Shareholder Prohibition in Joint-Stock Companies

SHAREHOLDERS’ PROHIBITION OF COMPETITION IN JOINT-STOCK COMPANIES

SHAREHOLDERS’ PROHIBITION OF COMPETITION IN JOINT-STOCK COMPANIES

 

Baris Erkan CELEBİ, Attorney at Law

 

            ABSTRACT

In joint-stock companies law, it is prohibited for people who are involved in the decision-taking mechanism of the company to carry out commercial transactions independently from the company within the work field of the company or to be involved in other ventures operating in the field thereof. This prohibition of competition as a principle includes the members of the board of directors of companies as well as other managers and is valid for the whole term of employment of these persons in companies

However in business, especially in certain sectors where the know-how of the partners or the managers are vital for the companies to exist, shareholders sometimes engage on their behalf in some ventures in competition with the companies. The controversial subject in these situations is whether or not the prohibition of competition is needed to be applied for certain shareholders who are in possession of the commercial secrets and in charge of the control mechanism of the company, just like the members of the board of directors are.

According to the widely recognized view in the doctrine, with respect to the principle of single obligation, the prohibition of competition cannot be applied for the shareholders. According to this view, apart from the obligation to invest capital, the only obligation that can be assumed for the shareholders is the duty of honest performance which all persons are subject to. However, the duty of honest performance only prevents the shareholders from conducting activities whose sole purpose is to harm the company; it cannot be considered as a prohibition of competition through open interpretation. In addition, again a widely recognized view in the doctrine considers the principle of single obligation as compelling and mandatory, and argues that the prohibition of competition cannot be adopted even through a regulation in the articles of association.

On the other hand, as discussed below, there are other views that argue that it is possible to conclude on a prohibition of competition through ways permitted by the law. When considered within the framework of especially some of the incidents in the practice, it would be injustice to accept that the prohibition of competition cannot be applied to shareholders under any circumstance.

Furthermore, in joint-stock companies with few partners, especially in companies that conduct business in sectors where know-how is equally important as the capital, the shareholders’ free competition with the company and the argument that this competition cannot be prevented even through a regulation in the articles of association, may cause serious issues in the practice.

In this article firstly the prohibition of competition in accordance with the legislation shall be briefly examined, afterwards whether or not the prohibition of competition as a principle includes the shareholders shall be evaluated and finally whether or not the scope of the prohibition of competition can be changed through articles of association or other contracts shall be discussed.

 

I. PROHIBITION OF COMPETITION IN GENERAL

Prohibition of competition in short is the obligation of the members of the board of directors to not compete with the company in joint-stock companies. The purpose of prohibition of competition is to prevent those who know the company’s trade secrets and who are included the decision mechanism from abusing their positions by unfairly competing with the company and thereby harming both the company and its assets.

As per Article 396 of Turkish Commercial Code (TCC) prohibition of competition bans the members of the board of directors (BoD) of a joint-stock company from getting involved in commercial works within the same work field as the company is in without the permission of the general assembly (GA). In the article, work field corresponds to the works that the company actually performs and not those written in the articles of association.

BoD members are prohibited from not only performing these commercial works on their behalf or on behalf of others, they are also prohibited from owning shares in any unlimited liability company which performs the same kind of works.  Due to the mention of “unlimited liability” it can be concluded that BoD members may own shares in limited liability or joint-stock companies that perform in the same work field without violating the prohibition of competition. On the other hand, due to the reason that acting as a board member or a commercial representative or attorney in another company in the same work field would mean “performing commercial works on behalf of others”, it would violate the prohibition of competition. Furthermore, due to the reason that the appointment of the BoD member in another company would conflict with the BoD members’ obligation of loyalty, it would again be unacceptable.[1]

For company directors and representatives other than the BoD members, such as CEO or other signatories, prohibition of competition is regulated not by TCC but by the article 553 of Turkish Code of Obligations. In the said article the scope and the penalty of the prohibition of competition match those in TCC Art.396.  Therefore this study will not include the prohibition of competition in Turkish Code of Obligations.

In order to perform works that are subject to the prohibition of competition, BoD members require permission from the general assembly. In case this permission is given via articles of association, it covers BoD members of all periods. On the other hands, if the permission is given via general assembly, it only concerns the current BoD members and the future BoD members will require permission to be given again. In other words, permission given by the articles of association is abstract and general whereas a permission by the general assembly is specific and personal. [2]

In the event of violation of the prohibition of competition, the joint-stock company would have the following options: a) To claim damages suffered by the company or b) Instead of indemnities, to consider the work as performed on behalf of the company and to sue for restitution of the funds gained through contracts made with 3rd parties. The right to choose any of the options belongs to the BoD members other than those who have violated the prohibition of competition. In case all BoD members are in violation, only the general assembly is entitled to choose any of the options.[3]

Although the statute of limitation in the code article was defined as “3 months starting from when the other members discover that the said commercial works were performed or the BoD member got involved in another company and in any event 1 month from the date of occurrence of any of these conditions” it is not mentioned whether or not board members continue to be subject to the prohibition of competition after their service terms end. The first matter to be discussed is when the prohibition of competition for board members end on principle and the second matter is whether or not this prohibition can be extended by articles of association or other contracts.

According to the dominant school of though in the doctrine[4] and the case law of Court of Cassation the prohibition of competition for board members continue for the period of their duty and end simultaneously on principle.

As for the issue of extending the prohibition of competition, what comes to mind first is the article 444 of the Code of Obligations regulating the employee’s prohibition competition. As per the said article the employee’s prohibition competition can be extended by up to 2 years starting from the end of the employment contract. In addition it is a condition that the prohibition is regulated in a narrow sense in terms of geography and sector; it cannot be made into a general prohibition of work. However, the relationship between the board members and the joint-stock company is considered to be an attorney-client relationship and not as an employment relationship. Although the code articles regulating joint-stock companies are on principle peremptory, due to the fact that the article 396 which regulates the prohibition of competition can be overruled by the permission of the general assembly, it can be concluded that the prohibition of competition is not peremptory. Therefore it is possible to broaden the prohibition of competition and to extend it beyond the period of duty. However, when broadening the prohibition of competition, constitutional rights such as the freedom of labor and contract and justice must be considered; prohibitions that go beyond their purpose are void.[5] While there is no strict limit to how far the period of prohibition of competition can be extended, it varies depending on the character of the work, the position of the BoD member in the copany and the trade secrets he/she acquires, the kind of sector and its width. When determining whether or not the period of prohibition of competition goes beyond its purpose, each case should be evaluated specifically, considering the age of the board member, period of service in the company, compensation in exchange for the service and especially the consideration in exchange for not competing with the company, if any. [6]

 

II. PROHIBITION OF COMPETITION FOR SHAREHOLDERS

In the Code only the prohibition of competition for BoD members is mentioned whereas a prohibition for the shareholders of a joint-stock company is not regulated. On the contrary, as per the principle of single obligation reulated by article 480 of TCC, the only obligation of the shareholders of a joint-stock company is to pay the share values, barring some exceptions set out by the Code. Likewise, as per the principle of mandatory provisions regulated by article 340 of TCC, articles of association cannot deviate from the Code’s provisions for joint-stock company, unless stated otherwise.

 

A. The Opinion Which Defends Shareholders are not Subject to the Obligation of Loyalty

The opinion which defends shareholders are not subject to the obligation of loyalty is the dominant school of thought in the doctrine. However even the supporters of this opinion admit that shareholders are oblige to abide by the principle of honest performance due to the reason that this principle precedes over the principle of single obligation and therefore shareholders have to act honestly as all people. The question here is whether the principle of honest performance would come with the obligation of loyalty.

The obligation of loyalty requires that shareholders supports the interests of the joint-stock company and the other shareholders’ partnership interests, that shareholders do not act against these interests and consider them before their own interests.[7] Another projection of the obligation of loyalty is the prohibition of competition with the company; therefore assuming that shareholders have the obligation of loyalty would naturally lead to the conclusion that they are also subject to the prohibition of competition. [8]

According to Tekinalp the joint strive for the collective goals and liability in real-person partnerships is not present in joint-stock companies. Therefore shareholders have an obligation of loyalty or prohibition of competition neither towards the company nor towards each other. Regardless of the number of shareholders, shareholders do not have a partnership between each other due to the reason that joint-stock companies are based on capital and devoid of personality. The principle of honesty, on the other hand, applies to the shareholders who manage the company by themselves or together with other groups and causes liability in the event that a shareholder acts with malicious intent while voting. However this principle is not an additional obligation for the shareholders but rater a natural result of everyone’s duty of honest performance.[9]Many other opinions in the doctrine concur with Tekinalp in this regard. [10]

Another school of thought mentions the extended duty of honest performance by “controlling” shareholders in joint-stock companies. “Control” in joint-stock companies means ruling over the management mechanism and giving directions to the company’s works. On principle shareholders who have the majority of the votes in the general assembly also have the said control. Article 2 of the Civil Code which dictates the duty of honest performance in all fields of private law limits the controlling shareholders’ freedom of operations within the company. Although a shareholder ma consider his/her own interests while casting a vote or dealing with company works, s/he may not unnecessarily cause harm to the interests of the company, its other shareholders or other concerned third parties. Therefore a shareholder’s duty of honest performance is broader in extent. [11]

In conclusions, according to the first school of thought regarding the shareholders’ prohibition of competition, especially shareholders who control the company via the majority of the votes or privileged votes need to abide by the duty of honest performance during the company-related operations and especially while casting vote. Even though some writers argue that this duty of honest performance is broader than in other people’s cases, this duty does not mean a prohibition of competition. Shareholders are entitled to consider their own interest while casting vote; however they cannot deliberately cause harm to the company or to the other shareholders.

 

B. The Opinion that Prohibition of Competition Applies to the Shareholders

As much as the prevailing school of thought is that shareholders are not subject to the prohibition of competition and that the duty of honest performance does not principally cause an obligation of loyalty, the descending opinion is that shareholders might be subject to the prohibition of competition especially in joint-stock companies with few shareholders, in the events that one or a few shareholders take a step beyond controlling the board of directors and actually control the company via majority or privileged votes, carry out communication and meetings, take the decisions and set out the strategies.

Nomer Ertan argues that in such cases prohibition of competition can be applied to the shareholders.[12] This school of thought is adapted in the Swiss doctrine and Federal Court precedence while being also supported by some writers in the Turkish and German doctrine.[13]

 

C. Contractual Prohibition of Competition with regards to the Shareholders

Another issue to be discussed is that whether shareholders can be subjected to the prohibition of competition via articles of association. Undoubtedly this matter is controversial in the doctrine and those who support that prohibition of competition cannot be agreed by the articles of association depend their view on the principle of single obligation regulated by TCC art.480.  The principle of single obligation dictates that shareholders cannot be obliged to do anything but to pay the share values.  Furthermore in the commentary of the said article it is stated that the article is peremptory and the principle of peremptory provisions in article 340 prohibits articles of association from deviating from the law.

The exception to the principle of single obligation is the secondary obligations permitted h law. However, although secondary obligations can be determined by the articles of association, they are, by nature, non-monetary obligations that repeat at stable intervals and therefore cannot include prohibition of competition.[14]

In the doctrine, there is no consensus on whether a contractual prohibition of competition set out in the articles of association is invalid. Tekinalp argues that, on principle a prohibition of competition cannot be determined as a secondary obligation in the articles of association, however in exceptional cases prohibition of competition can be discussed  as a secondary obligation in family joint-stock companies.17

At this point it should also be discussed, in the assumption that the principle of single obligation is applied strictly and prohibition of competition cannot be regulated in the articles of association, what would happen if a clause on the prohibition of competition was somehow written in the articles of association. As commonly known the director of trade registry checks whether the articles of association which is requested to be registered is according to the law and denies registration in case of presence of a subject outside of the content of the articles of association stated in the law. However, if a prohibition of competition is somehow registered in the articles of association despite the director’s review, one opinion in the doctrine argues that such clauses are invalid against the company under the Turkish Commercial Code but valid and effective between shareholders as per the principle of freedom of contract under the Turkish Code of Obligations and call for liability in the event of their violation.[15]

Whereas there is no consensus on the subject of articles of association, it is widely agreed in the doctrine that prohibition of competition could be applied to the shareholders via a shareholders agreement.[16] Shareholders agreement is “an agreement that all or some of the shareholders enter into in order to regulate the legal relationship with each other, with the company or to determine the provisions which they would like the company to be subject to”.[17]  This agreement is considered as a constitution between the contracting shareholders. A shareholders agreement may include matters that cannot be mentioned in the articles of association; such as financing the company, reasons for liquidation, obligation to sell or purchase shares, prohibition of competition, obligation of loyalty, call option, put option, right of first refusal, drag along right, tag along right  or other obligations and rights deviating from the provisions of the articles of association.

Shareholders agreement is not regulated in the Turkish Commercial Code and is a simple contract under the law of obligations and therefore the consequences of its violation are subject to the Turkish Code of Obligations and cannot be agreed to be governed by the law of companies.[18] Therefore, as much as some provisions can be directly enforced in the event of their violation, violation of the prohibition of competition could only be compensated by indemnity and not be enforced by a lawsuit under the provision of “Instead of indemnities, to consider the work as performed on behalf of the company and to sue for restitution of the funds gained through contracts made with 3rd parties” as per TCC art.396. Furthermore, the said indemnity can only be claimed in favor of the shareholder and not the company, unless otherwise agreed upon..

In shareholders agreement it can be agreed that the indemnity to be claimed in the event of the violation of the prohibition of competition is to be paid to the company. A joint-stock company can also be a party to the shareholders agreement.[19] In this case the company can directly sue the shareholder who violates the prohibition of competition and claim indemnities by itself. A shareholders agreement can also be made for the purpose of having the company take some direct enforcement measures such as preventing the registration into the share ledger in the event of violation of a share-transfer restriction..[20]

 

D. Evaluation and Discussion of All Opinions Regarding the Prohibition of Competition;

The first issue to be discussed is whether joint-stock company shareholders are principally subject to the prohibition of competition. Writers with negative opinion on this subject argue that shareholders only have the obligation of honest performance. Writers with affirmative opinion, on the other hand, argue that shareholders who act as the board of directors in reality should be subject to the obligation of loyalty just like the board of directors is.

The important question here is not whether there should be a penalty for the shareholders who act as the board of directors but rather whether it is acceptable that shareholders who know the trade secrets, determine the company’s decisions and operations and whose know-how and experience is needed by the company, to compete with the company.

In joint-stock companies the distribution of workload is that shareholders pay the capital whereas the board of directors manages and represents the company via their experience, knowledge and time of work. However, in joint-stock companies with few shareholders, operating in certain sectors where experience and know-how are more valuable than the capital (such as pharmaceutical, medical tools, chemical materials, technology products etc.) there is a more interactive relationship between the shareholders and the board of directors.

Let us take as an example a company founded for the purpose of processing raw chemical materials and transforming them into pharmaceuticals, paints and textile, manufacturing and distributing them.  For such a company to exist, the first thing that is needed is an investor with technical knowledge, sectoral experience and connections with companies that provide raw materials; therefore the primary consideration this investor guarantees as a shareholder to the company is his know-how. In such cases shareholders that undertakes to provide know-how act as managers of the company through the trusted directors they nominate and instruct.

The problem therein is that primarily in sectors where competition is tough, competitors are few and the real capital is based on know-how, shareholders who act as directors, manage the company in reality, know the trade secrets might also take on separate ventures that are in competition with the company or might directly work as directors in the competitor companies and this begs the question: Is the principle of single obligation for these shareholders still justified? A shareholder who is managing the company in reality and therefore critically important for the achieving of the corporate goals of the company will render these goals very difficult, if not impossible, if he competes with the company at the same time. Any act who contradicts the purpose of existence of the company should also considered to violate the principle of honest performance.

 

III. CONCLUSION

In conclusion, although joint-stock company shareholders are principally not considered to be subject to the prohibition of competition, shareholders whose competition with the company, in specific circumstances, cannot comply with the principle of honest performance due to their positions and control over the company should be considered to be subject to the obligation of loyalty and the prohibition of competition.

Although the Court of Cassation has not rendered a landmark decision on the subject, when the matter is brought before the court, the court of first instance should render its judgment by evaluating the specifics of the situation with regards to the competing shareholder’s position in the plaintiff company and the business which is claimed to be competing with the company, the type and structure of the company, number of shareholders and their share values, the company’s work field, the conditions and dynamics of the sector. Should the court decide that the defendant shareholder actually manages the company, that two companies are directly in competition and that this competition, when its specifics are evaluated, prevents the defendant shareholder from using his rights as a shareholder honestly and objectively – managing the company is a reflection of these rights – it should be decided that the prohibition of competition is violated.

 

BIBLIOGRAPHY

Aydoğan,Fatih: Tek Kişi Ortaklığı İstanbul 2012

Bahtiyar, Mehmet: Anonim Ortaklık Anasözleşmesi, İstanbul 2001

Domaniç, Hayri: Anonim Şirketler, İstanbul 1978

Göksoy, Yaşar Can:  Ortaklıklar Hukukunda Rekabet Yasaklarının Kapsamı, Dokuz Eylül Üniversitesi Fakültesi Dergisi Edition:9 Özel Sayı, 2007 p.647,648

Güney, Necla Akdağ.: Anonim Şirket Yönetim Kurulu, İstanbul 2002

Karasu, Rauf: Anonim Şirket Yönetim Kurulu Üyelerinin Üyelik Sıfatı Sona Erdikten Sonra Şirketle Rekabet Etme Yasağı, Rekabet Dergisi, Edition:20 p.25

Nomer, Füsun: Anonim Ortaklıkta Pay Sahibinin Sadakat Yükümlülüğü, İstanbul 1999

Okutan Nilsson, Gül: Anonim Ortaklıklarda PaySahipleri Sözleşmeleri, İstanbul 2004

Paslı, Ali: Anonim Ortaklıkta Kontrol Sahibinin Özel Durumu, İÜHFM C. LXVI (2008), Edition 2, p.345-358

Poroy,Reha/Tekinalp,Ünal/Çamoğlu,Ersin: Ortaklıklar ve Kooperatif Hukuku, İstanbul 2014

Pulaşlı, Hasan: Şirketler Hukuku, Ankara 2015

 

 

[1] Çamoğlu,E. (Poroy,R. Tekinalp,Ü.): Ortaklıklar ve Kooperatif Hukuku, İstanbul 2014, N.572

[2]. Çamoğlu (Poroy, Tekinalp),. N.573a

[3] Çamoğlu (Poroy, Tekinalp),. N.576

[4] Güney,A.:, Anonim Şirket Yönetim Kurulu, İstanbul 2002, p.146; Karasu,R.: “Anonim Şirket Yönetim Kurulu Üyelerinin Üyelik Sıfatı Sona Erdikten Sonra Şirketle Rekabet Etme Yasağı” Rekabet Dergisi, Issue:20 p.25 and all the authors mentioned in footnote 15; Y. 11. HD, 04.10.2012, E. 2010/11204 K. 2012/15168

[5] Karasu, p.22,23 and all the authors mentioned in footnotes 4 and 5.

[6]  See Karasu,  p.30-32.

[7] Tekinalp (Poroy, Çamoğlu),. N.1091

[8] Nomer,F.: Anonim Ortaklıkta Pay Sahibinin Sadakat Yükümlülüğü, İstanbul 1999, p.132

[9] Tekinalp (Poroy, Çamoğlu), N.1091-1091b

[10] See Pulaşlı,H.:, Şirketler Hukuku, Ankara 2015, p.576,577; Also see. Göksoy,Y.:  Ortaklıklar Hukukunda Rekabet Yasaklarının Kapsamı, Dokuz Eylül Üniversitesi Fakültesi Dergisi Edition:9, 2007 p.647,648; also see. Aydoğan,F.: Tek Kişi Ortaklığı, İstanbul 2012, p.237,238; also see. Domaniç,H.: Anonim Şirketler, İstanbul 1978, p.451.

[11] See Paslı,A.: Anonim Ortaklıkta Kontrol Sahibinin Özel Durumu, İÜHFM C. LXVI (2008), Edition 2, p.345-358

[12] Nomer,  Anonim Ortaklıkta Pay Sahibinin Sadakat Yükümlülüğü, İstanbul 1999,  p.134,

[13] See Füsun Nomer Ertan’s footnote: “Fortsmoser, Verantwortlichkeit N.701; Helvacı 7,8. Also see Wohlmann, Treuepflicht 127; Poroy/Tekinalp/Tekinalp 356; Würsch 37; Forstmoser/Meier-Hayoz/ Nobel 28 N.183,184; Zürcher Kom- Homburger, OR Art.707 N.133 vd; BGE 102 II 359; 107 II 349] [ and also see. Naklen Göksoy, Yaşar Can. Ortaklıklar Hukukunda Rekabet Yasaklarının Kapsamı, see footnote 54 and 56: Siegwart, Kommentar zum schweizerischen Zivilgesetzbuch, Band V: Obligationenrecht, 5.Teil: Die Aktiengesellschaft, Allgemeine Bestimmungen (Art. 620-659 OR), Zurich 1945, Art. 620, N.32. Türk öğretisinde Akın, Yusuf Murat, Şirketler Hukukunda ve Özellikle A.Ş.’lerde Pay Sahibinin Sadakat Borcu, İstanbul 2002, p.143-144. Ayrıca v.Greyerz, Die Aktiengesellschaft, in: Schweizerisehes Privatrecht VII/2, Basel 1982, p.164”

[14] Tekinalp (Poroy, Çamoğlu), N.1084

[15] Bahtiyar,M.: Anonim Ortaklık Anasözleşmesi, İstanbul 2001, p.224,225

[16] Tekinalp (Poroy, Çamoğlu), . N.1021

[17] Okutan Nilsson,G.: Anonim Ortaklıklarda PaySahipleri Sözleşmeleri, İstanbul 2004, p.4

[18] Okutan Nilsson,  p.343,344

[19] Okutan Nilsson, p.312 ve ayrıca bkz. Tekinalp (Poroy, Çamoğlu), N.1021a

[20] Okutan Nilsson,  p.313