Suppose Mr. A is a shareholder in the XYZ company. The company goes insolvent due to a breach of duty on the part of the company. Now, who will pay the loss suffered by Mr. A due to the insolvency of the company?
A direct claim is made to the director of the company who is responsible for the decision-making of the company. He must have taken care of the functioning of the company and informed earlier when there was doubt about the insolvency of the company. If the company goes bankrupt as a result of its negligence, then who will be held liable for such damages?
The Commercial Code, Criminal Code, and several other legislations of Turkey define the scope of liability of a director of a company in such circumstances. We will discuss that in detail in this article.
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The most important duties of the director are as follow
- He must act as a prudent person and in a diligent manner while conducting business.
- He has to ensure and supervise that the management of the whole company is complying with the principle of good faith and working in the interest of the company or not.
- There is much confidential information of the company which a director may receive during the duty and the director must keep it confidential during and after the term of his service as a director.
- In a meeting that has an agenda that is closely related to his interest or interest of his close relative, he must refrain from attending as it might result in a conflict of interest.
- He must not engage himself in a transaction with the company unless authorized by the general assembly meeting.
There are two kinds of liability:
- Civil Liability
The directors are liable to pay the penalty or losses suffered by the company or the shareholder due to their breach of duty.
- Criminal Liability
The director is liable personally to undergo punishment which may be imprisonment in some cases.
When a director is liable personally?
- When he breaches a duty which he is obliged to comply with under legislation or the Articles of the Company.
- The company has suffered loss or damage due to negligence on the part of the director.
- The shareholder or the creditor has suffered some loss or damage due to the negligence of the director.
- The loss must be a direct consequence of the breach done on the part of the director.
Liability under Commercial Code of Turkey
Under Article 437 of the Commercial Code of Turkey, the shareholders of a company have the right to ask for the information related to the annual reports and financial statement of the company and the Director has to make a report for financial status and activity and submit it to the branches of the company at least before 15 days of the annual general assembly meeting.
This ensures that shareholders have access to a copy of such a statement of income and balance sheet.
Under Article 549 of the Commercial Code, if the director has submitted some false, fraudulent, fake, or untrue documents, statements, commitments, and warranties and loss is caused due to this, then the director is liable.
The directors are personally liable for the public debts of the Company if the government cannot collect the public debts from the company itself.
If the directors who were in office when the relevant liabilities arose are no more existing in the company and new directors have taken place, then the current directors will be jointly and severally liable with the former directors to pay the relevant public debts.
Liability under Code on Enforcement and Bankruptcy
If the director has failed in management and the company becomes bankrupt, due to such failure of the director, the shareholders or the creditors of the company can hold the directors liable. The director must prepare an interim balance sheet and submit it to the court if it appears to him that the company might go insolvent.
If the director fails to request the bankruptcy of the company, then at the complaint of the creditor, the director can be punished with a maximum of three months of imprisonment.
The director is also liable to pay the debt of the company partially or fully and if he fails to do so with the intention of the creditor, he can be punished with imprisonment for six months and two years, and a judicial penalty of up to 5000 days.
The director cannot be held liable under this if they prove to the court that there exist some reasonable grounds for the losses and he has complied with the bankruptcy Code.
Negligent bankruptcy is also punishable under the Turkish Criminal Code. There is imprisonment from two months to one year for negligent bankruptcy. In case of fraudulent bankruptcy, punishment is imprisonment from three years to eight years.
Liability under Environment and Health and Safety laws
The directors are liable to comply with the Environment Code of the country. They have to obtain all the necessary reports before commencing any business activities that may result in environmental problems. Construction projects are one of the common examples where the environment is under threat. The directors must obtain all the licenses and permission that is required for the business activity that they are going to perform. In case of non-compliance with these rules, the director will be liable to pay for the losses in accordance with the general prin.
Limitations of the liability
Under Article 203 of the Turkey Commercial Code, if a company is a subsidiary of another parent company, then the board is obliged to follow the instruction of the parent company. In such cases, directors of the subsidiary company will not be held liable for the actions done in compliance with the order given by the parent company.
Under Article 553 of the Commercial Code, the liability of a director must be proved as to the fact that the director has failed to show reasonable care as a result of which such loss has caused. If there is a breach of the article that was non under the control of the director, he must not be held liable under the code. Reasonable care means the standard of care that is expected from a prudent director. A prudent director is expected to take decisions in the interest of the company and in good faith.
Who can initiate a proceeding against the Director?
If the director has committed a breach of duty that has resulted in damage, then the company, its shareholders, and creditors may be entitled to bring a claim against the relevant director. However, creditors are only entitled to bring a claim against directors for indirect damages if the company becomes insolvent.
Under Article 555, the company, as well as a shareholder, is entitled to initiate a proceeding against the director in case of prejudice on the part of the director. But the shareholder can request that damages be awarded only to the company.
The bankruptcy administration can institute a lawsuit against the director of the company under the bankruptcy code. In case of bankruptcy, a shareholder or a creditor have the right to institute a lawsuit against a director liable under Article 553 of the Commercial Code. Such a lawsuit is valid only after the bankruptcy administration fa toils initiate such a lawsuit.
Insurance Policy for Directors
There are many crucial decisions that a director has to take and thus it becomes important to protect the director from liabilities so that he can give his best for the company. To ensure such great performance on the part of the director, Turkey introduced D&O Insurance in its corporate law which is also a major step for the modernization of Turkish corporate law.
Article 361 of the Code enables the director to purchase insurance to ensure the loss that may be incurred by a joint-stock company as a result of the director’s action. It enables the directors to take strategic decisions without being exposed to the threat of personal liability. It is not a mandatory policy but it can be taken on a voluntary basis by the director. It can be purchased by the company and director both individually.
This insurance provides cover for the pecuniary damages the insured person is liable against a third party pursuant to an action brought against the insured for a negligent act, a negligent error, or a negligent omission. Such insurance policies generally cover civil fines, penalties, tax extensions, public receivables, etc.
Thus the director of a company is liable to pay for losses resulting from his breach of duty which he is obliged to do as a reasonable and prudent director. He must work for the interest of the company and in his good faith. In the example given at the start, the director is liable for the loss suffered by Mr. X because he suffered a loss due to a negligent act on the part of the director of the company. There is a certain procedure that the director is liable to comply with and in breach of such compliance, he would be held liable under the company law of Turkey.