TURKISH CONCORDATUM REGIME AND ITS EFFECT ON THE APPLICABILITY OF ISDA MASTER AGREEMENT CLOSE-OUT NETTING PROVISON(S)

BY: Ali Bugra Gokagacli

BIBLIOGRAPHY

WEBSITES

‘Yahoo Is Now Part Of Oath’ (Finance.yahoo.com, 2016) <https://finance.yahoo.com/news/how-buffett-used–financial-weapons-of-mass-destruction–to-make-billions-of-dollars-175922498.html> accessed 3 April 2019.

BOOKS

Kolb RJ Overdahl, Futures, Options and Swaps (5th edn, Blackwell Publishing 2012)

Pekcanıtez H, O AtalayM Ozekes, İcra Ve İflas Hukuku Ders Kitbı / Enforcement and Insolvency Law Textbook (3rd edn, Yetkin 2016)

Kuru B, İcra Ve İflas Hukuku / Enforcement and Insolvency Law (2nd edn, Adalet 2013)

M.Vefa Toroslu, Hukuksal Ve Finansal Açıdan Konkordato / Concordatum from a Legal and Financial Perspective (1st edn, Adalet 2019)

Baki Kuru, İstinaf Sistemine Göre Yazılmış İcra Ve İflas Hukuku / Enforcement and Insolvency Law Written in Accordance with the System of Appeal (1st edn, Legal 2016)

Hakan Pekcanıtez, İcra Ve İflas Hukuku Ders Kitabı / Enforcement and Insolvency Law Textbook (3rd edn, Yetkin 2016)

Jonathan Hill and Adeline Chong, International Commercial Disputes Commercial Conflict of Laws in English Courts (1st edn, Hart Publishing 2010)

Cemal Şanlı, Milletlerarası Özel Hukuk / International Private Law (5th edn, VedatKitapçılık 2016)

REPORTS & ARTICLES

International Swaps and Derivatives Association Inc., ‘2018 ISDA Netting Act and Guide’ (ISDA 2018)

Muhip Şeyda Işıktaç, ‘Konkordato / Concordatum’ (2018) 92 Istanbul Barosu Dergisi / Journal of Istanbul Bar

1. INTRODUCTION

The use of derivatives has come to play a very important role in modern economies. Unfortunately, however, we cannot say that this role is welcomed by everyone. In fact, derivatives are known to the general public mainly as  high-risk bearing products. This perception is perhaps best caught by Warren Buffet in his renowned description of derivatives as “financial weapons of mass destruction.”^[1]

Be that as it may, they are also great tools for risk management^[2] and the risk management feature of derivatives is essential for economies such as Turkey; because these economies tend to experience high volatility of the local currency and so other commodities. Thusly, it is important for the Turkish economy itself that the Turkish legislation provides conditions which can be taken as favorable by derivatives market participants.

Close-out netting, on the other hand, is perhaps the single most important provision which those participants would like to incorporate into their contracts. As we shall explore below, close-out netting provisions act as a key which one party can use to unlock himself from a contract whose counter-party is in serious financial distress and thus will not be able perform his duties. In other words, it is a way for a derivatives contract constituents’ to mitigate their counter-party risks.

However, under certain circumstances, the enforceability of close-out netting can be a matter of serious debate. This is especially the case when one party addresses to courts to benefit some sort of legal rescue and thus become protected by a legal shield. In that respect, whilst entering into a derivatives contract with an entity subject to the laws of Turkey, it is important for all market participants to know whether the legal recue method, namely concordatum, envisaged under Turkish Law will affect their ability to utilize the close-out netting provisions of ISDA Master Agreement.

To that end, this paper will examine the possible consequences of concordatum on ISDA Master Agreement’s close-out netting provisions based on a hypothetical case. Henceforth, we will first introduce our assumptions that set the scene for the hypothetical case. Then, move on to explore what concordatum and close-out netting is. Afterwards, we will introduce out interpretation for possible out-comes of the hypothetical case and then conclude this paper.[3]

1. ASSUMPTIONS

Unfortunately, it is not possible to delineate all possible effects of concordatum on a derivatives contract in this paper.  Under different circumstances, concordatum will affect a derivatives contract in different ways. To give an example, the jurisdiction clause may negate some provisions, most notably the close out netting provision, as public policy of some forums requires doing so. A similar comment can also be made for choice of law clauses, and qualifications of the parties to the contract and etc.

That is why, the first assumption we make will relate to the parties to the contract. In this paper, we will assume that the party terminating the contract is an English company duly incorporated in accordance with the laws of England. In parallel to this assumption, our other party which instates concordatum will be a Turkish company duly incorporated in accordance with the laws of Turkey. 

Moreover, the contract will be subjected to English Law and the dispute, which arises from the exercise of close-out netting, will be resolved before the English Courts.

Additionally, we will also assume that the enforceability of close-out netting provision, as set out in ISDA Master Agreement, is possible and there is not any legal handicap before its execution under the English Law. In addition, except when the concordatum regime may require otherwise, we will assume that both parties have the full transactional capacity to conclude such an agreement.

Thus, the hypothetical case we deal in this paper will consider a lawsuit which is raised against the English party (EP) by the Turkish party (TP) before the English courts upon the execution of the close-out netting provision by EP. Even though close-out netting is a contractual measure and does not require court involvement, we believe such scenario will best reflect how event would flow in real life.[4]

1. WHAT IS CONCORDATUM

Under Turkish Law concordatum can be defined as a debt restructuring contract which is compulsory and binding between a debtor and his creditors; provided that it is accepted with the majority set out in (Turkish) Enforcement & Insolvency Act^[5](E&IA) and attested by a (Turkish) Commercial Court. In other words, concordatum is a formal route which is based on the consent of qualified majority of the stakeholders to rescue an economically distressed person.^[6]

On temporal basis, E&IA provides for two different types of concordatum depending on when the concordatum is declared. If a Turkish person can be subjected to insolvency further to the provisions of Turkish Code of Commerce^[7] and declares concordatum to escape insolvency after he has been declared insolvent; this is called as concordatum in insolvency.^[8] On the other hand, a person may be subjected to insolvency and declare concordatum even before the insolvency processes begin. This is known as concordatum outside of insolvency.^[9] Essentially, both types of concordatum are quite similar; but they do come with some differences. ^[10] In this paper, however, we will only examine concordatum outside of insolvency for the simplicity sake. Therefore, it is advised that reader should understand the term concordatum accordingly.

1. HOW DOES CONCORDATUM PROCEED

When a debtor wants to declare concordatum, s/he first needs to produce some documents which are stipulated in E&IA. On top of that s/he is also required to prepare a financial projection, known as concordatum project, in order to demonstrate both to court and its creditors how s/he will be able to pay up its debts and how the creditors will collectively benefit from the concordatum.[11]

The documents and concordatum project then submitted to an (Enforcement)[12] Court which reconnoitres the application.  If the (Enforcement) Court holds that the production of documents is conducted as accorded by the law, it announces the debtor’s motion to declare concordatum to the public and for the attention of debtor’s creditors.[13]

Upon the announcement, the creditors have ten days to object debtor’s motion.[14] The objections are heard at a hearing in which both the debtor and the attending creditors present their arguments one by one.[15]

The (Enforcement) Court decides whether to proceed with the debtor’s motion after hearing the arguments of his creditors. E&IA sets out that whilst deciding on the motion the (Enforcement) Court needs to consider: a) if the assets and income streams of debtor is adequate enough to realize the purpose of concordatum and b) if the debtor acts in objective good-faith; i.e. s/he is sincerely pursuing concordatum in order to become able to pay his debts and not using it as a mere veil to avoid its obligations.[16]

If the (Enforcement) Court decides to proceed with the motion, it gives an interim measure order known as respiration.[17] The aim of respiration, as the name suggests, is to give some room to debtor to make it financially ready for the realization of concordatum via preventing it from being solicited by his creditors, and allow him to easily conduct its business.[18]

Aside from disallowing creditors from soliciting the debtor; respiration also bears some consequences for debtor and his contracts. In example, article 296/I of E&IA envisages that contractual closes which sets out that contracts that have importance for the debtor’s business may be terminated in the event of concordatum, cannot be exercised.

In addition, the (Enforcement) Court also appoints insolvency practitioners (IPs) known as komiser(ler) who are responsible with supervising the debtor’s affairs.[19] The transactional capacity of the debtor gets limited in other ways as well; however since those limitations fall outside of this paper’s scope we will not discuss them in this paper.

Upon their appointment; IPs call for a creditors’ meeting.[20] In the meeting the concordatum project gets voted by the creditors. If the creditors agree on the project with a qualified majority as accorded in art.297 of E&IA then the IPs submit the concordatum to a Commercial Court of General Jurisdiction (Commercial Court) for the attestation of the concordatum agreement.[21] Commercial court receiving the concordatum agreement decides whether to attest it a) by looking at the ratio of payment vs debtor’s assets, b) the collateral requirements set out in E&IA and c) other requirements promulgated in article 298 of E&IA. Once attested by the commercial court the concordatum, in principle, is carried out until the project is realized. The consequences of respiration, on the other hand, also carriy out to after attestation period mutadis mutandis to the peculiarities of this period.[22] However, after attestation, the debtor is required to discharge its debts in accordance with the project; thus if s/he fails to do so the relevant creditors can initiate (or continue) a legal solicitation.[23] Another significant aspect of attestation is that the concordatum project becomes binding upon all creditors regardless of their objection or participation in the whole processes.[24] We believe that these last two points are quite important for this paper and will elaborate on them further below.

• WHAT IS CLOSE-OUT NETTING & HOW DOES IT OPERATE

In the most abstract sense, close-out netting (CON) can be defined as a risk mitigation technique that operates within the boundaries of termination of a derivatives contract.[25] CON achieve this by applying a three-layered process:[26]

1. First, the contract is terminated upon a notice or occurrence of an event,
2. Second, all respective obligations are valued,
3. Third, a net balance is calculated by submitting the lower figure from the higher one.

In other words, CON provisions do two things to mitigate the risk exposure of derivatives contract. First off, they allow the non-financially distressed party to terminate the contract so that the distressed party will not pull him down. Secondly, they single out the respective obligations to a net balance which can be demanded from the other party.

Respectively, ISDA provides two formulations for a CON provision; namely set-off approach and conditional novation approach which can be used to achieve this result.[27]Subsequently, we will discuss the substantial effects of these two different formulations within the premise of our hypothetical case. At this point, however, we would like to make a general comment with regard to the faith of the netted amount. In our opinion, concordatum would disallow EP to solicit TP’s assets located in Turkey even if it wins the lawsuit in England. The reason being is that once EP wins the lawsuit in England, it will have to raise an enforcement action against TP before Turkish Courts to grant its English Court award a legal effect in Turkey.[28] However, since concordatum provides a shield against enforcement procedures the award granted in enforcement action would be rendered useless against the TP.

1. Set-Off Approach

The set-off approach is relatively simpler to understand. Upon a notice or occurrence of an event, all obligations of the parties are accelerated to create multiple obligations which are then contractually set-off to a single net balance.[29] This method is not the one that is opted in ISDA Mater Agreement.[30] However, it is used widely in foreign exchange transactions; meaning that it may probably constitute the basis of a netting agreement with a TP. For that reason we will, briefly elaborate on this matter within the scope of our hypothetical case.

In our opinion, if the set-off approach is adopted in formulating a CON provision this may prove to be quite problematic for our EP for the following reason. E&IA 294/V, via its reference to E&IA 200, provides that in the event of a concordatum declaration, no set-off can be done if the debtor’s creditor becomes its debtor after the order of respiration is given (announced).

This wording of the law is problematic for EP due to the approach taken by the English Law in determining a legal person’s transactional capacity. Whilst deciding whether a corporation has the capacity to conclude a contract; English Law looks at the law that governs the constitution of the corporation and the law governing the transaction.[31] In our opinion, both the wording and the spirit (ratio legis)[32] of E&IA 294/V and 200 suggest that Turkish corporations which undergo a concordatum process lack the transactional capacity to set-off their respective obligations for close-out netting. I.e., under English Law no Turkish corporation can, validly, enter into an agreement wherein it will be required to set-off its obligations after it has declared concordatum.

Consequently, if EP wants to have a binding contract with appropriate risk mitigation clauses, it needs to formulate its CON provision as to terminate the contract upon the occurrence of an event which will surely unfold prior to declaration of concordatum or in a way that would allow him to send a termination notice prior to declaration of concordatum.

• Conditional Novation

The conditional novation approach, on the other hand, does not rely on acceleration and set-off of the respective obligations. Instead, it relies on termination and discharge of the obligations which then become one by novation and valued in accordance to the market replacement figures of the novated obligations.[33]

As mentioned above, ISDA Master Agreement, generally bases its CON provisions on conditional novation approach. Therefore, the discussions below will only consider this approach. However, just as in the case of set-off approach we believe Turkish Law poses a preliminary challenge as to whether a valid CON provision can be inserted into a derivatives agreement which will be answered prior to the examination of the effects of concordatum on the CON provisions of ISDA Master Agreement.

E&IA artc.296/I-2 sets out that, contracts which are important for the continuity of the activities of debtor’s enterprise cannot be terminated due to concordatum; and clauses which envisages concordatum as a just cause to terminate this kind of contracts are inapplicable.

At first look, E&IA 296/I-2 may appear to put our EP in jeopardy; because it is clearly intended to prevent the termination of contracts, such as the one he is a party to, in the event of concordatum. However, unlike E&IA 294/V in set-off approach, we believe E&IA 296/I-2 should not cause any problem for EP in our hypothetical case. The rationale behind our mindset is that, contrary to E&IA 294/V which talks about what sort of transactions a Turkish party can(not) conclude, E&IA 296/I-2 talks about the inapplicability of certain provisions. In other words, E&IA 296/I-2 is bothered with the substantial applicability of some contractual clauses[34] whereas E&IA 294/V is bothered with transactional capacity. Hence the law governing the transaction in our case is not the Turkish but English Law, the E&IA 296/I-2 is effectively circumvented. We believe this interpretation should be the most appropriate one given the fact that Turkish Law allows its mandatory rules to be by-passed by allowing Turkish parties to become subjected to foreign laws in their contractual obligations in article 24 of International Private and Civil Procedure Law Act.[35] Thus, CON provisions based on conditional novation can, in our opinion, validly be inserted into derivatives contracts.

• WHAT SHOULD BE THE RESULT OF THE HYPOTHETICAL CASE

1. WITHOUT RECOGNITION

We can now turn to our hypothetical case and try to determine its fate in light of the foregoing. As known, the basic principles of International Public Law dictate that in the absence of consent, the act of one sovereign is not binding upon another, or upon its subjects. Therefore, considering that there is no Treaty ratified between the UK and Turkey, a declaration of concordatum by a Turkish Court is not binding on English Courts and thus the court hearing our case is not, in principle, required to take the respiration and attestation decisions of Turkish Court whilst rendering its decision.[36]

Subsequently, the English Court will merely be interested if the contract between the parties is validly concluded. As we have discussed above[37] Turkish Law does not disallow a Turkish corporation to enter into a netting agreement based on the conditional novation approach; provided that the law governing the contract allows such an agreement. Henceforth, we argue that, according with our assumptions, there is no legal ground for English Courts not to apply conditional novation based CON provisions of a derivatives contract. As a result, we believe that under these circumstances our TP should lose its case and Turkish concordatum regime will not have any substantive effect on ISDA Master Agreement’s CON provisions.

• WITH RECOGNITION

In above section, we place the emphasis on the fact that by International Law the concordatum decision of one sovereign’s court cannot have, in principle, binding effect on another sovereign’s court. Be that as it may, this principle comes with an exception.

Indeed, the English Law provides procedures that allow foreign reorganization schemes, like concordatum, to have legal effect within itself.[38] We think that depending on the extent which TP can import the consequences of concordatum into the English Law, s/he will be able to prevent the applicability of CON provisions; provided that EP tries to exercise its rights after recognition takes place. For that reason, down below we will identify how and if the Turkish Concordatum Regime can pose a challenge in the exercise of CON provisions of ISDA Master Agreement.

B.1. Challenges Posed By Respiration

As mentioned above, E&IA art.296/I does not take away the transactional capacity of a Turkish corporation to enter into an agreement which includes CON provisions.[39]

The article reads as: “

The Effect of Respiration on Contracts

Within the premise of respiration, those contracts which are important for the continuity of debtor’s business and contain clauses which construes the prayer for a concordatum as a breach of contract, a just cause for termination, or acceleration of obligations are not to applied in the event that debtor prays for a concordatum. Even if contract does not contain such a clause, it cannot be terminated due to debtor’s prayer for concordatum.” [author’s translation]

As a result, should the article is allowed to have substantial effect in a foreign forum such as England, our EP should not be able to exercise its right to terminate the contract after the respiration order is recognized by English Courts However, the body of rules that governs the recognition of foreign restructuring orders, namely The Cross-Border Insolvency Regulation 2006 (the Regulation), does not seem to give such a substantial effect.

As far as the Regulation is concerned the respiration order does fall under the category of “foreign proceedings” which is a prerequisite for recognition.[40]However, effects of recognition of concordatum and the subsequent reliefs available under the Regulation are somewhat limited with procedural matters such as staying of executions against debtor’s asset, actions, and individual proceedings.[41] None of the reliefs and effects set out in articles 19,20, and 21 of the Regulation relates to the substantial law. Thus, in our mind, even after a respiration order, given by a Turkish Court, is recognized into the English Law, the EP in our hypothetical case will be able to invoke the relevant CON provisions and therefore effectively terminate his contract; causing our TP to lose the lawsuit.

On the other hand, it would be fair to say that one possible benefit the TP might get is that if s/he has assets in the UK; those assets will be saved from the solicitation of the EP for the netted amount.[42]

B.2. Challenges Posed By Attestation

A similar argument can also be made on the challenges posed by attestation. E&IA asserts that once the concordatum project is attested by a (Turkish) Commercial Court, it becomes binding for all creditors; even when they abstain from or object to concordatum.[43]

However, since this binding effect is only limited to Turkish entities and within Turkey[44], and the Regulation does not grant any substantial effect to foreign restructuring decisions in England[45]; our EP should be able to exercise the CON provisions even if the concordatum project envisages otherwise. As a consequence our TP should lose his lawsuit.

• CONCLUSION

To recap, we have come to conclude that, with respect to the presumptions made in this paper, The Turkish Concordatum Regime will not have any major effect on the applicability of the ISDA Master Agremeent’s close-out netting provisions.

Our conclusion, on the other hand, is based on the English International Private Law rather than the Turkish Concordatum Regime itself. English Law allows the recognition of foreign reorganization and administration orders under the Cross-Border Insolvency Regulation 2006. However, the effect given to these orders are merely limited to procedural matter and not to the substantial law. Consequently, when an English Court decides if the close-out netting provisions has been validly exercised it does not have to, or in fact must not to, consider the substantial limitations brought by the Turkish Concordatum Regime even if the concordatum order of Turkish Courts is recognized into the English Law.

Having said that, concordatum is not without any effect to close-out netting provisions of ISDA Master Agreement. Most notably, once rendered, concordatum would bring all the enforcement procedures against a Turkish party’s assets located in Turkey to a halt. Moreover, the same would also happen if the Turkish Party can manage to have the order recognized in England. I.e., concordatum can preclude the netted amount from being acquired.

In addition, concordatum can also bare a substantial effect in English Law. The English conflict of law principles set out that whilst determining a corporation’s transactional capacity the law governing its constitution is to be considered. In our case, the law governing the Turkish Party’s constitution will be the laws of Turkey which does not allow a corporation to exercise set-off after it initiates concordatum in the context of concordatum. As a result, if an English Party concludes a derivativies contract based on the ISDA Master Agreement but adopts set-off approach for close-out netting provisions s/he may find himslef unable to invoke the close-out mechanisim. 

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[1] ‘Yahoo Is Now Part of Oath’ (Finance.yahoo.com, 2016) <https://finance.yahoo.com/news/how-buffett-used–financial-weapons-of-mass-destruction–to-make-billions-of-dollars-175922498.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS50ci8&guce_referrer_sig=AQAAAIvu4oeTvG3_2C2h9vPk16SyrGXAtrUN4ViENqJFpqJt6epvIXExh1cmC4tVBB0k8Q7SrobPIFFCIrGnstiGFZND0sW_JSpw8qHQ6mXs2tl8z4R8j7IY9TSwls-Rm2rvK2ELd0LDk5R1QV5RG4Gk-4hOV1YpXugGsxMqq-YVpebG> accessed 3 April 2019.

[2] Robert W Kolb and James A Overdahl, Futures, Options and Swaps (5th edn, Blackwell Publishing 2012), p:1.

[3] Reader should bear in mind that all interpretations and comments made in this paper will be done via considering the peculiarities of the hypothetical case.

[4] Additionally, the contractual nature of close-out netting (CON) does not make it immune to court decisions which do not acknowledge their applicability.

[5] Enforcement & Insolvency Act, Law No:2004, Offical Gazzete No: 2128, Date of Entry into Force: 01.01.2002

[6] Hakan Pekcanıtez, Oğuz Atalay and Muhammet Ozekes, İcra ve İflas Hukuku Ders Kitbı / Enforcement and Insolvency Law Textbook (3rd edn, Yetkin 2016).p.527.; For a lawyer trained in English Law, concordatum should resemble Company Arrangements as set out between sections 895-901 of Companies Act 2006.

[7] Turkish Code of Commerce, Law No:6102, Offical Gazzete No: 27846, Date of Entry into Force: 01.01.2012

[8] Supra Note:2,p:528-529

[9] Ibid

[10] For more on this see: Baki Kuru, İcra ve İflas Hukuku / Enforcement and Insolvency Law (2nd edn, Adalet 2013), p:1443-1530

[11] M.Vefa Toroslu, Hukuksal Ve Finansal Açıdan Konkordato / Concordatum From a Legal and Financial Perspective (1st edn, Adalet 2019),p:233-236

[12] The Turkish Courts are separeted to speciality fields. According with E&IA article 4 Enforcement Courts constitutes the judiciary body which is responsible with overseeing the procedures carried out by enforcement and insolvency (rescue) administrations.

[13] Baki Kuru, İstinaf Sistemine Göre Yazılmış İcra Ve İflas Hukuku / Enforcement and Insolvency Law in Written Accordance with the System of Appeal (1st edn, Legal 2016),p:684

[14] Ibid.

[15] Ibid,p:685

[16] Ibid.

[17] Ibid, p:686

[18] Ibid.

[19] Ibid, p.689

[20] E&IA art.292

[21] Hakan Pekcanıtez, İcra Ve İflas Hukuku Ders Kitabı / Enforcement and Insolvency Law Textbook (3rd edn, Yetkin 2016),p: 546

[22] Supra note:13, p:698-700

[23] Ibid.

[24] Ibid.

[25] International Swaps and Derivatives Association Inc., ‘2018 ISDA Netting Act And Guide’ (ISDA 2018),p:1

[26] Ibid.

[27] Ibid,p:12

[28] Article 50 of (Turkish) International Private and Civil Procedure Law Act, Law No:5718, Offical Gazzete No: 26728, Date of Entry into Force: 12.12.2007

[29] Ibid.

[30] Ibid

[31] Jonathan Hill and Adeline Chong, International Commercial Disputes Commercial Conflict of Laws in English Courts (1st edn, Hart Publishing 2010),p:552

[32] These two elements are required by the first article of the Turkish Civil Code to be collectively taken into consideration in statutory interpretation.

[33] Supra Note:25

[34] Supra Note:11,p:78

[35] For more on this see: Cemal Şanlı, Milletlerarası Özel Hukuk / International Private Law (5th edn, VedatKitapçılık 2016),p:291-292

[36] Supra note:10,p:1575

[37] See:V-B

[38] Supra Note:31,p:721

[39] See:V-B

[40] Supra Note:31,p:736,741-742

[41] Ibid,p:743-744

[42] Ibid.

[43] Muhip Şeyda Işıktaç, ‘Konkordato / Concordatum’ (2018) 92 Istanbul Barosu Dergisi / Journal of Istanbul Bar,p:28-29

[44] Supra note:10,p:1575

[45] See: VI-B1