One of the methods companies may use to increase their capital is by converting the receivables owed to shareholders into company capital. In this method, a shareholder’s claim against the company is contributed as in-kind capital, thereby increasing the company’s share capital and issuing new shares to the relevant shareholder. However, for this transaction to be legally valid, it is important to comply with the procedures and conditions set forth under the Turkish Commercial Code No. 6102 (“TCC”). In this article, we discuss in detail the conversion of shareholder receivables into capital in both joint-stock and limited liability companies with a focus on practical considerations observed in practice.
Legal Requirements for Converting Receivables into Capital
a. The Maturity (Due Status) of the Receivable
TCC clearly lists the assets that may be contributed as capital to commercial companies. In this respect, it is clearly stated that, alongside cash contributions, receivables may also be regarded as capital; thus, the conversion of a shareholder’s receivable into capital constitutes a form of in-kind capital contribution. However, the legislator imposes certain limitations on the types of assets that may be contributed as in-kind capital in joint-stock and limited liability companies. Under these provisions, services, personal labor, commercial reputation, and receivables that have not yet matured are expressly excluded from being accepted as capital. Therefore, for a shareholder to contribute their receivable as capital, the receivable must first be matured (i.e., payable to the shareholder) Furthermore, the receivable must be free from any encumbrance, pledge, attachment, or precautionary measure, as these would otherwise prevent its valid contribution as capital.
When the legal requirements set forth in the TCC are collectively met, there is, in principle, no obstacle to converting a shareholder’s receivable into capital. In other words, a matured and disposable receivable may be contributed to the company as in-kind capital, thereby enabling a capital increase through this method.
On the other hand, the accounting treatment of debts owed to shareholders plays an important role in determining this process. In company balance sheets, shareholder receivables are recorded typically under account 431 “Payables to Shareholders (Long-Term)” and 331 “Payables to Shareholders (Short-Term)”. In practice, debts recorded under account 431 are generally considered long-term and therefore may not yet be regarded as matured. By contrast, debts tracked under account 331 are usually short-term liabilities, meaning they are due within one year and are therefore considered closer to maturity.
b. Obtaining an Expert or Certified Public Accountant Report
The conversion of a shareholder’s receivable into capital is legally regarded as a contribution of in-kind capital. Unlike a cash capital increase, the TCC requires that the value of the asset contributed as in-kind capital be verified through an official report. Accordingly, whether at the time of incorporation or during a capital increase, the existence and actual value of the asset to be contributed as in-kind capital must be assessed by experts appointed by the commercial court of first instance located in the company’s registered seat. This report includes the appropriateness of the valuation method used, whether the receivable is actually existing and valid, its collectability, and its full value, and is ultimately approved by the court.
However, in cases where a shareholder converts their own receivable into company capital, the Turkish Ministry of Customs and Trade introduced a procedural simplification to avoid delays caused by the court-appointed expert process. Pursuant to the Circular No. 7326 dated 27 September 2013, commercial registry offices were granted flexibility in such transactions. According to the Circular, when a shareholder contributes their own receivable as capital, a report prepared by a Certified Public Accountant (CPA) or a Sworn-in Certified Public Accountant (SCPA) may be accepted in lieu of the expert report required under the TCC. For companies subject to independent audit, an auditor’s report is deemed sufficient for registration purposes. In practice, commercial registry offices also accept these reports as adequate documentation and proceed with the registration of capital increases based on the conversion of shareholder receivables.
However, it should not be overlooked that this administrative approach is not explicitly regulated under the TCC. The law still requires valuation by court-appointed experts, and a statutory provision cannot be amended or expanded through an administrative circular. Accordingly, capital increase resolutions adopted solely on the basis of a CPA or SCPA report may be legally debatable. Indeed, general assembly decisions that violate the law, the articles of association, or, in particular, the principle of good faith may be subject to annulment proceedings within three (3) months from the date of the decision. Thus, although capital increases based on CPA/SCPA reports are established practice in application, the binding provisions of the TCC should not be disregarded in the event of any dispute.
c. Priority of Utilizing Internal Resources
Another important point to consider in capital increases made through capital commitments is the requirement to prioritize internal resources. The TCC explicitly stipulates that if there are funds or reserves shown in the balance sheet that may be converted into capital, a capital increase cannot be carried out through new commitments before these internal resources are utilized. The legislator states that the purpose of this rule is to prevent capital increases that could harm existing shareholders. Indeed, when the company already has internal funds that can be capitalized free of charge, conducting a capital increase through external means (such as new cash contributions or conversion of receivables) may constitute a breach of the principle of good faith.
From a technical perspective, a company’s debt to its shareholder forms part of that shareholder’s personal assets, and thus such a receivable is considered an external resource. Accordingly, before implementing a capital increase through such an external item, the company must first utilize its internal resources. Indeed, the Court of Cassation has confirmed this interpretation in several decision.[1]
Additionally, although Article 462 is primarily drafted for joint-stock companies, Article 622 of the TCC expressly provides that the grounds for nullity and annulment applicable to joint-stock companies also apply by analogy to limited liability companies. Consequently, considering the limited liability companies, if a capital increase is made from an external source without first utilizing internal resources, the resulting general assembly resolution may be deemed contrary to the principle of good faith and thus subject to annulment proceedings.
In conclusion, when planning a capital increase through the conversion of shareholder receivables into capital, it is crucial to first examine whether the company’s balance sheet contains any internal resources that may be capitalized. If such resources exist, they should be
utilized in priority, and the overall transaction should be evaluated within the framework of the principle of good faith, taking into account its purpose and commercial rationale.
Conclusion
Capital increases carried out through the conversion of shareholder receivables into capital constitute an effective method that, when properly implemented, both reduces the company’s debt burden and strengthens its capital structure. The TCC allows for matured receivables to be contributed to the company as in-kind capital; however, for this process to be conducted properly, the existence and value of the receivable must be verified either through a court-appointed expert report or a report prepared by a certified public accountant.
Although certain administrative simplifications have been introduced through ministerial opinions, compliance with the provisions of the TCC remains essential. In particular, when internal resources are available, resorting to external sources may carry the risk of violating the principle of good faith, and this should not be overlooked in practice.
[1] In its 2019 decision (11th Civil Chamber of the Court of Cassation, E.2019/88, K.2019/7008), the Court annulled a general assembly resolution on the grounds that conducting a capital increase from external resources without first capitalizing all internal funds violated the mandatory provision of Article 462/3 of the TCC. For a similar ruling, refer Court of Cassation, 11th Civil Chamber, Decision dated 07.07.2022, E.2021/1887, K.2022/6427 (the Court annulled a capital increase made from external resources that reduced the minority shareholder’s ownership ratio, on the grounds that priority was not given to internal resources).
Frequently Asked Questions
Can shareholder receivables be converted into capital?
Yes, they can. However, only matured receivables that are free from any pledge or attachment may be contributed as capital.
What does it mean to convert a shareholder’s receivable into capital?
It means that a shareholder’s claim against the company is contributed as in-kind capital instead of cash, thereby increasing the company’s share capital.
Is a court-appointed expert report mandatory for converting a shareholder’s receivable into capital?
As a rule, Article 343 of the TCC requires a court-appointed expert report; however, in practice, reports prepared by CPAs or SCPAs are also accepted.
Are shareholder receivables considered internal or external resources?
Shareholder receivables are generally regarded as external resources.
Can a capital increase be made from external resources when internal resources are available?
No, as a rule, a capital increase cannot be made from external resources while internal resources remain available. Otherwise, the general assembly resolution may be subject to annulment proceedings.
Are the rules requiring priority for the use of internal resources also applicable to limited liability companies?
Yes. Although Article 462 is drafted for joint stock companies (A.Ş.), under Article 622 of the TCC, the grounds for nullity and annulment applicable to joint stock companies are applied by analogy to limited liability companies (Ltd.) as well.