One Person Boards vs. Multi Member Boards
The Turkish Commercial Code published in the Trade Registry Gazette dated 14 February 2011 and numbered 27846 (the “TCC“), makes significant changes in the management of joint stock corporations (anonim şirket). The TCC introduces the possibility of having a board of directors (a “Board“) that is comprised of one member; whereas, the previous legislation mandated the presence of at least three members on the Board. This article provides a general assessment of the management of a joint stock corporation with a Board consisting of only one member.
For companies that have a Board with three members, as per the former legal rules, in most cases, only one of the three members must be located in Turkey and involved in the day-to-day operations of such company. With the possibility to have a one person Board now, the question now seems to be what exactly the roles of other two Board members are.
The TCC specifically lists the duties of the Board that cannot be delegated to others1:
- High-level management of the company and the power to give orders to high-level management;
- Determining the management organization of the company;
- Establishing the organization for the accounting, financial auditing and financial planning (at the level required for the specific company according to the size of the company);
- Appointment and dismissal of managers and other managerial-level personnel, and persons who hold representation and binding powers;
- High-level auditing of persons engaged in management of compliance with the law, the AoA, internal directives and written orders of the Board;
- Maintaining share, board resolution and general assembly meeting ledgers; organizing and serving the general assembly the annual activity report, and declaration regarding compliance with corporate governance rules; preparing for general assembly meetings; and realizing general assembly meeting resolutions; and
- Notifying the court if the capital of the company is eroded.
The TCC allows for legal entities to become a Board member. It is possible to adopt a structure wherein a professional management company is appointed as the Board member of the company, and whereby an individual representing such professional management company is registered with the trade registry.
The Company will have a service agreement with the professional management company and, thus, may benefit from a right of indemnification in its favour for any misconduct of the individual sitting at the Board level.
The foregoing structure will not enable the company to refuse liability for actions of the individual sitting on the Board. However, the management company may be in a position to better indemnify the company due to its employee’s failure in fulfilling his/her duties.
Based on the above-drawn picture for the legal aspects of the issue, it is a commercial decision for companies to choose between one person Boards and multi-person Boards, depending on their operational needs.
Comparative Board Member Liability Concept between the Abolished Code and the TCC
In the era of the previous Commercial Code, in principle, the members of the Board could not be held personally liable for agreements and transactions that they executed on behalf of the company. Only in certain circumstances could several and joint liability be triggered for breach of specific duties delegated to the Board under the applicable laws and the governing agreements of the company. Article 336 of the abolished code provided an exhaustive list of circumstances when the members of the Board could be held jointly and severally liable, which are as follows:
- Where the company records indicate that shareholders have paid for their shares, but in fact no payment, or sufficient payment, has been made;
- Where the company has distributed dividends that are more than the distributable profit;
- Where books required that to be maintained do not exist or have not been properly maintained;
- Where, in the absence of justification or excuse, shareholders’ decisions have not been implemented; and
- Where the board has negligently or intentionally failed to perform its duties delegated by the laws and the governing documents of the company.
If any of the circumstances in Article 336 of the abolished code existed, the shareholders of the company could bring a lawsuit against all the Board members. Once such lawsuit was filed, if one of the duties were delegated to a specific member of the Board, then the remaining members would be entitled to reject liability, since that specific duty had been delegated to another.
The TCC that has been in force since July 1st, 2012, distinguishes the legal and criminal liabilities of the members of the Board. The TCC, prior to its amendment on June 30, 2012 (the “June 2012 Amendments“) set forth a black and white picture for allocation of liability. Prior to the June 2012 Amendments, if there was a breach of duties and responsibilities arising under the laws and the governing documents of the company, and if the members of the Board, incorporators, and managers of the companies could not prove that they were faultless, they would be held liable. The June 2012 Amendments presented a certain level of flexibility to the liability principles by introducing the condition of being at fault in order to be held liable. After the June 2012 Amendments, the part that specifically designated the burden of proof to Board Members was removed. Thus, based on the general law principle that the claimant is responsible for proving its claim, it may be argued that the burden of proof would be on the party claiming that a Board Member is in fault, and such party would be under the obligation to prove his/her claim. Nevertheless, in practice, if the elements of liability (i) damage and/or loss and (ii) the causation are present, the Board Members may be expected to prove that the outcome of their actions would not have changed had they performed all and every measure of diligence.
The TCC states that if the documents relating to the incorporation, share capital increase or decrease, mergers, spin offs, transformation of company forms or issuance of bonds are inaccurate, faulty, false, or if such documents do not reflect the actual status of the company, (i) the individuals that prepared such documentation will have strict liability, and those that made statements based on such documentation and (iii) agreed with such documentation shall be liable, if they are at fault.
The principle adopted in the abolished code did not focus on the “existence of fault.” Back in time, the Board would be severally and jointly liable for the damage and loss incurred by the company. On the other hand, the TCC, after the June 2012 Amendments, specifically places a focus on the element of fault while determining liability of Board members with certain exceptions, as discussed above.
The TCC allows the Board to delegate its powers to the extent permitted via internal by-laws and regulations. Although delegation of powers was permitted in the era of the abolished code, the TCC explicitly states that if the members act diligently while delegating their powers to others, they will not be held liable for the breaches of these individuals.
Exposure of Board Members to Claims by Third Parties (e.g., Creditors)
The crucial difference between the TCC and the abolished code lies in the ability of third parties to be able to bring claims directly against the members of the Board. The abolished code only enabled the shareholders to bring claims against the members of the Board. Diverting from the practice established under the abolished code, Article 553 of the TCC explicitly allows the creditors of the company to bring claims against the incorporators, Board members, and managers. The commentaries of the liability provisions of the TCC explicitly state that the parties affected from the faulty acts of the Board members are entitled to make claims directly against the Board members.
Although the June 2012 Amendments lightened Article 553, there is much to be established by the scholars and through court precedents. It is important to note that for the purposes of Article 553, the scholars agree on the issue that the creditors may only claim the direct damages they suffered resulting from the violation of Board members’ duties – as opposed to claiming the damages and loss incurred by the company.
The commentaries to the liability provisions of the TCC introduce the concepts of active and passive capacity to sue. The company and/or any of the shareholders, at all times, have the capacity to sue Board members for damages and loss incurred by the company. As per the commentary of Article 549 of the TCC, the parties that are affected by a Board member’s violation of his/her duties shall be deemed to have active capacity to sue the Board members, managers and other officers of the company.
Considering the above-mentioned expansion of the legal right to sue Board members to third parties, such as creditors, the June 2012 Amendments seem to bring balance into the liability equation by placing the focus on the requirement of fault in most cases. After the June 2012 Amendments, Article 553 explicitly states that the violation of duties must have occurred due to a fault on the part of the Board member, in order for such Board member to be held liable. If the Board members act diligently and perform their duties taking the “business judgment rule” into consideration, they should not be held liable for any loss and damage incurred by the company and/or third parties.
Another revolutionary development under the TCC is the allocation of liability among the Board members depending on their levels of diligence and fault. If there are more than one Board member accountable for the damages and losses incurred by the company, instead of ruling categorically on joint and several liability (as was the case under the abolished code), the court shall allocate the responsibility taking into account the specific circumstances affecting each member’s liability level.
In light of the foregoing, considering the broadened nature of board liability, the role of professional management service providers and significance of the directors and officers’ liability insurance would gain more weight over time – depending on how the court precedents would set the standards for fault and accountability.
As a final reminder, it is noteworthy to state that the liabilities of the Board members arising under laws, such as the Law on the Protection of Competition, Protection of Environment, etc., and from the public receivables of the company, continue to be in effect without any alteration.
1 Article 375 of the TCC clearly sets forth the duties of the Board members that may not be delegated.