This post is an extract from the first edition of GAR’s The Guide to M&A Arbitration, first published in December 2018. The whole publication is available at https://globalarbitrationreview.com/edition/1001270/the-guide-to-m-a-arbitration-first-edition.
Frequency of M&A disputes
The frequency of disputes largely depends on market conditions and M&A literacy. Turkey’s
attractiveness to investors over the past decade has naturally resulted in an increase in M&A transactions. The number of transactions in Turkey for the year 2016 was 243; for 2015, it was 319; and for 2014, it was 318. The decrease in 2016 is the consequence of many socio-economic and political factors, such as Brexit (the UK is one of Turkey’s most significant trade partners); increasing uncertainty about the EU’s future; a coup attempt in Turkey; and a subsequent prolonged state of emergency, among others. Global M&A activity also fell in 2016. As such, the decrease of transactions join year to year is understandable and recoverable. Furthermore, M&A literacy in Turkey has greatly improved in the last 20 years, bringing heightened professionalism to transactions. As Turkey’s economy strengthened, M&A transactions increased, outnumbering transaction-related disputes (that is, many marriages and very few divorces). Recently, around one-third of M&A transactions have ended up in dispute. A few years ago, commercial arbitration tended only to relate to construction, distributorship, sale of goods or provision of services, etc. Nowadays, the arbitration arena has expanded to include M&A transaction disputes.
Form of dispute resolution
The surge in M&A transactions could be traced to foreign investors’ increased interest in Turkey. Foreign investors meant M&A transactions become international; investors requested an independent forum for disputes, the answer to which was arbitration. Consequently, the arbitration practice developed concurrently with the M&A practice. Over the last 20 years, M&A contracts tend to include arbitration clauses and all related disputes are resolved through arbitration. Furthermore, as arbitration has a settled practice and many advantages, arbitration clauses specifying local institutions (such as Istanbul Arbitration Centre arbitration) are routinely included in contracts even when all involved parties are Turkish.
Arbitration has several advantages, the first and most significant of which is the ability to opt for confidentiality. The importance attributed to confidentiality is based in the sensitive nature of M&A transactions, in which due diligence reports, long-term business plans containing the target company’s minutiae, and trade secrets are exchanged during and after the transaction. Secondly, efficiency is a sine qua non for these types of disputes. Because of their overwhelming caseload, local courts in Turkey may not always be efficient or expedient enough in dispute resolution, which may jeopardise companies’ operations, especially when disputes are among shareholders. Thirdly, the types of contracts used in transactions are complex, and few judges in Turkey possess the legal expertise required to resolve related disputes. In arbitration, parties have the right to choose their arbitrator – usually one who possesses the relevant expertise – making it more likely the parties will reach a satisfactory resolution. Lastly, arbitration is procedurally flexible, making it a mechanism where parties can more broadly enjoy their right to be heard. Therefore, what typically is being negotiated in the Turkish context is not whether to choose arbitration, but the seat of arbitration, the governing law and the drafting of the arbitration clause.
Grounds for M&A arbitrations
The main transactional documents are sale and purchase agreements (SPAs – these may include share subscription instead of or in addition to share purchase, or may be designed as asset transfer agreements instead of share sales) and shareholders’ agreements (SHAs). The common types of disputes arising from SPAs concern breach of representations and warranties terms especially based on failure to disclose or misrepresentation by sellers (very frequent) and disagreements on post-closing price adjustments (very frequent). The most common SHA disputes arise out of the exercise of corporate governance (frequent) and share option rights (very frequent). Lastly, fraud (frequent) is another recurring reason for dispute; however, proving it is highly difficult under Turkish law.
To be more specific, representations and warranties are one of the most important terms in SPAs. Their purpose is to define the target company’s condition and guarantee its past and current (representations) and future (warranties) peformance. They map out the sellers’ boundaries of liability for the target company. The representations generally included in SPAs are to ascertain the accuracy of the information the sellers provide about a target company’s financial, legal and operational status as of the closing date. Disputes arise when representations turn out to be inaccurate, leading the target company and buyer to suffer losses. In this case, the buyer claims for damages.
The majority of warranties disputes arise as a result of the vague wording of representation and warranty terms. Parties frequently agree on purchase price adjustments to track changes in the target company’s valuation in the period between a given commencement date (such as the signing date or last accounts date as of the end of the year immediately prior to the signing date) and an end-date (such as the closing date, immediately prior to the closing date or the post-closing date). These mechanisms are prone to disputes because of the complexity of agreeing on the definition of the relevant balance sheet positions and performance characteristics, and agreeing on the standards and methods applicable for valuation and later adjustments.
After the closing of the transaction, if the sellers remain in the target with majority or minority shareholdings, an SHA kicks in and the target company is, usually, under joint control of at least two shareholders, that can be natural persons or corporate entities, or a combination of natural and legal persons. Wherever there is split control, disputes are likely; however, not all disputes are amicably resolved between shareholders, and arbitration becomes a necessity. Arbitrated disputes occur because parties cannot agree if a share sale or purchase option right is valid, if it is exercised rightfully, in whose favour certain elements in the option right are to be interpreted, or on the structure and management of the target company.
Fraud and failure to disclose
In general, the seller is expected to disclose everything it knows to the buyer. Under Turkish law, the seller cannot evade liability (unless the liability is contractually limited to the extent allowed by law) based on the argument that it was unaware of certain information, or does not possess certain documents with respect to the target company, as its shares are at stake.
The only party who possesses such detailed information is the seller. In this context, it is necessary for the seller to know everything about the target company that is crucial to the deal and to disclose it to the buyer. To avoid the omission of crucial information and a blind sale, buyers conduct extensive due diligence. In the due diligence process, a professional team examines all of the target company’s documents for anything missing from the target company’s history and prepares a report wherein it inspects the target company’s existing condition. Moreover, in the context of Turkish M&A, parties tend to attach either a list of due diligence documents, the documents themselves, or a CD containing the documents uploaded to virtual data room to indicate which documents were submitted for the buyers’ review. This aims to limit the sellers’ liability that may arise out of the documents or events disclosed to the buyer during the due diligence process. However, depending on the negotiations and the parties’ bargaining powers, buyers can request to hold the sellers liable even if the buyer conducted proper due diligence and can include this provision in the transaction documents. Alternatively, though rarely, sellers can limit their liabilities irrespective of the due diligence exercise and disclosed information.
Apart from the above, if the sellers do not disclose information willingly (that is, commit fraud), and this leads to a loss for the target company or the buyers, the limitation of liability clauses are invalid.
A due diligence report cannot realistically reflect the target company’s position with complete accuracy, and the best option is to prepare a disclosure letter.
Burden of proof
The burden of proof is a procedural issue and the general rule is the party that makes a claim must prove the facts supporting its claim. A claimant must prove (1) the respondent’s breach of contract; (2) the loss the claimant suffered; and (3) the causal link between claimant’s loss and the breach of contract. The respondent must prove it did not cause the breach of contract. However, there are certain situations where the burden of proof is swapped. For instance, if a seller claims the price of a product sold or service provided was not paid, and the buyer claims it paid the agreed amount, the buyer must prove this. If the buyer can show that it made a payment, the burden of proof would be incumbent on the seller to prove the payment was not received.
Another example can be the burden of proof rules for penalty clauses. Under Turkish law, if an agreement contains penalty clauses (such as penalty clauses to secure the seller’s non-compete or non-solicitation covenants), the claimant does not have to prove the amount of its losses but can directly claim the penalty amount. However, if the claimant’s losses are higher than the penalty amount, the claimant must prove its losses exceeding the penalty amount established under the agreement, and that the losses were caused by the counterparty.
Apart from the above, parties are free to enter into ne plus ultra or burden of proof agreements under which they can eliminate one of the elements of liability: the party’s fault. For instance, the buyers and the sellers can be held liable for their breach of the SPA, and representations and warranties terms, respectively. Moreover, parties commonly enter into agreements or include a clause in SPAs where a buyer’s prior knowledge of the target company will not prevent it from making demands under the SPA (pro-sandbagging) or that will prevent it from making any demands (anti-sandbagging).
Under Turkish law, for persons to know whether particular information is adequate, how they obtained that information is unimportant (it is an outcome of the good faith principle).
As a party to the transaction agreements, the seller s responsible to the buyer. In ordinary circumstances, the target company’s management or representatives cannot be held liable for the breach of any representation and warranties terms based on the seller’s knowledge, if the management or representatives are not party to the transaction agreements and assumed no liability specifically under these agreements. However, as stated above, the sellers must prove they are not at fault (ne plus ultra) to avoid liability; if the seller can prove this, and that the management or representatives possessed the knowledge in question, the seller can avoid liability. In this case, the buyer must make a claim against the management or representatives. If some evidence must be collected in order to prove a fact, a party may request document production. However, it does not switch the burden of proof.
If there is a breach of the transaction agreement, claimants tend to claim damages, which is the easiest remedy if the claim is monetary and the quantum is calculable. In contrast, the enforcement of specific performance, such as the exercise of option rights is the most problematic remedy to execute under Turkish law, like in many other jurisdictions. For instance, in practice it is difficult to enforce a call option if the party possessing the shares does not transfer its shares willingly, since the performance of the share transfer is subject to the endorsement and physical delivery of the share certificates to the option holder. If the party granting the option right does not transfer the shares voluntarily, the option right holder must initiate arbitration proceedings (or litigation proceedings if there is no arbitration agreement between the parties). If the party granting the option right does not transfer the shares despite the award rendered against it, the option right holder must start execution proceedings for the physical delivery of the shares in accordance with Article 24 of the Turkish Enforcement and Bankruptcy Law. The competent execution office must order the party granting the option right to deliver the shares to the option holder within seven days following receipt of the execution order. If the party granting the option right does not transfer the shares, the execution office will try to find, collect and physically deliver the share certificates to the option holder. If the execution office cannot find the certificates, this option becomes a fool’s errand. As the certificates are movable, they can be easily hidden, lost or destroyed. If the share certificates are lost or destroyed, only the last rightful owner whose names are written on the share certificates can request the cancellation of the lost or destroyed share certificates from the Turkish commercial courts.
Upon receipt of the court decision, the party granting the option right must request the company’s board of directors to issue new share certificates. However, if it fails to do so, no new share certificates can be issued, and the option right cannot be enforced. If the share certificates cannot be found or reissued, the claimant can only request the monetary losses it suffered, if these can be proven. To avoid such difficulties in exercising prospective share transfers, the parties prefer to secure their rights through an escrow mechanism.
Measure of damages
Quantification of compensation in an M&A dispute is often difficult because if the share transfer is valid, it means the SPA is still in force, which leads claimants to request positive damages and loss of profit, if this can be proven.
Unfortunately, calculation mechanisms make it difficult to render a quantum analysis in practice. Under Turkish law, only compensatory damages can be awarded; awarding punitive damages is forbidden. Theoretically, positive damages are calculated by subtracting the current financial status from what the financial status should have been if the breach of contract had not occurred. Loss of profit is calculated by subtracting the profit gained from what the financial status should have been if the breach of contract had not occurred. However, calculation of the expression of ‘what the financial status should have been’ is quite difficult and complicated, as this depends on varying factors like the constantly changing economy, and the difficulty of obtaining demonstrable evidence. Quantum analysis reports can be used as evidence in arbitrations. However, since the finding of these reports are based on assumptions, they are not 100 percent reliable. The greater the number of experts involved in a dispute, the more confusion can occur. Therefore, it is advisable for the parties to an M&A transaction to agree on which method to apply for measuring damages or to include a penalty clause to avoid unnecessary disagreements.
Special substantive issues
Many M&A transaction agreements contain ‘best efforts’ clauses. This expression, originating in global M&A practice, does not exist inTurkish law. Therefore, in Turkey, parties and judges alike do not perceive best-efforts clauses as a meaningful obligation, resulting in conflicts of interpretation and usage of these clauses. The general M&A practice in Turkey interprets best-efforts clauses as underlining that the parties are to undertake commercially reasonable efforts: to act like a prudent merchant; to be aware of the financial and political effects; and to act in the company’s interest. ‘To act in good faith’ or ‘to act like a prudent merchant’ are possible replacement clauses that can be easily understandable under Turkish law, are supported by sufficient case law and are based on the Commercial Code and Civil Code.
Special procedural issues
Parallel procedures, such as simultaneous arbitration and litigation proceedings, and the enforcement of arbitral awards, are subject to special procedural issues.
In parallel procedures, Turkish parties may attempt to initiate a lawsuit in the local courts to take advantage of the application of Turkish law and the judge’s questionable prejudice against the foreign party, even if a valid and explicit arbitration clause exists. This results in parallel proceedings before different fora on the same subject matter, which presents an unsettled legal problem. Some scholars opine that the second proceeding initiated must await the first proceeding’s judgment. However, if the tribunal or the court does not follow this general principle, or if there are two different judgments on the same dispute, what are the consequences? Since this issue remains unsolved, lawyers generally try to draft agreements with unequivocal arbitration clauses that will be engaged if a dispute arises.
The enforcement of foreign arbitral awards is another difficulty. Unfortunately, since enforcement proceedings are heard before the Turkish courts, the procedure takes longer than necessary and can last up to three years, including the higher court review. Even though the examination of the courts are limited to the reasons given under the New York Convention and the Turkish International Private and Procedure Law, judges take an excessive amount of time to consider whether the enforcement conditions are lawful or to examine the substance of the case, although it may be beyond their authority. Additionally, one of the most difficult conditions for the enforcement of the award is not to be against public policy. Because the term ‘public policy’ is vague and a judge can interpret it in many ways, it can lead a judge to render an incorrect decision. Consequently, this leads the claimant to apply for an appeal and extends the process.
 Ernst and Young Turkey, Mergers and Acquisitions Report Turkey 2016, January 2017, https://www.ey.com/Publication/vwLUAssets/MA_2016_Raporu_ENG/%24FILE/EY_M&A_Report_2016_ENG.pdf (last accessed 10 September 2018).
 Ismail G Esin, Özgün Celebi, Sevgin Erker, Demet Kasarcioglu, Chapter 10: Arbitrating M&A Disputes, Ali Yesilirmak and Ismail G Esin (eds), Arbitration in Turkey, 2015. pp. 265-266.
 Code of Obligations Article 219: ‘The seller is liable even he has not been aware of the defects.’
 Code of Obligations Article 221: ‘Any agreement to exclude or limit the warranty is void and null, if the seller has gross fault in transferring the object sold with defect.’
 Civil Code Article 6: ‘Unless otherwise is stated in the law, every party is under the burden to prove the existence of the facts he relies his right on.’
 Code of Obligations Article 112: ‘Where the obligation has not been performed at all or as required, the obligor must compensate the damage or loss of the creditor unless the obligor proves that he was not at fault.’
 Code of Obligations Article 180(2): ‘Where the damage that the creditor suffers is higher than the amount of penalty, the creditor does not demand this further compensation without proving the fault of debtor.’
 Ali Ergin Celebi, Disputes regarding the Mergers and Acquisitions Transactions and Arbitration, p. 32; Ismail G Esin/ S Tung Lokmanhekim, Mergers and Acquisitions in Practice, pp. 22-23.
 Civil Code Article 2(1): ‘Everyone must act according to the good faith principles while exercising his rights and fulfilling his obligations.‘
 Law No. 2004.
 Enforcement and Bankruptcy Law Article 24(3): ‘ln the event that the debtor fails to comply with this order either in part or in whole, and the asset which constitutes the subject matter of the judgment is in the debtor’s physical possession, either as the exact asset or in kind, the asset is taken from the debtor by force and delivered to the creditor.‘
 Enforcement and Bankruptcy Law Article 24(4): ‘To the extent that the debtor does not posses the asset, the value of the asset indicated in the court judgment is collected from the debtor. If the debtor fails to pay the relevant sum, it is collected by way of attachment, without the need to serve a further enforcement order. In the event that the value of the movable asset is not indicated in the judgment or is disputed, then the enforcement officer shall asses the value of the asset based on its market value as of the date of the attachment.’
 ‘The judge must, before anything, determine the amount of damage caused when deciding on the damages.The amount of damages cannot exceed the amount of damage caused.’ Tekinay/Akman/Burcuoglu/Altop, Tekinay Law of Obligations General Provisions, . p. 583; Turkish Code of Obligations Article 51: ‘The judge defines the scope and payment method of the damages according to the situation’s circumstances and aggravation of the fault.’
 Code of Commerce Article 18(2): ‘Every merchant must act like a prudent businessman in all the activities related to his commerce.‘
 Law No. 5718.
 International Private and Procedure Law Article 54: ‘The competent court shall render enforcement subject to the following conditions: . . . The court decree shall not openly be contrary to public policy.’