Ercüment Erdem Att. Sevgi Unsal Ozden

Institutionalization in Family Businesses and Family Constitution

July 2021

Introduction

It is a well-known fact that the majority of companies operating in Turkey and around the world are family businesses, and few of these companies are able to transfer their assets to future generations. In order for a family business to successfully manage this, it is necessary and substantial to establish a solid corporate structure and to prevent conflicts which may arise between family members or at least to resolve them in a way that does not adversely affect the operation of the company. One of the most important steps that can be taken towards this goal is the preparation of a family constitution. In this Newsletter, the scope, content and binding nature of the family constitution are examined.

What is a Family Constitution?

The goals of the preparation of a family constitution are transferring a company's operation, family mission, and values to the next generation, regulating relations between current family members and people who join the family later on, and regulating relations between family members and the company. Thus, a family constitution serves as a guide for future generations in terms of family values, principles, mission, goals and the roles of family members, and includes solutions for possible conflicts within the family.

The family constitution is an atypical contract. It can be drafted in any way that the parties decide within the scope of the principle of freedom of contract set forth under Turkish Code of Obligations No. 6098[1] ("TCO"). There is no registration or announcement obligation for a constitution. This provides flexibility to family members regarding the content and revision of the constitution, as well as protecting the confidentiality of constitutional articles. However, it is recommended that the family constitution be made in writing and signed by all family members in order to make the text accessible to the family and to provide ease of proof to the parties in case of disputes that may arise.

As a requirement of pacta sunt servanda and the rule of legal certainty, integrity and honesty, the family constitution, being a contract, binds every signatory family member as a debt contract. However, the provisions are not legally-binding for family members who are not signatories, members who join the family later, or shareholders of the family businesses and companies. On the other hand, it is possible to reflect some of the provisions in the family constitution in the articles of association or the shareholders' agreement[2] to the extent permitted by Turkish Commercial Code No. 6102[3] (“TCC”), thus making these rules binding for the company and its shareholders.

Which Subjects Can be Regulated in a Family Constitution?

The regulations of the family constitution are formed by the joint decision of the family members, their demands, and the needs of the family. Therefore, each family constitution is unique. Family members can freely determine the content of the constitution by considering the general rules and principles of the TCO and Turkish Civil Code No. 4721[4], and within the limits stipulated in the law. However, according to Article 27 of the TCO, family constitutions that are contrary to the mandatory provisions of the law, morality, public order, personal rights, or whose subject and content are impossible, shall be null and void.

Given the purpose of a constitution, there are of course some basic issues that are frequently encountered in every constitutional text. These issues may be grouped under three main headings: i) family related regulations, ii) arrangements with regards to the family’s businesses, and iii) the general provisions of the family constitution.

Regulations Regarding the Family

In order for the family to transfer its values to future generations, to establish healthy communication within the family, and to ensure the sustainability of this communication, common values and awareness, it is extremely important that the issues which concern the family are properly identified and written down. Therefore, family constitutions usually begin by describing the family's vision, mission, values, goals, culture, communication principles, and continue with articles which define family members and family-owned companies.

The separation of family and company assets, which is one of the most important issues for family businesses, as well as asset management, are also regulated under this section of the constitution. Policies can be determined on the storage of family assets, the use and distribution of return-on-assets, or how these assets will be used in case of need or of a new investment. In this respect, borrowing limits of the shareholder family members against the company can be specified by considering the provisions of the TCC. Moreover, it is also possible to determine the rules and principles regarding the education and career development of young family members, to create funds such as family banks or family safes, and to include all these issues in the text of the constitution.

In some cases, if there is a museum, school, nursery or park, which a family has already built, a family constitution can determine the responsibilities for ensuring the continuity of these projects, whether a provision is made for social responsibility projects from the family budget, and the processes for the selection and approval of the projects.

Regulations Regarding Companies

The rules and principles with regards to the management of companies are among the basic and substantive provisions in a family constitution. Within this scope, working or internship conditions in the companies, recruitment and evaluation processes, performance evaluations, conditions for taking part in the management such as being a member of the board of directors, formation of the management bodies, rules and limitations regarding shareholding of the family members, and succession plans, may be included in the text in detail. However, it is generally preferred to regulate issues such as aggravated quorums in general assembly and board of directors’ meetings, restrictions on the transfer of shares, the procedure for sale and transfer of shares to family members, the determination of privileged shares, dividend rates and distribution periods, in the shareholders’ agreement. Therefore, giving the general outlines of the aforementioned rules and principles in family constitutions and referring to the shareholders’ agreement for elaboration may be deemed sufficient.

General Provisions Regarding Family Constitution

One of the notable roles of a family constitution is the regulation of family assemblies and/or family councils.  These can be formed within the scope of the text, and then the purpose, duties and responsibilities of these structures, their decision-making and meeting procedures can be determined. In addition, membership conditions or election procedures and the boundaries of their relations with family and family companies may be designated. The family assembly usually consists of natural members of the family. Family members have the opportunity to discuss and obtain information on issues concerning the future of the family and companies at the family assembly/council meetings, which are held at pre-determined intervals. During these meetings, they have a chance to take decisions on essential matters by consulting with each other. The family assembly can be considered as the general assembly of the family. On the other hand, the family council, which may act as a board of directors for the family, is a platform that regulates the necessary policies, takes decisions, implements, and supervises the issues with regards to the family and the companies.  These structures can be in communication and coordination with the boards of directors of family owned companies, and the boundaries of this coordination can be specified with the provisions to be included in the constitution.

Furthermore, it is also possible to establish various committees and working groups connected with the council and/or assembly. The number and fields of activity of such committees and groups may vary depending on the needs and demands of the family members. These structures provide support in establishing a strong communication within the family and fulfilling the duties and responsibilities of the assembly/council.

Like any contract, family constitutions usually end with standard contractual clauses such as confidentiality, amendment, and enforcement. It is extremely important that the family constitution is reviewed and updated at regular intervals in order to adapt to changing conditions over time, the needs of the family, the developments in the companies, and new legislation. By considering the importance of this issue, the obligations related to periodic review of the provisions of the constitution are generally envisaged, and the duties and responsibilities of the family members within this obligation are included. The family council or assembly may be appointed and authorized to update the constitution.

Breach of the Constitution

The key to the sustainable success of family businesses is to resolve the problems that may arise between family members, or between family members and the company, in a short time and in strict confidence, without allowing them to turn into serious conflicts or to affect the operation of the company. For this reason, the constitution, which is prepared by considering the values and dynamics of each family, includes sanctions that can be applied in case of violation of the prescribed rules and principles. These sanctions may include written or verbal warnings, termination of family membership or board membership, compensation for damages, and penalty for breach of contract. For instance, if agreed, any signatory family member may have the right to demand penalty from another family member acting in violation of the constitution, in accordance with the provisions of Article 179 of TCO. In case of breach of the constitution, the use of call-option or put-option within the scope of the share transfer restrictions may also be regulated as a punitive sanction. In this context, signatory family members could exercise the right to receive the shares (call-option) against the relevant shareholder member who violates the constitution. However, it is usually preferable to include such sanctions in the shareholders' agreements.

The family assembly and/or council could be authorized for the resolution of disputes and the applicable sanctions against family members. It is also possible to take support from an objective consultant, mediator or lawyer during the resolution of such conflicts.

Conclusion

Family constitutions complement the provisions of the articles of association of family owned companies, such as shareholders' agreements, and support the prevention of conflicts by regulating the issues that concern family members and the companies. Therefore, it is important for family members to create a constitution that is designed to ensure the continuity of family businesses and their transfer to future generations. It is possible to extend the binding nature of the rules and regulations stipulated in the family constitutions, which can be regulated without any written form and registration requirement, by reflecting them in the articles of association or shareholders' agreements to the extent permitted by the law.


[1] TCO was published in the Official Gazette dated 04.02.2011 and numbered 27836 and entered into force on 01.07.2012.

[2] For detailed information regarding the shareholders' agreement please see Çetinyılmaz, Ecem: “Shareholders’ Agreement in Family Businesses” Erdem & Erdem Newsletter, May 2021,  http://www.erdem-erdem.av.tr/publications/newsletter/shareholders-agreements-in-family-businesses/

[3] TCC was published in the Official Gazette dated 14.02.2011 and numbered 27846 and entered into force on 01.07.2012.

[4] The Turkish Civil Code No. 4721 was published in the Official Gazette dated 08.12.2001 and numbered 24607 and entered into force on 01.01.2002.