Corporate Groups and the Controlling Company’s Equalization Obligation

Abstract

This article examines the equalization obligation of the controlling company within the framework of the concept of corporate groups. Article 195 and subsequent articles of the Turkish Commercial Code regulate the relationship between the controlling and subsidiary companies. The article analyzes the liabilities that may arise in cases of unlawful use of control and the equalization mechanism designed to eliminate such liabilities.

Keywords: Corporate Groups, Joint Stock Company, Controlling Company, Subsidiary company, Equalization Obligation, Liability, Turkish Commercial Code

1.  INTRODUCTION

Corporate group is a structure formed when one company establishes direct or indirect control over other companies. With the enactment of the Turkish Commercial Code numbered 6102 (“TCC”)[1], the effects of the controlling company on subsidiary companies and the limits of such influence have been legally defined. The relationships within a corporate group are significant not only from an economic or managerial perspective but also in terms of legal responsibilities.

In this context, the question arises as to how the losses resulting from the controlling company’s actions that violate the interests of the subsidiary company will be compensated. TCC provides an equalization mechanism to ensure that losses incurred by subsidiary companies due to the controlling company’s actions are remedied.

This study explains the equalization obligation of the controlling company over the subsidiary companies within the framework of the corporate group concept, examines the relevant legislative provisions, and presents legal evaluations on the subject.

2.  CORPORATE GROUPS

A corporate group refers to a structure formed when one or more companies are linked to a controlling company either directly or indirectly through legal control criteria or a contractual arrangement[2]. This concept was not regulated under the former Turkish Commercial Code numbered 6762 but has been introduced for the first time under the new TCC in articles 195 to 209.

While in some cases the existence of a corporate group is definitively recognized under the TCC, in others, it is identified as a presumption.

(i)     Controlling Company and Subsidiary Company

According to Article 195 of the TCC, a) A commercial company is considered a controlling company if it directly or indirectly; i) holds the majority of voting rights in another commercial company; or ii) has the right to elect a majority of the members of the management body pursuant to the company’s articles of association; or iii) possesses, along with its own voting rights, the majority of voting rights alone or jointly with other shareholders or partners based on an agreement; b) A commercial company that maintains control over another commercial company under a contract or by other means is also considered a controlling company, with the latter being its subsidiary company. If at least one of these companies has its registered office in Türkiye, the provisions of the TCC concerning corporate groups shall apply[3].

A significant issue in the context of the corporate group concept is whether the defining element in the definition is "dominance and centralized management" or merely "control”. The reasoning of Article 195 of the TCC explains this notion as follows: "Control is a mathematically precise and therefore definitive criterion. Dominance, on the other hand, draws conclusions associated with legal presumptions. The instruments of control include capital majority, voting majority, and the majority of members in the management body. Under the control system, the actual exercise of dominance is not assessed; moreover, no legal consequences arise from proving that dominance is not exercised. The fundamental principle of this system is: Whoever holds control is presumed to be exercising dominance as well. In contrast, in a system based on dominance and centralized management, the mere presence of dominance is insufficient to conclude that it is being exercised; actual implementation of dominance must be evident and (if needed) proven."

As clearly stated in the first paragraph of Article 195 of the TCC, the "control" system is the basis, with only a presumption being accepted in the second paragraph. If reliance is placed on this presumption, the party challenging it bears the burden of proof.

(ii)   Presumption of Control

The fact that a commercial company holds the majority of shares in another commercial company or possesses enough shares to make managerial decisions constitutes a presumption of the existence of a controlling company[4]. The ability to make management decisions, particularly in large-capital joint stock companies (especially publicly traded companies), arises when voting rights held at the general assembly allow a shareholder to form a majority despite not achieving the shareholding majority explicitly required under the TCC. Consequently, a shareholder who has not obtained majority shareholding in the company may still acquire control through the general assembly by utilizing the power vacuum resulting from dispersed shareholding[5]. The majority in the management body and privileged voting rights may completely neutralize capital majority. Therefore, the presumption in this context is not an irrebuttable legal assumption but one that can always be refuted.

(iii)  Indirect Control

Indirect control occurs when a controlling company establishes control over another company through one or more subsidiary companies[6]. In this case, the controlling company can exercise control over other companies through the subsidiary company under its control.

For instance, if Company A holds 60% of the shares and voting rights in Company B, and Company B, while holding only 10% of the shares in Company C, has the privilege to elect a number of board members sufficient to form a majority in Company C’s governing body, then Company A and Company B have a controlling company – subsidiary company relationship. Consequently, Company A, despite not being a shareholder in Company C, attains an indirect controlling position over Company C.

(iv)  Mutual Participation

Companies that hold at least one-fourth of each other's shares are considered to be in a mutual participation relationship. If one company is controlling the other, the latter is also regarded as a subsidiary company. If both companies control each other, they are both considered controlling and subsidiary companies[7]. The regulation introduced in the TCC aims to prevent misleading perceptions caused by mutual participation, avoid capital dilution (bubble capital)[8], and eliminate concerns regarding the accuracy of balance sheets. If the shareholding ratio between companies remains below 25%, no legal mutual participation is deemed to exist. Another limitation imposed on mutual participation is the freezing of rights. A corporation that knowingly acquires shares of another corporation, thereby establishing a mutual participation status, may only exercise one-fourth of the total voting rights and other shareholder rights arising from those shares. Except for the right to acquire bonus shares, all other shareholder rights are frozen. Such shares are not considered in the calculation of quorum for meetings and decisions[9]. However, this limitation does not apply if the subsidiary company acquires shares of the controlling company or if both companies are controlling each other.

3.  LIABILITY

Dominance does not grant the controlling company the right to unlawfully exercise this power over subsidiary companies. As with any unlawful use, there are legal consequences attached to such misconduct. The TCC does not provide a limited list of instances where control is exercised unlawfully. Accordingly:

a)  Certain legal transactions imposed by the controlling company on the subsidiary company (such as transfer of business, assets, profits, receivables, and liabilities) and material actions (such as failing to renew facilities without a justified reason, restricting or halting investments, making decisions or taking measures that negatively affect efficiency or operations, or refraining from taking measures that would promote development) and

b)  Transactions carried out through the exercise of control, which lack a clearly justifiable reason from the perspective of the subsidiary company (such as mergers, demergers, conversions, issuance of securities and significant amendments to the articles of association)[10] are also covered under this framework.

Any transaction stipulated under the relevant articles of the TCC, such as providing guarantees, transferring receivables or liabilities, mergers, and demergers, is not inherently unlawful. The unlawfulness arises from the manner in which control is exercised and implemented. Unlawfulness arises from a transaction, decision, or measure that is either implemented or deliberately avoided by the controlling company, leading to losses for the subsidiary company, causing harm to shareholders and creditors, and lacking a justified reason from the company's standpoint[11].

4.  LIABILITY OF THE CONTROLLING COMPANY FOR THE LOSS OF THE SUBSIDIRARY COMPANY AND THE RIGHT OF ACTION OF THE SUBSIDIARY COMPANY'S SHAREHOLDER

Article 202/1 of the TCC regulates how equalization shall be provided for the losses incurred by a subsidiary company as a result of the transactions carried out by the controlling company, as specified in the relevant provision. Meanwhile, Article 202/2 grants the subsidiary company’s shareholders the right to file a lawsuit for compensation of damages or for the repurchase of their shares in cases where significant transactions are carried out through the exercise of control without a clearly justifiable reason from the subsidiary company’s perspective.

Article 202/1 of the TCC stipulates that the controlling company may not exercise its control in a manner that causes losses to the subsidiary company. However, the provision does not explicitly define the scope of the term “loss”. At this point, reference should be made to the reasoning of the article, which provides the following explanation regarding the concept of “loss”: “It is broader than, and encompasses, “damage” as defined in the law of obligations. Loss may arise in the form of a decrease in assets or the prevention of asset growth, as well as through the loss of opportunity or the ability to successfully carry out a business activity, as in the case of the transfer of business, funds, or personnel.”

Since business activities, by their nature, may involve risky decisions and potential losses that may be unavoidable even with the utmost care, expecting subsidiary companies to never suffer a loss under any circumstances would contradict the natural course of commerce and, consequently, life[12]. If the listed transactions and actions do not arise from a dominance relationship but instead result from prudent commercial conduct, this provision cannot be applied. If the loss occurs without a violation of the controlling entity’s duty of care and is based on a decision, legal transaction, or material act that the subsidiary company’s own management body or an independent decision could have undertaken, it does not fall within the scope of equalization[13].

For the controlling entity to be held liable for the loss suffered by the subsidiary company, such loss must have directly resulted from the intervention of the controlling entity. Without clear direction demonstrating the exercise of dominance, the controlling entity cannot be held responsible solely due to the economic conditions or commercial risks faced by the company. In this context, the liability of the controlling entity depends on the existence of an influence that directly led to the loss incurred by the subsidiary company. Such influence may take the form of written or verbal instructions, direct or indirect intervention in decision-making processes, the exercise of voting rights, exertion of pressure, or actual control through other means.

If the subsidiary company acts under the direction of the controlling entity and would not have made such decisions otherwise, the resulting losses do not automatically establish liability for the controlling entity. Various mechanisms allow the controlling entity to avoid such liability. According to TCC Article 202/1-a, in order to prevent liability from arising, the relevant losses must “either be effectively equalized within the same financial year or the subsidiary company must be granted a legally enforceable claim of equivalent value, specifying how and when equalization will be carried out, no later than the end of that financial year.”. Although these mechanisms might suggest that the controlling entity could cause losses to subsidiary companies as long as it compensates them, it is crucial to remember that the purpose of the equalization mechanism is to balance the interests of the parties[14].

Equalization may involve granting the subsidiary company a benefit or advantage to offset the loss. For instance, it may take the form of providing guarantees or sureties, securing guarantees through counter-guarantees or endorsements, granting licenses and trademark usage rights, offering research and development services free of charge, providing know-how, facilitating internships and training for personnel, allowing access to a marketing network, transferring an equivalent real estate asset, granting preemptive rights in a capital increase ensuring that the company suffering the loss is designated as a beneficiary in a conditional capital increase. Equalization may be performed within the financial year in which the loss occurs, or a legally enforceable claim may be provided within that year specifying when and how equalization will take place. However, it is preferable to ensure that the right to claim equalization is not delayed for an extended period, which would undermine its expected benefit, and that mechanisms are in place for the subsidiary company to exercise its right effectively[15].

If the controlling company causes losses to the subsidiary company but does not actually equalize for them within the financial year or does not grant a legally enforceable claim within the required period, each shareholder of the subsidiary company is entitled to demand equalization for the company’s loss from the controlling company and its board members responsible for the loss. In the event of the subsidiary company’s insolvency, its creditors are also entitled to make such claims. Moreover, in cases where control is exercised and the transaction lacks a clearly justifiable reason from the perspective of the subsidiary company, such as mergers, demergers, conversions, dissolution, the issuance of securities, or significant amendments to the articles of association, shareholders who cast a dissenting vote in the general assembly and ensure their objection is recorded in the minutes, or those who submit a written objection to similar board decisions, have the right to demand compensation for their losses from the controlling entity. Alternatively, they may request that their shares be purchased at a value no less than their stock exchange price, or if no such price exists, or if it does not reflect fair value, at a price determined based on generally accepted valuation methods[16].

5.  CONCLUSION

The influence of controlling companies over subsidiary companies has significant legal consequences. The TCC regulates the equalization mechanism to protect the interests of subsidiary companies against losses arising from the controlling company’s influence.

The equalization obligation, although sometimes perceived as a mechanism allowing the controlling company to evade liability, actually aims to maintain power balances within the corporate group. The effective implementation of this obligation minimizes the financial losses of subsidiary companies and ensures the sustainability of the companies within the group. Ultimately, the compensation of losses resulting from the controlling company’s direction is not merely a legal requirement but should also be considered an ethical necessity within the framework of corporate governance principles. The proper and effective application of the equalization mechanism stipulated in the legislation will ensure both the healthy operation of the corporate group and the preservation of trust in commercial life.

REFERENCES

1.    Gül Okutan Nilsson, Türk Ticaret Kanunu Tasarısı’na Göre Şirketler Topluluğu Hukuku, İstanbul 2009.

2.    Hasan Pulaşlı, “Türk Ticaret Kanunu Tasarısına Göre Şirketler Topluluğunun Temel Nitelikleri ve Hâkim Şirketin Güven Sorumluluğu”, Gazi University Law Faculty Magazine C. XI, Sa.12, Y. 2007.

3.    Sevda Bora Çınar, “Şirketler Topluluğunda Hâkim Teşebbüs”, İzmir Bar Association Magazine, 2023 (https://www.izmirbarosu.org.tr/pdfdosya/sirketler-toplu2023912174126784).