Non-Competition in Limited Liability Companies
Non-competition is defined as a regulation that includes the obligation of a partnership, enterprise, client or employer to refrain from engaging in activities in the same field of business or from all kinds of commercial and professional activities that may harm the interests of trade secrets and customer environment. Under the Turkish Commercial Code No. 6102 (‘TCC’), it is accepted that managers are included in the scope of non-competition without any distinction between whether they are partners in a limited liability company or not, or whether they are appointed by the decision of the limited liability company’s shareholders’ meeting or by the articles of association of the company.
Furthermore, Article 626 of the TCC regulating the obligation of loyalty of the managers of a limited liability company to the company in addition to the prohibition of competition is as follows
‘(1) Managers and persons in charge of management are obliged to fulfil their duties with all due diligence and to observe the interests of the company within the framework of the rule of honesty. The provisions of Articles 202 to 205 are reserved.
(2) Unless otherwise stipulated in the articles of association or authorised in writing by all other shareholders, directors may not engage in any activity that constitutes competition with the company. The articles of association may provide for the approval of the general assembly of shareholders instead of the approval of the shareholders.
(3) The directors are also subject to the duty of loyalty foreseen for the shareholders.’
The second paragraph of the above-mentioned article stipulates that the directors may not engage in activities that compete with the company in a limited liability partnership. However, this prohibition may be cancelled by stipulating otherwise in the articles of association of the company or with the approval of the general assembly of shareholders. Therefore, the provision of the TCC regarding the prohibition of competition of the directors is not a mandatory provision.
In addition, Article 613/2 of the TCC states that ‘Shareholders may not engage in behaviours that may harm the interests of the company. In particular, they may not engage in transactions that provide a special benefit to themselves and harm the purpose of the company. The articles of association may stipulate that the shareholders are obliged to refrain from transactions and behaviours that compete with the company.’ This article stipulates that the articles of association of the company may include the obligation of the shareholders to refrain from competing with the company.
The last sentence of paragraph 613/2 of the TCC reads as follows: ‘The articles of association may stipulate that the shareholders are obliged to refrain from transactions and behaviours that compete with the company’. In this context, it is stipulated that a contractual prohibition of competition may be imposed on the shareholders. Thus, the scope of the prohibition of competition may be expanded or narrowed in the articles of association of the company or with the consent of the shareholders. In summary, all of the legal regulations regarding the prohibition of competition in commercial partnerships prohibit two types of activities. These are: i) carrying out a business that falls within the subject matter of the partnership itself, ii) becoming a partner in or taking part in the management of other partnerships of a certain type operating in the same field as the partnership.
As a rule, the prohibition of competition will be terminated upon the termination of certain legal titles (partner, member of the board of directors, etc.) held by the persons in the company. However, it is possible to conclude an agreement regarding the continuation of the prohibition of competition even after the loss of the titles of the persons before the company. An explicit agreement must be made for the continuation of the prohibition of competition after the loss of the titles of the persons. This agreement may be included in the articles of association of the partnership, or it may be made separately from it at the time of separation. As a rule, the manager of a limited liability company is subject to a very broad prohibition of competition. Although the common point of the rules on non-competition regulated under the TCC can be considered as preventing the persons with the aforementioned legal title from participating in other companies as unlimited liability partners or conducting business in the fields of activity of the company within the framework of the interests of the company.
The scope of the contractual prohibition of competition is determined within the framework of the provisions of the contract. There is contractual freedom provided that it is not contrary to Articles 2 and 23 of the Turkish Civil Code and Articles 19 and 20 of the Code of Obligations. As a rule, the contractual prohibition of competition arises in two ways in Turkish law:
The first one is in cases where the contracting parties agree to extend or narrow the prohibition of competition arising from the law by a contract. As can be understood, the competition prohibitions regulated by the law are not mandatory provisions. The second situation is the prohibition of competition that is agreed to be valid for a certain period of time after the company manager leaves his/her office or the termination of the proxy relationship. As a rule, the limits, sanctions and validity conditions of the non-competition stipulated by the contract may be freely determined by the parties. However, despite the principle of freedom of contract, the legislator has not foreseen an unlimited prohibition here. The prohibition of competition must be compatible with Articles 19 and 23 of the Turkish Civil Code and Article 26 of the Turkish Code of Obligations. In addition, the prohibition of competition should not be contrary to the freedom of labour regulated in Article 49 of our Constitution.
Within the scope of the Limited Liability Company Law, the managers must perform their duties with all the diligence expected from them during their term of office. They must also protect the interests of the company in good faith. The obligations of managers in limited liability companies are regulated under Article 626 of the TCC. According to the predominant view in the doctrine, the scope of the prohibition of competition is limited to the fields of business in which the company actually operates. According to this view, the prohibition of competition should be interpreted narrowly and should be limited to the company’s actual fields of activity.
The director’s obligation of loyalty towards the company starts with the establishment of the organ bond between the company and the director, and as a result, the prohibition of competition also starts. None of the provisions regulating the non-competition under the TCC limit the subjection of the persons subject to the non-competition to any period of time. Even though there is no limitation in this regard, the prohibition will remain valid as long as the limited liability company manager who is subject to the prohibition of competition maintains his/her position. As a rule, the prohibition is valid during the term of office of the manager. After the end of the term of office, the manager shall not be subject to the obligation of loyalty stipulated under Article 613 and the prohibition of competition stipulated under Article 626 of the TCC. It is accepted in the doctrine that the ‘conflict of interest’ between the company and the director will cease after the end of the term of office, and therefore the director will not be subject to the prohibition of competition. However, it should be taken into consideration that conflicts of interest may arise if the parties act in breach of the rules of good faith after the end of the directors’ term of office. As a result, if the director’s prohibition of competition is stipulated in the articles of association of the company or by a separate agreement, it is stipulated that the director shall be liable for the damages caused within the scope of Article 553 of the TCC in the event that the director acts negligently in violation of the prohibition.
As a rule, the director is not subject to any prohibition of competition after the term of office expires. However, the contrary may be agreed upon by a separate agreement that determines the main legal relationship. In the event that a prohibition of competition is agreed upon by such an agreement, the limited liability company must have a legitimate interest in the agreement of the prohibition of competition. Otherwise, the prohibition will only restrict the economic freedom of the manager in violation of equity. In addition, it is necessary to examine whether the manager is aware of the company’s customer circle or trade secrets within the framework of the contract of employment. In conclusion, in order for a contractual non-competition clause to be applicable to the director, it must be subject to reasonable and equitable limits.
Contractual non-competition is also regulated under the section of the TCO regulating the provisions of the service contract (employee-employer relationship), and according to Article 445 of the TCO, the non-competition shall not exceed two years, except for special circumstances and conditions. According to an opinion in the doctrine, as long as the prohibition of competition is equitable in terms of place and subject matter and does not unfairly jeopardise the economic future of the employee, it may exceed the two-year time limit. According to the Court of Cassation, time limitations that are too broadly regulated will limit the economic situation of the relevant person unfairly and will be null and void. It is clear that it would not be equitable to prohibit a manager from working in all these fields of activity on the basis of a competition agreement, if the company writes more than one type of activity in the subject of the company while registering with the trade registry and does not operate in all of these fields of activity.
The legal consequences of the violation of the non-competition agreement in terms of the employee-employer relationship are regulated under Article 446 of the TCO. If the relevant provisions are applied to the manager of a limited liability company by analogy, the manager who violates the non-competition agreement will be required to compensate the company for the damages. Likewise, the breach of the non-competition agreement is a breach of contract, and the damages arising from the breach will have to be compensated in accordance with the provisions of the law of obligations. Based on Article 446 of the TCO, the company may also request the termination of the non-competitive behaviour in the presence of the conditions listed in the article. For this request, it is required that the non-competition agreement has been expressly agreed upon in the contract and that the importance of the company’s interests that are violated or threatened and the director’s behaviour contrary to the non-competition are justified.
When evaluated within the scope of the service contract, if the employee and the employer wish to continue the non-competition obligation after the termination of the employment contract, they must include a separate clause in the employment contract or conclude a separate non-competition agreement. A non-competition agreement is a contract in which the employee undertakes not to enter into a competitive relationship with the employer in a certain field of activity, in a certain geographical area, within a certain period of time, after the termination of the employment contract. It is clear that the agreement prohibiting the employee from competing with the employer after the termination of the employment contract will limit the economic future of the employee. Article 444 of the TCO sets forth the conditions that must be included in the agreement in order to establish a valid non-competition agreement. These conditions must be met in order for the agreement to be valid and binding by the parties, otherwise the agreement will be deemed invalid subject to the sanction of nullity. The conditions required for the conclusion of the agreement under Article 444 of the TCO are as follows: the existence of a valid employment contract, the agreement must be in writing, the employer must have a legitimate interest worthy of protection, there must be the opportunity to obtain information about production secrets or the employer’s business, and there must be the opportunity to obtain information about the customer environment, sales and marketing conditions. In addition, the limits of the non-competition undertaking are restricted in terms of location, type of work and duration.
It is possible to argue that the agreements stipulating the continuation of the prohibition of competition despite the loss of the title of the persons in the company must be made in writing (by analogy to Art. 350 of the Code – Art. 443/I of the Draft Code), the prohibition must be limited in terms of time, place and type of work, and other principles set forth in Art. 348-352 of the Code (Art. 443- 446 of the Draft Code) must also be taken into consideration. As a matter of fact, the decision of the 11th Civil Chamber of the Court of Cassation numbered E. 2000/1263- K. 2000/1729 is close to this view by stating that the contractual provision preventing a shareholder who leaves a limited liability company from working under the condition of a registered life is invalid.
As a rule, the contractual non-competition clause expires upon the expiry of the specified period. The concepts of waiver of contractual non-competition and statute of limitations are not regulated under the Turkish Code of Obligations. Thus, as a result, the parties may waive the non-competition agreement. The accepted view in practice is that the agreement may be terminated by contract in accordance with Article 26 of the TCO. Accordingly, the parties may waive the valid agreement and its legal consequences by declarations of will in agreement with each other.
As a result, the managers of a limited liability company may be required to sign a non-competition agreement, which will be effective upon termination of the limited liability company, regarding the performance of a business that falls within the subject matter of the partnership, or becoming a partner of, or taking part in the management of, other partnerships of a certain type operating in the same field as the partnership.
