By Zeynep Sener

Turkey is hoping that the prospect of 5% annual growth and ratings upgrades in Turkish sovereign debt will attract foreign investment.

The country suffered its own version of the recent global financial crisis in 2001. This forced it to reduce government debt and reform the banking sector in the early part of the decade, and spared it from as severe a downturn as other countries when the worldwide recession hit in 2008. Turkey has been making a steady recovery.

The Organization for Economic Co-operation and Development, or OECD, said in a report in late May that the Turkish economy “rebounded sharply since the second quarter of 2009 thanks to good export performance and GDP [is] projected to expand by 6.8% in 2010 and 4.5% in 2011.”

In line with the confident outlook, rating agencies have upgraded their ratings of Turkish sovereign debt over the last six months. The debt is currently rated BB by Standard & Poor’s with a positive outlook. Some commentators expect Turkish debt to be rated investment grade by 2011.

Turkish GDP more than tripled between 2002 and 2008, from US$231 billion (2002) to US$742 billion (2008). Turkey was the 15th largest economy in the world in 2008 and the sixth largest economy in the 27-country European Union.

Unemployment remains a persistent problem, but no worse than in some of the larger European economies. It is 17% currently in urban areas and 27% for young urban workers.

High direct foreign direct investment is a key element in the strong GDP numbers being reported. By the end of 2009, the Turkish Treasury listed more than 23,000 companies with foreign capital in Turkey. The most visible growth in foreign investment has been in the electricity, gas and water supply sector, according to the latest monthly foreign investment bulletin by the Turkish Treasury, as shown in table 1.

Companies in Holland, the United States, Germany, Britain and the Arab countries have been the major investors. Inbound investment slowed noticeably in 2008 and 2009, in keeping with the slowdown in the global economy, and had yet to record in the first three months of 2010. US inbound investment increased six fold from 2006 to 2007 before the recession hit in 2008 as shown in table 2 on this page.

Legal Framework

Turkey has a civil law system following the continental European tradition rather than a common law system like the legal regimes in place in Britain and the United States. There are no general restrictions on foreign investment, though there are a few provisions of local legislation of which foreign investors should be aware.

Foreign investors are free to make any “direct foreign investments” in Turkey, defined as establishing a company in Turkey, acquiring shares of an unlisted or private Turkish company, and acquiring 10% or more of the shares of a listed or public company.

The Turkish Treasury advertises on its website that since the introduction of the direct foreign investment legislation, there is “freedom to invest” and all former screening, approval, share transfer and minimum share capital requirements have been dropped. The country makes “guarantees to foreign investors of their rights in one transparent stable document.” There is no discrimination between Turkish and foreign investors in Turkish companies. According to the Treasury website:

The new law guarantees national treatment and comprehensive investor rights. All companies established with a foreign capital contribution and under the rules of the Turkish Commercial Code (existing and newly established foreign companies) are regarded as a Turkish company. Therefore equal treatment both in rights and responsibilities as stated in the Constitution and other laws is applicable to all such companies (including national treatment, a guarantee against expropriation without compensation, transfer of proceeds, access to expatriate personnel, and international arbitration or any other means of dispute settlement).

What are the remaining restrictions?

Some restrictions remain, even after the foreign direct investment law. The most visible restrictions are in the area of ownership of real property in Turkey. Foreign persons can only acquire up to 10% of designated zoning areas in each district. Companies incorporated in Turkey by foreign investors (or companies with foreign shareholders) can only acquire and use real property in order to conduct the activities listed in their articles of association. Foreign companies (not incorporated in Turkey) can only acquire real property in limited circumstances, in accordance with certain laws governing particular economic sectors. These sector promotion laws will need to be reviewed in light of the particular circumstances of each potential acquisition.

Foreign investors are freely allowed to repatriate earnings to their home countries, but the dividends, capital gains from sales of assets, interest, rents, royalties and other proceeds or payments must pass through Turkish banks.

There is no currency control, but certain currency transactions require notice to the government.

Most foreign investors set up local corporations. The two most common forms of corporations are the joint stock company, called a JSC, and a limited liability company or LLC.

A JSC requires at least five shareholders, whereas an LLC needs at least two. The minimum share capital of an LLC is TL 5,000, while it is TL 50,000 for a JSC. (Turkey still uses the lira rather than the Euro.) There are no restrictions on foreign shareholders.

Foreign investors and corporations they own are subject to the general reporting requirements under Turkish law — for instance, certain corporate documents, such as the articles of association and any amendments to them, must be filed with the Trade Registry (much like Companies House in the United Kingdom). In addition, foreign companies must provide certain additional information to the Foreign Investment General Directorate.

Any companies incorporated in Turkey (including foreign-owned) as well as the Turkish branch offices of foreign parent companies are subject to corporate income taxes in Turkey at a 20% rate. Dividends are generally subject to withholding tax at the border at a 22% rate. The withholding tax on interest is 13.2%, but it is 0% on some foreign loans. Turkey has a range of tax treaties with other countries that reduce the withholding rates to as low as 10%.

Legal Protections

The latest annual “Doing Business” report from the World Bank that compares business climates in 180 countries ranks Turkey 73rd. (For comparison, Singapore is first and Russia ranks 120th.) The biggest problems in Turkey, according to the World Bank, are labor issues and obtaining construction permits. Turkey does relatively well on the legal protections it provides to enforce contract rights in the local courts, ranking 27th in this category. According to the World Bank, a legal judgment can usually be obtained within 420 days at a cost in legal fees of just under 19% of the amount claimed.

Many businesses prefer to submit their disputes to private arbitration. Turkey introduced a new international arbitration law in 2001. One of the main goals was to make arbitration more effective. The law is based mainly on the UNCITRAL model law, with additional inspiration taken from Swiss arbitration procedures. It applies to all disputes with a foreign element where the place of arbitration is in Turkey, and it can also be chosen by the parties.

Recent decisions of the Turkish courts have, on the whole, been favorable to arbitration. The Turkish judiciary is becoming more familiar with arbitration, particularly as regards the enforcement of awards, and is reaching more and more decisions that reflect the international pro-arbitration consensus.

The Turkish court of appeals has held that the question of jurisdiction — whether arbitrators (or the courts) can hear a claim — is to be determined by the arbitrators themselves in the first instance. When arbitration proceedings are commenced, the arbitrators will decide whether they have jurisdiction without interference from the national courts at this stage. However, lack of jurisdiction may be invoked as a ground later for resisting enforcement of an arbitral award.

The Turkish courts have also considered the scope and effectiveness of arbitration clauses. For example, in one decision the court of appeals found that a defective arbitration clause that provided that disputes would go to arbitration but would ‘finally’ be submitted to the courts was not effective. The court said the intention of the parties to choose arbitration instead of litigation before the courts had to be clear.

As part of Turkey’s efforts to establish itself as a more investment-friendly jurisdiction, Turkey has agreed to international obligations that support both international arbitration and foreign investment. In 1992, it acceded to the New York Convention 1958, a multilateral treaty that provides an international framework for the reciprocal enforcement of arbitral awards handed down in any signatory states.

Today, most foreign arbitral awards are enforced in Turkey under the New York convention. Turkey does have a domestic statute that applies technically to the enforcement of foreign arbitral awards. However, Turkish law also says that international conventions to which Turkey is a party have priority (including the New York convention). The national law in question has also been amended to bring it more in line with the New York Convention. Decisions of the Turkish court of appeals since 2000 show that the principles in the New York convention are applied more and more consistently.

Turkey made a reservation from its accession to the New York convention, the so-called “commercial reservation.” The Turkish Courts will only apply the New York convention to awards made in disputes the subject matter of which is considered “commercial” under Turkish law. Turkish law also provides for mandatory jurisdiction of the state courts over certain matters, such as real property rights, public law matters, criminal offences and matters relating to tax collection.

Turkey also ratified a separate treaty called the ICSID convention in 1989 (to give it its full name, the Convention on the Settlement of Investment Disputes between States and Nationals of Other Member States, Washington, 1965). The ICSID convention, another multilateral treaty, was originally formulated under the stewardship of the World Bank. There are currently more than 150 signatories. ICSID’s link with the World Bank, though not based on any formal treaty provision, has given rise to a perception by states that ICSID awards should be paid (to avoid repercussions on credit ratings). The ICSID Convention provides for a regime of automatic enforcement of awards by signatory states. The circumstances in which an ICSID award can be set aside (annulled) are very limited (for example, lack of jurisdiction). These awards are not subject to any kind of detailed review by national courts during enforcement proceedings.

Foreign investors have so far brought seven arbitration cases before ICSID against Turkey. These cases arose either out of the energy sector — particularly as regards electricity concession agreements — or the licensing arrangements for mobile telecommunications.

One of the energy cases involved US power company PSEG. PSEG was awarded a concession contract by the government in 1989 to build a lignite-fired thermal power plant in Turkey. It charged that the government effectively terminated the concession agreement during the development phase of the project after protracted negotiations and post-contractual amendments. The ICSID tribunal agreed with PSEG that Turkey had acted in breach of international law. However, the tribunal did not award PSEG the US$500 million PSEG wanted for loss of potential profits and was awarded only US$6 million to cover out-of-pocket costs.