The Turkish Commercial Code No. 6102 ("TCC") sets certain restrictions on the rights and authorities of shareholders and board members in joint-stock companies. These restrictions are primarily aim to protect the company's assets and maintain the corporate structure of the joint-stock companies. Especially, Article 358 of the TCC addresses the borrowing of shareholders from the company, while Articles 395 and 396 focus on board members' transactions, their non-compete obligations, and the prohibition on borrowing for board members who are not also shareholders. The provisions mentioned work together to prevent conflicts of interest between the board members, and shareholders. However, in practice, approvals granted by the general assembly which are "pre-emptive and blanket" can render the protection mechanisms ineffective.
Prohibition on Borrowing by Shareholders (TCC Article 358)
Under Article 358 of TCC shareholders are prohibited from borrowing from the company unless certain conditions are met. These conditions include the full repayment of debts arising from capital commitments, as well as the company's free reserves and profits (after offsetting the past loses) reaching a level that can cover such debts. This cumulative requirement is designed to protect the company's assets and prevent potential conflicts between shareholders (especially conflicts between the controlling shareholders and others).
The scope of this prohibition on borrowing by shareholders is also a debate in legal doctrine. One view argues that it should be broadly interpreted, suggesting that it encompasses not only cash and in-kind borrowings from the company, but also actions such as the company providing guarantees, sureties, and/or collateral for the debts of shareholders, as well as assuming responsibility and taking over the shareholders' debts. The opposing view, however, contends that the prohibition on borrowing by shareholders from the company should be interpreted more narrowly, applying only to cash and in-kind borrowings is better for practice etc. This restrictive interpretation aims to prevent delays in business operations by ensuring that shareholders and board members are not required to seek approval from the general assembly for every transaction, thus avoiding outcomes that would disrupt the normal course of commercial like.
Prohibition on Transactions and Borrowing by Board Members (TCC Articles 395-396)
Under Article 395, board members are not allowed to conduct transactions with the company, either for themselves or on behalf of others, without obtaining pre-emptive approval from the general assembly. If they proceed without approval, the company may declare the transaction void. Additionally, Article 395 also prohibits board members from borrowing from the company or carrying out transactions without general assembly approval.
The transaction prohibition, outlined in Article 395/1, covers all types of transactions by board members, regardless of whether they relate to the company's operations. It applies whether the board member is acting on their own behalf or as a representative of a third party. The borrowing prohibition, outlined in the second paragraph of the same article, is a provision designed to protect the company's assets and its shareholders in a manner similar to Article 358. Furthermore, under Article 396 a non-compete obligation applies to board members, which prohibits them from engaging in commercial activities that fall within the company's line of business, either for themselves or for others. In case of a breach, the company may seek compensation for damages through the general assembly. Although the provisions mentioned are designed to protect the company's assets and prevent conflicts of interest, in practice, blanket approvals from the general assembly can circumvent these protections, leaving minority shareholders vulnerable to the actions of controlling shareholders and board members. This can lead to disputes and management crises that negatively affect the company's performance.
Shareholders Who Are Also Board Members: Which Rule Applies?
For individuals who are both shareholders and board members, the borrowing prohibition should be considered from two perspectives: the special and absolute prohibition on borrowing under Article 358 of the TCC and the prohibition on transactions without general assembly approval as regulated under Article 395 of the TCC.
The most important factor in determining which provision of the law applies is the nature of the transaction. Article 358 is a special provision that directly prohibits "shareholders from borrowing from the company." As an illustration, where an individual concurrently holds the positions of shareholder and board member and seeks to enter into a borrowing transaction with the company in their personal capacity, the provisions of Article 358 shall apply as a matter of priority. General assembly approvals for the proposed transaction would be rendered ineffective unless the company's financial standing meets, in its entirety, the cumulative conditions established by Article 358 of the TCC. However, if the transaction does not involve borrowing, such as when a board member and shareholder seeks to sell land to the company, the transaction would not fall under the prohibitive scope of Article 358. Consequently, Article 358 would not be applicable, and the transaction could instead proceed with approval from the general assembly, in accordance with Article 395.
The Nature of General Assembly Approval
The general assembly approval, as mentioned above, serves as an exception mechanism allowing board members to engage in transactions with the company or compete with the company. However, this approval has no effect in the context of Article 358 of the TCC. It only becomes effective, if the transaction is relevant to the provisions in Articles 395 and 396, and should be granted due consideration to the company's interests. Additionally, there are differing doctrinal views on the granting of such approval. One view asserts that general assembly approval is merely a formal requirement and its validity is not affected by whether it is given in advance or as a blanket authorization. On the other hand, another perspective emphasizes that this approval should be given on a case-by-case basis; otherwise, board members would be granted unlimited freedom to act.
Problems Arising from Automatic (Blanket and Pre-emptive) Approvals
One of the recurring issues observed in corporate practice involves the general assembly conferring authorizes the members of the board of directors in a general scope and provides them with a wide range of action, resolutions phrased as "authorized to engage in transactions with the company" or "permitted to compete with the company" can be given as examples. Such blanket approvals raise significant concerns from the perspective of corporate governance, particularly in terms of the protection of the company's interests, the potential detriment to minority shareholders, and the increased risk of conflicts of interest.
In addressing this practice, which has also drawn the scrutiny of the judiciary, the 11th Civil Chamber of the Court of Cassation, in its decision numbered 2017/4921 E., 2018/6763 K., held that general and undifferentiated authorizations granted by the general assembly cannot be deemed sufficient or valid for each specific transaction. The Court underlined that such permissions must be evaluated and granted on a transaction-specific basis, with due consideration given to the interests of the company and its stakeholders.
Conclusion and Recommendations
The restrictions imposed on board members who are also shareholders in joint stock companies regarding self-dealing and incurring debt towards the company are reflections of the Turkish Commercial Code's overarching aim to safeguard corporate interests. These restrictions are primarily regulated under Articles 358, 395, and 396 of the TCC. While Article 358 introduces an absolute prohibition on shareholder indebtedness to the company, one that cannot be circumvented even with general assembly approval, transactions falling outside its scope but covered by Articles 395 and 396 (namely, self-dealing and competition with the company) may be permitted, subject to authorization by the general assembly.
However, in practice, general assembly approvals have become somewhat automatic and routine, which in turn they generally undermine the effectiveness of these protective mechanisms. Such blanket authorizations carry significant risks, including the inability to assess the company's interests on a case-by-case basis, the erosion of minority shareholder protections, and the conferral of an unreasonably broad discretionary scope upon board members.
The key takeaways that can be considered within the scope of the evaluation for companies are as follows:
- Authorization by the general assembly should be transaction-specific, well-reasoned, and based on a concrete evaluation of the company's interests.
- Blanket or advance approvals distort the delicate balance between corporate interest and shareholder rights.
- Internal audit mechanisms and the involvement of independent board members should be actively integrated into the authorization process.
In conclusion, the authorization mechanism should not be perceived as a blanket safeguard granting board members unfettered discretion, but rather as an exceptional and controlled instrument designed to protect corporate interests. Adopting such a prudent and interest-based approach in practice is crucial not only to mitigate legal disputes but also to ensure long-term corporate sustainability.
***
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.
