Liability of the Board of Directors in Corporations

Liability of the board of directors in corporations from a comparative perspective.

A.   Generally

Liability of the Board of Directors for their decisions and transactions that are harmful to the corporation is regulated in Turkish Commercial Code (“TCC”). As in many legal systems including US Law and European Law, liability of directors arises primarily from violation of fiduciary duties of care and loyalty[1]. Article 369 of TCC explicitly burdens directors and third parties using directors’ powers on behalf of them with duty of care and loyalty and mandates them to prioritize the interest of the corporation in case of any conflict between their and company’s interest. Directors owe these duties to the shareholders of the company and in case of violation of these duties, either the company itself or shareholders in a derivative lawsuit have the right to sue the directors for the damages and, separately, if shareholders suffer directly, such as through bad-faith decision to not pay dividends, can sue in their own names for damages.


B. The Source of Liability

The source of directors’ liability is the Article 553 of the TCC according to which directors of the board are liable against both the company and the shareholders for the damages that they caused through their illegal or faulty acts.[2] For the liability of the director, it doesn’t make any difference whether he is also a shareholder or a third party, or a single manager vested with the whole authority of the board.[3] Moreover, in Turkish doctrine, it is accepted that controlling shareholder is also kept liability for abovementioned damages even though he doesn’t personally take place on the board. This flows from the interpretation of word “managers” in the Article 553 of the TCC that is entitled “The liability of founders, board members, managers and liquidation officers”. Liability is not a strict one as for a director to be liable he should have violated his duties and responsibilities arising either from law or from the articles of incorporation. For instance, Article 375 of TCC states keeping the stock ownership records, minutes of board meeting and shareholder meeting among the responsibilities of the board, though, not fulfilling these duties would still engender the liability of the directors even if these were not enumerated explicitly in the code as they are considered as the natural extension of directors’ duty of care. Indeed, all the duties and responsibilities of the directors can be traced back to the fiduciary duties manifested in the Article 369 of TCC, however, because of the casuistic law-making approach that is controlling in Turkish Law, they were separately listed. Violation of duties or responsibilities is not strict liability on the part of directors. This means that directors’ liability in essence is a torts liability and director can avoid the liability if he can prove that he acted without any fault in the course of action that gave rise to the liability claims. Flows naturally from this that even though act of a directors proved grossly harmful to the corporation, he wouldn’t be kept responsible if he didn’t act with fault. This brings up the question: What is the measure of fault?


C.   Measure of Liability

As stated above, in essence, liability of directors stems from violation of fiduciary duties, namely duty of care and duty of loyalty. Therefore, theory of fault in corporate law is also relies on determining when directors should be considered as having violated duty of care. Turkish Law doesn’t provide much guidance except for the language of the Article 369 of TCC which reads as “directors should perform their duties with the care of a prudent director”. From this language, we infer that the law adopted objective theory of fault as it determined prudently careful third persons in the same or similar position as a measure of fault instead of individual characteristic and mind of the director in action. At this point it would be beneficial to touch up on how the issue is addressed in US Law as the pinnacle of the Corporate Governance.

Model Business Corporations Act (“MBCA”) and Delaware General Corporation Law (“DGCL”) carry utmost importance in regulating corporations throughout the US as most states have adopted MBCA and most of the companies is registered in Delaware. MBCA approach to the issue is fairly similar to Turkish Law. MBCA section 8.30 is titled “Standard of Conduct for Directors” and it reads as follows:


§ 8.30 Standards of Conduct for Directors

(a) Each member of the board of directors, when discharging the duties of a director, shall act:

(i) in good faith, and (ii) in a manner the director reasonably believes to be in the best interests of the corporation.

(b) The members of the board of directors or a board committee, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.


As seen, subsection (a) explicitly states directors are under the obligation to act with good faith and should prioritize the interest of the corporation and subsection (b), fairly similar to Turkish Law, burdens directors with acting with due care that person in a like position would consider appropriate. In this sense MBCA can be said to have adopted objective theory for the measure of fault of directors.

DGCL doesn’t include any specific term as to fiduciary duties of directors as included in MBCA, however, in Article 141 it designates the Board of Directors as “trustees” of shareholders and authorize it to manage operations of the business and it entrusts directors that they should act in the best interest of the corporation.[4] This trust includes silent rebuttal presumption that the directors act with good faith, due care and with undivided loyalty to the corporation. This presumption is known as “business judgment rule”.[5] The rule provides significant legroom to the directors in making corporate decisions, executing their duties and governing operations of the corporation. In practice, Courts traditionally see the rule as deferring to the board of directors and said, “they won’t interfere with the board decision as long as it can be attributed to a rational business purpose”.[6] This means that regardless of how damaging the decision was, Courts would be reluctant to interfere with the board decision as long some rationale can be set out for that and by doing that raises the responsibility threshold since in this understanding directors wouldn’t be liable as long as there is some reasonable corporate purpose even if 90 out of 100 directors in alike position wouldn’t have made the same decision. Indeed, directors are under the obligation to make an informed decision not the right one.[7]

Deferring effect of the business judgment rule can be best seen in the In re Walt Disney Derivative Litigation, 907 A 2d 693, that is known as the pinnacle of corporate governance litigation in US. Facts of the case were as follows: Michael Ovitz was appointed as the new CEO of the Walt Disney Company with huge compensation package. Compensation package included provisions that would provide Ovitz with huge lump sum of money, nearly as much as he would have paid if he completed his term, in case of no-fault termination. The new board terminated his contract and Ovitz got generously paid. Shareholders brought a lawsuit alleging that the old board making the contract wasted corporate resources and the new board also committed waste by deciding that Ovitz contract could be terminated on no-fault basis.

The Court found that Disney hired an expert during the process and relied on his opinions to meet the process duty. The Court said that to rebut the process of duty presumption, in this case, the plaintiff should prove either the board didn’t rely on expert or did so in bad faith. Plaintiff could prove none of them in the case. Second the Court also held that requirements of waste test weren’t met i.e., for waste to be found “the transaction should be so one sided that no businessperson of ordinary could say that the corporation took adequate consideration in exchange.” It also said that when it comes to allegation on new board’s termination of Ovitz’s contract, the plaintiff couldn’t show that no businessperson would have made the decision the new board made in this case. The Court also found that Ovitz had accumulated huge bonuses in his old company that was roughly equal to his non-fault termination compensation from Disney and Ovitz wouldn’t get the bonus if he walked away from his old company; and this was one of the reasons why the contract was structured in that way. The Board basically guaranteed the bonus Ovitz was leaving in his old company in the face of non-fault termination. Considering all these factors, the Court decided that the actions taken by old and new boards were in scope of the protection of the business judgment rule and upheld the board decisions, rejecting the shareholders’ claims.

 As you can see the Courts tend to uphold board decisions if there is some valid corporate reason underlying them regardless of how ridiculous those actions sound even to uninitiated people. From theoretical approach, it can be said that this doctrine is an extension of a free-market policy. In a free market, shareholders are basically investors in a company, and they are compensated only for systematic risks. Unsystematic, i.e., company specific risks, are not counted for the purpose of reward. Management’s incapability is essentially a company specific risk should be burdened completely by shareholders. What courts are doing here is essentially an allocation of risk. Shareholders should appoint capable managements that they believe will make good decisions. If they make bad decisions this is investors’ problem if there is no bad faith or fraud involved in which case the managers’ action threatens the system and should be stopped or penalized by the courts. It can be debated whether this approach should also be adopted by the Turkish Courts as a measure of a good practice, but suits and defenses based on this approach can be brought.


D.   Limit of Liability

In Turkish practice, as opposed to joint and several liability that is controlling in US Law, a principal called “differentiated solidarity” is used to determine amount of liability of the directors. In classical joint and several liability each director is liable with the totality of damages, and it can be demanded in whole from each director carrying liability. In Turkish practice, principal of differentiated solidarity is enshrined in the Article 557 of the TCC and it limits each director’s liability with the amount that can be attributed to his share of the wrongful action. In other words, each director is liable for the damages in proportion with their contribution.

There are practical reasons behind adopting such policy. First, given that most of the corporations in Turkey are closely held and controlled by the families it wouldn’t be fair to leave directors without any protection since such regulation would have deterred most of the savvy businesspeople from taking up a seat on the board. Further, uninitiated shareholder cannot be expected know which director was primarily responsible for the damaging action therefore legislator also wanted to preserve his right to sue whole board and expect the court to allocate liability among directors in proportion with their fault as the courts are better positioned to determine this through forcing corporations to produce documents and records. Carving out a solution to protect these interests, Article 557/II of TCC allows plaintiff to sue all directors together and demand the judge to allocate liability among respondents in proportion to their fault. One should keep in mind that differentiated solidarity applies to the relations between directors and claimant third parties and cannot be used to recourse to other directors for the amount paid. Right to recourse will be determined by the court considering factors such as compensation of each director, hierarchical relationship between them any other conditions. Indeed, the court has broad discretion in determining whether to grant right to recourse.


E. Who Can Sue?

Corporation is basically collectivity of investors of whose interests are represented in form of a share of stock and therefore they are called shareholders. Corporation has a legal personality representing collective interest of all shareholders. It can own rights and liabilities on its own name, but this doesn’t mean that just because it has legal personality, shareholders are alienated to their interests in the corporation. Indeed, corporation itself and shareholders can separately sue for the damages that the corporation suffered, and shareholders can also sue for the damages that they directly suffered because of the actions of the directors.[8] Here, differentiation between direct and indirect damages comes into play.

As a rule, corporation’s damages are direct as it has separate legal responsibility. Indeed, Article 553 of TCC uses the language “damages inflicted” which indicates the directness of damages. In case of a damage directly suffered by corporation, it can sue for the damages through the hand of the board of directors. However, direct damages suffered by corporation are indirect damages on the part of shareholders. In this case Article 555 of TCC explicitly allows shareholders to bring derivative lawsuit on the condition that demanding damages to be paid directly to the corporation. However, not only corporation can suffer from direct damages. Shareholders may suffer from direct damages too in many forms, not paying dividends with bad faith, violation of subscription rights with bad faith being just two of them. In these cases, “damages inflicted” wording of Article 533 also protects the shareholders, and they can sue in their own name demanding the damages be paid to them. Shareholders and the company should keep in mind that the purpose of this lawsuit is collect damages from the directors and as other damage claims under TCC, plaintiff should resort the mediation first according to Article 5/A of TCC.


F. Termination of Liability

Liability of the board of directors ceases in two cases, either through statute of limitations or acquittal.

1) Statute of Limitations

Article 560 of TCC sets out the primary rule for the statute of limitation. Article stipulates three different limitations on the liability of directors. As a primary rule, plaintiff is estopped from suing for the damages 2 years after he learnt the damage and the director(s) caused the damage. For this limitation to be effective, plaintiff should learn responsible directors and the damage at the same time.[9]

Besides of the 2-year limitation, Article 560 also stipulates 5-year limitation starting from the day that the damaging action took place. In conjunction with the 2-year limitation, it means that the plaintiff has 2 years to claim for the damages after he learns the damage and responsible party and he is completely estopped after 5-years regardless of whether he learnt the responsible and the damage or not. On top of those catch-all limitations, Article stipulates another extended limitation for the acts that constitutes crime in the Turkish Criminal Code. According to this, if the harmful action also constitutes a crime that is subject to longer statute of limitation in the Criminal Code, that extended limitation is also applies for corporate law claims. In other words, if the criminal action is subject to 10-year limitation according to the criminal code, this applies to corporate damages claims regardless of whether 2-year and 5-year period has been breached. Statute of limitation is a legal defense that should be claimed by the respondent in the court.

2) Acquittal

Acquittal basically means that shareholders’ approval of the corporate actions taken by the board of directors in the course of preceding financial year as in compliance with the law and the articles of incorporation.[10] Article 408 of TCC stipulates that acquittal is one of the “inalienable powers” of the shareholders and should be used in shareholders meeting. Acquittal, unless article of incorporation didn’t deviate, requires the affirmative vote of the simple majority of shareholders given that there is quorum in accordance with the Article 418 of TCC. Shareholders that are also directors cannot vote in this process and also, they are prohibited from indirectly effecting the vote. For instance, if another business entity or legal person effectively controlled by a director is also a shareholder in the company, it cannot vote for its shares. In the vote for acquittal, some directors can be excluded from the scope.[11] Acquittal can be explicit as well as tacit. If the shareholders approve the financial statements, unless stated explicitly, such approval is also considered acquittal.[12] Finally, it should be kept in mind that acquittal has its legal effects on internal relations between directors, corporation and the shareholders and it only prevents lawsuits against directors from the corporation and shareholders. Shareholders who voted for acquittal in the meeting lose their right to sue immediately whereas those who voted against acquittal lose this right 6 months after the acquittal. Acquittal doesn’t prevent third parties from suing for damages.

[1] Üçışık, Güzin, Çelik, Aydın, Anonim Ortaklıklar Hukuku, Adalet Yayınevi, Ağustos, 2013, s. 509.

[2] Şener, Oruç Hami: Ortaklıklar Hukuku, 4. Baskı, Ankara 2019, s. 419

[3] Yargıtay, 11. HD, 21.12.1992, E. 5424, K. 11589


[4] Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. 1939)

[5] Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (“It is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”)

[6] Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993)

[7] Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985)

[8] Bahtiyar, Mehmet, Ortaklıklar Hukuku, Güncellenmiş 11. Bası, Mart, 2016, s.391.

[9] Şener, Ortaklıklar Hukuku, s. 429

[10] Akdağ Güney, Necla, 6102 sayılı TTK’ya Göre Anonim Şirket Yönetim Kurulu, Ankara, 2012, s. 291

[11] Yargıtay 11. HD, E. 1976/2890, K. 1976/3333

[12] Şener, Ortaklıklar Hukuku, s. 430; Kendigelen, Abuzer, Yeni Türk Ticaret Kanunu Değişiklikler Yenilikler ve      İlk Tespitler, İstanbul, 2012, s.323.

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