Parties to a Share Transfer Agreement and Privity of Contract

Introduction

As a rule, rights and obligations arising from an agreement have legal consequences only between the creditor and the debtor which are parties to the agreement. This principle is referred to as "privity of contract." In general, contracts for the benefit of third parties, where the fulfillment of an obligation is undertaken to a third party other than the parties to the agreement, constitute an exception to the principle of privity of contract. This article will analyze the decision^[1] of the 11th Civil Chamber of the Court of Cassation dated 08.06.2021 ("Decision") concerning the question of who is bound by a share transfer agreement where the transfer of goods is undertaken in favor of a company other than the contracting parties, within the scope of the principle of privity of contract.

The Case and the Assessments of the Judicial Authorities

This case concerned a liquidation agreement ("Agreement") signed between the shareholders of the plaintiff company ("Plaintiff") and the shareholders of the defendant company ("Defendant"). The subject matter of the Agreement was the commitment of the real person shareholders who were parties to the Agreement to mutually transfer their shares in the Plaintiff and the Defendant companies. According to the Agreement, vehicles belonging to the Defendant were to be transferred to the Plaintiff or to another company to be nominated by the Plaintiff. However, the Defendant did not transfer the disputed vehicles to the Plaintiff. As a result, the Plaintiff requested the registration of the vehicles in its own name, and if this was not possible, to collect the cost of the vehicles from the Defendant with interest.

The court of first instance dismissed the case due to the Defendant’s lack of standing as the Defendant company was not a party to the Agreement.

The Defendant appealed the decision of the court of first instance, and the Court of Appeal stated that neither the Plaintiff nor the Defendant company was a party to the Agreement, but that the Agreement was a contract for the benefit of third parties made for the benefit of the Plaintiff. According to the Court of Appeal, the shareholders who were parties to the share transfer agreement undertook to ensure the transfer of Defendant’s vehicles to the Plaintiff company. However, there was no commitment made by the authorized body of the Defendant company. The court held that the commitment to transfer the goods made by the shareholders of the Defendant company bound only the shareholders who made the commitment, in accordance with the principle of privity of contract. Therefore, the court dismissed the appeal on the merits.

In its Decision, the 11th Civil Chamber of the Court of Cassation emphasized that the Agreement was signed by all the shareholders of the Defendant company, and all shareholders authorized to represent the Plaintiff company, and concluded that the argument that these companies were not bound by the Agreement constituted an abuse of right pursuant to Article 2 of the Turkish Civil Code. Consequently, the Court of Appeal's decision of dismissal on the merits was reversed and annulled.

Assessment within the Framework of the Principle of Privity of Contracts

Under Turkish law, the debtor-creditor relationship is of relative nature.^[2] As a rule, a contract is effective only between the parties. However, there are some exceptions to the principle of privity of contract. Contracts for the benefit of third parties are one of these exceptions. A contract for the benefit of third parties is a contract in which one of the parties undertakes to fulfill an obligation to the other party for the benefit of a third party. In a contract for the benefit of third parties, granting the third party the right to claim makes an exception to the principle of privity of contract.

Contracts for the benefit of third parties may be established as quasi-contracts for the benefit of third parties and genuine contracts for the benefit of third parties. Whether the contract is quasi or genuine is important due to the different legal consequences. In quasi-contracts for the benefit of third parties, the third party does not have a right to make a claim. In other words, only the parties to the contract can demand the performance of the obligation or the compensation of the damage suffered by the third party due to the failure to perform the obligation properly. In genuine contracts for the benefit of third parties, the beneficiary third party has the right to make a claim. However, even in this case, the third party does not become a party to the contract.[3]

The Court of Cassation has addressed the issue of how to determine whether a contract was drafted for the benefit of a third party:

"It does not seem possible to adopt a definitive principle as to the circumstances under which a contract may be interpreted as a contract for the benefit of third parties. In addition, the balance of interests between the parties, the behavior of the parties after the conclusion of the contract, and especially their behavior towards the relevant third party, are also taken into account in determining whether the third party has a right to make a claim. If it is not clear from the interpretation of the contract that this is the common intention of the parties, custom and usage shall be considered. In some cases, as a matter of custom, the third party may be granted the right to apply directly to the debtor."^[4]

The court has also addressed the question of when a third-party beneficiary may make a claim:

"Again, in contracts for the benefit of third parties, it is accepted that the third party cannot make a claim personally. On the contrary, that the third party may make a claim on its behalf must either be expressly written in the contract, or this situation must be understood from the will of the parties expressed in the contract, or there must be a custom in this regard."^[5]

It should be noted that in accordance with the principle of freedom of contract, which is closely related to the principle of privity of contract, no one can be forced to enter into a contract against their will. For this reason, while rights can be granted to the third party by the contract for the benefit of third parties, a third party cannot be put under obligation.

It is well known that the parties to a share transfer agreement are generally the person who is a shareholder or who will be a shareholder in the future, and the person who wants to take over the share. Since the share transfer agreement is a transaction between the person who undertakes to transfer the share and the person who undertakes to take over the share, it creates an obligation only between them. In particular, the company has nothing to do with this transaction. Therefore, there is no need for the approval of the company or shareholders for the transfer.^[6]

Hence, in the case discussed above, the parties to the share transfer agreement were the shareholders. The Plaintiff and the Defendant companies were not parties to the Agreement, and only the shares in the Plaintiff and the Defendant company constituted the subject of the share transfer agreement. In addition, a commitment to transfer property was made by the shareholders in favor of the Plaintiff company. Based on the interpretation of the Agreement and the common purpose of the parties, even if there was a genuine contract for the benefit of the third-party Plaintiff, it cannot be said that the third-party Plaintiff had become a party to the Agreement. The statement of the 11th Civil Chamber of the Court of Cassation that since the Agreement was signed by all shareholders authorized to represent the Plaintiff and the Defendant company, the assertion that the Agreement is not binding on these companies is an abuse of right within the meaning of Article 2 of the Turkish Civil Code is fundamentally incompatible with the principle of privity of contracts. As far as it is understood from the Decision, there is no explicit commitment made on behalf of the Defendant company in the Agreement.

In this respect, it should be emphasized that legal entities have separate and independent personalities. Holding companies liable for the legal transactions carried out by the shareholders on their own behalf may lead to inappropriate results.

Conclusion

In line with the principles of freedom of contract and privity of contract, contractual rights and obligations can generally only be asserted against the parties. Although there are exceptions to these principles, the exceptions should be handled carefully. Especially in share transfer agreements where the parties to the agreement and the rights and obligations of the parties are defined in detail, the broad interpretation of the “party” definition and direct applicability of the share transfer agreements to the companies which are not parties to the agreement and whose shares are transferred, may involve the danger of exceeding the subject matter of the share transfer agreement. When drafting share transfer agreements, it is important that the contractual provisions intended to be introduced for the benefit of third parties are regulated in a clear manner that leaves no room for doubt.