New Era in Commercial Leases in Turkey

New Era in Commercial Leases in Turkey

When the Turkish Code of Obligations (the “TCO”) entered into force on 1 July 2012, it introduced numerous provisions in favor of lessees, similar to the pro-lessee provisions of the former Law on Real Estate Leases, without distinguishing between residential leases and workplace leases. However, upon the request of prominent investors, particularly shopping mall investors, a transition period was granted for parties of commercial leases to comply with the new provisions of the TCO. Through Provisional Article 2 of Law numbered 6217, the implementation of nine provisions of the TCO was postponed to 1 July 2020 for commercial leases.  

During the transition period, parties were free to determine the matters that fell within the scope of the postponed provisions, and in the absence of relevant provisions in their agreement, the provisions of the former Code of Obligations (the “Former TCO”), former Law on Real Estate Leases as well as the established precedent of the Cassation Court applied. On the other hand, the TCO’s postponed provisions applied to residential leases throughout the transition period. Accordingly, the precedent established for residential leases based on the TCO during the transition period, will also apply to the commercial leases as of 1 July 2020.

  1. Assignment of Lease Agreement (Article 323 of the TCO)

During the transition period, without any prejudice to the specific provisions in the agreements between the parties, lessors of commercial leases had the opportunity to refrain from providing their written consent to the agreement’s assignment by lessees. On the other hand, under the postponed Article 323 of the TCO, lessees cannot assign the lease agreement to third parties without obtaining the lessor’s written consent. However, in commercial leases, lessors cannot refrain from granting their consent to such assignment without a just cause. Therefore, as of 1 July 2020, lessors of commercial leases can only refuse to grant their consents to the agreement’s assignment if there is a valid reason, such as the new lessee’s financial incompetence. In addition, lessees of commercial leases assigning the lease agreement will be jointly liable with the new lessees until the end of the lease term, and for a term of two years at the most.

  1. Return of Leased Property Before Expiry of the Agreement (Article 325 of the TCO)

During the transition period, the parties could freely agree on the term during which the lessee would be liable for paying rental fees, following termination of the agreement by the lessee before its expiration date, without a just cause. Moreover, the parties could agree on an early termination penalty either in addition to or instead of the rental fee. In cases where the agreement did not include any provisions regarding early eviction, experts calculated the reasonable period for which the premises could be leased to a new lessee (under ordinary conditions), and the rental fee corresponding to such period was collected from lessees, after deducting the amounts which the lessor saved during this period.

As the postponed Article 325 of the TCO is a reflection of precedent established based on the Former TCO, it provides a legal mechanism for early termination similar to the one explained above. According to Article 325, the lessee’s obligation to pay the rental fees and ancillary expenses arising from early termination continues for a reasonable period required for leasing the premises to a new lessee under similar conditions. In the Cassation Court’s precedent, this period is calculated by experts and varies from two to six months depending on the premises’ qualifications. In addition, similar to the Former TCO’s rule applied during the transition period, the amount saved by the lessors will be deducted from the amount to be paid by the lessees.

Contrary to the practice adopted during the transition period, the payment obligations and penalty amounts determined for early termination events, will be deemed invalid as of 1 July 2020 if they exceed the reasonable period. Lessees may refrain from the above liabilities, if they can find a new lessee that is ready to take over the lease relationship. The new lessee must be financially competent and reasonably acceptable to the lessor. 

  1. Termination with Just Cause (Article 331 of the TCO)

Article 331 of the TCO provides that, in the event of material reasons making the lease relationship’s continuance unbearable, both the lessee and lessor can terminate the lease agreement by complying with the notice periods. As the Former TCO had similar provisions and there was precedent established based on such provisions of the Former TCO, during the transition period, commercial leases’ parties could terminate the lease agreements based on material reasons and the rule could not be altered by the parties’ mutual agreement.

On the other hand, the second paragraph of Article 331 provides that in the event of termination based on material reasons, the court, at its sole discretion, will consider the circumstances and conditions and decide on the termination’s monetary results. The Former TCO did not have a similar clause. As per the Former TCO and the precedent established based on the Former TCO, the party exercising its termination right was obliged to compensate all damages incurred by the other party due to such termination. As of 1 July 2020, the amount of compensation to be paid to the counterparty will be determined by the court in accordance with the fairness principle  and if the specifics of the case do not necessitate payment of compensation, the party terminating the agreement based on a material reason will not be under any payment obligation.   

Additionally, when the Former TCO was in force, the rule on termination for material reasons did not apply to real property leases with an indefinite term, and lessees were not obliged to return the premises to the lessor until the lessor paid the relevant compensation. These rules continued to apply to commercial leases during the transition period. However, as of 1 July 2020, the relevant provisions of Article 331 will become applicable to indefinite term commercial leases, and lessees will be obliged to return the premises without waiting for the lessor to pay the relevant compensation.

  1. Restriction on Linked Agreements (Article 340 of the TCO)

The postponed Article 340 of the TCO prohibits lessors from imposing additional obligations on lessees, by forcing them to execute additional agreements that are not in their favor and do not directly relate to the use of the leased premises. During the transition period, these additional obligations and agreements were deemed valid. As of 1 July 2020, such additional obligations and agreements will be deemed invalid. However, the lease agreement will continue to be valid.

  1. Security Payment by Lessee (Article 342 of the TCO)

During the transition period, commercial leases’ parties could freely determine the amount and payment method of security deposits that could be requested from lessees. In practice, lessors requested very high amounts as security deposits.

According to the postponed Article 342 of the TCO, parties cannot agree on a deposit amount exceeding three months’ rental fee. Additionally, (i) if the deposit is to be paid in cash, that payment must be deposited in a savings account in a bank, in a way that cannot be withdrawn without the lessor’s approval and (ii) if it is agreed that the deposit will be paid by negotiable instruments, such negotiable instrument must be stored in a bank. The relevant provision also regulates certain assurances for the return of the deposit amount. Banks can only return the deposit amount based on (i) both parties’ consents, (ii) a final enforcement proceeding or (iii) a final court decision. As of 1 July 2020, these rules will also apply to commercial leases.

The Cassation Court’s precedent is expected to shed light on the status of deposits already paid during the transition period. In practice, the TCO’s provisions regarding the payment method of the deposit amount has not been applied for residential leases either, due to practical difficulties. Despite the relevant provision, in practice, deposit amounts are paid in person or through a bank wire to the lessors’ account.

  1. Prohibition of Amendments to the Lessee’s Detriment (Article 343 of the TCO)

Under Article 343 of the TCO, parties cannot amend the lease agreement to the lessee’s detriment following its execution. However, adjustments to be made in the rental fee constitutes the exception to this restriction. Although this was a postponed provision, due to established precedent, it has been treated as if the provision was not postponed.

  1. Determination of Rental Fee (Article 344 of the TCO)

During the transition period, parties of commercial leases could freely determine the annual rental fee increase rate to be applied during the lease term and renewal terms, regardless of whether the rent was denominated in foreign currency or Turkish Lira.

On the other hand, as per the suspended Article 344 of the TCO, the annual rental fee increase rate to be applied during the lease term and renewal terms cannot be more than the average of the change in the consumer price index in the last twelve months (the “Increase Rate Cap”). Accordingly, if the annual increase rate set forth under the agreement exceeds the Increase Rate Cap, the rental fee will be increased by the Increase Rate Cap. However, this restriction applies only for a five-year lease term. At the end of each five-year lease term, the parties may apply to court for adjustment of the rental fee on an arm’s length basis. In such a case, the court will decide on the new rental fee in accordance with the Increase Rate Cap, leased premises’ condition, sample rental fees and fairness principle.

If the rental fee is denominated in a foreign currency (in compliance with Decree No. 32 on Protection of the Value of Turkish Currency), it cannot be increased until the end of each five-year lease term. However, after each five-year lease term, parties may apply to court for adjustment of the rental fee on an arm’s length basis.

As of 1 July 2020, the TCO’s restriction on rental fee increases will become applicable for commercial leases. 

  1. Prohibition on Regulation to the Lessee’s Detriment (Article 346 of the TCO)

During the transition period, in practice, lessors of commercial leases often included penalties or rent acceleration clauses to the detriment of lessees, applicable in case of late payments. Those provisions were deemed valid based on the freedom of contract.

Under Article 346 of the TCO, payment obligations other than rental fees and ancillary expenses cannot be imposed on lessees. Although such provisions are commonly used in practice, they are invalid. However, the validity of payment obligations imposed on lessees as common expenses, must be evaluated together with the Law on Regulation of Retail Trade, the Regulation on Shopping Malls and the Condominium Law, to the extent applicable.

Provisions stipulating penalties or rent acceleration clauses to the lessees’s detriment in case of late payment are invalid, as per Article 346. This such restriction will become applicable for commercial leases too, as of 1 July 2020.

  1. Limited Termination Grounds (Article 354 of the TCO)

Article 354 of the TCO provides that the conditions for the termination of a lease agreement by way of filing a lawsuit, cannot be altered to the lessees’ detriment. This provision aims to limit the termination grounds and prevent parties from broadening the existing termination grounds to the lessees’ detriment. During the transition period, it was very common for parties to stipulate long and detailed termination grounds, in addition to the ones regulated in the TCO. However, the validity of such provisions was debated among scholars, as there was a similar statutory provision in the Former TCO, and judicial decisions were shaped and established based on the same understanding.

The principle of limited termination grounds will be applicable for commercial leases as of 1 July 2020. Lessors will not be able to evict lessees based on grounds that are not set forth under the TCO

When the Turkish Code of Obligations (the “TCO”) entered into force on 1 July 2012, it introduced numerous provisions in favor of lessees, similar to the pro-lessee provisions of the former Law on Real Estate Leases, without distinguishing between residential leases and workplace leases. However, upon the request of prominent investors, particularly shopping mall investors, a transition period was granted for parties of commercial leases to comply with the new provisions of the TCO. Through Provisional Article 2 of Law numbered 6217, the implementation of nine provisions of the TCO was postponed to 1 July 2020 for commercial leases.  

During the transition period, parties were free to determine the matters that fell within the scope of the postponed provisions, and in the absence of relevant provisions in their agreement, the provisions of the former Code of Obligations (the “Former TCO”), former Law on Real Estate Leases as well as the established precedent of the Cassation Court applied. On the other hand, the TCO’s postponed provisions applied to residential leases throughout the transition period. Accordingly, the precedent established for residential leases based on the TCO during the transition period, will also apply to the commercial leases as of 1 July 2020.

  1. Assignment of Lease Agreement (Article 323 of the TCO)

During the transition period, without any prejudice to the specific provisions in the agreements between the parties, lessors of commercial leases had the opportunity to refrain from providing their written consent to the agreement’s assignment by lessees. On the other hand, under the postponed Article 323 of the TCO, lessees cannot assign the lease agreement to third parties without obtaining the lessor’s written consent. However, in commercial leases, lessors cannot refrain from granting their consent to such assignment without a just cause. Therefore, as of 1 July 2020, lessors of commercial leases can only refuse to grant their consents to the agreement’s assignment if there is a valid reason, such as the new lessee’s financial incompetence. In addition, lessees of commercial leases assigning the lease agreement will be jointly liable with the new lessees until the end of the lease term, and for a term of two years at the most.

  1. Return of Leased Property Before Expiry of the Agreement (Article 325 of the TCO)

During the transition period, the parties could freely agree on the term during which the lessee would be liable for paying rental fees, following termination of the agreement by the lessee before its expiration date, without a just cause. Moreover, the parties could agree on an early termination penalty either in addition to or instead of the rental fee. In cases where the agreement did not include any provisions regarding early eviction, experts calculated the reasonable period for which the premises could be leased to a new lessee (under ordinary conditions), and the rental fee corresponding to such period was collected from lessees, after deducting the amounts which the lessor saved during this period.

As the postponed Article 325 of the TCO is a reflection of precedent established based on the Former TCO, it provides a legal mechanism for early termination similar to the one explained above. According to Article 325, the lessee’s obligation to pay the rental fees and ancillary expenses arising from early termination continues for a reasonable period required for leasing the premises to a new lessee under similar conditions. In the Cassation Court’s precedent, this period is calculated by experts and varies from two to six months depending on the premises’ qualifications. In addition, similar to the Former TCO’s rule applied during the transition period, the amount saved by the lessors will be deducted from the amount to be paid by the lessees.

Contrary to the practice adopted during the transition period, the payment obligations and penalty amounts determined for early termination events, will be deemed invalid as of 1 July 2020 if they exceed the reasonable period. Lessees may refrain from the above liabilities, if they can find a new lessee that is ready to take over the lease relationship. The new lessee must be financially competent and reasonably acceptable to the lessor. 

  1. Termination with Just Cause (Article 331 of the TCO)

Article 331 of the TCO provides that, in the event of material reasons making the lease relationship’s continuance unbearable, both the lessee and lessor can terminate the lease agreement by complying with the notice periods. As the Former TCO had similar provisions and there was precedent established based on such provisions of the Former TCO, during the transition period, commercial leases’ parties could terminate the lease agreements based on material reasons and the rule could not be altered by the parties’ mutual agreement.

On the other hand, the second paragraph of Article 331 provides that in the event of termination based on material reasons, the court, at its sole discretion, will consider the circumstances and conditions and decide on the termination’s monetary results. The Former TCO did not have a similar clause. As per the Former TCO and the precedent established based on the Former TCO, the party exercising its termination right was obliged to compensate all damages incurred by the other party due to such termination. As of 1 July 2020, the amount of compensation to be paid to the counterparty will be determined by the court in accordance with the fairness principle  and if the specifics of the case do not necessitate payment of compensation, the party terminating the agreement based on a material reason will not be under any payment obligation.   

Additionally, when the Former TCO was in force, the rule on termination for material reasons did not apply to real property leases with an indefinite term, and lessees were not obliged to return the premises to the lessor until the lessor paid the relevant compensation. These rules continued to apply to commercial leases during the transition period. However, as of 1 July 2020, the relevant provisions of Article 331 will become applicable to indefinite term commercial leases, and lessees will be obliged to return the premises without waiting for the lessor to pay the relevant compensation.

  1. Restriction on Linked Agreements (Article 340 of the TCO)

The postponed Article 340 of the TCO prohibits lessors from imposing additional obligations on lessees, by forcing them to execute additional agreements that are not in their favor and do not directly relate to the use of the leased premises. During the transition period, these additional obligations and agreements were deemed valid. As of 1 July 2020, such additional obligations and agreements will be deemed invalid. However, the lease agreement will continue to be valid.

  1. Security Payment by Lessee (Article 342 of the TCO)

During the transition period, commercial leases’ parties could freely determine the amount and payment method of security deposits that could be requested from lessees. In practice, lessors requested very high amounts as security deposits.

According to the postponed Article 342 of the TCO, parties cannot agree on a deposit amount exceeding three months’ rental fee. Additionally, (i) if the deposit is to be paid in cash, that payment must be deposited in a savings account in a bank, in a way that cannot be withdrawn without the lessor’s approval and (ii) if it is agreed that the deposit will be paid by negotiable instruments, such negotiable instrument must be stored in a bank. The relevant provision also regulates certain assurances for the return of the deposit amount. Banks can only return the deposit amount based on (i) both parties’ consents, (ii) a final enforcement proceeding or (iii) a final court decision. As of 1 July 2020, these rules will also apply to commercial leases.

The Cassation Court’s precedent is expected to shed light on the status of deposits already paid during the transition period. In practice, the TCO’s provisions regarding the payment method of the deposit amount has not been applied for residential leases either, due to practical difficulties. Despite the relevant provision, in practice, deposit amounts are paid in person or through a bank wire to the lessors’ account.

  1. Prohibition of Amendments to the Lessee’s Detriment (Article 343 of the TCO)

Under Article 343 of the TCO, parties cannot amend the lease agreement to the lessee’s detriment following its execution. However, adjustments to be made in the rental fee constitutes the exception to this restriction. Although this was a postponed provision, due to established precedent, it has been treated as if the provision was not postponed.

  1. Determination of Rental Fee (Article 344 of the TCO)

During the transition period, parties of commercial leases could freely determine the annual rental fee increase rate to be applied during the lease term and renewal terms, regardless of whether the rent was denominated in foreign currency or Turkish Lira.

On the other hand, as per the suspended Article 344 of the TCO, the annual rental fee increase rate to be applied during the lease term and renewal terms cannot be more than the average of the change in the consumer price index in the last twelve months (the “Increase Rate Cap”). Accordingly, if the annual increase rate set forth under the agreement exceeds the Increase Rate Cap, the rental fee will be increased by the Increase Rate Cap. However, this restriction applies only for a five-year lease term. At the end of each five-year lease term, the parties may apply to court for adjustment of the rental fee on an arm’s length basis. In such a case, the court will decide on the new rental fee in accordance with the Increase Rate Cap, leased premises’ condition, sample rental fees and fairness principle.

If the rental fee is denominated in a foreign currency (in compliance with Decree No. 32 on Protection of the Value of Turkish Currency), it cannot be increased until the end of each five-year lease term. However, after each five-year lease term, parties may apply to court for adjustment of the rental fee on an arm’s length basis.

As of 1 July 2020, the TCO’s restriction on rental fee increases will become applicable for commercial leases. 

  1. Prohibition on Regulation to the Lessee’s Detriment (Article 346 of the TCO)

During the transition period, in practice, lessors of commercial leases often included penalties or rent acceleration clauses to the detriment of lessees, applicable in case of late payments. Those provisions were deemed valid based on the freedom of contract.

Under Article 346 of the TCO, payment obligations other than rental fees and ancillary expenses cannot be imposed on lessees. Although such provisions are commonly used in practice, they are invalid. However, the validity of payment obligations imposed on lessees as common expenses, must be evaluated together with the Law on Regulation of Retail Trade, the Regulation on Shopping Malls and the Condominium Law, to the extent applicable.

Provisions stipulating penalties or rent acceleration clauses to the lessees’s detriment in case of late payment are invalid, as per Article 346. This such restriction will become applicable for commercial leases too, as of 1 July 2020.

  1. Limited Termination Grounds (Article 354 of the TCO)

Article 354 of the TCO provides that the conditions for the termination of a lease agreement by way of filing a lawsuit, cannot be altered to the lessees’ detriment. This provision aims to limit the termination grounds and prevent parties from broadening the existing termination grounds to the lessees’ detriment. During the transition period, it was very common for parties to stipulate long and detailed termination grounds, in addition to the ones regulated in the TCO. However, the validity of such provisions was debated among scholars, as there was a similar statutory provision in the Former TCO, and judicial decisions were shaped and established based on the same understanding.

The principle of limited termination grounds will be applicable for commercial leases as of 1 July 2020. Lessors will not be able to evict lessees based on grounds that are not set forth under the TCO