Personal Liability Of Bank Managers And Controlling Shareholders

I. PERSPECTIVES ON LEGAL BACKGROUND OF PERSONAL LIABILITY

A. Relevant Provision

The main legal regulation of Turkish banking system is Banking Law numbered 5411 and came into force in 2005 and the legal background of personal liability of managers, auditors and controlling shareholders is determined by the Article 110 of Banking Law as following:

“Personal Liability

Article 110

1. If it is determined that the managers and auditors of a bank, or its general manager and assistant general managers, or its authorized signatory officers have caused the application of the provisions of Article 71 for the bank through their decisions and actions that are in violation of the applicable laws, on the basis of a decision of the Fund Board[1] and upon the request of the Fund, such person shall be held personally liable to the extent of the damage they have caused to the bank and a court may declare any such person bankrupt. Where any such decision or act have been made or taken in order to provide benefits to controlling shareholders of the bank, the same provision shall also be applied to such controlling shareholders to the extent of the benefits so obtained. The outstanding amount of the collected funds after the deduction of deposits and contribution funds as well as their accessory obligations paid by the Fund shall be returned to the bank whose liquidation or bankruptcy procedures have been initiated.

2. The Fund shall institute legal proceedings against any person declared bankrupt by court.

3. The courts shall apply the provisions of the Article 257 and the following articles of the Execution and Bankruptcy Law no. 2004 when dealing with those whose bankruptcy is claimed under the provisions of this Article.

4. The provisions of Article 106 and 109 shall be applicable for those that are personally declared bankrupt as per the provisions of this article”.

B. Ratio Legis of the Provision

Ratio Legis, in other words, occasions of making the provision of the Article 110, regulating personal liability, could be determined as:

a. Deterrence (preventive function): The provision aims to direct bank managers to rational and safe management system via tremendous liability pressure.

b. Compensation of occurred losses (compensatory function): In consequence of poor management and getting unfair advantage by using managing position in a bank, relevant managers are under the obligation of compensation of all losses occurred in the bank as a result of their actions.

C. Basic Terms of the Provision

1. Bank managers

In the meaning of the Art.110 a term “bank managers” includes:

Members of Board of Directors (Art.23, Law No5411);
Audit Committee (Art.24, Law No5411);
Head and members of credit committee (Art.51/2, Law No5411);
General manager and deputy general managers (Art.25, Law No5411)
Officials, that have a signing authority on behalf of the bank, including regional managers, branch managers and the managers of the units within the head office central organization such as departments, sections, groups, etc. (Art.3, Law No5411)

2. Auditor

Within the meaning of Art.110, auditor is a person appointed by the company’s General Assembly for fiscal year and before the end of the fiscal year in which he/she will perform his/her duty and whose appointment registered with the Trade Registry and announced it in the Turkish Trade Registry Gazette in accordance with the provisions of Art.399 of Turkish Commercial Code No399.

D. Areas of Application of the Provision

Provisions of the Art.110, regulating personal liability, are only applicable to the managers, auditors and controlling shareholders of deposit and participation banks. In accordance with the

Art.77 of Law No 5411 provisions of Art. 110 are not applicable to the development and investment banks.

In this regard, giving a legal definition of deposit and participation banks would be appropriate:

Deposit banks: The institutions operating primarily for the purpose of accepting deposit and granting loan in their own names and for their own accounts as per the provisions of this Law and the branches in Turkey of such institutions established abroad. Bankruptcy of managers and controlling shareholders of such kind of bank might be claimed.

Participation banks: The institutions operating primarily for the purposes of collecting fund through special current accounts and participation accounts and granting loan pursuant to this Law and the branches in Turkey of such institutions established abroad. Bankruptcy of managers and controlling shareholders of such kind of bank might be claimed.

II. PERSONAL LIABILITY OF BANK MANAGERS

A. Material Conditions of Personal Liability

1. Occurrence of Loss in the Result of Breach of Contract or Tort (Wrongful Action)

a. Actions and Decisions of Bank Managers, that are Contrary to the Laws

Art.110 refers to “decisions and actions that are in violation of the applicable laws”, that result in application of the provision of Art.71 as one of initial conditions of personal liability. However, it is not clear what is meant by “applicable laws”.

According to general consent accepted in academic area[2], the term “applicable laws” shall be interpreted firstly as Banking Law and by-laws, directives, communiqués, memorandums and decisions enacted, basing on provisions of Banking Law. The second line of “applicable law” shall consist of provisions of Turkish Commercial Code, Capital Market’s Law, Turkish Code of Obligations and other codes and laws in in the extent they are related to Banking Law.

b. Type of Actions and Decisions

Actions and decisions of bank managers contrary to the laws, that generally become a matter of personal bankruptcy cases are might be summarized as:

Issuance of unjust credits to shareholders of bank;
Sharing of fictive dividends;
Reimbursement of the cash expected to be provided by the partners in the capital increase from bank sources;
Presentation of uncollected interest charges in the balance as collected;
Share of dividends based on positive balance prepared fictively;
Reimbursement of real estate purchase operations of partners from the bank resources under the credit allocation image;
Issuance of credits without collection enough security intelligence when opening credits or disregard to the security intelligence reports;
Pretermit of market value of mortgages received as loan collateral, etc.

In cases regarding the personal bankruptcy, it was mostly observed, that actions and decisions cause violation of law were made in order to provide benefits to the controlling shareholders. As a very broad example, transfer of cash from deposit accounts to controlling shareholders’ accounts in offshore banking zones without any consent of deposit account’s holders might be mentioned. In such cases unlawful actions of bank manager shall be accepted as performance of unlawful instructions of controlling shareholders.

In order to prevent personal bankruptcy, bank manager who has faced with unlawful instructions of controlling shareholder, should decline such instruction and avoid its performance. Any action of manager, simplifying performance of unlawful instruction, is also accepted as a legal ground for personal liability.

2. Loss

According to the Art.110, managers are “held personally liable to the extent of the damage they have caused to the bank”. In this respect damage might be defined as a decrease in assets of bank as a result of unlawful actions of manager or/and shareholders. Since the nature of banking operations are directly connected with risks, such as, existence of non-returned credits in bank fit for the ordinary course of commercial life. In order to initiate a claim on personal bankruptcy of bank managers, non-returned credit must had been issued contrary to the law.

In order to consider bank manager responsible, damage must be concrete and definite. Presumptive losses and risks, in other words indefinite damages, cannot be a legal ground for personal liability.

However bank managers are responsible for both proximate and consequential losses of bank occurred as a result of their actions. In this regard proximate loss is loss occurred as a direct result of unjust action, whereas the consequential loss is the amount of loss incurred as a result of being unable to use business assets that have been lost as a result of unjust action.

3. Fault of Bank Manager

Legal practice accepts two types of fault of bank managers:

Intent: Bank manager, intending to provide a benefit for third party, recognizes that in order to provide a such a benefit he/she must take action or decision that is contrary to the law.

Negligence: Since the bank managers are obliged to research lawfulness of their actions and decisions, absence of knowledge on illegality of their actions and decisions could not prevent the personal responsibility of manager. In other words, bank manager must display prudent behavior, by showing a manner similar to the behavior of bank manager, acting under analogical circumstances.

4. Determination and Proof of Damage in Personal Bankruptcy Case

Case on personal bankruptcy might be initiated only in the extent of damage that have caused to the bank. In this regard it must be proven contrary to which law acted the bank manager, whose personal bankruptcy is claimed, together with exact determination and proof of damage. Amount of damage not related with unlawful action and/or decision of bank manager could not be a subject of compensation in the frame of personal bankruptcy case.

5. Liability of Bank Managers Who Have Previously Left the Job

If a bank manager, who has previously left the position, caused a loss to bank by his unlawful acts and decisions, but the existence of loss has been revealed later, personal liability of such manager also could be claimed by the Fund. Such managers might only be held liable until end of the lapse of time.

According to the precedent decision of Supreme Court dated 12/07/2007 and numbered 2773/7423, in case of death of liable bank manager during the proceeding, heirs could not be considered liable.

Considering a variety and complexity of banking operations, it is very complicated to fully and exactly determine amount of damage caused by each manager, so it is clear that person that will count the damage shall have a specific technical knowledge and experience.

E. Formal Conditions of Personal Liability

1. Savings Deposit Insurance Fund Decision on Bank Manager(s)

In order to raise a claim on personal bankruptcy of bank managers, the Fund must take a decision in this regard. In case if the Fund file a lawsuit before the Courts without the said Fund’s decision, Court may reject the case for procedural gaps or may give an additional period of time to bridge the gap.

Fund’s decision on raising a claim on personal liability of bank managers is in the quality of administrative decision. In accordance with Article 128 of Banking Law, lawsuits could be filed directly before Counsel of State against these kinds of decisions.

2. Savings Deposit Insurance Fund’s a Lawsuit in the Court for Personal Bankruptcy of Bank Managers

The personal bankruptcy lawsuit’s legal reason, subject and claim limit is the loss caused by managers to the bank.

The case is ruled to be initiated before Commercial Courts. The Fund is under burden of proof for the fault of bank manager together with determination of required compensation amount.

III. PERSONAL LIABILITY OF CONTROLLING SHAREHOLDER

A. Personal Condition

According to Article 110 of Banking Law, controlling shareholders of a bank are personally liable from bankruptcy.^{^[3]}

“If it is determined that the managers and auditors a bank, or its general manager and assistant general managers, or its authorized signatory officers have caused the application of the provisions of Article 71 for the bank through their decisions and actions that are in violation of the applicable laws, on the basis of a decision of the Fund Board and upon the request of the Fund, such person shall be held personally liable to the ex- tent of the damage they have caused to the bank and a court may declare any such person bankrupt.”

Therefore, the first condition for a controlling shareholder might be considered as liable is “being a controlling shareholder”.

What is a controlling shareholder and when the shareholder should carry this title? (The most effective defense discussion for such a liability case)

According to the view of doctrine, this title should exist at the exact time of application of the Article 71 of the Law.

In contradiction with the personal liability of managers and auditors, personal liability of the controlling shareholder is restricted with the benefit he gained from the acts of managers and auditors. However, the below stated conditions that are sought for the liability of managers and auditors shall also be sought for the controlling managers:

1. taking decisions and conducting actions in contrary to the law

2. being in fault in decisions and actions

3. causing the damage of the bank with his decisions and actions

4. causal link between the law/action and the damage

5. having caused the application of the provisions of Article 71 for the bank through their decisions and actions that are in violation of the applicable laws.

Definition of the Controlling Shareholder

Control is defined in Article 3 of the Banking Law as follows:

“The power to appoint or remove from office the decision taking majority of members of board of directors through direct or indirect possession of the majority of a legal person’s capital irrespective of the requirement of owning minimum fifty-one percent of its capital; or by having control over the majority of the voting right as a consequence of holding privileged shares or of agreements with other shareholders although not owning the majority of capital”.

Therefore, a controlling partner may be defined as a real person or legal entity who controls the company directly or indirectly. Direct control (direct share ownership) may be considered as the same with having the controlling interest. Indirect control (indirect share ownership) is also regulated within Article 5 of the Banking Law as the following:

“In the implementation of this Law, for the purposes of determining indirect share ownership by a real person, the shares belonging to real person, his spouse and children and the undertakings in which such persons participate with unlimited responsibility as well as the shares belonging to undertakings controlled by such individually or jointly, shall be taken into account together. For the purposes of determining indirect share ownership by legal persons, the shares belonging them as well as the shares belonging to undertakings which are controlled by such shall be taken into account together.”

Controlling types may be listed as follows:

1.Having the controlling interest directly (having the majority of the shares directly): There is no condition to have the 51% of the shares. It is enough to have the majority directly or indirectly. However, if 51% of the shares are in question, it is accepted that controlling interest is accomplished.

2. Having the controlling interest indirectly (having the majority of the shares indirectly)

3. Having the privileged shares

4. Having the ability to appoint or dismiss board of directors in the enough number to form quorum of decision

B. Material Conditions

Taking the Decisions and Conducting Actions that are in Violation of the Applicable Laws in order to Afford Benefits

For the application of this material condition, it is not enough that managers and/or auditors take decision or conduct actions that are in violation of the laws. Controlling shareholder should apply pressure in this regard.

In principle, the Fund is under burden of proof that such a special purpose of controlling shareholder exists. However, Turkish Courts mostly accepts as a presumption that if the controlling shareholder had any benefit at the end of the unlawful decisions and actions of the manager (auditor), then the controlling shareholder has applied pressure on manager (auditor).

If there is any decision or action that cannot be applied for an ordinary customer, e.g. bank’s guarantee to a company of the controlling shareholder or letting controlling shareholder or his relatives to use credits with low interest and long-term, then such circumstances may prove the purpose.

Controlling Shareholder(s)’ Actions to Have Benefit

Controlling shareholder should put pressure or force managers (auditors) to take decisions or conduct actions in violation with the applicable law. However, since it is not easy to prove, it is presumed that the controlling shareholder had benefit at the end of the unlawful decisions and actions of the manager (auditor), then the controlling shareholder has applied pressure on manager (auditor).

Benefit of Controlling Shareholder(s) at the End of the Decisions and/or Actions

De-facto benefit is required for the application of the Article 110 of the Banking Law.

It is not important whether the targeted benefit is accomplished fully or partially, the Fund is under burden of proof that controlling shareholder had a benefit at the end of the decisions and/or actions.

Benefit should be concrete and economical.

The benefit should be beyond the benefits regulated with the law or sub-legislation.

Causing Cancellation of the Operation License or Transfer to the Fund (Application of Article 71 on the Bank) with Their Unlawful Applications

This is a precondition for personal liability of the managers (auditors) and controlling shareholders.

C. Formal Conditions

Savings Deposit Insurance Fund Decision on Controlling Shareholder(s)

The exclusive power to initiate the bankruptcy case against managers (auditors) and controlling shareholders belongs to the Fund.

Savings Deposit Insurance Fund’s Request on Bankruptcy from the Court on Controlling Shareholder(s)

The case is initiated before commercial courts

Fund is under burden of proof of the amount that is benefited.

The monetary amount of the case is restricted with the benefit that is gained both for managers (auditors) and controlling shareholder.

Fund is also responsible from registering the amount of the benefit after the decision of bankruptcy to the bankruptcy estate.

D. Provisions of The Personal Liability

If the conditions are fulfilled, at the end of the case, court will order to the direct personal bankruptcy of the managers (auditors) and controlling shareholder(s).[4] In direct bankruptcy, creditor is not required to follow a certain procedure.

The claimant (creditor) of the personal bankruptcy, the Fund, is not obliged to follow a certain execution procedure before initiating the bankruptcy before commercial court and to serve payment order to the managers (auditors) and controlling shareholder(s).

Fund cannot transfer claimant title throughout the case to a third party.

The defendant title belongs to the managers (auditors) and controlling shareholder(s) who causes the damage of the bank. Fund can file the case with a single lawsuit petition towards the plural defendants.

The competent court to see the case is defined in Article 142/2 of the Banking Law is as follows:

“Any civil action or bankruptcy proceeding which may be brought by the Fund, the Fund banks and the bankruptcy and liquidation offices of the banks whose operating permission has been revoked, against any person whose registered office or abode is located within the boundaries of Istanbul province, shall be heard by Istanbul Commercial Courts of First and Second Instance. If a bankruptcy proceeding has been instituted, then the court referred to above shall notify the commercial court of first instance, located in the place wherein the debtor, against whom the bankruptcy proceedings have been instituted, has his registered office, that a bankruptcy proceeding has been instituted against the debtor.”

Ordinary proceeding procedure shall be applied to the cases instead of written proceeding procedure as per Article 106/4 of the Banking Law and within six months’ term.

Fund shall carry out the “administration of bankruptcy” function.

According to Article 109/2 of the Banking Law; “A preliminary injunction or preliminary attachment may be issued by a court upon the Fund’s request in respect of properties, rights and receivables of controlling shareholders, managers as well as real person shareholders who own more than 10 percent of the capital of corporate bodies that are shareholders of the bank whose operation license has been revoked or that has been transferred to the Fund, without requiring a security deposit, and such persons may be prohibited from leaving Turkey.”

As per Banking Law (Article 8), bankrupt persons cannot be a founding shareholder within the bank.

The lapse of time for the executions and cases regarding the Fund’s receivables is twenty years.

According to Article 132/10 of the Banking Law,

“In connection with its all kinds of claims the Fund shall be authorized to make all kinds of dispositions including discount; to enter into compromises; to sell or buy back, to take over movables and immovable and all kinds of rights and claims on account of its claim under the conditions it will specify; to enter into agreements with debtors including application of a new re payment plan for the claim; and to apply or not to apply custody measure under the principles and procedures to be determined by the Fund Board pursuant to provision of this Law under the agreements it has made with the debtors; to file or not to file law- suits and to ask the court to suspend the lawsuits already filed, during the validity period of the agreements made.”

[1] According to Turkish Enforcement and Bankruptcy Law, there are three different types of bankruptcy which are general (ordinary) bankruptcy (a. 155-166); bankruptcy particular to promissory notes (a. 167, 171-176) and direct bankruptcy (a. 177-181).

[2] Other than the controlling shareholders, bank managers (auditors) are also personally liable from bankruptcy.

[3] Tekinalp, Ünal: Fondaki Bankanın Hukuki Durumu (The Legal position of Bank in the Fund), p.76; Doğrusöz, Hanife: Banka Yöneticilerinin ve Hakim Ortaklarının Şahsi Sorumluluğu (Personal Liability of Bank Managers and Controlling shareholders), İstanbul 2010, p.104.

[4] Fund Board: Savings Deposit Insurance Fund Board (Art.3, Law No 5411)