The Binding Nature of Corporate Constitutions: Remedies for Breach

Binding nature of the corporate constitution of a joint stock company is acknowledged. This binding nature expresses itself both as the obligation to refrain from taking resolutions conflicting with the corporate constitution (negative obligations) and obligation to take resolutions which are required by the corporate constitution (positive obligations).

While the binding nature of corporate constitution is undisputed, the consequences of its breach are less settled and a subject of significant legal debate and divergent practice.

1. Negative Obligations: Invalidating the Legal Effect

For general assembly (GA) resolutions, a breach of the corporate constitution is a ground for annulment as stipulated by Turkish Commercial Code (TCC) Art 445, while exceptional breaches (e.g., in quorum requirements) may lead to nullity or non-existence instead of annulment. The law enforces the binding nature of the constitution fully by securing shareholders’ right to invalidate the legal effect of GA resolutions breaching the corporate constitution. 

For board resolutions, the legal position is more complex. Apart from exceptions, the TCC generally does not allow for the "annulment" of board resolutions and the courts’ review of board resolutions is based on the nullity review which sets a higher bar than annulment. 

Pursuant to TCC Art. 391, courts might declare "nullity" of board resolutions. TCC Art. 391 sets the examples for nullity grounds, and the breach of corporate constitution is not among the stated grounds. Even if the grounds stated in TCC Art 391 are only examples, the agreed principle is that the grounds for nullity should be interpreted in a restrictive manner, and courts should adopt a restrictive approach in extending grounds for nullity. 

The prevailing doctrine suggests that a breach of the constitution does not inherently (per se) lead to invalidity of a board resolution. Apart from the quorum requirements, it is generally suggested that a breach of the corporate constitution results in nullity, only if such a breach also meets nullity standards exemplified by TCC Art 391.

However, jurisprudence indicates that mere breach of corporate constitution might lead to the nullity of board resolutions. For instance, the Court of Cassation in 2022 declared a board resolution invalid when board approved a share transfer that disregarded a pre-emptive purchase right granted in the corporate constitution. Similarly, Kayseri Regional Court of Appeal found a resolution invalid on the grounds of breaching the corporate constitution when the board called for capital contributions earlier than the time stipulated in the corporate constitution.

2. The Challenge of Positive Obligations: Can Courts Substitute a Decision?

Corporate constitutions might also include positive obligations such as appointing a designated candidate to the board or distributing a mandatory percentage of net yearly profit set in the corporate constitution. When a GA refuses to vote on or votes against a resolution required by the constitution, the central question emerges: Can the courts render a substitute decision?

The established jurisprudence is that courts can only annul the decision but cannot render a substitute resolution. A Court of Cassation decision dated 2013 exemplifies this view: The High Court ruled that the authority for distributing dividends, including timing and method, rests solely with the GA. In the case cited, since there was no GA resolution on the matter, the court could not order the payment of a dividend, even one seemingly mandated by the corporate constitution. The prevailing doctrine adopts a similar approach.

Even if this approach might seem overly formalistic at first glance, this legal reasoning is rooted in the "objective norm" theory of the corporate constitution, and the structure of judicial review. In reviewing an objective norm, the principle is that a higher norm can invalidate a lower one but not substitute it. If corporate constitution is deemed as an objective norm, the judiciary’s limitation in enforcing the corporate constitution by issuing a resolution is theoretically consistent.

An Alternative Reading: Specific Performance and Contractual Nature

An alternative approach to the corporate constitution by acknowledging its contractual nature reframes this reasoning. If the corporate constitution is a contract, any resolution not complying with it should be viewed as a breach of contract. This approach leads to the question: Can a shareholder request "specific performance" of the positive obligation arising from the constitution? 

From contract law perspective, it can be argued that a categorical rejection of this remedy is unwarranted. Even though there might be incidental obstacles for requesting specific performance such as ambiguous terms, it is not fundamentally beyond courts’ authority to remedy the breach by substitution of the resolution violating the corporate constitution. 

In this context, the legal question is connected to the nature of the corporate constitution. Unlike the prevailing opinion which recognizes the corporate constitution purely as an objective norm following incorporation, it can be argued that the corporate constitution also sets the terms of exchange for investment by granting shareholder rights to the investor. This is especially visible in venture capital investments. Therefore, the contractual aspect of the company constitution should not be entirely disregarded. This change in perspective would empower courts to enforce the corporate constitution as a contract and ensure its protective effect for shareholders.

There is general agreement on the binding nature of the corporate constitution. For breaches of negative obligations, legal remedies are relatively efficient. However, for breaches of positive obligations, the prevailing judicial approach, though coherent with the "objective norm" theory, provides suboptimal shareholder protection, as the binding nature of the constitution cannot be fully enforced through a substitute decision. Adopting a contractual approach to the corporate constitution could offer specific performance as a remedy, which would significantly increase shareholder protection by recognizing the contractual aspect between the corporation and investor. 

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Kerem Çelikboya is an Assistant Professor of Commercial Law at Istanbul Bilgi University - Faculty of Law.

This blog is based on a paper presented at the Koç University – ECGI Conference “Corporate Constitution and Private Ordering”.  Visit the event page to explore more conference-related blogs.

The ECGI does not, consistent with its constitutional purpose, have a view or opinion. If you wish to respond to this article, you can submit a blog article or 'letter to the editor' by clicking here.