the company.
Investment function: Provides financing for the company's operations.

Types of Capital

In joint-stock companies, capital is generally cash and in-kind . Cash capital refers to the amount of money deposited into the company's bank account, while in-kind capital consists of assets such as movable and immovable property, trademarks, patents, and business premises.

In addition, receivables can also be contributed as capital . Article 127/1 of the Turkish Commercial Code explicitly stipulates that "receivables" can be contributed as capital. At this point, the question arises as to whether the company's debts to its partners can be accepted as capital.

Inclusion of Shareholder Debt in Capital

A company's debt to its partners often arises from current account relationships, share transfers, dividend receivables, or loan transactions. Accepting these debts as capital in a capital increase strengthens the company's balance sheet structure and provides financial relief.

However, this practice carries various legal risks. Converting a company's debt to its partners into capital can undermine the principle of capital preservation. If the debt does not actually exist or has been created fraudulently, the capital increase becomes a transaction detrimental to the creditors.

Legal Basis

Article 127 of the Turkish Commercial Code explicitly permits the contribution of receivables as capital. Therefore, it is generally possible to add a company's debt to its shareholders to its capital. However, certain conditions must be met for this to happen

The debt must be real and existing
It has a transferable nature,
It should be convertible into cash
Its value will be determined by an independent expert report.

In addition, pursuant to Article 342 of the Turkish Commercial Code, the conversion of a company's debt to a partner into capital, like any element constituting in-kind capital, is subject to an expert report.

Implementation and Procedure

The process of incorporating a company's debt to its shareholders into its capital involves the following steps:

The board of directors proposes a capital increase to the general assembly
The general assembly's decision to increase capital through an amendment to the articles of association,
The existence and value of the company's debt shall be determined by an independent expert report
Registration and announcement of the capital increase in the commercial registry.

Transparency is extremely important at these stages. Otherwise, both shareholders and creditors would be misled.

Evaluation in Light of Supreme Court Decisions

The Supreme Court has issued numerous rulings regarding the contribution of receivables as capital. The 11th Civil Chamber, has established precedents in this area.

In its decision numbered 2017/4358 E., 2019/2211 K., the Supreme Court stated that the company's debt to its partner could be offset against the capital increase, thus fulfilling the capital commitment.
In its decision numbered 2015/13462 E., 2017/6789 K., the court emphasized that it is not possible to include fraudulent receivables in capital, as this clearly constitutes a violation of the principle of capital protection.

Therefore, the Court of Cassation draws attention to two main principles:

The reality of the debt
of capital protection

Comparative Law

In German law, it is possible to contribute receivables as capital; however, valuation and auditing are subject to strict conditions according to Article 27 of the Act. In Swiss law, Article 634 and subsequent articles of the Code of Civil Procedure regulate the acceptance of receivables as capital and require an auditor's report. In European Union company law, the protection of capital and the principle of transparency are also prioritized.

Views in Doctrine

There are two views on this issue in legal doctrine.

Argument in Favor: Adding the company's debt to its partner to its capital reduces the company's debt burden, strengthens its balance sheet structure, and increases the security of its creditors.
Contrary Argument: This method can be used, especially by loss-making companies, to conceal capital losses, resulting in losses for creditors.

Problems and Proposed Solutions

The most important issue is determining the veracity of the company's debt to its partners. It should not be legally possible to add collusive or fictitious debts, not supported by accounting records, to the company's capital. Furthermore, valuation issues and lack of oversight also pose significant risks.

To solve these problems:

Independent audit reports should be made mandatory
The nature and source of the receivable must be clearly stated in the commercial registry
Judicial oversight mechanisms should be strengthened.

Conclusion

In joint-stock companies, the inclusion of debt owed to shareholders into capital is possible within the framework of the Turkish Commercial Code. However, this requires the debt to be real, existing, transferable, and convertible into cash. Supreme Court precedents also prioritize the prohibition of collusion and the principle of capital protection in this regard.

In conclusion, incorporating shareholder debt into equity is a beneficial method for strengthening companies' financial structure in practice; however, it is a risky transaction that can result in losses for creditors and other shareholders if transparency and oversight mechanisms are not in place.

joint-stock company, Istanbul lawyer, capital, company law, commercial law, TCC, Supreme Court decisions

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