The concept of conflict of interests as it relates to board of directors is (in) famous among business professionals, but somehow is often not sufficiently appreciated as a rule, like many others, that intends to maximize shareholder value.
All companies are comprised of various interest groups which creates different dimensions of conflict of interest. In joint stock corporations, the most common type of company in Turkey for sizeable businesses, each director serving on the board has some degree of individual interest that risks competing with the relevant entity’s business. For this reason, board members’ conflict of interest has been one of the most debated topics in the world of corporate governance. This article focuses on the conflicts of interest that exist between board members and companies, including a summary of the applicable Turkish legal rules, and explores several measures that can be taken to prevent these conflicts.
How to Identify a Conflict of Interest
“Interest” is a very broad term that encompasses any situation that could potentially divert a board member’s mind from making decisions impartially. However, given the number of unknown factors, it is not always easy to identify what constitutes a conflict of interest prior to or during the course of the board’s decision-making process. Although there is no statutory definition of “conflict of interest” in Turkish law, the applicable legislation offers some insight as to what may be considered a conflict of interest.
Conflicts of interest are regulated in separate pieces of legislation including the Turkish Commercial Code (“TCC”),1 which is binding on all companies as the main source of Turkish company law, and the Capital Markets Law (“CML”) 2 along with its secondary regulations (i.e., communiqués) issued by the Capital Markets Board (“CMB”), which mainly concerns publiclyheld companies.
Conflict of Interest under the TCC
According to the TCC, board members owe a duty of loyalty to their company and are responsible for protecting the company’s interests in compliance with the principle of good faith. In line with this, board members should not take advantage of their position and should avoid any potential conflicts of interest with the company.
While the TCC does not provide an explicit definition for conflict of interest, it sets forth several restrictions on board members regarding acts or actions that could create a conflict of interest between the board member and the company.
These restrictions are prohibitions against (i) participating in discussions of matters/ transactions that may take place between the company and the board member and/ or their relatives (Article 393); (ii) engaging in transactions with the company for their own benefit or for the benefit of their relatives without obtaining prior consent from the shareholders (Article 395); and (iii) directly or indirectly competing with the company’s business in the absence of permission from the shareholders (Article 396).
Below is a more detailed analysis on the abovementioned restrictions:
Article 393 – Prohibition of Participating in Discussions:
The TCC targets preventing board members from participating in discussions where a conflict may exist between the company’s interests and the personal interests of a board member or its relatives.
According to Article 393 of the TCC, a board member cannot participate in discussions regarding matters that may lead to a conflict between the interests of the company and the “personal interests” of the board member or its relatives. Relatives include the board member’s (i) lineal consanguinity, (ii) spouse, or (iii) blood or in-law relatives up to and including the third degree. According to scholarly opinions, a good faith test should be applied when board discussions contain matters relating to close friends, significant others, and the like, and board member should refrain from participating to these discussions. Since the TCC allows a legal entity to act as a board member, it may be argued that the individual elected to represent the legal entity board member should also be subject to these restrictions.
These prohibitions refer to the “personal interests” of the board member and/ or their relatives. The term “personal interests” and its contents are however not crystal clear in Turkish law and should be evaluated on a case-by-case basis. Some examples of cases where the personal interest of a board member may be at stake are discussions regarding the member’s former or actual partner or former spouse. The legal reasoning for these article states that the term “personal” refers to a benefit of, or relating to, the member or a relative of the member. However, a gain or benefit for a community or group in which the board member will also benefit from is not considered personal.
In addition, the benefit must be “outside” of the company; if a benefit is related to or concerns the company is being discussed, the relevant board member is not subject to this restriction. In any case, whether or not the benefit is inside or outside of the company should be delicately assessed.
In cases where there is doubt as to whether the relevant board member should be prohibited from participating in discussions, the remaining board members should cast a vote to determine the appropriateness of such member’s presence.
A board member who: (i) is conflicted but has failed to disclose this to the other members and attends the meeting, (ii) does not object to the relevant board member’s participation when a conflict of interest exists and is known, or (iii) decides in favor of the member participating in the meeting may be held liable for any damages incurred by the company.
Article 395 – Prohibition of Engaging in Transactions with the Company & Article 396 – Non-Compete Prohibition
Article 395 prohibits a board member from entering into transactions with the company either by himself/herself or on behalf of a third party without shareholder approval, and Article 396 prohibits a board member from competing with the company without shareholder approval.
In the event that the general assembly grants the board member permission in regards to either Articles 395 or 396, the board member is entitled to (i) enter into any transaction with the company or (ii) compete with the company and engage in commercial activity directly or on behalf of third parties in the same field of activity as the company. We should also note that the permission granted by the shareholders in regards to Articles 395 and 396 does not preclude application of the restrictions imposed by Article 393 concerning the issues of persona interest.
This permission with regards to Articles 395 or 396 may be granted partially, in which case the general assembly resolves that only certain board members are entitled to such permission. If a board member who was not granted permission breaches one of these prohibitions and enters into a transaction with the company on his/her own behalf or on behalf of a third party, the company may declare the transaction invalid. Alternatively, the general assembly may choose to approve the transaction. In such case, the transaction would be treated as if it were entered into with permission.
Conflicts of Interest under the CML
For publicly held companies, the issue of conflict of interest is mainly regulated under the Corporate Governance Communiqué numbered II-17.1 (“Communiqué”).3 The main principle set under the Communiqué is that board members must disclose any potential or actual conflicts of interest– details of these principles are explained as:
According to the Communiqué, in cases where board members and their relatives4 conduct a “significant transaction” with the company or subsidiaries thereof that may cause a conflict of interest, this transaction should be included in the agenda of the shareholders meeting as a separate item to provide the shareholders detailed information on the matter. This disclosure requirement also arises if board members conduct a transaction on behalf of themselves or a third party in the same field of activity as the company or subsidiaries thereof, or become an unlimited shareholder of a company operating in the same field of activity as the company or subsidiaries thereof.
When it comes to board members’ roles in other entities, there are no strict restrictions in the Communiqué. According to the Communiqué, board members assuming a role in the management of another company, or serving as a board member, or providing consultancy services to another company should not lead to any conflict of interest and should not hinder any duties that the board member has to the company. To that end, companies may issue internal policies to regulate and/or restrict the roles and duties of board members outside of the company. The external duties conducted by board members (within or out of the group) and the grounds thereof should be submitted to the shareholders’ information at the shareholder meeting in which board elections are discussed.
Apart from the foregoing, the Communiqué requires the board of directors of publicly held companies to prepare a Communiqué Compliance Report annually. This report should include information as to whether the Communiqué’s principals are implemented by the company, the reasons for not applying any of the Communiqué principals, and any conflicts of interest that have arisen from inadequate implementation of the Communiqué principals.
Managing Conflict of Interest
Effectively managing conflicts of interest requires diligent work. There is no one-sizefits-all approach in dealing with conflicts of interest and each company should develop their own method to handle such situations by taking into account the dynamics of the company and its board structure.
Below are some general ideas for measures that may be implemented to prevent conflicts of interest between companies and board members. Companies may consider:
• issuing an internal policy/guideline that sets out the conflict of interest principles applicable to the board in order to ensure that the board members act in the best interest of the company,
• informing board members of the entire group structure and operated sectors,
• preparing a code of conduct regulating the set of rules that board members must comply with while exercising their duties and having the board members sign such conduct at the time of their appointment, or
• organizing regular trainings for board members in order to educate them on the applicable legislation as well as the company’s internal regulations in regards to conflicts of interest.