Share Option Agreements in Turkey: Legal Framework and Practical Uncertainties

I. Introduction

Allowing employees to own company shares and signing share option agreements for this purpose has become an effective method for enhancing employee loyalty and incentivizing performance. While different types of share option agreements are frequently used in practice to achieve this goal, the lack of legal regulations and limitations in practice under Turkish law pose significant challenges for companies in establishing share ownership plans for employees.

This article provides an analysis of the methods that can be employed to grant employees real share ownership within the framework of the Turkish Commercial Code No. 6102 (the “TCC”) for private joint stock companies and addresses the key considerations in implementing these methods.

II. Methods Applicable under the TCC for Share Option Agreements

The TCC offers various methods that can serve as a legal basis for share option agreements enabling private joint-stock companies to provide real share ownership to employees. These include capital commitment, conditional capital increase, and the transfer of the company’s own shares to employees. Each method has its own fundamental principles and legal considerations.

a. Capital Increase Through Capital Commitment

In this method, the company typically increases its capital through a general assembly resolution, issues new shares, and allocates these shares to employees as per the share option agreement plan. This involves increasing the company’s capital by restricting or waiving the pre-emption rights of existing shareholders to allocate new shares to employees.
In all cases where pre-emption rights are restricted, the “necessity principle” must be considered. To determine necessity, it must be evaluated whether equal or more appropriate alternatives are available. If granting shares to employees is not essential for enhancing loyalty and productivity and these goals can be achieved through other financial benefits, these alternatives should be prioritized. Additionally, the principles of “equal treatment” and “proportionality” must also be taken into account.
To facilitate employees’ acquisition of new shares, it is often ensured that new shares are issued without premiums and are acquired at their nominal value. However, as with any capital increase, the necessity of issuing shares at a premium should be assessed on a case-by-case basis. The company may also provide financial support to employees (in compliance with TCC provisions on reserve funds) for share acquisition.
To adopt this method, the company’s existing capital must be fully paid before the capital increase.
If there are funds in the balance sheet that are allowed to be added to the capital under the legislation, these funds should first be converted into capital. In some cases, the capital increase can be carried out simultaneously with the conversion of these funds into capital.
At least 25% of the nominal value of shares subscribed in cash must be paid before registration, with the remainder payable within 24 months following registration. In cases where shares are issued at a premium, the premium must be fully paid before registration.
When this method is adopted (although the structure of each share option agreement may differ), it may be necessary to increase the capital through a general assembly resolution each time employees wish to exercise their share acquisition rights.

b. Conditional Capital Increase

The TCC allows for conditional capital increases to grant employees the right to acquire shares. To apply this method, the articles of association must include a specific provision. This provision must specify the nominal value of the conditionally increased capital, the number, value and types of shares, the groups entitled to exercise conversion or acquisition rights, the removal of existing shareholders’ pre-emption rights, privileges granted to certain share groups, and limitations on the transfer of new registered shares.
In this method, the existence of an article of association provision for a conditional capital increase is sufficient, and there is no need for a general assembly resolution on capital increase. The capital automatically increases when the acquisition or conversion rights are exercised, and the capital obligation is fulfilled through set-off or payment. The fulfillment of obligations is conducted through a deposit or participation bank.
Regarding conditional capital increases, existing shareholders have the right to be offered the opportunity to participate in the capital increase. However, as noted in the preamble of the TCC’s relevant article, this right does not apply where the shares are allocated to employees.
While the relevant legislation explicitly requires the preparation of share acquisition programs for conditional capital increases in publicly held companies, the TCC imposes no such requirement for privately held companies. Nonetheless, as with all methods, it is crucial to prepare and distribute share acquisition options within a plan based on objective criteria, adhering to the principles mentioned earlier.
It should be noted that the nominal value of the conditionally increased capital cannot exceed half of the existing capital. Payments must be at least equal to the nominal value.
Although the articles of association impose restrictions on the transfer of shares, additional provisions may be required to specifically address the transfer of new registered shares issued through a conditional capital increase. Existing restrictions for current shareholders may also need to be revised to ensure consistency with the share option agreements for employees.

c. Acquisition of the Company’s Own Shares

It is established that a company may acquire its own shares for consideration or without consideration. Both types are subject to different sets of conditions.
Acquisition for consideration: The nominal value of the shares acquired by the company cannot exceed 10% of its capital. After deducting the value of the acquired shares, the company’s net assets must not fall below the sum of its capital and legally required reserves. The consideration for the shares to be acquired must be fully paid. Additionally, the general assembly must authorize the board of directors for the acquisition. If all conditions under the TCC are met, the company is not required to dispose of the shares it acquires.
Acquisition without consideration: In the case of acquisition without consideration, the price of the shares to be acquired by the company must have been pre-paid. Additionally, shares exceeding the 10% limit must be disposed of as soon as possible and within 3 years, provided there is no loss to the company.
There are no special or exceptional provisions in the legislation concerning the acquisition of its own shares by a company to grant them to employees. Therefore, companies intending to adopt this method must comply with the relevant provisions of the TCC.

III. Key Considerations in Structuring Share Option Agreements

Share option agreements that genuinely grant employees shares do not only serve to enhance workforce motivation but also have significant impacts on the company’s shareholding structure, investment processes, and corporate decision-making mechanisms. This section outlines the key considerations to be taken into account before implementing such methods and before drafting share option agreements.

An increase in the number of shareholders can create certain challenges for companies planning to seek investment in the future. For instance, this situation may deter certain types of investors from investing in the company or complicate negotiation processes during investment stages. While these challenges may seem addressable through shareholder agreements and/or share option agreements (e.g., with the addition of provisions like drag-along rights), the functionality of these mechanisms is often debatable.

Indeed, the employment law aspect of agreements to be signed with employees must not be overlooked, and clauses related to share transfers, just like termination clauses, should also be evaluated from an employment law perspective and drafted accordingly (e.g., by considering issues such as the revocation of granted rights, unilateral amendments, etc.).

Employees will inevitably have an impact on the company’s operations. Although existing shareholders (founders/investors) may be granted privileges to increase their control power over employees who hold shares, privately held companies cannot issue non-voting shares. Therefore, employees, like existing shareholders, will have the right to participate in the company’s general assembly.

In certain cases, if employees do not attend meetings in person or by proxy, it may not be possible to hold general assembly meetings without a call to the shareholders. Moreover, decisions requiring unanimity may not be achievable without the participation of the employees.

Employees will also have pre-emption rights. Unless they waive these rights or there is a justified restriction on their pre-emption rights, the company cannot prevent employees from acquiring new shares. Such situations may disrupt the shareholding structure initially planned by the company. Since employees, as shareholders, will acquire rights such as filing lawsuits to annul general assembly decisions or liability claims against directors, they could potentially influence the company’s decision-making processes by exercising these rights.

If employees hold minority shares, they may prevent the approval of settlements and releases for board members and auditors if they oppose these at the general assembly. The discussion of financial statements and related matters (such as the election of the board of directors, release of the board of directors, determination of board members’ remuneration, profit distribution, etc.) may be postponed by one month at the decision of the meeting chairperson, upon the request of the employees. Such scenarios could slow down the company’s operations.

Moreover, it will not be absolutely possible to restrict or limit the transfer of registered shares allocated to employees. Restrictions on share transfers in the articles of association will only apply if the refusal of approval is justified by reasons related to the company’s business scope or the economic independence of the enterprise.

If it is desired to impose further restrictions on the transfer of shares beyond those provided under the TCC via provisions in the articles of association, contractual rights (such as right of first refusal) in favor of a specific share group may be established in the relevant agreements. However, if employees transfer their shares in violation of such agreements, this would result in an obligation to pay damages on the part of the employees, but the registration of the new shareholder in the share ledger cannot be prevented.

IV. Conclusion

It must be acknowledged that in today’s economy, granting employees real share ownership appears to be one of the most effective tools for retaining qualified labor, enhancing performance, and fostering loyalty. However, companies must thoroughly assess the legal framework and compatibility of these methods with their future strategic goals before drafting share option agreements. During this assessment, the legal and administrative costs and implementation challenges of each method must also be taken into consideration. Business decisions made without detailed evaluations may result in unforeseen losses of rights for employers and, consequently, for employees.