Turkey: Non-Compete Obligation Of Board Of Directors Members In Joint Stock Companies

1. The Rule

According to Article 396 of the Turkish Commercial Code, which entered into force in 2012 ("TCC"), unless consent of the General Assembly (by simple majority) is obtained, the Board of Directors ("Board") members cannot engage (directly or as a partner with unlimited liability) in activities that fall within the scope of the company's business, either on their own or on a third party's account. This non-compete obligation only applies to the businesses that the company actually performs and which are carried out with a commercial purpose. A business that is merely mentioned in the articles of association, but not actually performed by the company does not fall under the scope of Article 396, meaning that the Board members are permitted to engage in such activities regardless of whether such activities are indicated in the "scope and purpose" clause of the articles of association as long as the company does not physically carry out the same.

A partner with unlimited liability means either a shareholder in an ordinary partnership (in Turkish, "adi ortaklık"), an active partner –i.e. a shareholder with unlimited liability- in a commandite partnership (in Turkish, "komandit şirket") or a shareholder in a collective company (in Turkish, "kollektif şirket"). Therefore, merely being a shareholder in a joint stock company (in Turkish, "anonim şirket") or a limited liability company (in Turkish, "limited şirket") by and of itself does not directly present an issue under Article 396. That said, in such cases, actions of a Board member who becomes a shareholder in a competitor joint stock or a limited liability company (with no executive or representation powers), may constitute a breach of the Board member's loyalty and care duties regulated under Article 369 of the TCC. Examples of such actions could be; giving advice to the executives, sharing confidential information or unofficially directing the management. According to Article 369 of the TCC, the Board members are obligated to perform their duties with the care of a prudent merchant and always protect the interests of the company under the principle of honesty. Therefore it is safe to say that Article 369 puts forward a broader liability that encompasses the above-mentioned non-compete obligation.

In addition, Article 396 does not expressly prohibit being a Board member, manager or an authorized representative in another company that conducts activities which fall within the scope of the company's business. However, it is widely accepted by the High Court of Appeals and also among the scholars that Board members should not be permitted to become a board member, manager or an authorized executive in another company that engages in the same business as the first company, based on the spirit and purpose of the non-compete obligation and also taking account the duty of loyalty and care mentioned above.

2. Exceptions

A Board member may be relieved from the non-compete obligation with the consent of the General Assembly which can be obtained with the affirmative votes of simple majority of the shareholders (or their proxies) present in a meeting (unless a higher quorum is mandated in the articles of association). General Assembly meetings are held with the presence of shareholders (or their proxies) owning/representing shares which represent at least 1/4 of the capital of the company (unless a higher quorum is mandated in the articles of association).

As a crucial issue, according to Article 436 of the TCC, a shareholder is prohibited from participating in General Assembly meetings which are held to discuss a personal transaction or a legal/arbitral case between the company and himself/herself, his/her spouse, lineal kinship or the companies in which the same are shareholders. In a recent decision in 2014, High Court of Appeals ruled that a shareholder (who is also a Board member) is prohibited from voting in a General Assembly convened to decide on relieving the said shareholder from his/her non-compete obligation regulated under Article 396. The court also ruled this prohibition also extends to spouse and lineal kinship and even sisters and brothers.

In addition, Article 436 of the TCC also regulates that shareholders who are also Board members or authorized signatories are prohibited from participating in General Assembly meetings held to decide on releasing them from liabilities or obligations.

3. Sanctions

3.1 Special Liability under Article 396

According to Article 396, in case of a violation of the non-compete obligation, the company may either i) demand compensation from the breaching Board member or ii) file a lawsuit to request to have the benefits/proceeds of the competing transaction/action performed by the breaching Board member to be transferred to the company. The Board decides on which option will be preferred and the breaching Board member cannot participate in the meetings held to make such decision.

Either one of the above-mentioned rights must be exercised by the company within 3 months following the performance of the competing activity by the breaching Board member or the date when the company becomes aware of such competing activity; and in any case within 1 year following the performance of the competing activity.

The company is not required to prove that it actually suffered any damage or that the breaching Board member is negligent in order to make any claim against the Breaching member. Mere occurrence of the breach itself is sufficient to trigger liability under Article 396.

3.2 General Liability under Article 553

According to Article 553 of the TCC, founding shareholders, Board members, managers or liquidation officers breaching their liabilities arising out of the law or articles of association due to their fault, shall be liable against the shareholders and the creditors of the company for the damages that the company incurs as a result of such breach. Any shareholder can request compensation for damages; however payment may only be made to the company. Unlike the exercise of non-compete clause under Article 396, plaintiff must prove negligence of the defendant and existence of the damages in lawsuits arising out of Article 553.

The statute of limitations for enforcing Article 553 is 2 years following the date the plaintiff becomes aware of the breaching activity and the damage that is incurred by the company; and in any way 5 years upon occurrence of the breaching activity.

As a final note, as mentioned above, in case of a breach of non-compete obligation under Article 396 of the TCC, the company is required to exercise one of the rights regulated under the said article within 3 months following the performance of the competing activity by the breaching Board member or the date when the company becomes aware of such competing activity and in any case within 1 year following the performance of the competing activity. If the company fails to exercise such rights within the said time period, shareholders may nevertheless file a lawsuit against the breaching Board member due to breach of duty of loyalty and care within the time period regulated under Article 553.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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