Turkey: Non-Compete Clauses In Share Transfer Agreements Review Of The Court Of Cassation's Decision

Introduction

The 11th Civil Chamber of the Court of Cassation approved the decision of the court of first instance by the majority of votes with its decision dated 11.06.20151. The court of first instance stated in its decision regarding a non-competition clause for a 15 year period provided in a joint stock company's share transfer agreement that "the penalty clause is null and void as it restricts the economic freedom of the parties and is incompatible with the principle of good faith and morality." We will assess the relevant decision along with the rationale behind the decision and the dissenting votes.

Summary of the Case

The claimants, N. and Ç.G., acquired a certain amount of shares of the company from the persons who were non-parties to the lawsuit, and acquired the remaining amount of shares from the defendant S.K.K. The transferors accepted and undertook through the transfer agreement that they shall not conduct any storekeeping activities within the limits of the province of Antalya, and they shall pay a penalty for non-conformance. Nevertheless, the employer of the defendant, S.K.K., procured another defendant, A.Ç., to establish a company that is active in storekeeping; thus, it continued to conduct storekeeping activities in Antalya. The claimant requested the prevention of unfair competition as the defendants prevent the company from operating in the field of storekeeping by submitting better offers to the ships to which the company submits offers and, thus, they damage the company; the claimant also demanded from the defendant, S.K.K, to pay the penalty in the amount of TRY 160.000.

The defendant, A.Ç., argued that he is not a party to the share transfer agreement, and he has no commercial partnership with the other defendant. On the other hand, the defendant, S.K.K., requested the dismissal of the lawsuit by also alleging that he has no commercial relation with the other defendant. Following the dismissal of the lawsuit by the court of first instance, the claimants appealed the decision, and the 11th Civil Chamber of the Court Cassation quashed the decision as the defendants undertook the protocol regarding the share transfer not to compete with the company during the company's license term; therefore, the Court ruled that the term of the license should be determined and the court of first instance should assess whether the non-compete clause for such period infringes the economic freedom and freedom of labor of the defendants. Following the quashing of the decision, the court of first instance followed the ruling of the Court of Cassation, and concluded that the 15 year term is unreasonable, and is contrary to the economic freedom of the defendants, as well as the principle of good faith and ethics, and ruled that the penalty clause is null and void for this reason, and that the operations do not constitute an act of unfair competition. In relation to the defendant, A.Ç., the court ruled that the defendant is not a party to the protocol. Thus, the court dismissed the requests of the claimants, and the Court of Cassation approved the relevant decision with the majority of votes.

Dissenting Opinions

There are two dissenting opinions to the abovementioned decision. The first one states that the term of non-competition is, in fact, 12 years considering the date of conclusion of the share transfer protocol; therefore, the assessment of 15 years is inadequate, although the term of the license is 15 years. Subsequent to this determination, the judge states that the non-competition clause and penalty clause provided in the share transfer agreement may be evaluated similarly with the rules provided for the non-competition clauses in the case of transfer of the commercial enterprise. With the transfer of the commercial enterprise, the goodwill of the enterprise is also transferred to the transferee, and in accordance with the principle of good faith, the transferor shall have the obligation of non-compete with the enterprise that it transferred, even if such non-compete clause is not expressly provided in the agreement. The judge concluded that the parties agreed that the goodwill of the company is of substantial importance and, therefore, the non-compete period of 12 years provided within the limits of freedom of contract is reasonable, and it does not illegally infringe upon the economic freedom of the defendants.

The second dissenting opinion also determined that the non-compete clause is set forth for 12 years. Subsequently, the judge underlined that the non-compete clause has arisen from necessity, in practice, and that it is foreseen under the provisions regarding the employment contract of the Turkish Code of Obligations ("TCO"), as well as the provisions regarding the commercial agency under Article 123 of the Turkish Commercial Code ("TCC"); the judge noted that the non-compete clauses are also permitted within the scope of a transfer of the commercial enterprise, although there no explicit provisions set forth by the TCO. The judge also noted that the non-competition clauses are often subject to certain restrictions in terms of location, term and subject matter, and that any contract violating the general principles of ethics are null and void pursuant to Articles 26 and 27 of the TCO. After this general introduction, the judge applied these rules to the case at hand, and stated that the non-competition clause provided by the share transfer agreement is in conformity with Articles 26 and 27 in terms of location and subject matter limitations, and that the term of 12 years is reasonable for these contracts. It is noted that non-competition clauses in such contracts shall not be evaluated pursuant to the restrictions provided for the employment contracts and license agreements, because the consideration paid for the transfer of shares was principally paid for the goodwill and customer portfolio of the company. The judge further underlined that the storekeeping company subjected to the share transfer does not have any production facility, and the goodwill of the company is its substantial asset; even if the 12 year term is not considered reasonable, nullity of the non-compete clause and total freedom of the transferor is not in conformity with the principle of interpretation in favor of the parties (favor negotii/favor contractus) in terms of contractual economy and the parties' interests. Therefore, the judge concluded that the non-compete clause was violated by the storekeeping activities of S., in Antalya, right after the conclusion of the contract, and the judge disagrees with the decision of the majority.

Our Opinion

The 11th Civil Chamber of the Court of Cassation, in its two decisions dated 2011 and 20122, ruled that non-compete obligation after the termination of the agreement is null and void, as it is a form of tying, and violates the freedom of labor, and restricts the economic freedom of the other party. In the abovementioned decision, the 11th Civil Chamber maintained its position, and confirmed that the non-compete clause restricts economic freedom, and is contrary to the principle of good faith and ethics; therefore, the non-compete clause and the relevant penalty clause are deemed void. Under Turkish law, the non-compete obligation after termination of the contract is provided for under Articles 444 and 445 of TCO in relation to the employment contract, and by Article 123 of the TCC in relation to the agency contract. In our opinion, these provisions are not directly, nor by analogy, applicable to the non-compete clauses provided in share transfer agreements, as they are substantially different in nature. The purpose of these provisions is to protect the inferior party (which is the employee in the employment contract and the commercial agent in the agency contracts). On the other hand, Law No. 4045 on the Protection of Competition and the relevant communiqués set forth certain provisions on non-compete obligations3. Such agreements are referred to as ancillary non-compete agreements under Turkish law, and the validity of these agreements are subject to certain conditions4. Non-compete clauses are usually provided in mergers or acquisitions transactions as an ancillary to these transactions. In order for a non-compete obligation to be deemed an ancillary to a merger or acquisition transaction, and to be valid, the restriction should be compulsory, objective, reasonable and enforceable for a reasonable period5.

Under competition law, the condition of compulsion is deemed satisfied if the ancillary non-compete obligation imposed upon the seller is obligatory to ensure and guarantee the full enjoyment of the purchaser of the company's commercial assets. In the abovementioned case, the purpose of the purchaser, the claimant, is to acquire the totality of the commercial assets of the company. The commercial assets of the company is comprised of material assets, such as immovables, machineries, materials, and vehicles, as well as non-material assets, especially in the case at hand, such as customer portfolios, know-how, licenses, trade names, trademarks, reputation and goodwill. We believe that the condition of compulsion is satisfied when the parties set forth a non-compete clause in order for the full and efficient enforcement of the terms of the agreement, to ensure the outcomes expected by both parties, and to guarantee the full enjoyment of the purchaser from the non-material assets of the company6.

In our opinion, the condition of objectivity is also satisfied. The objectivity means that such a restriction is necessary pursuant to the conditions of that specific merger or acquisition7 In our case, the parties of the share transfer agreement do not have any purpose of eliminating the seller, defendant, from the market or restricting its freedom of enterprise or liberty of trade. The parties' objective is to protect the purchaser8 from the competition to be created by the seller and, thus, to protect its right to benefit from the non-material assets of the company, to develop know-how and goodwill, and especially to preserve its position in the market.

With regard to the condition of reasonability, the non-compete obligation should not exceed the extent to which is necessary for its purpose. In other words, the non-compete obligation should not be more restrictive than the extent necessary to limit the competition of the seller in the area in which the seller may potentially compete in relation to the object of the transfer9. The Guidelines provide that "in order for the non-competition obligation placed on the seller to be accepted as an ancillary restraint, its scope in terms of duration, subject, geographic area and persons must not exceed the reasonably necessary level.10" Accordingly, the persons who are subject to the restriction, geographical limits of the restriction, and the areas subject to the restriction are also assessed under the condition of reasonability. In the abovementioned case, it is possible to discuss whether the non-compete obligation is reasonable or not. As is clear from the Court of Cassation's decision, the non-compete obligation is limited to the Antalya region, where the company's customer portfolio is located, in terms of location, to the storekeeping activities in terms of goods or commercial activities, to the term of the license in terms of restriction period, and to the seller, along with the companies in which the seller holds, or will hold, any shares, and the relatives of the seller in terms of persons subject to restriction. In order for the non-compete obligation to be valid, the obligation should be limited to the area where the company provides goods or services and limited to the goods and services that are provided by the transferred company11. Accordingly, the restriction could be deemed reasonable, as it is limited to the activities of the company at the moment of the share transfer, which is storekeeping, and to the Antalya region. However, some may argue that limiting the activities of the companies in which the seller holds any shares or of the relatives of the seller, is not reasonable considering the "principle of being binding on the parties," and the "principle of proportionality."12 With regard to the non-compete obligation imposed on companies in which the purchaser holds shares, the prevailing opinion states that the non-compete obligation may include activities having a direct influence on the competition, such as production, distribution, sales, marketing, as well as holding shares in companies that are active in these areas; however, it should exclude the research and development activities13.

The condition of a reasonable term is interpreted differently in every case by the Competition Board, the Commission, and the European Court of Justice. The Competition Board deems the non-compete clause to be valid for a maximum period of 3 years, yet it accepts that a longer period may be foreseen if customer loyalty endures for a longer period, and if the transfer of know-how requires such restriction, provided that the time restrictions do not exceed the extent required by the specific case.14 The Competition Board, in certain decisions, approved the non-compete clauses for a period of 5 or even 10 years. In our case, the 12 year period may be deemed excessive and limited to 3 or 5 years. However, we strongly agree with the second dissenting opinion, which states that the total nullity of the non-compete clause is incompatible with the contractual economy and principle of interpretation in favor of the parties (favor negotii/favor contractus).

Besides the evaluation based on the conditions provided by the competition law, we will assess the opinion set forth by the first dissenting vote, whether "the non-compete clause in a share transfer agreement may be evaluated in accordance with the principles for the non-compete clauses in the transfer of commercial enterprise."

The majority affirms that the transferor of the commercial enterprise is subject to a non-compete obligation, even if such clause is not expressly provided in the agreement. This opinion underlines that the transfer of commercial enterprises includes goodwill; therefore, the transferor has an obligation to non-compete in accordance with the principle of good faith.15 Furthermore, the scholars accept that the parties may determine the extent of the non-compete obligation; however, it should be limited in terms of at least one of the following criteria: location, object and time. Additionally, the parties shall not completely waive, or illegally or unethically restrict their personal rights (Article 23 of the Civil Code, and Articles 26 and 27 of the TCO).16 If the parties provided a non-compete clause in the agreement upon the transfer of the commercial enterprise, the extent of the obligation is determined pursuant to these provisions. Soma states that in the absence of the explicit provision in the agreement, the non-compete obligation remains in force until the risk created by the transferor is equal to the risk created by any third party. In general, a period of 2 or 3 years (maximum 5 years) is considered to be adequate17.

In our case, all of the shares of the claimant company were transferred, the company is operating mainly in the area of storekeeping in Antalya, and a non-compete clause that is limited to the same region and same activities during the term of the company's license is provided by the parties in order to protect the goodwill of the company in question. As the parties already provided an explicit provision, there is no need to apply, by analogy, the non-compete obligation regarding the transfer of the commercial enterprise, arising from the principle of good faith.

Conclusion

The non-compete clause, after the termination of the agreement, is provided for by the provisions regarding the employment contract under the TCO, and by the provisions regarding the agency contract under the TCC. The purpose of these provisions is to protect the inferior party (which is the employee in the employment contract and the commercial agent in the agency contracts); therefore, these provisions should not apply to the non-compete clauses after the termination of share transfer agreements in which the parties are in equal positions. On the other hand, non-compete clauses, after the termination of the share transfer agreements, are set forth under the competition law, and the criteria provided by the competition legislation may be taken into account by the judge in order to resolve any disputes arising from the non-compete clauses in share transfer agreements. In our opinion, the abovementioned case should have been resolved in accordance with the principles provided in competition law. It should be noted that the Competition Board would have assessed the dispute, accordingly, if the relevant concentration exceeded the thresholds set forth by Communiqué No.2010/4 Concerning the Mergers and Acquisitions Calling for the Authorization of the Competition Board.

In our opinion, the 15 (or 12) year period for non-compete is unreasonable; however, the appropriate solution would be the limitation of that period in accordance with competition law. Thus, the common and real intention of the parties will be determined and applied. In contrast, the ruling of the 11th Civil Chamber of the Court of Cassation rendering the non-compete clause totally invalid, and releasing the transferor from the non-compete obligation, is contrary to the principle of contract economy, as well as the intention of the parties; therefore, we are not in agreement with the decision of the 11th Civil Chamber.

Footnotes

[1] Yargıtay 11. HD, E. 2014/11565, K. 2015/8187, T. 11.6.2015 (www.kazanci.com).

[2] Yargıtay 11. H.D. E. 2011/13747, K. 2012/356, T. 19.01.2012; Yargıtay 11. H.D. E. 2012/17736, K. 2013/9814, T. 13.05.2013 (www.kazanci.com).

[3] The Law No. 4054 on the Protection of the Competition, Official Gazette dated 13.12.1994 and numbered 22140; the Communiqué Concerning the Mergers and Acquisitions Calling for the Authorization of the Competition Board (Communiqué No: 2010/4), Official Gazette dated 07.10.2010 and numbered 27722; Block Exemption Communiqué on Vertical Agreements Amended with the Communiqué No. 2003/3 and 2007/2 (Communiqué No: 2002/2); Official Gazette dated 14.07.2002 and numbered 24815.

[4] Ercüment Erdem, Rekabet Hukuku Açısından Birleşme ve Devralmalarda (Yoğunlaşmalarda) Yan Sınırlamalar, Rekabet Kurumu Perşembe Konferansları, 15.10.20014, p. 122.

[5] Erdem p. 124; Guidelines on Undertakings Concerned, Turnover and Ancillary Restraints in Mergers and Acquisitions, n. 45-55.

See: http://www.rekabet.gov.tr/File/?path=ROOT%2f1%2fDocuments%2fKilavuz%2f2013-2.pdf (Access Date: 03.03.2015)

[6] Rekabet Kurumu Birleşme ve Devralmalarda İlgili Teşebbüs, Ciro ve Yan Sınırlamalar Hakkında Kılavuz, n. 52.

[7] Erdem p. 127.

[8] Pelin Güven, Türk Rekabet Hukuku ve Avrupa Birliği Rekabet Hukukunda Birleşme ve Devralmaların Denetlenmesi, Ankara 2003, p. 277.

[9] Erdem p. 127.

[10] Guidelines on Undertakings Concerned, Turnover and Ancillary Restraints in Mergers and Acquisitions, n. 50.

[11] Güven, p. 279.

[12] Erdem p. 129.

[13] I. Yılmaz Aslan, Avrupa Topluluğu Rekabet Hukuku, Ankara 1992, s. 104.

[14] Guidelines on Undertakings Concerned, Turnover and Ancillary Restraints in Mergers and Acquisitions, n. 51.

[15] Koray Demir, Ticari İşletmenin devrinde Yeni Dönem, Eski ve Yeni Sorunlar; İÜHFM Volume LXXI, Issue 2, 2013; p. 111.

[16] Mehmet Akçaal, İşletmenin Devri, Ankara 2014, s. 158, fn. 19.

[17] Mehmet Fatih Arıcı, Ticari İşletmenin Aktif ve Pasifi ile Devri, İstanbul 2008, p. 84.

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