Capital increase through internal resources in joint stock companies

In a joint stock company, share capital is beyond being just one of the elements of the partnership concept. Share capital, determined in the articles of association of a joint stock company is, as a rule, taken as a basis for the distribution of rights within the partnership and constitutes the minimum amount of the shareholders' debt to the company. It is also a nominal value considered in the evaluation of the financial status of the company. The company may choose to increase this nominal value for various economic purposes or exceptionally as required by law. In this case, the company is required to perform a series of transactions regulated by the law. As a result of the series of transactions, the increase of the capital amount determined in the articles of association of the company, is a capital increase. The capital increase affects the relations of the company with third parties as well as the relations within the company. The capital increase has an outstanding character even among other amendments to the articles of association in terms of its procedure, results and the legal sanction to be applied when necessary. For this reason, capital increase is characterized and regulated as a "special amendment to the articles of association". In line with the purpose of capital increase, the company may apply to different types of capital increase, which differ from each other according how to provide increased capital amount, its source, and the capital system adopted by the company. One of these types of capital increases is the capital increase from internal resources, which is the subject of this study. The study aims to examine the characteristics of this special type of capital increase, the equity items that may be converted into capital, the procedure governing the capital increase and the protection of the shareholders in this type of capital increase. In the first chapter of our study, the conceptual framework and grounds of capital increase from internal resources are explained. Capital increase from internal resources is the increase of the capital amount and, accordingly, the number of shares or the nominal value of the existing shares in order to be covered from the reserve funds arising from the articles of association or the general assembly resolution and not allocated for any purpose or set aside for use in capital increase, the freely used parts of the legal reserve funds, the funds permitted by the legislation to be placed in the balance sheet and added to the capital, and the distributable net profit, without subscription and without adding new assets to the company. The theoretical structure of the capital increase from internal sources was initially evaluated in French, German, Swiss and Turkish law doctrine as consisting of two transactions: dividend distribution and capital increase from external sources. In the following period, the theoretical structure of the capital increase from internal sources was explained as it constitutes a single accounting transaction realized on the balance sheet. Today, as reflected in our positive law, capital increase from internal resources is recognized as a special type of capital increase and is distinguished from the concepts and procedures specific to external capital increase. The main reasons that lead corporations to this special type of capital increase are to provide autofinancing, in other words, to cover their expenses with their own assets; to maintain their liquidity by using it as a profit distribution model; to increase the circulation ability of the share by reducing the dividend rate and the value of the share; to strengthen their credibility; to benefit from tax exclusions; and to increase capital from external sources in the presence of certain conditions. In terms of its place within the types of capital increases, capital increase from internal resources is a type of capital increase in which the increased amount is provided from the shareholders' equity, not through capital commitments; which is outside the classification of capital increases in kind and in cash; which can be applied in the capital systems, in the basic and authorized capital systems; and which can be decided together with the capital increase from external resources. The distinctive features of this type of capital increase are that it does not increase the active assets of the company -but increases the subsidiary assets; it does not require a subscription; and the increase resolution is two folded regarding the articles of association and the shareholders' equity. Although there are parallels between them in terms of their economic results, the capital increase from internal resources differs from the division of shares and some dividend distribution models. Capital increase from internal resources is regulated as a special type of capital increase in the German Stock Corporation Act (Art. 207-220) and the Turkish Commercial Code (Art. 462), and as a type of capital increase in the Swiss Code of Obligations (Art. 652d). The second chapter of our study focuses the equity, which qualifies as internal resources. Internal resources are listed by Article 462/1 of Turkish Commercial Code. Accoring to the provision, internal resources are not limited. However, the categories of internal resources are defined as reserves and funds. Internal resources are equity items. Equity is a concept related to accounting law. The fact that accounting law is under the influence of tax law places the concept of equity, and therefore internal resources, at the intersection of corporate law and tax law. These two branches of law are also in conflict due to their differences in purpose. This conflict is especially embodied in the differences in the accounting system adopted by corporate law and tax law. Pursuant to Article 462/1 of the Turkish Commercial Code, the portion of the general legal reserve fund that exceeds half of the share capital and is not earmarked for a specific purpose is an internal source. Additionally, reserves that are not earmarked for a specific purpose and set aside to be used in capital increases are also equity that can be converted into capital. The reserves allocated by the general assembly, can be coverted into share as long as the capital increase does not conflict with the purposes stipulated under Article 523/2 of the Turkish Commercial Code. If the reserved allocated by general assembly is earmarked for a specific purpose, increase decision also change specific purpose. Another category of internal resources is the funds "permitted by the legislation to be included in the balance sheet and added to the capital". The term "fund" is used in the narrow sense in Art. 462/1 of the Turkish Commercial Code and in the broad sense in Art. 462/3, s. 1-2 of the Turkish Commercial Code; in other words, it is used to refer to all internal resources that can be converted into capital. The main examples of funds in the narrow sense are revaluation (value increase fund), inflation positive difference accounts, gain on sale of subsidiaries and real estate funds, funds arising from tax amnesty and foreign exchange difference funds. Finally, distributable net profit for the period may also be converted into capital by a general assembly resolution. In the third chapter of our study, the procedure governing the capital increase from internal resources is evaluated. The main focus of the capital increase procedure is the verification of the existence of internal resources. As a rule, the existence of internal resources is verified by the approved annual balance sheet and the statement of the board of directors. However, if more than six months have passed since the balance sheet date, a new balance sheet shall be prepared and approved by the board of directors (Turkish Commercial Code Art. 462/2). The need for an audit by an expert on the existence of internal resources, is answered by secondary regulations which requires the financial consultant's report. In publicly held corporations, the existence of internal resources is verified by comparing the financial statements prepared in accordance with the capital markets legislation with the legal records. If there is a difference between these two instruments, the lower amount shall be taken as basis. This comparative control system is a prudent choice to ensure that internal resources are actually in the assets of the company. The capital increase process starts with the preparatory actions of the board of directors, continues with the adoption of the capital increase resolution and is completed with the implementation of the capital increase resolution. There are two main characteristics of capital increase resolution for this type of capital increase. The first is, in the authorized capital system, it is permitted to exceed the authorized capital amount through capital increases from internal resources. The second is the company may increase the capital from internal resources along with capital subscription. Article 462/3, s. 1 of the Turkish Commercial Code stipulates that "if there are funds in the balance sheet that are permitted by the legislation to be added to the capital", the funds must first be converted into capital for the capital increase from external resources. Moreover, in terms of the implementation of the capital increase resolution, two issues should be mentioned. Firstly, in capital increase through internal resources, the shareholder's right to acquire bonus shares is not sufficient to eliminate the risk of violation of privileges, if any. Depending on the characteristics of the case, the resolution may violate the rights of the privileged shareholders, and in this case, Article 454 of the Turkish Commercial Code shall be applied. Secondly, the registration of the increase has a constitutive effect in terms of internal and external relations. The shareholding rights arising from the shares and bonus shares, including voting rights, shall arise upon registration. The fourth and final chapter of our study analyzes the measures regarding the protection of shareholders in capital increases through internal resources. The internal resources used in the capital increase are included in the actual value of the shares existing before the increase as part of the shareholders' equity. As a result of the capital increase, the real (intrinsic) value of the decreases inevitably by the amount of the value of the bonus shares. The right to acquire bonus shares prevents the reflection of this decrease in the value of the existing shares to shareholder's assets. The right to acquire bonus shares stipulates that the shareholders at the date of the increase shall acquire the bonus shares to be issued by the increase according to the principle of proportionality. The right to acquire bonus shares is recognized as an irrevocable, unrestricted and inalienable shareholding right (Art. 462/ 3 of Turkish Commercial Code). As being unrestricted, it differs from other inalienable rights such as the right to obtain information, inspection and audit, which may be limited to the extent stipulated by law. Furthermore, unlike other inalienable rights, it is subject to the principle of absolute proportionality. The right to acquire bonus shares prevents the dilution of shareholding rights as well as the real value of existing shares. In this respect, it protects not only the financial interests of the shareholder but also the effectiveness of managerial rights. Bonus shares shall be automatically acquired by the shareholders upon the registration of the increase (Art. 462/3 Turkish Commercial Code). The board of directors may only take decisions to take the necessary actions to register the shares in the share ledger or to register bearer shares with the Central Registry Agency. In capital increases through internal resources, the shareholder is also protected within the framework of the sanctions regarding the invalidity of increase resolution and the sanctions stipulated in Art. 549, Art. 553 and Art. 554 of the Turkish Commercial Code. An increase resolution that violates the right to acquire bonus shares is also null and void. The infringement may arise in the form of foreseeing the acquisition of bonus shares in violation of the principle of proportionality or making the acquisition of bonus shares conditional or requesting shares and share certificates within a certain period of time. In addition, the violation of the right to acquire bonus shares or violation of shareholder privileges cause loss for shareholders. In these cases, the provision of Article 553 of the Turkish Commercial Code will be applicable.