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D&O Liability Insurance Under the New Turkish Commercial Code

Directors and officers are increasingly exposed to investigations, regulatory enforcement actions and lawsuits which press demand for Directors and Officers Liability Insurance (D&O Insurance). As a result D&O Insurance is increasingly regarded as essential insurance protection for companies’ decision makers. Many directors regard adequate D&O protection as a prerequisite for serving on board.

Repealed Turkish Commercial Code numbered 6762 of 1956 did not regulate D&O Insurance. With the entry into force of the new Turkish Commercial Code numbered 6102 (Code) in July 2012, a major step was taken for the modernization of Turkish corporate law and introduction of corporate governance reforms. As one of the crucial pillars of this modernization process, D&0 Insurance has been introduced under Article 361 of the Code.

Article 361 of the Code enables the purchase of D&O Insurance to insure the loss that may be incurred by a joint stock company as a result of directors’ actions.

D&O Liability Insurance which has been known and frequently applied in the USA, European Countries and Japan since 1930s was also known in Turkey, however, it has been applied very rarely. As stated in the Code’s preamble, the new provision aims at initiating an expansion of D&O Insurance in Turkey.

This Client Alert aims at presenting a summary explanation of D&O Insurance in light of the newly adopted provision of the Code.

Drivers of D&O Insurance

• Professionalism as an added value

The main reason underlying the need for D&O Insurance is to enable members of board of directors and other senior officers to render strategic decisions and take risks according to the information being provided to them at the time of decision without being exposed to threat of personal liability. Thus the companies can encourage the most skilful, knowledgeable and reasonable directors and officers to work with them. It is widely accepted that D&O Insurance has an effective role on composing a board of directors consisting of directors and officers who are professionals and bear sense of responsibility and appropriate skills for the nature of the work.

• Increased transparency and accountability

Over the past decade, perceived or actual negligence by corporate leadership resulted in a significant increase in the number of corporate disasters. The need for protection against such disasters is reflected in the Code as corporate governance reforms, which in turn require greater transparency and in some cases heightened accountability for directors.

• Suits Against Directors by Shareholders, the Company itself and Creditors of the Company:

Simultaneously with the introduction of corporate governance reforms, the legal environment became more plaintiff-friendly at the expense of directors. For instance, Article 553 of the Code expressly states that members of the board of directors and officers are liable for the loss incurred by the shareholders, company and creditors of the company in the event of negligent breach of duties arising out of law or the articles of association of the company.

The Code allows the establishment of a two-tier board system, which consists of a Management Board bearing the responsibility to manage the company and a Supervisory Board that oversees and appoints the members of the Management Board. If and when Managing Directors breach their duty and such breach results in a financial loss to the company, Supervisory Directors can sue Managing Directors responsible for such loss.

Furthermore, under Article 371 of the Code directors’ and officers’ liability can be challenged by the company for tort committed during the course their work.

Last but certainly not least; derivative actions –where shareholders are entitled to sue directors or officers on behalf of the company- are permitted by virtue of Article 555 of the Code.

• Regulatory Enforcement

Companies are under greater regulatory scrutiny and more likely to be subject to enforcement actions. Directors and officers may be exposed to liabilities in various fields such as health and safety, pollution, competition and cartel activity. Regulators including Capital Markets Board of Turkey (CMB), Banking Regulation and Supervision Agency (BRSA), Turkish Competition Authority (TCA) are increasing their focus on top management.

It is worth to note that directors and officers of multinational companies are further exposed to investigations and regulatory actions coordinated across national borders by regulators in Europe, the US and elsewhere.

• Criminal Actions:

In addition to the above mentioned liabilities, the Code also provides for rules under which individuals can be charged for criminal actions for their actions as company directors and officers. Fines and penalties can be significantly high in amount, which further increases the importance of D&O Insurance Liability for directors and officers.

• Employee Suits:

Employees are entitled to bring claims against directors and officers as well as the company itself with regard to employment- related acts such as harassment, discrimination, wrongful dismissal. As a result, employee claims appear as another significant source of D&O claims.

Fundamentals of D&O Insurance Policy

D&O Insurance is qualified as liability insurance. As per the Code, it is not mandatory but rather voluntary. Even though D&O is traditionally conceived to be for the benefit of directors and officers, it is typically purchased by the company itself as the policyholder and as an insured entity. Without prejudice to the generality of the foregoing, directors and officers can independently purchase D&O Insurance as well.

Public Announcement of D&O Policies

Article 361 of the Code sets forth an announcement requirement with regard to publicly traded companies and companies which have share certificates traded on a stock exchange. In this case if directors and officers are insured for an amount exceeding 25% of the company’s capital, then the purchase of D&O Insurance must be announced at the bulletin of CMB or the stock exchange.

What Does D&O Insurance Cover?

D&O Insurance typically provides cover for the pecuniary damages the insured person is liable against a third party pursuant an action brought against the insured for a negligent act, a negligent error or a negligent omission.

The coverage and specially extensions of the D&O Insurance is determined according to the structure, the business field and prospective future transactions of the company willing to buy the D&O Insurance. The main scope of the policy typically includes the follows:

• Managerial Liability: loss arising out of alleged or actual wrongful managerial act

• Professional Liability: loss arising out of alleged or actual wrongful professional act

• Outside Directors Liability: covers employees of private equity firms sitting on the boards of portfolio companies.

• Loss: cover for both financial loss and legal expenses arising out of a claim made against directors and officers for wrongful acts committed in their capacity as directors and officers.

• Claims made: if policy is drafted without a retroactive date this policy is effective for any incident that is reported during the policy period. On the other hand, the policy can include a retroactivity date pursuant to which the policy will provide cover for claims that are reported during the policy period but which occurred after the retroactivity date.

• Insured: Any person who is currently, will in the future be or was in the past a director or officer of the insured company. This can further provide cover for shadow directors, de facto directors, employees acting on behalf of a director or officer and any equivalent position under the laws of any jurisdiction.

• It can further provide extensions for discovery period; heirs, estates and legal personal representations; investigation attendance costs; new subsidiaries; emergency costs; bail bond expenses; extradition costs; subsidiary and portfolio company prospectus liability; run-off coverage and loss arising from any claim with regard to Intellectual property.

• Territory: As a market practice D&O Insurance provide its protection worldwide except U.S. claims, including claims based on U.S. laws. If a policyholder required additional cover for these it is either possible to revise the policy terms or purchase additional cover.

• The General Conditions of Professional Liability Insurance published by the Treasury stipulate that some claims will be considered as excluded unless explicitly written in the policy. Therefore revisions to the extensions can be made on the basis of the needs of the company.

Further Protection via Endorsements

The loss definition found in D&O insurance policies bears certain exclusions and endorsements. Negotiating endorsements in Turkish D&O Insurance typically include the following:

• Civil Fines and Penalties: civil fines and penalties levied upon directors and officers pursuant an official proceeding or examination commissioned by any regulatory or governmental authority can be covered by virtue of an endorsement.

• Tax Extension: the policy can be extended to include directors’ and officers’ loss arising from their liability for unpaid taxes in case of company’s insolvency.

• Public Receivables: Loss arising from directors’ and officers’ liability for unpaid public receivables under the Law numbered

6183 on the Procedures Governing the Collection of Public Receivables in the event of company’s liquidation is another matter of concern which are not originally included in the definition of loss.

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