The relationship between a parent company and the subsidiary under the exercise of its dominance is subject to a special regime under the provisions that govern group of companies in the Turkish Commercial Code.
The Law defines the "controlling company" as a company which owns, directly or indirectly, the majority of the voting rights of another company or constitutes the majority that may render decisions at the management body of such company. Furthermore, the Law stipulates that even in cases where no affiliation between these companies exists, a controlling company-subsidiary relationship may form and the parties, thereby, could be subject to the group of companies regime under a contractual arrangement if certain requirements are met.
Even though the controlling company wholly or partly controls the subsidiary, such control is required to be exercised in accordance with law. Otherwise, the Law provides for certain rights of action based on indemnification and other claims against the controlling company and the board of directors for the subsidiary and in favor of its creditors.
Unlawfulness and Losses
In principle, the controlling company may not exercise its control in a way that would cause its subsidiary to incur losses. As stated in the reasoning of the Law, "unlawfulness arises when a transaction, a decision made, or a measure taken or omitted to be taken causes losses for the subsidiary and damages to the company's creditors and does not have a justified reason on the part of the company". In other words, it is not the exercise of control in itself which is unlawful, but the exercise of control in such a way that would cause the subsidiary to incur losses.1
Although the Law does not define the term "loss", it explains such term with examples. In this regard, the Law provides the following cases as illustrative of loss events: i) transfer by the subsidiary of business, assets, funds, personnel, debts and receivables to another company, ii) the subsidiary being compelled to carry out transactions that would cause the subsidiary's profits to decrease or be transferred to others; iii) provision by the subsidiary of sureties and guarantees, and iv) the subsidiary shutting down its facilities, limiting its investments without any justified reason. Furthermore, it should be noted that the term "losses" is different than the term "damages" within the meaning of the law of obligations and has a broader meaning which covers the term "damages". In this respect, the subsidiary's being deprived of an opportunity without any diminution of its assets is deemed to be sufficient for the occurrence of loss.
The Law allows, for a limited amount of time, the event of unlawfulness based on the presumption that the losses will be compensated for within such time. This tolerance is basically rooted in the belief that the controlling company would carry out transactions in the interest of the group of companies and is competent in the group's management. Accordingly, if the losses mentioned are compensated for within the activity period in which such losses were incurred, the event of unlawfulness will cease to exist.
In the event of unlawfulness which arises from control exercised in such a way that causes the subsidiary to incur losses, actually eliminating and compensating for the losses is referred to as "compensation". Compensation may be made by the controlling company in the interest of the subsidiary either by actually providing opportunities and/or rights or by granting a right of request (claim). In any case, the relevant action must be taken within the activity year in which the damage was incurred. However, in order to protect the interests of the subsidiary, promptly allowing the subsidiary, within the relevant activity period, to exercise the right of request (claim) after the grant thereof is crucial for the avoidance of potential disputes.
For instance, in case the guarantee or surety given by the subsidiary is secured by a counter-guarantee given by the controlling company, compensation may actually be made by the subsidiary's recourse to the controlling company, which provided the counter-guarantee. Likewise, giving usufruct certificates or guaranteeing dividends to the shareholders of the subsidiary that incurred losses are among the other examples of actual compensation. Furthermore, if the compensation were to be made by granting a right of request to the subsidiary, one of the examples of such right would be as follows: The controlling company of a group of companies which owns a foundation operating a university requires its subsidiaries, in accordance with a provision in its Articles of Association, that they donate a certain amount from their dividends to such foundation. The controlling company, however, exempts one of its subsidiaries, which was caused by the controlling company to incur damages, from this obligation for a certain amount of time. The controlling company's commitment to provide such exemption constitutes a form of the right of request.
In certain cases, the control power exercised by the controlling company over the subsidiary takes the form of full control. The concept of full control is defined as "the direct or indirect ownership by the commercial company of 100% of the shares and voting rights of another capital company". In this respect, in the event of full control, the case would be that the subsidiary must abide by the controlling company's instructions. Nevertheless, these instructions must not be of such a nature that would allow the control to be exercised contrary to law. Accordingly, the controlling company would not be allowed to give instructions that are beyond the solvency of the subsidiary, or in a way that may pose a threat to or result in the cessation of the subsidiary's existence. Otherwise, the subsidiary's managers and board members would not be liable against the company and the shareholders for the damages arisen as a result of such instructions. Insofar as these damages are not rectified by an act of compensation, the subsidiary and its shareholders would be entitled to bring action for damages against the controlling company and its executives on the ground of the responsibility thereof.
Finally, if full control is not the case, the subsidiary would not be required to comply with the controlling company's instructions and directions under all circumstances. In other words, the case would be that the executives of the subsidiary would have discretion in taking initiatives with respect to the responsibilities assumed and rights owned by them. This discretion enables the executives of the subsidiary to approach the controlling company's instructions with caution if the controlling company gives instructions which would undermine the trust placed in the group. Otherwise, given the decisions rendered by the Court of Cassation, the board members of the subsidiary may, most likely, be held liable.
If, after the unlawful exercise of control, the losses incurred by the subsidiary is not rectified by compensation or the compensation is not duly made, the following actions may be brought against the controlling company and the company's board members that caused such losses: i) action by the subsidiary's shareholders for damages, where the judge may decide on an alternative remedy, ii) action by the subsidiary's creditors for damages, iii) action on the grounds of inadequacy and inappropriateness of compensation, iv) action for nullification or annulment of the general assembly decision which caused losses to be incurred.
Another form of unlawful exercise of control occurs when the controlling party causes detriment to the subsidiary's shareholders by having, through the use of its voting power, such subsidiary render certain general assembly or board of directors decisions. Such unlawfulness arises when, without any justified reason, the subsidiary's structure is changed (mergers, spin-offs, change of the company's legal form), existence is ceased (dissolution of the company), financial structure is changed, or articles of association is amended. The following actions may be brought if the controlling company makes its subsidiary render such decisions: i) action for damages, ii) action for acquisition of the plaintiff's shares, iii) action for declaration of general assembly decision's nullity or action for such decision's annulment, iv) action for declaration of board of directors decision's nullity.
The companies forming a group of companies, in particular those that have controlling power, must act in compliance with the foregoing rules and principles while carrying out transactions with other group companies or while instructing them. In this regard, abuse of the subsidiary's interests may cause liability, on the part of the company that has controlling power, against the subsidiary's shareholders and creditors for the damages incurred by them. Prioritizing the interests of the group of companies as a whole, conducting business and carrying out transactions between the group companies within the framework of a legal and financial plan made beforehand would minimize certain risks of action.
1. Tekinalp, Sermaye Ortaklıklarının Yeni Hukuku, p. 572
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