A derivative suit is a right granted to joint-stock corporation shareholders. The former Turkish Commercial Code had regulated this right and the “new” Turkish Commercial Code (“TCC”), which came into force on 01 July 2012, preserves it.
The derivative suit’s subject matter is claiming compensation of losses incurred by the corporation if the founders, board members, executives, or liquidators negligently violate their obligations under the law or the corporate articles (TCC Article 553). Each shareholder has the right to file this lawsuit (TCC Article 555).
Limited liability company shareholders can also enjoy this right (TCC Article 644).
This study discusses the derivative suit against the board members or executives in joint-stock corporations (“Executives”).
Scope and Characteristics
Shareholders file a derivative suit for a corporation’s losses (TCC Articles 555 and 1534(1)). The distinction between loss and reflective loss clarifies the scope of the derivative suit.
If a shareholder has personally incurred losses, this is the shareholder’s own loss. In contrast, if the corporation has incurred losses, this is the shareholder’s reflective loss. For example, a decrease in the share value, shareholders’ inability to receive dividends, or a reduction of shareholders’ liquidation shares are shareholders’ reflective losses.
For their losses, a shareholder files a direct suit to request compensation for themselves. This lawsuit does not fall under the scope of the derivative case. However, for reflective losses, a shareholder files a derivative suit to request compensation for the corporation, not for themselves (TCC Article 555(1)). Only in the corporation’s bankruptcy shareholders have priority over the corporation in distributing the compensation (TCC Article 556(2)).
The fact that the compensation for the corporation’s losses is paid to the corporation but not to the shareholders individually contributes to all shareholders’ equal benefit, which is in line with the principle of equal treatment of shareholders, one of the basic tenets for joint-stock corporations (TCC Article 357).
Reason behind the Right to Derivative Suit
One could argue that the corporation should file this lawsuit. However, if the corporation’s losses do arise from the Executives’ actions, the corporation may not file a lawsuit for de jure or de facto reasons. That is why the legislator has granted the right to file a lawsuit to each shareholder.
The deadlock in the board of directors’ decision-making process due to the corporate articles’ management and representation provisions is an example of de jure reasons. Corporation’s negligence, responsible Executives’ presence in the corporation management, personal relations of the Executives with the other party of a transaction that causes losses to the corporation are examples for de facto reasons.
Conditions of the Lawsuit
Under Turkish law, the derivative suit is an independent lawsuit; the shareholders do not have to wait for the corporation to take any action before filing it. On the contrary, it grants the shareholders the right to file the lawsuit with the anticipation that the corporation (the Executives who manage the corporation) may not file the case.
Only in the corporation’s bankruptcy there is an exception to this rule (TCC Article 556). In this case, the shareholders should first have to wait for the bankruptcy administration to file the lawsuit, and if the bankruptcy administration fails to file the lawsuit, then the shareholders can file this lawsuit (TCC Article 556(2)).
The plaintiff must be a shareholder at the date they file the lawsuit. TCC Article 555(1), which states that “The corporation and each shareholder may claim compensation for the loss incurred by the corporation.”, is evident in this respect.
Shareholders should not release the Executives from liability during the corporation’s general assembly. Otherwise, such a decision will exclude the shareholders’ right to file a lawsuit regarding the matters covered by the release (TCC Article 558(2)).
Shareholders should also consider the statute of limitations. The right to file the lawsuit against the Executives is time-barred by two years from the date the plaintiff shareholder has become aware of the losses and responsible Executives and in any case, five years from the day the action causing the losses has occurred. If this action does also constitute a crime and criminal laws require a longer statute of limitations, then the longer statute of limitations will apply to this civil lawsuit as well (TCC Article 560).
Basis of the Claim
The corporation and Executives have a contractual relationship, so the basis of Executives’ liability in a derivative suit is contractual.
The duty of care and loyalty (TCC Article 369) will determine whether the Executives acted contrary to the contract. This duty obliges the Executives to perform their functions with a prudent manager’s care and protect the corporation’s interests in good faith.
TCC Article Justifications state that the business judgment rule draws the boundaries of the prudent manager concept; however, there is no mention of the business judgment rule in the TCC itself. Thus, accepting this as a criterion for the Executives’ duty of care will be misleading.
The Executives’ degree of care should be in line with an attorney-in-fact’s degree of care, as the relationship between the Executives and the corporation is acknowledged as an attorney and principal contract unless there is an employment contract.
In determining an attorney’s liability arising from the duty of care, the reference is the behavior expected from a prudent attorney who undertakes business and services in a similar field (Turkish Code of Obligations (“TCO”) Article 506(3)). This objective criterion does not consider the Executives’ knowledge, capacity, experience, or education who may be held liable. This objective criterion expects a higher level of care when compared to the business judgment rule because the business judgment rule makes a “presumption that in making business decisions not involving direct self-interest or self-dealing, corporate directors act on an informed basis, in good faith, and the honest belief that their actions are in the corporation’s best interest.”
Nevertheless, the legislator, not expecting superhuman behavior from the Executives, has limited their liability by stating that “No one shall be held liable for any breaches of law or corporate articles or other corruption beyond their control; the duty of care and loyalty cannot override this non-liability” (TCC Article 553(3)).
Burden of Proof
In breach of a contract, the party who violates the agreement “is obliged to compensate the obligee’s loss unless they prove that they are not negligent.”(TCO Article 112). In line with this rule, when the Official Journal first published the TCC, Article 553(1) on the liability of the Executives was as follows:
“If founders, board members, executives, or liquidators violate their obligations arising from the law or the corporate articles, they shall be liable for compensation towards the corporation, the shareholders, and the creditors of the corporation unless they prove that they are not negligent.”
In this version of the provision, considering the TCO, the presence of the Executives’ negligence was regarded as a presumption, and the Executives would be liable for compensation unless they proved that they were not negligent.
Just before the TCC came into force on 01 July 2012, on 30 June 2012, Law No. 6335 amended this provision; it repealed the negligence presumption and shifted the burden of proof. The new and current version is as follows:
“If founders, board members, executives, or liquidators negligently violate their obligations arising from the law or the corporate articles, they shall be liable for compensation towards the corporation, the shareholders, and the creditors of the corporation.”
According to this new version of the provision, shareholders who will file a derivative suit have to prove that the Executives are negligent; otherwise, the court may dismiss the lawsuit.
Although this amendment is consistent with the general rule that the burden of proof falls to the plaintiff first, it is not easy for the shareholders to prove that the Executives are negligent, given that shareholders are not involved in the management of joint-stock corporations (TCC Articles 408 and 375). In this context, shareholders have limited access to information about the corporation under certain conditions (TCC Articles 437 and 438).
In addition to this drawback, the amendment also contradicts the TCO principles, the primary law governing contractual relations. Mainly for this reason, despite the new wording of TCC Article 553(1), there are opinions of scholars commenting that one should interpret this provision within the TCO framework.
However, considering that the legislator has specifically made this amendment, the courts can read the TCC ignoring the TCO since the justice commission report on the amending law clarifies that the amendment aimed to put the burden of proof on the plaintiff.
Shareholders do not have an obligation to present collateral for filing the derivative suit. However, claiming that the Executives violated their obligations arising from the law or the corporate articles may impair the corporation’s reputation, and thus the corporation may incur losses if such claim lacks any basis.
The legislator’s preference for this lawsuit was to encourage the shareholders to file the lawsuit. The TCC, regarding the legal expenses, states that:
“If legal or material reasons justify the lawsuit filed by the shareholder, the court shall distribute the litigation costs and the attorney’s fees between the plaintiff and the corporation equitably, in cases where the court cannot award these expenses to the defendant.” (TCC Article 555(2)).
This provision has brought a new approach in respect of the procedural law. In terms of procedural law, the rule is to award the litigation costs and the attorney’s fees to the party who loses the lawsuit (Civil Procedural Law (“CPL”) Articles 323 and 326). According to this general procedural rule, if the plaintiff shareholder fails the derivative suit, the court will not award litigation costs and attorney’s fees to the defendant (the Executives). However, in this case, per the special rule introduced by the TCC, litigation costs and attorney’s payments may be distributed between the corporation and the plaintiff shareholder.
The reason behind this rule is that under certain circumstances, the shareholder claims the corporation’s losses due to the corporation’s failure to do so for some de jure or de facto reasons. The legislator has introduced this rule anticipating that some shareholders may not consider filing a derivative suit because of litigation costs and attorney’s fees.
Court of Competent Jurisdiction
Shareholders may file the derivative suit at the commercial first instance court having jurisdiction over the corporation’s headquarters (TCC Article 561). The rules stated in the CPL on the court of competent jurisdiction are reserved. Shareholders should not overlook the precondition of mandatorily applying to a mediator before filing a commercial lawsuit with a compensation claim under TCC Article 5/A, which was added to the TCC by Law No. 7155 and came into force on 01 January 2019.
Shareholders of Turkish companies have filed a limited number of derivative suits. The main reasons triggering a derivative case are wasting of corporation assets and mismanagement.
The right to derivative suit, granting the shareholders the right to file a lawsuit for compensation of the corporation’s losses, caused some first instance courts to render erroneous judgments in terms of legal standing. These courts dismissed the derivative suits on the ground that only the corporation may claim the losses it incurred and that the shareholders were not entitled to such a request, but the Supreme Court, in line with the apparent rule stated in TCC Article 555(1), reversed these judgments.
The Supreme Court rendered a similar judgment in a derivative suit regarding a corporation in bankruptcy. The first instance court dismissed the lawsuit stating that only the bankruptcy administration had legal standing, but the Supreme Court, in line with the apparent rule stated in TCC Article 556(2), reversed this judgment as well.
Unfortunately, these judgments are not satisfactory enough to guide the derivative suit practice in Turkey. There will be more to comment on once pending lawsuits are heard and concluded on the merits.
Av. Müge Önal Başer, LL.M., LL.B.