1. Introduction
Mergers and acquisitions, as defined under Article 136 of the Turkish Commercial Code (TCC), encompass the acquisition of one company by another, technically termed as a “merger through acquisition,” or the coming together within a new company, technically termed as a “merger through the formation of a new entity.” In international legal practice, the M&A practice widely covers all transactions that enable the acquisition of a company or business.1 Under Turkish law, share transfer agreements are evaluated within the framework of sales contracts pursuant to Article 207 of the Turkish Code of Obligations.
2. Letter of Intent
The M&A and share transfer processes typically commence in practice with pre-negotiations between the buyer and the seller. During this stage, the parties often sign a “letter of intent” or a “memorandum of understanding” or “heads of terms” to outline the key aspects of the process for the sale and transfer of shares. Alongside the letter of intent, the parties usually enter into a non-disclosure agreement. Additionally, at this stage, the exclusivity clause (no-shop clause) is widely used in practice with the letter of intent, particularly to prevent the seller from engaging in negotiations or contact with other potential buyers.2 Although these stages are generally referred to as letters, they are in fact contracts mutually agreed by the parties to govern how the process will unfold.
3. Due Diligence and Preparation of the Disclosure Letter
After the execution of the letter of intent and other contracts during the pre-negotiation stage, the buyer proceeds to the “due diligence” stage. Due diligence primarily entails an assessment of the situation, aiming to identify risks associated with the acquisition of the company. It is crucial for the parties to conduct inspections, examinations, and reporting to assess potential risks comprehensively. This examination does not only cover legal matters but may also extend to tax, accounting, and technical aspects relevant to the company’s operations.
In terms of the seller’s representations and warranties liability and the risks imposed on the buyer, the Disclosure Letter and Data Room are significant. Although not directly regulated in Turkish Law, these structures derive their legal basis from Article 222 of the Turkish Commercial Code (TCC). Article 222 of the TCC stipulates the exemption of liability arising from risks through disclosure as follows: “The seller is not liable for defects known to the buyer at the time of conclusion of the sales contract. The seller shall also be liable for defects that the buyer may see by adequate inspection of the sold goods, but only if he has undertaken that such defects do not exist.”
The Data Room, in practice, is an environment where all documents and information related to the company subject to share transfer are made available for the buyer’s examination, either in a physical or virtual setting. The information and documents in the Data Room should be added as an additional list to both the share transfer agreement and legal due diligence reports. The seller’s liability may be limited by adding that the necessary documents and information have been provided to the buyer and that the parties have mutually reviewed and agreed.
However, in practice, a certain period of time elapses between the signing date of the Share Purchase Agreement and the closing date, in other words, the completion date of the share transfer process. Due to the company’s ongoing activities until the closing, information related to the company subject to the share purchase agreement provided by the seller in the form of representations and warranties may be affected by events that may affect the share value of the company. In such cases that would constitute an exception to the declarations and warranties provided by the seller, the disclosure letter is used in practice. The disclosure letter, as a list of exceptions, has the characteristic of a disclosure obligation regarding the issues that may exceptionally cause the seller’s liability in the information and documents in the Data Room. The purpose of preparing a Disclosure Letter is to inform the parties about existing risks, to limit their responsibilities, and to establish limits on representations and warranties through mutual agreement. The Disclosure Letter transforms undisclosed hidden defects, unknown to the buyer at that stage, into open defects, thereby limiting the seller’s liability. Except for the exceptions stated in the Disclosure Letter, the seller commits to the existence, accuracy, and completeness of the documents and information related to the company within the contractual boundaries.
The seller’s liability for the defects known by the buyer is exempted with the agreement made by recording that the information contained in the disclosure letter is known by the buyer correctly and completely. At this stage, it is important to note that the matters disclosed must be included in the disclosure letter in a complete and proper manner, free from any misleading information. In practice, legal disputes arise between the buyer and the seller due to conflicting disclosures in the disclosure letter, such as the insufficient scope of the disclosure letter and the fact that the disclosure letter does not fully reflect the reality. The important issue here is the conformity of the statement in the disclosure letter to the concrete situation.
As a matter of fact, in a decision of the Istanbul 21st Commercial Court of First Instance, Case No. E. 2019/964 K. 2021/966, dated 22.12.2021, it was ruled that the seller’s responsibility to pay compensation will be eliminated only for the matters disclosed by the seller to the buyer. Sellers that act dishonestly and fail to disclose relevant information before and during the Share Purchase Agreement are held liable towards the buyer.4 As an example of the most frequently included provisions in the Disclosure Letter, it may be mentioned that the activity permits of the transferred company are full and accurate. In case there is an expired, non-renewed or incomplete activity permit, the seller will not be liable for this deficiency if a record is included in the disclosure letter regarding the deficiency of the said document. In this case, the buyer will make the purchase knowing the aforementioned deficiency. Depending on the field of activity of the company, it is important that compliance with the relevant environmental, health, safety, production legislation and the Ministry Directives and Circulars to which the company’s field of activity is affiliated and the exceptions within this scope are also included in the disclosure letter.
An important part of the disclosure letters consists of the commercial transactions of the company and the penal clauses, if any, included in the contractual provisions of these transactions. In case there is a penalty clause due to a change in the nature of the party performing the business as a result of the share transfer and change of ownership, disclosure of this issue shall exempt the seller from liability.
Another common example is the existing disputes over the assets of the transferred company. Since the company will be transferred as a whole with all its assets and debts, if there is a new dispute posing a risk on movable and immovable assets or if there is a change in ongoing files, this issue should be included in the disclosure letter
4. Conclusion
The “Disclosure Letter” is common practice to limit the seller’s liability in the representations and warranties clauses concerning mergers and acquisitions. It serves the purpose of informing the buyer about issues that may pose risks regarding the valuation of the company. If the records in the Disclosure Letter are complete and accurate, the seller cannot be held responsible for these matters. Therefore, it is beneficial for the parties to ensure that the disclosure letter contains detailed and clear information about the company in a way that does not leave any grounds for dispute, and that it is included as an annex to the share purchase and sale agreement.
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Hansu Attorney Partnership provides legal services to local and international clients, particularly in the areas of real estate, corporate, tax, energy and intellectual property law. This article is intended to present recent developments in Turkey and does not constitute legal or professional advice. Readers of this article should contact a lawyer to obtain advice with respect to any particular legal matter.