INTRODUCTION
The scope of business set out in the articles of association of joint stock companies (the “Company”) is not merely a technical provision defining their field of activity. The scope of business also serves as an important reference point in determining the areas in which the Company may carry out transactions, how the authority of representation may be exercised, and the circumstances under which members of the board of directors and representatives may incur liability.
With the Turkish Commercial Code No. 6102 (the “TCC”), the ultra vires principle was abandoned, and it was accepted that transactions carried out outside the Company’s scope of business would, as a rule, be binding on the Company. Nevertheless, transactions outside the scope of business may give rise to liability in the internal relationship for members of the board of directors and persons authorised to represent the Company. Therefore, the legal consequences of carrying out transactions outside the Company’s scope of business should be assessed within the framework of the distinction between the validity of the transaction and managerial liability.
Does Carrying Out Transactions Outside the Company’s Scope of Business Give Rise to Liability for Members of the Board of Directors?
As a rule, carrying out a transaction outside a company’s scope of business does not result in the transaction being automatically invalid. However, this does not mean that no liability will arise for members of the board of directors and persons authorised to represent the company.
With the TCC, the ultra vires principle was abandoned, and it was accepted that the legal capacity of companies is not limited to the scope of business set out in their articles of association. Nevertheless, the scope of business continues to retain its importance, particularly in determining the limits of authority and liability of members of the board of directors and representatives in the internal relationship.
What Is the Ultra Vires Principle?
The ultra vires principle refers to the concept that a company may acquire rights and incur obligations only within the scope of business specified in its articles of association.
Under the former Turkish Commercial Code No. 6762, the legal capacity of commercial companies was considered to be limited to the scope of business set out in their articles of association. For this reason, whether transactions carried out outside the company’s scope of business would bind the company gave rise to significant debate. This approach was abandoned with the TCC. As a rule, a company’s legal capacity is no longer limited to its scope of business. In other words, the mere fact that a transaction falls outside the scope of business specified in the company’s articles of association does not, in itself, mean that the transaction is invalid.
Do Transactions Carried Out Outside the Company’s Scope of Business Bind the Company?
Yes. As a rule, transactions carried out by persons authorised to represent the company with third parties outside the company’s scope of business bind the company.
Pursuant to Article 371/2 of the TCC, transactions carried out by persons authorised to represent the company with third parties outside the company’s scope of business are also binding on the company. The exception to this rule is where the company proves that the third party knew, or was in a position to know in view of the circumstances, that the transaction fell outside the company’s scope of business.
At this point, two matters are important:
– The mere fact that the articles of association have been published is not, in itself, sufficient to prove that the third party knew that the transaction fell outside the company’s scope of business.
– The burden of proof rests with the company claiming that the transaction does not bind it.
Accordingly, where a transaction is carried out outside the company’s scope of business, the fundamental rule in the external relationship is the protection of transactional security. The legislator intended to prevent transactions entered into by third parties with the company from being readily deemed invalid.
If the Transaction Binds the Company, Why May a Member of the Board of Directors Be Held Liable?
This is because the fact that a transaction binds the company in the external relationship and the liability of a member of the board of directors towards the company in the internal relationship are separate matters. Pursuant to Article 371/1 of the TCC, persons authorised to represent the company may carry out, on behalf of the company, acts and legal transactions falling within the company’s purpose and scope of business. The same provision expressly states that the company’s right of recourse in respect of transactions contrary to the law and the articles of association is reserved. Therefore, even if a transaction carried out outside the company’s scope of business binds the company vis-à-vis a third party, the company may have recourse against the member of the board of directors or representative who carried out the transaction if the company has suffered damage as a result of that transaction.
Such liability may arise particularly in the following circumstances:
– The transaction clearly falls outside the scope of business set out in the articles of association;
– The company suffers damage as a result of the transaction;
– The member of the board of directors or representative fails to exercise the required degree of care;
– It cannot be demonstrated that the transaction is in the company’s interests; and
– Activities outside the company’s scope of business become continuous.
What Are the Duties of Care and Loyalty of Members of the Board of Directors?
Members of the board of directors are obliged to perform their duties with the care of a prudent manager and to safeguard the interests of the company in accordance with the principles of good faith.
This obligation, regulated under Article 369 of the TCC, does not consider the mere formal authorisation of members of the board of directors to be sufficient. When carrying out transactions, members of the board of directors must take into account the company’s field of activity, the provisions of the articles of association, the company’s interests and the risks that may arise. Carrying out transactions that are not included in the company’s articles of association or that have no reasonable connection with the company’s scope of business may, depending on the circumstances of the specific case, be considered a breach of the duties of care and loyalty.
How Does Liability Arise Under Article 553 of the TCC?
Pursuant to Article 553 of the TCC, members of the board of directors may be held liable to the company, its shareholders and its creditors for the damage they cause if they breach, through fault, their obligations arising from the law or the articles of association.
Where a transaction is carried out outside the company’s scope of business, the assessment of liability is generally made by reference to the following questions:
– Is the transaction compatible with the scope of business set out in the company’s articles of association?
– Does the transaction serve the interests of the company?
– Did the member of the board of directors conduct the necessary review before the decision was taken?
– Did the transaction cause damage to the company?
– Is there a causal link between the damage and the transaction carried out outside the company’s scope of business?
Depending on the answers to these questions, the member of the board of directors or the representative may incur liability towards the company for compensation. Indeed, pursuant to Article 371/1 of the TCC, “the company’s right of recourse in respect of transactions contrary to the law or the articles of association is reserved.” Under this provision, the scope of business establishes the limits of the authority of the company’s representatives in the internal relationship; although the company is, as a rule, bound by a transaction carried out outside its scope of business, the liability of the representatives may arise. In this respect, the 6th Civil Chamber of the Court of Cassation held as follows: “…Since the ultra vires rule has been abolished, the scope of business no longer determines the limits of the company’s legal capacity. Rather, the company’s purpose and scope of business determine the limits within which the company may or may not have recourse against its authorised signatory. … Transactions carried out outside the company’s purpose and scope of business also bind the company; however, the company may seek recourse against the person vested with the authority of representation who exceeded such limits.”
In this context, the mere fact that a transaction has been carried out outside the company’s scope of business is not sufficient for liability to arise. As a rule, a breach of obligation, fault, damage and an adequate causal link between such damage and the conduct constituting the breach of obligation must exist concurrently. Therefore, not every transaction carried out outside the company’s scope of business automatically gives rise to the liability of a member of the board of directors; a separate assessment must be made in light of the circumstances of the specific case.
CONCLUSION
Although the ultra vires principle has been abandoned under the TCC, the company’s scope of business has not become entirely irrelevant. As a rule, transactions carried out outside the company’s scope of business bind the company vis-à-vis third parties. However, such transactions may give rise to liability in the internal relationship for members of the board of directors and persons authorised to represent the company.
Therefore, it is important for companies to regularly review whether the activities they actually carry out are consistent with their articles of association. Where the company’s field of activity expands, updating the articles of association so that they clearly and comprehensibly cover such new activities will be beneficial in terms of both transactional security and reducing the risk of managerial liability.
FREQUENTLY ASKED QUESTIONS
Is a transaction carried out outside the company’s scope of business invalid?
No. Pursuant to the TCC, transactions carried out by persons authorised to represent the company outside its scope of business bind the company as a rule. However, a different assessment may be made if it is proven that the third party knew, or was in a position to know, that the transaction fell outside the company’s scope of business.
Does the ultra vires principle still apply?
No, not in the classical sense. With the TCC, the principle that companies’ legal capacity is limited to their scope of business has been abandoned. However, the scope of business continues to retain its importance in terms of the liability of managers and representatives.
Can a member of the board of directors be held liable for a transaction outside the company’s scope of business?
Yes. Liability may arise if the company suffers damage as a result of the transaction and the member of the board of directors has breached, through fault, their obligations arising from the law or the articles of association.
Is it necessary to amend the articles of association?
Where the activities actually carried out by the company fall outside its existing scope of business, it is recommended that the articles of association be amended to cover such activities. This reduces both managerial liability risks and corporate compliance risks.
