Israeli Law Series 3 – Merger and Acquisition of Companies
Dec 06, 2017
In the previous parts of our Israeli Law Series, we focused on the basic methods and procedures of doing business in Israel. In this Part 3, we shall look into M&A aspects of Israel regarding private companies. Israel is a nation of start-ups with an entrepreneurial infrastructure that promotes innovation. With the innovators more focused on the technical developments rather than marketing, foreign investors have the potential of reaping considerable rewards from purchasing new inventions. In this Article, we will explore the common models and procedures in acquiring an Israeli private company. Please note that M&A is a complex subject and this article aims to serve as an introduction only.
M&A dynamic between Japan and Israel
The background of the growing relationship between Japan and Israel was already touched upon in our previous article. Among the various collaborative agreements entered into between Japan and Israel in the recent years was Japan’s first ever Industrial R&D Collaboration Agreement. Although beyond the scope of this article, it is useful to note this agreement provides funding to eligible Israeli and Japanese companies that have collaborative R&D projects as well as assistance in locating potential business partners.
Both countries are observing increasing exchanges of companies. Cybersecurity, medical devices, autonomous driving technology, artificial intelligence, augmented reality, and wireless technology are the main sectors attracting the most interests. Major companies have already established continuing ties, for example, Sony’s acquisition of Altair Semiconductor; Fujitsu’s opening of Israel branch; Teijin’s research with Israeli firms; and All Nippon Airways’ collaborative research with El Al Israel Airlines.
M&A – Common Methods in Israel
There are several ways for one corporate entity gaining control of another. Which method will best suit a particular situation require detail analysis of the two companies’ circumstances such as financial, management, shareholders’ numbers and attitudes, urgency, consideration on offer and many more. As such we will not be discussing the advantages and disadvantages of different methods but simply providing an overview of the procedures. The most common methods are:
- Stock purchase
The Buyer buys the outstanding shares (ie. all shares, capital stock) of the target company from the shareholders thus achieving the controllership of the target company. Warranties and representations about the company and shares would be made to the Buyer by the selling shareholders. The target company is mainly unaffected as the deal is between the Buyer and each shareholder, although the selling shareholders may affect some changes as part of the deal.
The main governing law in Israel regarding companies is the Companies Law 1999 which generally does not contain restrictions on share transfers for private companies. However certain highly regulated sectors such as banking, core infrastructure, broadcasting, security are subject to greater regulatory restrictions. There is generally no restrictions on the transfer of shares to a foreign Buyer (except when the Buyer is residing in countries defined as enemy countries, namely Iran, Syria and Lebanon). However, companies are at liberty to impose restrictions in their Articles of Association (referred to as “Articles of Incorporation”, “Company Constitution” or similar in other countries). It is not uncommon for companies to express the need for Board of Director’s approval. Venture investors of the target company may also have veto power over acquisitions. If some of the shareholders do not agree to a transaction, there is the possibility of using a contractual bring along (drag along) provision to force minority shareholders to consent.
In Israel, share ownership is recorded in a share register maintained by the company rather than officially recorded with a governmental authority. However, a company is required to update the Registrar of Companies of changes in its shareholding, and the shareholding structure is publicly available. Transfer of share is done by a share transfer deed executed by both parties.
- Asset purchase
The Buyer buys the target company’s assets and liabilities from the target company commonly via different instruments of transfers. The target company remains an independent entity from the Buyer, however, business operations, assets, and liabilities become the Buyer’s.
Israel does not have a doctrine of “successor liability”. Therefore in general, no liability is transferred in an asset sale unless expressly assumed by the Buyer. There are some exceptions, however, in the employment context where employees hired from the target company under same conditions may retain rights accrued over the years working at the target company. However, in an asset deal, there is no automatic transfer of the employees, and their transfer is subject to their own will and signing of a new employment agreement with terms satisfactory to the transferred employees.
The acquirer usually has two options: “fire and rehire” where the employees are fired and get all their benefits and entitlements from the old employer and then rehired by the acquirer, or that the acquirer takes upon itself contractually to sponsor all transferred employees’ old benefits and entitlements. This is usually a topic for negotiation between the Seller and Buyer and often an issue for a tax and finance analysis.
Unlike stock purchase or asset purchase, there is no transfer from the target company to the Buyer. The Buyer and target company agrees to “merge” their entities through an entity re-structuring. One corporate entity disappears while the surviving entity obtains all the other’s assets and liabilities. This merge is recorded to the official corporate authorities according to local law. Often, the Buyer creates a subsidiary for the purpose of the merger. The subsidiary will merge with the target company and the target company will become the wholly owned subsidiary of the Buyer. In Israel, a reverse triangular merger is becoming more popular for tax and other reasons.
Mergers in Israel are subject to antitrust regulatory requirements if the merging entities fall in certain criteria. An investment can also fall within these requirements.
- Two-step merger
A merger requires the consent of at least the majority of the shareholders. There is a difference between a merger of a private company and those of a public company. Public companies are subject to the requirements of the Securities law and regulations. The Buyer might first purchase shares of the target company through a tender offer then with the majority of the shares, perform a back-end merger.
Common documents and tasks
- Perform due diligence
- Create Preliminary Agreement in form of term sheet, letter of intent or memorandum of understanding.
- Obtaining approvals from key stakeholders in accordance with Articles of Association
- Create Principle Agreement in form of a share purchase agreement; asset purchase agreement; or a merger agreement depending on the nature of the transaction.
- Create a shareholders’ agreement (Articles of Association) (if certain shareholders remain shareholders of the company after the transaction)
- Create an escrow agreement (which governs money place as guarantee to handle any indemnification claims by the buyer)
- Create retention agreements with key employees who will continue after the transaction
- Notice to necessary authorities such as Israeli Antitrust Authority (IAA)
- Signing of share transfer deeds (for any share transfer)
- Notice to the Companies Registrar
- Others such as notifying industry regulators and accounting.
Operation of Antitrust Law in certain circumstances
Mergers in Israel is subject to the Restrictive Trade Practices Law, 5748-1988 (the Antitrust Law) which is administered by the Israeli Antitrust Authority (IAA). Head of the IAA is referred to as the General Director. The Antitrust Law defines “Merger” as:
“including the acquisition of the principal assets of a company by another company or the acquisition of shares in a company by another company which accord the acquiring company more than a quarter of the nominal value of the issued share capital, or of the voting power, or the power to appoint more than a quarter of the directors, or participation in more than a quarter of the profits of said company; the acquisition may be direct or indirect or by way of rights accorded by contract”
Due to this broad interpretation of “merger”, some joint venture agreements may also be caught by the operation of the Antitrust Law.
Notification to the General Director is required if the following applies:
(1) Both parties to the merger agreement have a nexus to Israel. The conditions for a nexus to Israel are: (i) the company is registered in Israel; or (ii) the company or its ultimate controlling owner hold, directly or indirectly, more than 25% of the rights in an Israeli company. For this purpose, “control” means having over 50% of the votes in the general assembly or over 50% of the power to appoint directors; or (iii) the company has a representative in Israel (such as an exclusive distributor or a representative over whom the foreign company has a significant impact on matters such as pricing or quantities of products sold or inventory or other aspects of the management of the business, whether such impact is a result of a written agreement or another arrangement).
(2) As a result of the merger, the combined share of the merging companies in the total production, sale, marketing or purchase of a particular asset and a similar asset or in the provision of a particular service and a similar service, would exceed fifty percent, or a lower market share if the Minister so determined with regard to a monopoly. It should be noted that, to date, the Minister has not used this determination power with regard to any market;
(3) The combined sales turnover of the merging companies in Israel, in the fiscal year preceding the merger, exceeded 150 million NIS and at least each of the merging parties’ sales turnover exceeds 10 million NIS (If the merging company has parent companies or subsidiaries, its turnover should be determined according to the consolidated financial statements);
(4) One of the merging companies is a monopoly within the meaning of the Antitrust Law, roughly defined as over 50% market share.
For companies that also do business outside of Israel, it is only the business activities in Israel that is examined. All these thresholds apply also to a group of companies, i.e., the company, its controlling entity and any companies under their respective control. For this purpose, “control” means having over 50% of the votes in the general assembly or over 50% of the power to appoint directors
The merger must not be implemented before receiving the approval from the General Director. Failure to comply is a criminal offense which may result in imprisonment sanction up to 3 years and even 5 years in aggravated circumstances or in administrative fines. The IAA noted that administrative fines are the preferred method of enforcement with regard to non-horizontal mergers. The decision regarding approval should be decided within 30 days of the application. If no decision is made within 30 days, it is generally deemed that the merger is compatible with the Antitrust law.
A merger will be approved unless, in the opinion of the General Director of the Antitrust Authority, there is a reasonable risk that, as a result of the merger, either:
- Competition will be substantially lessened (for example if the merged entity will have a market share of more than 50%).
- The public will be harmed by the price level, quality, quantity, regularity or terms of supply of a particular asset or service.
Sincere appreciations to Herzog Fox & Neeman Law Office (www.hfn.co.il) for assistance and local expertise in the creation of this article.