Aslı Başgöz, Yalın Akmenek, Bora Durmaz
Edited By: William Johnston, Thomas Werlen, Frederick Link
- Banks and cross-border issues — Money and the conflict of laws — Contractual set-off — Judicial set-off
34.01 This chapter generally examines the legal framework of set-off under Turkish law both outside and within the context of bankruptcy, and describes its mechanisms, requirements, limitations, and consequences under the Turkish Code of Obligations2 (TCO) and the Turkish Execution and Bankruptcy Law3 (TEBL) and at contract. This chapter concludes with a discussion on Turkish law’s approach under the Turkish International Private and Procedural Law4 (TIPPL) with regard to cross-border issues in connection with set-off.
34.02 Please note that the information contained herein is generic and general conceptual information, and, as the issue being discussed is controversial, one needs always to run case-specific details of any potential legal matters by a Turkish-qualified lawyer as this chapter will not be able to assist any third parties in (p. 542) respect of their case-specific issues, given the general nature of the explanations herein.
34.03 For purposes of this chapter, the party seeking to set off its claim shall be referred to as the ‘creditor’ and the party whose counterclaim is being set off against shall be referred to as the ‘debtor’.5
34.04 Under Turkish law, set-off is one of the instruments (eg performance, novation, and release) employed to extinguish an obligation. Set-off does not provide for the actual performance of an obligation; rather it serves to extinguish an obligation as if performed in exchange for a counterclaim.
34.05 Set-off means the extinguishment of a creditor’s claim in exchange of a debtor’s counterclaim by the unilateral declaration of the creditor against the debtor.6 Set-off is a method guaranteeing and simplifying payment in commercial transactions. However, with the exception of the provisions governing bankruptcy of the TEBL, it is possible as a contractual matter to waive the legal set-off rights granted by law or to agree to limit such rights because the set-off provisions set forth in the TCO are not of mandatory application, ie such requirements are generally able to be modified by a contractual agreement among the parties.
1. Requirements for set-off
34.06 Under Turkish law, set-off constitutes a unilateral and irrevocable7 act of a creditor extinguishing its claim in exchange for the debtor’s counterclaim which is available when certain conditions are met. With the exception of those specific obligations set forth in Article 144 of the TCO, which are discussed below in Section B.1 under ‘Eligibility’, set-off does not require the consent of the debtor. In order to be valid and binding, the creditor must declare set-off and such declaration must reach the debtor. The creditor must specify in its declaration the cross-obligations to be set off where several cross-obligations exist between the creditor and the debtor. There are no legal requirements as to the form of a set-off declaration. However, a written declaration is preferable for evidentiary purposes since set-off depends upon a valid declaration and is not automatic under Turkish law.
(p. 543) 34.07 The principal requirement for set-off is the existence of two obligations. The other requirements under the TCO are that the obligations must be: (1) mutual, (2) of the same kind, (3) due, and (4) enforceable. In addition, the right of set-off must not have been waived by the debtor or excluded by the TCO.
Positive requirements for set-off:
Two mutual obligations (mutuality)
34.08 The two obligations subject to set-off must be mutual, in the sense that the debtor of one obligation must also be the creditor of the other obligation. However, such obligations need not be related, have the same legal basis,8 or be equal in amount. If the party seeking to extinguish its obligation by way of set-off is not the creditor of the counterparty, it will not have the right of set-off against that counterparty. For instance, a debtor who is jointly and severally liable to a creditor together with another debtor cannot set off its obligation to the creditor in exchange for the other debtor’s claim against the same creditor due to lack of mutuality. Likewise, it is not possible, for the same reason, for a debtor to set off its obligation to a company in exchange for its claim against the controlling shareholder or an affiliate of such company. However, a claim against a branch of a company may be set off against an obligation of another branch or against the company itself, since branches are not legal entities separate from the company.
34.09 Article 140 of the TCO provides that a surety guaranteeing the performance of a debtor’s obligation9 to a creditor may abstain from its payment obligation arising under such surety relationship so long as the debtor continues to retain its right of set-off against that creditor. This provision does not constitute an exception to the mutuality requirement as the surety cannot set off the debtor’s claim against the creditor in exchange for its payment obligation to the creditor arising under the surety relationship; rather, it provides the surety with the right to abstain from performing.10
34.10 Article 188 of the TCO sets forth two exceptions to the mutuality requirement, both of which arise in the context of an assignment.11 First, pursuant to Article 188(1) of the TCO, if a receivable is assigned, and the debtor of the assigned receivable was entitled to exercise its right of set-off against the assignor at the time the debtor became aware of the assignment, then the debtor is also entitled (p. 544) to exercise its right of set-off against the assignee, who is the new creditor of the assigned receivable.
34.11 The debtor of the assigned receivable need not have become the creditor of the assignor before the assignment took place so long as the debtor is able to exercise its set-off right against the assignor at the time the debtor becomes aware of the assignment. In other words, mutuality must be established, with the debtor becoming the creditor of the assignor, before the debtor becomes aware of the assignment, even if the assignment has already taken place. The requirement (that the debtor of the assigned receivable must be the creditor of the assignor before learning of the assignment) protects the assignee, who would otherwise be at risk from the debtor and the assignor colluding against it to establish a claim whose purpose is to permit set off and extinguish the assigned receivable now held by the assignee.
34.12 Second, pursuant to Article 188(2) of the TCO, if the debtor of the assigned claim has a claim from the assignor which is not yet due at the time the debtor becomes aware of the assignment, the debtor may set off such claim against its obligation to the assignee provided that the claim of the debtor from the assignor does not become due after the assigned claim (ie the claim of the debtor of the assigned claim becomes due before or simultaneously with the assigned claim).
Obligations must be of the same kind
34.13 The obligations must be of the same kind (eg, both in money or in fungible goods) in order to be set off. While equal amounts are not required (if the amounts are not equal, the lesser obligation will be extinguished and the balance of the greater obligation will survive the set-off), the characteristics of the fungible goods must be identical. For example, two parties owing five litres of olive oil with different percentages of acidity cannot set off their obligations against one another.
34.14 With the exception of obligations expressly stated to require the debtor to tender payment in a particular currency, counterobligations expressed in different currencies may be set off so long as a conversion rate can be determined. The time of conversion is the subject of doctrinal debate in Turkey (ie whether it should be the time when set-off first became possible or the time of the set-off declaration).12
Obligations must be due
34.15 While Article 139 of the TCO requires that both obligations become due prior to set-off, in practice it is sufficient that only the claim of the party declaring set-off be due at the time of set-off.13 Article 142 of (p. 545) the TCO further provides that the creditors of an insolvent party may exercise their right of set-off even if their claims have not yet become due.14
Obligations must be enforceable
34.17 The claim of the party declaring set-off must be legally enforceable. For example, claims arising from imperfect obligations (eksik borçlar) such as gambling cannot be set off against the claim of a third party as such claims do not carry the right to file lawsuits or to initiate execution proceedings. However, it is possible for that third party to extinguish its obligation arising from gambling in exchange for its claim which is legally enforceable.
34.18 Article 139 of the TCO provides an exception to the enforceability requirement. Even if a claim lacks enforceability because the applicable statute of limitations has passed, such claim may be set off so long as it was not time-barred at the moment when set-off first became possible.15
34.19 Claims subject to exceptions postponing their satisfaction dates (eg a non-payment exception) cannot be set off if the relevant exception is exercised. Likewise, if the debtor of a counterclaim has the right to make a choice in relation to performance of the main claim, it is not possible to declare set-off for the extinguishment of the main claim in exchange for the counterclaim as any such set-off will eliminate the debtor’s right to choose.
Negative requirements for set-off
(p. 546) (iii) obligations the nature of which demand actual performance to their creditors and which are essential for the living expenses of their creditors and their families, such as salary obligations and alimony.16
2. Contractual set-off
34.23 Since provisions relating to set-off contained in the TCO are not of mandatory application and there exists freedom of contract in Turkey, with the exception of the provisions governing bankruptcy of the TEBL and some other issues that pertain to mandatory provisions of Turkish law and public policy issues, parties can agree on their own rules for set-off in an agreement, under certain circumstances. For example, the parties to an agreement may alter certain set-off requirements of the TCO (eg, mutuality or due date), agree an automatic set-off regime, or agree to eliminate the retroactive effect of set-off in certain ways.
1. Function of set-off
34.24 The basic rule under Article 200 of the TEBL is that a creditor may exercise its right of set-off against a bankrupt debtor, yet this is a very controversial issue that requires various case-specific reviews.
34.25 Once a party has been declared bankrupt by a court decision, such party’s debtors must satisfy their obligations to the bankrupt party in full while the unsecured and non-privileged creditors of the bankrupt party typically recover only a portion of their claims. However, if a creditor of a bankrupt party is simultaneously a debtor of such bankrupt party, it may exercise its right of set-off against the bankrupt party and very substantially enhance its likelihood of recovery. If the creditor’s indebtedness to the bankrupt party is greater than its claims against the bankrupt party, the creditor is still required to pay the balance of its debt (after setting off the debtor’s claims against the creditors) to the bankrupt party in full. Likewise, if the creditor’s claim against the bankrupt party is greater than its indebtedness to the bankrupt party, set-off will extinguish the creditor’s indebtedness in full and the balance of the creditor’s claim against the bankrupt party will be treated as an unsecured and non-privileged claim.
34.26 Because creditors exercising their right of set-off in the bankruptcy setting are at an advantage compared to other creditors of the bankrupt party who are not similarly indebted to such party, Article 200 of the TEBL restricts the right of (p. 547) set-off against insolvent parties in order to prevent deterioration in the bankruptcy estate and to protect the rights of unsecured and non-privileged creditors. These restrictions are discussed further in section C.3 below.
2. More possibilities for set-off
34.27 Pursuant to Turkish law, so long as the claim of the party declaring set-off has become due, it may exercise the right of set-off. As noted above, the counterclaim need not yet be due at the time of set-off. However, Article 142 of the TCO provides an exception to the requirement that the claim be due, allowing the creditors of a bankrupt party to exercise their right of set-off upon declaration of bankruptcy since all obligations of a bankrupt party become due upon such declaration under Article 195 of the TEBL. This provision specifically authorizes the right of set-off in the bankruptcy setting even if the claim of the party declaring set-off has not yet become due, if the ‘becoming due’ conditions under the TEBL are legally valid in the current circumstances.
34.28 While creditors are generally entitled to exercise their right of set-off against bankrupt debtors, Article 200 of the TEBL does not permit set-off in the bankruptcy setting in the circumstances described below in order to prevent a decrease in assets of the bankruptcy estate and to protect unsecured and non-privileged creditors of a bankrupt party from fraudulent acts:
(1) If a party indebted to a bankrupt party becomes a creditor of such bankrupt party only after declaration of bankruptcy or if a creditor of the bankrupt party becomes indebted to such bankrupt party or to the bankruptcy estate only after declaration of bankruptcy …
In other words, the TEBL requires the claims of both parties (including the bankrupt party) to exist before the declaration of bankruptcy. However, if a claim already existing against a bankrupt party is obtained (for example, by assignment) by a debtor indebted to such bankrupt party after declaration of bankruptcy, such claim will not be eligible for set-off as the debtor would not have been entitled to exercise its right of set-off as of the declaration of bankruptcy. However, while an existing claim obtained by the debtor of a bankrupt party by way of assignment17 after declaration of bankruptcy is not eligible for set-off, such claim will remain valid and enforceable against the bankruptcy estate. The claim remains ineligible for set-off even if the assignee was ignorant of the declaration of bankruptcy.
A negotiable instrument made out to the bearer can be transferred without endorsement and ownership is acquired through delivery. Because of this, the TEBL restricts the right of set-off of the holder of a bearer instrument as it would be impossible to determine whether the holder acquired the instrument before or after the declaration of bankruptcy. This provision is unfavourable to bona fide holders of bearer instruments acquiring such instruments before the initiation of bankruptcy proceedings.18
(3) Shareholders of joint-stock or limited-liability companies or cooperatives may not extinguish their obligations to contribute capital by setting off their claims against such legal entities in case of bankruptcy of such entities.
This restriction under the TEBL is justified as capital contribution obligations of shareholders constitute security for creditors of a legal entity whose shareholders have limited liability.19
34.29 Under Article 201 of the TEBL, any creditor of a bankrupt party can challenge the set-off right of another creditor of that bankrupt party which was aware of the bankrupt party’s financial distress and became a creditor of the bankrupt party in bad faith before declaration of bankruptcy.20 A lawsuit asserting such a claim must be filed in the court handling the bankruptcy.
34.30 TIPPL sets forth the Turkish conflict-of-laws rules. Pursuant to the TIPPL, the parties are free to choose the governing law of a contract where there exists a ‘foreign element’. If they have not expressly chosen the governing law of a contract, a Turkish court will determine the law most closely related to such contract according to certain presumptions set forth in the TIPPL and deem such law the governing law of the contract by applying certain criteria.
(p. 549) 34.31 In case the receivables subject to set-off have arisen from different contracts with different governing laws or deemed different pursuant to the conflict-of-laws rules, the issue of determining the governing law for the set-off mechanism will arise. Turkish conflict-of-laws rules set forth under the TIPPL do not contain any express rule determining the governing law of the set-off between solvent parties. Such governing law would regulate validity, conditions, and consequences of set-off.
34.32 In the absence of such express rule, despite the very limited sources on this, in Turkish jurisprudence, we think, there are three main positions for determining the governing law. First, it is argued that the governing law should be accepted as lex fori, the laws of the jurisdiction in which a legal action is brought. Second, it is argued that the governing law should be accepted as the governing law of the passive receivable, ie the receivable against which the set-off is exercised. Third, it is argued that the governing laws should apply cumulatively and the set-off should be deemed legally realized only if the set-off is valid and fulfils the relevant conditions under both of the governing laws. Given the lack of court precedents on this issue, it would be very hard to predict the approach of Turkish courts in the event of a dispute on this. Yet in the event of a dispute—especially given the lack of clarity on this—we think that the Turkish courts may try to come up with hybrid formulas with a view to reaching a fair solution and may also have a tendency to favour the first view, to a certain degree, and may also look for a way to apply Turkish law as well (if the application of the first view were to require a different solution). Given the exceeding number of disputes in Turkey with multinational aspects, we hope to see court precedents on this issue that would shed light to the currently unclear and vague situation.
34.33 With regard to determining the law governing set-off against bankrupt parties, although there is no express rule regulating the issue, the prevailing view seems to be that the governing law of the bankruptcy, ie lex fori concursus, should apply to such circumstances.
34.34 Regardless of the law governing set-off, in cases of set-off claims against insolvent Turkish-domiciled parties, including claims of non-Turkish parties against such insolvent parties, we believe that the restrictions set forth above under section C.3 arising from the TEBL would be applied by the Turkish enforcement offices and courts.
34.35 Turkish law permits parties to extinguish mutual claims of the same kind through unilateral declaration of the party whose claim is due at the time of the set-off declaration. Aside from the rules governing set-off under the TCO, which (p. 550) operate by default in the absence of agreement by parties, parties may themselves agree on broad rights for set-off by way of contract. Parties may also waive or limit their legal right of set-off since the TCO’s rules governing set-off are not of mandatory application, save for then-mandatory provisions of the TEBL.
34.36 Set-off extinguishes the lesser obligation while the balance of the greater obligation survives with retroactive effect to the extent that it exceeds the lesser obligation. If counterclaims are equal in amount, then set-off will extinguish both. Claims subject to set-off are not considered extinguished at the time of the set-off declaration; rather, they are deemed by law to have been extinguished as of the time when set-off first became possible.
34.37 Article 200 of the TEBL provides as a general rule that creditors are entitled to exercise the right of set-off against their bankrupt debtors. The TEBL expands upon the possibility of set-off, thereby enabling more claims to be set off in the bankruptcy context while simultaneously restricting set-off rights under certain circumstances in order to prevent a reduction in the assets of the bankruptcy estate and to protect unsecured and non-privileged creditors of a bankrupt party from the fraudulent acts of other creditors.
1 This chapter is an updated version of the chapter in the first edition, the authors of which are Aslı Başgöz, Meltem Akol, and Burcu Boso; and has been updated by Aslı Başgöz, Yalın Akmenek, Can Argon, and Bora Durmaz in August 2017, with the permission of the original authors.
12 Several cases of the Turkish Court of Appeals state that the time of the set-off declaration should be taken into account. Turkish Court of Appeals, 11th Chamber, decision no 1997/6429 dated 30 September 1997; Turkish Court of Appeals, 11th Chamber, decision no 2002/6271 dated 18 June 2002; Turkish Court of Appeals, 13th Chamber, decision no 10383/16887 dated 15 November 2005.
14 A case of the Turkish Court of Appeals has provided the same rights to creditors of a debtor entering into a composition agreement with such debtor. Turkish Court of Appeals, Execution and Bankruptcy Chamber, decision no 137627/13607 dated 20 December 1963 (the aim of a composition proceeding is the financial reorganization of a debtor in distress with the consent of its creditors).
18 This restriction has been heavily criticized by scholars who contend that bona fide holders of bearer instruments evidencing that such instruments were acquired before declaration of bankruptcy should be entitled to exercise their rights of set-off.