|February 17, 2014|
Previously published on February 2014
American and British directors of corporations should be mindful of the different standards of conduct, obligations, and potential personal liability when holding directorships in Turkish companies, particularly if such companies’ financial situation is deteriorating. Unlike the rules generally prevalent in Delaware and other US jurisdictions, and likewise in the UK, directors of Turkish companies have technical and very specific obligations that must be followed well before the eve of bankruptcy, which, if not followed, may result in the personal liability of directors towards both shareholders and other parties in interest, including the company’s creditors.
General Standard of Conduct for Directors
As a general rule, under Turkish law, directors of Turkish companies are liable towards the company, its shareholders and creditors for any damages caused thereto which are attributable to the director’s breach of the company’s articles of association and/or applicable law. Regardless of the financial position of the company, there is no obligation to act in the best interests of any particular stakeholder other than the company per se; however, according to Article 369 of the Turkish Commercial Code (the “TCC”), there is an obligation on each director to carry out his/her duties with a degree of caution and care that can be expected from a cautious director. Given the lack of binding case law in Turkey and the relevant novelty of the current law (the most recent version of the TCC took effect only in 2012), courts will subjectively determine whether a director’s action has met the standard; however, the standard would likely be higher than the Delaware or UK counterparts.
For example, under Delaware law, corporate directors are entitled to the protection of the business judgment rule so long as they comply with their basic fiduciary duties: the duty of due care and the duty of loyalty. As articulated by the Delaware courts, the duty of due care generally requires directors to act with full information and after careful deliberation. The duty of loyalty requires directors to act in good faith, and to act in the best interests of both the corporation and its stockholders. The duty of loyalty also requires that directors refrain from self-dealing and receiving improper personal benefits as a result of their relationship with the corporation. Assuming that the corporation’s directors initially establish that they satisfied their duties of due care and loyalty, they are effectively immunized from personal liability.
Similarly, in the UK, directors owe a fiduciary duty to act in the best interests of the company. This can be broken down into stating, generally, that a director has a duty to act for proper purposes, act with the skill and competence that is reasonable for someone carrying out that director’s function, avoid conflicts of interest, take no third-party benefits, disclose any self-dealing, and promote the company’s success.
Financially Distressed Companies
In the case of a financially distressed company, the obligations imposed under Turkish law, again, are quite different from those imposed under US or UK laws.
For example, in Delaware, insolvency does not alter a director’s fiduciary duties to the corporation. Instead, the beneficiaries of those duties expand upon insolvency to include not just the corporation and the corporation’s stockholders, but also the corporation’s creditors. In general, so long as the directors continue to adhere to their fiduciary duties, they continue to receive the protection of the business judgment rule.
In the UK, a director will only incur personal liability if he or she forms the opinion, or ought reasonably, in the view of the Court, to have formed the opinion, that the company will not avoid an insolvent liquidation, and thereafter fails to take every step to minimize loss to creditors.
In contrast, Turkish law imposes strict obligations on directors depending on the objective financial standing of the company and its on-going deterioration towards insolvency at set milestones: (i) depletion of 50% or more of the company’s registered share capital and legal reserves (i.e. shareholders’ equity is less than 50% of registered share capital); (ii) depletion of 66.67% or more of the company’s registered share capital and legal reserves (i.e. shareholders’ equity is less than 33.34% of registered share capital); and (iii) the occurrence of an actual balance sheet insolvency.
The obligations of a director will depend on the milestone reached. Upon reaching the first milestone, directors will be required to formally acknowledge the existence of the deteriorated financial condition, inform the company’s shareholders thereof, prepare a report specifying the reasons for the deteriorated financial condition of the company and suggesting potential remedial actions, and finally, convene a general meeting of the company’s shareholders to deliberate on proposed remedial measures. On reaching the second milestone, Turkish companies may find themselves in technical bankruptcy and dissolved by operation of law unless the company formally reduces its registered share capital or supplemental capital is injected into the company. Upon reaching the third milestone, directors will be under an obligation to file for bankruptcy or a stay of bankruptcy pending attempted reorganization. In all events, directors failing to fulfil the formal requirements of the law may bear personal liability for damages caused to shareholders, company creditors, and other third parties in interest.
Other provisions of Turkish law may also lead to director personal liability. For example, according to Article 10 of the Tax Procedural Law, the directors and other legal representatives of a company may be held liable for the company’s tax liabilities if he/she is found to have not fulfilled his/her respective legal duties.
Similarly, according to Article 35 of Law no. 6183 on the Procedure for Collection of Public Receivables, a director may be held liable for the company’s debts to the extent such debts are public receivables other than tax (e.g. social security premiums) that cannot be collected in whole or in part from the company.
In certain circumstances, criminal sanctions may be applied to directors. For example, pursuant to Article 164 of the Turkish Criminal Law (“TCL”), directors who materially give misleading information regarding the legal entity in their public declarations or in their reports or offers submitted to the General Assembly of shareholders, thereby causing losses to related persons, face imprisonment of 6 months to 3 years.
In addition, pursuant to Article 333/a of the Bankruptcy and Enforcement Law (“BEL”), persons who are granted legal or de facto management powers and who deliberately cause losses to creditors by not paying debts may be sentenced to imprisonment of 6 months to 2 years.
Finally, pursuant to Article 345/a of the BEL, if the representatives of legal entities who are obliged by law to file for bankruptcy of the legal entity fail to do so, they may be sentenced to imprisonment of 10 days to 3 months, upon complaint by a creditor.