A Legal Vehicle in Institutionalization Of Family Companies And Transfer Between Generations: Internal Directive

December 2015 Ali Sami Er
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An internal directive may constitute a stepping stone for family companies to become institutionalized. A simple distribution of duties to be provided in consideration of the accountability principle may enable differentiation in decision-making processes, and may convert the board of directors from an executive organ to a surveillance organ. Moreover, it may enable the company to be transferred from generation to generation in a more planned manner. Although it may seem hard to delegate management authorities, the main hardship stems from the transfer of representation authorities. Each member of the board of directors, from the second and third generations that are almost deemed to be the heads in internal affairs, usually is not vested with the representation authority of the company in external affairs. However, the substructure of the transfer to the next generation may be procured by an internal directive, which governs both management and representation authorities.

What is an internal directive?

An internal directive is a regulation issued by the board of directors, governing the management of the company, and its representation structure against third parties, which results in consequences, both related and unrelated to the company.

What are the elements of an internal directive?

“Management of the company” means a comprehensible explanation of the management process setting forth sharing of the duties, authorities of the board of directors, transferred authorities, definitions of the management duties and work flow charts, along with hierarchical reporting structure. Actually, the internal directive, presenting the management process, renders the job definitions, which are mostly designated by companies in order to meet the ISO Quality Certificate requirements, as applicable, rather than being non-functional.

“Representation structure against third parties,” on the other hand, resembles a signature circular. The mere difference here is that the representation authorities become evident, as opposed to managerial duties. For instance, one of the duties that falls within the job definition of the finance director, which is the investigation of appropriate loans, constitutes the managerial duty, and the signature on the loan agreement constitutes the representation dutyIt is possible to restrict the representation authority to be granted via an internal directive, in terms of subject and monetary amount (for instance: it is possible to limit the authority in the loan agreements to be signed to a certain degree or according to the type of the loan).

What is an internal directive not comprised of?

As mentioned earlier in the introduction of the article, an internal directive may serve as a vehicle for institutionalization. In furtherance of this view, Trade Registries also state that only duties and authorities shall be mentioned in the internal directive, but no authorizations shall be made by name. Therefore, the representation authorities of the Store Manager shall be designated under the internal directive, but not the authorities of Mr. Ahmet the Store Manager. As it is noted, below, authorization by name shall separately be made via a board of directors’ resolution (for joint stock companies) or board of managers’ resolution (for limited liability companies).

Can a limitation be made in the internal directive in terms of subject and amount?

The answer to such question is both yes and no. If authorities as found in the internal directive are appointed to the designated duties, then all kinds of limitations may be made for these persons. However, it is not possible to set forth limitations with regard to authorized persons who are not set forth in the internal directive (for instance: board of directors’ members having representation authority).

What are the necessary resolutions to be taken in order to issue an internal directive?

In order to issue an internal directive, first of all, there must be a provision in the articles of association stating that the board of directors are authorized in this regard[1]. To add a provision to the articles of association, such as the following, is sufficient: The board of directors may either use the management and representation authorities, or may delegate such authorities via an internal directive.

If the internal directive does not contain such provision, the general assembly will need to amend the article concerning the management and representation authorities of the board of directors. A participation rate of ½, and the majority vote of the shareholders attending the meeting, is sufficient to take such resolution in the general assembly.

Along with the modification of the articles of association, the board of directors may prepare an internal directive dated either the same as the resolution, or a future date, before such resolution is registered.

How can the appointments of the duties determined in the internal directive be made?

Appointments to such duties shall be made via a board of directors’ resolution in joint stock companies, and via a general assembly, namely, a board of shareholders’ resolution in limited liability companies. This resolution shall absolutely include the TR Identification number of the related person. Therefore, immediately after a resolution regarding the internal directive, appointments may be made via a board of directors’ resolution (in joint stock companies) or general assembly resolution (in limited liability companies). For instance: It has been resolved in our Board of Directors’ resolution dated X and numbered Y that Mr. Ahmet shall be appointed as a store manager, of which its authorities are indicated in our Internal Directive […]

Does the internal directive require registration?

Only the parts of the internal directive concerning representation should be registered. In other words, there is no need for registration of the regulations related to management. At some point, the regulations concerning management of the company may be comprised of confidential information of the company. Thus, the lawmaker does not require registration of such parts. If there is a dispute that requires the management transfer to be demonstrated, an internal directive may be preserved for years as a confidential document only to be disclosed via a court order.

The parts concerning representation, on the other hand, are subject to registration. The aforementioned resolution of appointment is also subject to registration.

As of this part of this newsletter article, some properties of the internal directive in terms of representation authority shall be evaluated.

What shall be done following the registration of the internal directive?

Following the registration of the internal directive, in terms of the necessities of commercial life, it is required to get the signature specimens authenticated by the Notary Public. The document issued by the Notary Public, within the scope of this authentication, shall constitute the signature circular of the company.

Who can be granted the representation authority by means of internal directive?

Any employee who is connected to the company via a service agreement, and any member of the board of directors who is not granted a representation authority via a general assembly meeting, may be rendered authorized via an internal directive. Therefore, at first view, it may be claimed that the persons who are not in connection with the company in terms of an employee-employer relation cannot be authorized via an internal directive. However, if we interpret the law in accordance with its purpose, it can be said that the required service is not, independently, about being permanent, but more about continuously serving the company[2]. Due to the fact that Trade Registries do not conduct examinations, in practice, persons in group companies who are not employed by the company are also authorized in the internal directive.

Can the internal directive contain persons who are not vested with limited representation authority?

Since there are no limitations stipulated in the law in this regard, persons authorized to jointly represent the company, or branch representatives, may also be mentioned in the internal directive. However, in practice, different approaches of trade registries may be encountered. The benefit of such document is to allow the company to demonstrate its representation authorities by means of more than one document. Moreover, it is more suitable in terms of commercial life to avoid the dispersed structure of the law to enforce a burden upon the companies in issuing different documents in order to transfer their representation authorities. Therefore, it is more practical to mention the authorities whom shall be appointed in accordance with the board of directors’ resolution regarding joint or several representations, and the authorities to be appointed via an internal directive within the same resolution.

How can persons who cannot be authorized by means of an internal directive be authorized?

It is possible for companies to authorize persons who are not their employees, for certain operations, by means of a power of attorney, via a board of directors’ resolution or via their representatives (for example: members of the Board of Directors or the authorized persons as per the internal directive). Such authorizations shall not be registered with the Trade Registry, and shall not be announced. On the other hand, upon the appointment of a generally authorized attorney, such attorney shall be legally deemed as a commercial agent, namely, a commercial representative, and such appointment shall be registered with the Trade Registry.

In practice, notaries public examine authorities granted via powers of attorney and, meanwhile, they abstain from issuance of a power of attorney when they encounter expressions, such as “to represent the company to the greatest extent possible.” In such a case, they indicate that this authorization is subject to authorization, and can only be made via a board of directors’ resolution. Within this context, the power of attorney that is issued by a notary public must concern a certain limited operation.

Are amendments to the internal directive also subject to registration?

Legally, all amendments made in matters that are subject to registration shall also be subject to registration. However, it must be pointed out that there are differences, in practice. Some trade registry directorates solely require the registration of amendments; whereas, others require the entire internal directive to be registered[3]. It can be foreseen that the practice will harmonize over time, just as the registration of only the amended article in the articles of association.

What are the effects of the internal directive in terms of liability?

The internal directive system is a shield that can protect the company from third persons. Therefore, it must be registered before the trade registry. In order for an agreement concluded by the representatives of the company shown in the internal directive to be binding upon the company, such representatives shall hold representation authority. Otherwise, the counterparty of the agreement’s concluded representative without authority shall have no claims arising from the agreement. Here, the effect of a registered internal directive is observed. The counterparty to the contract may confirm whether the representative in the internal directive has authority, or not, from the trade registry gazette. In short, in the case of a representation without authority, the company will be protected by means of a registered internal directive.

However, the internal directive system does not comfort the board of directors in terms of responsibility. The wording of TCC Art. 371/7 states that persons who are granted representation authority through an internal directive shall be severally liable along with the board of directors. This means that if damages arise as a result of an agreement, the creditors and the shareholders may claim their damages from either the representatives shown in the internal directive who signed the said agreement, or the board of directors’ members, irrespective of whether or not they signed it. At this point, a board of directors’ member may waive liability by claiming that he/she acted with due care in choosing, instructing, and supervising the said representative[4].

Conclusion

In a nutshell, there is great benefit in re-evaluating the current signatory circular of a company within the framework of an internal directive system. This way, while taking a step towards institutionalization of the company, the transfer of authority from generation to generation in family companies are facilitated. Obviously, this work has to be done in consideration of the law of liability. Otherwise, given that a simple signatory circular has not been issued, this may have unwanted consequences, and may also give rise to the responsibility of the members of the board of directors.

[1] For our readers who are also law practitioners, we would like to remind that as per the TCC, there is a provision in the articles of association solely about the transfer of management. Therefore, in order to issue an internal directive in terms of representation transfers, there is no need to have a provision thereof in the articles of association.

[2] Yanlı/Okutan Nilsson P. 12 BATIDER V. XXX No. 4 2014.

[3] Istanbul Trade Registry Directorate: “In case of amendment to the internal directive which is registered and announced in the company records or in case of additions to such internal directive, a new and differently dated, numbered internal directive should be registered and announced.”

http://www.ito.org.tr/wps/portal/tescil-ilan-kurulus?WCM_GLOBAL_CONTEXT=Sirket_Sinirli_Yetkili.

[4] On the other hand, it is also stated by the academics that the liability structure envisaged by Art. 371/7 shall not be eliminated by Art. 553. Akdağ Güney p. 22 Evaluations Regarding the 7th paragraph added to TCC Art. 371 by the Omnibus Law numbered 6552 www.arslanlibilimarsivi.com.

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