• Unlawful Exercise of Dominance
  • June 7, 2016
  • Law Firm: Erdem Erdem Law Office - Istanbul Office
  • Introduction

    According to the definition provided under Article 195 of the Turkish Commercial Code No. 6102[1] (“TCC”) where a company directly or indirectly holds the majority of voting rights in another company, or holds the right to appoint the members to the management body of another company as per the articles of association in a number that constitutes the majority to make decisions, or constitutes among its own voting rights the majority of the voting rights alone or together with other shareholders or partners based on an agreement, or keeps such company under its dominance pursuant to an agreement, or otherwise; the first company is the dominant company, and the other is the dependent company. Dominance does not entitle the dominant company to exercise such power against the dependent companies unlawfully. As in all unlawful exercises several consequences are attached to this unlawful exercise under Article 202 of the TCC and the following articles. This Newsletter examines the situations where dominance is exercised unlawfully and the consequences attached thereto.

    Unlawful Exercise

    Exercise of dominance by the dominant company so as to cause losses to the dependent company is deemed unlawful. Unlawful exercise situations are listed under Article 202 of the TCC without limitation. Direction of the dependent company by the dominant company to conclude legal transactions such as transfer of business, assets, funds, personnel, receivables and debts; to decrease or transfer its profits; to restrict its assets with in kind and personal rights; to assume liabilities such as provide security, guarantee and aval; to make payments; to make decisions or take precautions that negatively affect its productivity or business, such as not to renew its facilities without just reasons, to restrict or stop its investments, or to avoid taking precautions that would provide its development are listed among such situations.

    Under the preamble of Article 202 of the TCC[2], it stated that such transactions, e.g. provision of security or guarantee or transfer of receivables and debts are not unlawful themselves, but the unlawfulness arises in terms of exercise and enforcement of dominance. Unlawfulness derives from the fact that the transaction, or the decision or precaution that has been taken or avoided, causes losses to the dependent company and damages the company, shareholders and the creditors of the company, and there is no just cause thereof for the company.

    Losses and Equalization

    For unlawful exercise, the transactions specified, above, must be in a nature so as to cause losses to the dependent company. According to the preamble of the article, “the expression ‘losses’ is different from ‘damages’ in legal terms and is so broad to cover ‘damages’ as well. Losses may occur as a decrease in the assets or prevention of an increase in the assets, as well as loss of an opportunity to conclude a transaction with success such as in the transfer of business, funds or personnel.” Moreover, for the occurrence of unlawfulness, it is not mandatory that losses have been incurred, and it is sufficient that it is clear from convincing findings and reasoning that such transaction that the dependent company was made to conclude may cause losses. What is important is the preparation for the conditions of loss by the dependent company upon instruction by the dominant company.

    An exemption to the unlawfulness is the actual equalization of the incurred losses within the activity period in which the transaction was concluded, or entitlement of the dependent company to a right to claim in equal value until the end of such activity period at the latest, by indication as to how and when the losses will be equalized. However, in the second option, the exercise of such right to claim should not expand to a longer period that would not be able to provide the expected benefits.

    The preamble of the article states that the equalization may be related to a consideration that would provide the recovery of the damages, such as vesting a benefit or advantage to the dependent company, and explains this with various examples: Securing the provided guarantee or security with a counter guarantee and security or aval, entitling a license or trademark usage right, provision of research and development services without any consideration, provision of know-how, provision of internship and education opportunities to personnel, allowing to make use of its marketing network, transfer of an immovable of equal value, vesting pre-emption right in the capital increase of another dependent company that was provided with benefits in return for losses to the dependent company, entitling the dependent company to rights in the conditional capital increase.

    Liability from Unlawful Exercise

    Compensation

    The TCC entitles all of the shareholders and creditors of the dependent company to claim liability of the dominant company in cases where dominance is exercised unlawfully. As explained, above, if equalization is unconcluded within such activity period, or an equal right to claim is not vested within its term, it is possible for each shareholder of the dependent company to ask the dominant company and its members of board of directors who caused the losses to compensate the losses of the dependent company. Similarly, the creditors of the dependent company may also claim payment of losses of the company to the company. For making such claim, it is not mandatory that the dependent company has declared bankruptcy.

    The right to claim compensation of losses from the dominant company is not vested with the dependent company, because whether or not the dependent company may file, and honestly follow such a claim against the dominant company, even if it is entitled to file, is found to be doubtful. Further, according to the preamble of the article, it is mostly argued that it is not a correct law policy to involve the board of directors of a dependent company against the dominant company and its board of directors.

    Exemption to the Compensation

    As an exemption to the liability of the dominant company, it is regulated under the TCC that compensation shall not be applicable where it is evidenced that the transaction that caused losses would be also concluded or avoided by the board of directors of an independent company that looks after the company’s interest in accordance with good faith principles, and acts with the diligence of a prudent director. In such a case, exercise of dominance in such a way to cause losses to the dependent company is due to necessity and, therefore, ruling for compensation against the dominant company would be unjust.

    Other Remedies

    In transactions such as mergers, demergers, changes of types, liquidation, issuance of instruments, and important amendments to the articles of association that do not originate from an explicitly understandable just cause for the dependent company the shareholders who cast negative votes in the relevant general assembly meeting and annotated such to the meeting minutes, or the shareholders who objected in writing to the resolutions of the board of directors on similar subjects, are entitled to not only claim compensation from the dominant company, but also to ask the court for acquisition of their shares. Through this, the shareholders who are in the minority position against the exercise of dominance, and who object to the method of exercise of dominance, are provided with the opportunity to exit from the company. The value of the shares in such a case shall be the least stock exchange value, if any, or if there is no such value, or such value is not compatible with the principle of equity, the value shall be the actual value, or a value to be determined according to a commonly acceptable method. The court decision shall be based on the most recent data. When such a lawsuit is filed, a security shall be requested in an amount covering the possible damages of the claimants or the acquisition value of the shares and unless such security is provided, no transaction shall be allowed to be made regarding the general assembly or board of directors resolution.

    Liability Agreement

    In practice, members of the board of directors of the dependent company may be obliged to fulfill the instructions from the dominant company, although they believe that such instructions may lead to their liability. In such a case, since such member will not be able to eliminate his liability arising from the law, the last paragraph of Article 202 of the TCC entitles the members of the board of directors of the dependent company to ask the dominant company to execute an agreement for the assumption by the dominant company of the legal consequences of their liabilities that may be due against the shareholders.

    Full Dominance Situations

    Articles 203 to 206 of the TCC regulate the abuse of dominant position in the case of full dominance. In the event that a commercial company directly or indirectly holds one-hundred percent of the shares and voting rights of a capital company, there is full dominance.

    Different from other dominance situations, in the event of full dominance, the dominant company may give instructions for the direction and management of the dependent company even if they are of a nature to cause losses to the dependent company, provided that such instructions are due to determined and solid policies of the group of companies. Bodies of the dependent company shall be obliged to comply with the instructions of the dominant company and cannot be held liable against the company and shareholders due to such compliance. According to the preamble of Article 203 of the TCC[3], the reasoning of such non-liability is that in practice, the members of a fully dependent board of directors are persons who must comply with the policies of the dominant company and group of companies, or will otherwise lose their jobs. It is unrealistic to accept that a board of directors in such a situation would have to value the interests of the dependent company above those of the dominant company.

    An exemption to the obligation to comply with the instructions is that such instructions explicitly exceed the payment ability of the dependent company or endanger its existence, or may lead to its loss of its important assets. If the members of the board of directors of the dependent company have complied with such instructions, they cannot benefit from the non-liability protection.

    There are no different provisions regarding the creditors of the dependent company who incurred losses, and they are, again, entitled to file compensation claims against the dominant company and its members of the board of directors who are liable for such losses, provided that the losses have not been equalized within the same activity period or an equal right to claim has not been vested. Regarding the receivables arising from loans or similar reasons, defendant dominant company and its members of the board of directors may dispose of liability by evidencing that the claimant creditors have entered into the relationship that has given rise to the subject receivable by knowing that an equalization has not been made, or a right to claim has not been vested, or should have known due to the circumstances of the transaction.

    Conclusion

    Dominance does not entitle the dominant company to exercise such unlawful power against the dependent companies. Exercise of dominance by the dominant company so as to cause losses to the dependent company is deemed unlawful. The transactions that the dependent company was made to conclude are not unlawful themselves, but the unlawfulness arises in terms of exercise and enforcement of dominance. In the event of unlawful exercise of dominance, if the incurred losses have not been equalized within the activity period in which the transaction was concluded, or the dependent company has not been vested a right to claim in equal value until the end of such activity period at the latest by indication as to how and when the losses will be equalized, each shareholder and creditor of the dependent company may request compensation of losses by the dominant company and its members of the board of directors who caused the losses to the dependent company. In cases of full dominance where a commercial company directly or indirectly holds one-hundred percent of the shares and voting rights of a capital company, members of the board of directors of the dependent company shall be, in principle, obliged to comply with the instructions of the dominant company even if they are in a nature to cause losses to the dependent company and cannot be held liable against the company and shareholders due to such compliance.



    [1] Turkish Commercial Code No. 6012 was published in the Official Gazette dated February 14, 2011 and numbered 27846, and entered into force on July 1, 2012.

    [2]  Preamble of Article 202 of the TCC.

    [3]  Preamble of Article 203 of the TCC.