Articles of Association in Family Businesses

July 2021 Helin Akbulut
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Introduction

Family companies, basically, are commercial companies in which the company shares or the authority to manage the company belong to various members of a family. The main criteria that may be used to identify family companies are one or more of the following elements: either the majority of the shareholders are family members, family members dominate the management or the family has a strategic effect on the company management, or the continuity of family relations in the company. For this reason, family relationships and commercial ties between individuals add an intricate dynamic to the shareholding relationship.

Among the main goals seen in family companies lies the establishment of a corporate structure that will ensure the transition between generations. Often, various legal documents are created both in order to prevent conflicts between family members by providing legal certainty and, in cases where conflict arises, to resolve the conflict with the least damage to the company’s business. Especially in family companies that are established as joint stock companies, the shareholders’ agreement and the family constitution come first among these legal documents. To what extent these arrangements – especially the provisions of the shareholders’ agreement between the shareholders of the company – may be reflected in the articles of association are of great importance.

The Family Constitution and The Shareholders’ Agreement in Family Businesses

As stated above, the family constitution is one of the most important steps a family company may take to establish a solid corporate structure. The basic purpose of a family constitution is to regulate relations between current and future members of the family and between these people and the company, by considering family values and principles. The aim here is to bring the activities of the company and the family’s mission and values to a harmonious level, and to effectively prepare for transitions to future generations. In this sense, family constitutions would also serve as a guide for future generations.

Another important legal instrument is the shareholders’ agreement.[1] The objectives of the shareholders’ agreement includes regulating the duties and responsibilities of the shareholders in the company, if any, and preventing or minimizing the disagreements between the shareholders. The contract has a binding effect on the parties and especially the provisions regarding compensation and penalty clauses strengthen its binding nature by increasing its sanction power. The shareholders’ agreement, which offers a more flexible structure compared to the articles of association, also meets the confidentiality needs of the parties, unlike the articles of association.

However, the shareholders’ agreement establishes a contractual relationship between the parties, and therefore, the remedies are limited to the contractual level. In other words, unlike the articles of association, it does not entail a corporate effect; therefore, it can only be enforced against parties to the agreement and sanctions are limited to the remedies of contract law.

Incorporating the Provisions Specific to Family Businesses to the Articles of Association

Parallel to the family constitution and the shareholders’ agreement, a company’s articles of association is one of the most effective legal instruments to ensure harmony within the company. The articles of association, as a tool with a corporate effect unlike the shareholders’ agreement, makes it possible to challenge the validity of a resolution or a transaction, which would also impact the company. However, the extent that the Turkish Commercial Code (“TCC” or “Law”) allows for these regulations in the articles of association should be examined.

One of the most important obstacles while drafting a non-mandatory provision in the articles of association, is Article 340 of the TCC, entitled Mandatory Provisions. As per the mentioned article, “The articles of association may deviate from the provisions of this law regarding joint stock companies, only if it is expressly permitted by the law”. The recital of the article provides the following explanations:

“The phrase “if it is expressly permitted by law” in the provision, also covers cases where the possibility of “deviating” from the wording of the article is not clearly understood but the “deviation” is justified with an interpretation that is in line with the ratio legis, not contrary to the methodological interpretation, based on satisfactory justifications, entailing fair results and considering the balance of interests. In cases where the law is silent about the particular case, the methodological rules regarding filling the legal gap would be applied.”

As can be seen, the wording of the Article 340 of the TCC allows for optional regulations in the articles of association only in cases where it is expressly permitted by law. Also, the recital of the article supports this strict attitude. On the other hand, Article 340 and its recital have been heavily discussed by scholars, and an effort has been made to stretch the limitation through liberal interpretation. [2]

Erdoğan Moroğluused the metaphor of a steel corset for the limitation of being expressly permitted in the law, and describes it as an obstacle to the advancement of company law.[3] The author also mentions that this article would cause an increase in the execution of shareholders’ agreements among company partners.[4] Abuzer Kendigelen also states that the Article 340 is too restrictive and hinders the development of joint stock companies’ law. He also states that even the recital of the article tries to stretch the provision.[5] Ali Paslı criticized the provision by drawing attention to the risk that it would invalidate many articles of association regulations. Therefore, the author states that the provision should be interpreted narrowly, “without a doubt”.[6] The author argues that the supplementary regulation should be allowed, – interpreting the regulation quite flexibly – by referring to the referenced code, the German Stock Corporation Act.[7]

Other authors argue that such a flexible interpretation would be contrary to the purpose of the provision. Feyzan Şehirali Çelik argues that a liberal interpretation without considering the wording of the Article 340 of TCC as “if it is expressly permitted”, would make the article dysfunctional and meaningless.[8] Mehmet Bahtiyar, who is critical about the article de lege feranda, states that the current version of the provision does not allow for a liberal interpretation, and confirms that optional regulations may only be inserted in cases where it is expressly permitted.[9]

Reflecting the Optional Regulations in the Articles of Association

It is of crucial importance to incorporate the issues regulated under the shareholders’ agreement, where the principle of contractual freedom is enjoyed in its broadest sense, to the articles of association to the fullest extent permitted by the TCC. It is critical that issues such as representation in the board of directors, privileges in voting rights, or the right to profit, be incorporated to the articles of association in order to have an enforcement option at the corporate level. For instance, in the event that the right to veto or the increased quorums are not duly incorporated to the articles of association, it will not be possible to claim the invalidity of a resolution, and only sanctions such as compensation or a penalty clause may be stipulated, provided that they are included in the shareholders’ agreement.

One of the most important issues to benefit from the company law sanctions is the limitation of share transfer. Beyond the legal restriction stipulated by the TCC, a contractual restriction – which is frequently preferred in family businesses – should be carefully established. The reason for this is that the remedy of breaching the contractual restriction is the deprivation of the buyer from certain shareholders’ rights, including administrative rights. The importance of the articles of association is especially seen for share transfers, as it is not only binding on current shareholders but also on future shareholders. Since the shareholders’ agreement cannot be brought forward against the shareholders who are not party to the agreement, it only appears as a binding instrument inter parties.

In the practice of company law, the veto right may be stipulated by increasing the quorum, and such an arrangement is considered as a method that is permitted under Article 340 of the TCC. However, creating privileges that are not expressly classified in the Law, such as the right of veto or making optional additional arrangements in the privilege of voting right or profit share, might trigger controversies under Article 340 of the TCC. The share transfer limitation, which is another important issue that is usually addressed in shareholders’ agreements, is regulated under TCC Article 492 ff., and in practice, the transfer limitation is usually reflected in the articles of association, to the broadest extent that Article 340 of the TCC allows.

Conclusion

The family constitution and the shareholders’ agreement, which are frequently created in family businesses, are important legal instruments that ensure generational transition and institutionalism in family companies. The provisions of these documents aim to prevent disputes among family members regarding the business as much as possible, and to ensure that company activities are interrupted to the least possible extent, in case of disputes. When these goals are considered, it is of great importance that the provisions of the family constitution and the shareholders’ agreement are reflected in the articles of association to the greatest extent possible and thus have an enforcement power at the corporate level. In order to duly incorporate specific regulations to the articles of association, the compatibility of such regulations under Article 340 of the TCC should be considered. The articles of association should be drafted and amended with regard to Article 340 of the TCC and its scholarly interpretations, for each optional regulation.

[1] For detailed information on shareholders’ agreements in family businesses, please see. Çetinyılmaz, Ecem: “Shareholders’ Agreements In Family Businesses”, Erdem & Erdem Newsletter, May 2021 (http://www.erdem-erdem.av.tr/publications/newsletter/shareholders-agreements-in-family-businesses/).

[2] For further discussions on the interpretation of the referred article, please see. Ayoğlu, Tolga: Sermaye Şirketleri Özelinde Şirketler Hukuku Uyuşmazlıklarının Çözümünde Tahkim, On İki Levha Yayıncılık, 2018, p. 25 ff.

[3] Moroğlu, Erdoğan: 6102 Sayılı Türk Ticaret Kanunu Değerlendirme ve Öneriler, On İki Levha Yayıncılık, 2016, p. 152.

[4] Moroğlu, p. 152.

[5] Kendigelen, Abuzer: Yeni Türk Ticaret Kanunu: Değişiklikler, Yenilikler ve İlk Tespitler. On İki Levha Yayıncılık, 2016, p. 229.

[6] Paslı, Ali: “Yeni Türk Ticaret Kanunu Anonim Ortaklık Hükümlerinin Tanıtılması (II) YTK Kitap 2- Kısım 4- Bölüm 1 “Kuruluşa İlişkin Sisteme Yönelik Temel Değişiklikler ve Kuruluş İşlemleri”.” Banka ve Ticaret Hukuku Dergisi, 28. Volume, 2012, p. 172.

[7] Paslı, p. 172.

[8] Şehirali Çelik, Feyzan Hayal (Kırca, İsmail / Manavgat, Çağlar): Anonim Şirketler Hukuku Cilt 1, 2013, pp. 160-161.

[9] Bahtiyar, Mehmet: Ortaklıklar Hukuku, Updated 12th Edition, 2017, p. 129.

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