Israeli Law Series 2 – Companies Law and Corporate Governance
Dec 05, 2017
In Part 1, we dealt with the types of business entities and foreign registration options in Israel. For Part 2, we would like to deal with Israeli corporate governance under the Companies Law 5759-1999 (“the Act”).
In this article, we will briefly outline the functions of company organs in Israel. This will include the duties, appointment and removal requirements for officers. These regulations are largely set out in the Act and according to the articles of association of the company.[1]
The Companies Law – Background
Prior to Israel’s declaration of independence in 1948, it was governed by British Mandate. As a consequence, the British common law has a strong influence over Israel’s companies laws and regulations. The country’s companies law also underwent a major overhaul with the adoption of the Act in 1999. It introduced many new approaches, and brought the law closer to that of the Delaware law of corporations.[2]
The Companies Law has also undergone a number of amendments, with the most recent 28th amendment published on March 17, 2016.
Purpose of a Company
According to the Act, the purpose of a company shall be to operate in accordance with business considerations in realizing profits, and within such a scope, the interests of creditors, its employees and the public.[3]
Donations are considered within the scope of such business considerations if provided for in the articles of association. This however does not apply to companies established for public purposes only where the articles of association prohibit the distribution of profits to shareholders.[4]
Structure of a Company
The organs of a company consist of:
- the general meeting of shareholders,
- the board of directors,
- the general managers,
- and any person whose acts are considered acts of the company by virtue of law or the articles of association.[5]
The company shall be directly liable in tort for any civil wrongs committed by its organs.[6]
Public companies
Israeli public companies must have at least 7 shareholders. They may offer their shares and debentures to the public on the stock exchange by issuing a prospectus approved by the Securities Authority, or, where there are 35 investors or less, through private placements.
Public companies must file financial statements with the Companies Registrar. If listed on the stock exchange, they must abide by the regulations of the exchange and the Securities Authority.
Under the Act, public companies must also hold a general meeting of shareholders at least once a year at which time they must present their managers’ report and audited financial statements. Also, public companies must have at least two outside, or independent, directors on the board who serve as representative of the public.[7]
Private companies
Israeli private companies, on the other hand, are either limited by shares or by guarantee and may have between 2 to 50 shareholders. Transfer of shares by private companies is subject to board approval.
Furthermore, unlike public companies, private companies may not offer their shares or debentures to the public. They are not obligated to publish a prospectus in order to issue securities, or submit audited financial statements to the Registrar of Companies.[8]
Composition Requirements for Officers
Officer | Public Company | Private company |
Directors | At least 2*[9] * At least two outside directors shall hold office in a public company | At least 1[10] |
General Manager | 1 or more[11] | 1 or more[12] |
Auditors | 1 or more[13] | 1 or more[14]* |
Audit Committee | No less than 3 members of an Audit Committee and all outside directors shall be members thereof.[15] | Privately held companies may, but are not required to, appoint an audit committee. |
General Meeting
Companies must hold a general meeting of shareholders every year. This must be done no later than 15 months from the date of the previous annual general meeting. This is so that deliberation and approval cam be given to the annual financial reports and the reports of the board of directors.[16]
Private companies may provide in its articles of association that it is not required to have an annual general meeting unless it is required to appoint an auditor or if a shareholder or director requires it to be held.[17]
Powers
Other than deliberation and approval of financial reports and board reports, the general meeting’s powers, as set out in Part III, Chapter 2 Article A of the Act; include making resolutions with respect to matters such as: altering the articles of association; appointment of auditors; increase and reduction of share capital; and company mergers.[18] These matters cannot be excluded or contracted out, however, a company may add matters where resolutions shall be passed by the general meeting within its articles of association.[19]
The annual general meeting shall appoint the directors of the company unless the articles of association provide otherwise.[20]
Where the board of directors is precluded from exercising its powers, the general meeting may exercise those powers in its place.[21] Also, if stated in the articles of association, the general meeting can exercise the powers of other organs for a certain period of time or for certain matters.[22]
Various voting rights may be provided for different classes of shares in the articles of association, where no such provisions have been provided for, each share shall be equal to one vote.[23]
Qualifications/Restrictions
The general meetings of public companies with shares offered to the public in Israel only, or whose shares are traded on a stock exchange in Israel only, must be held in Israel.[24]
The agenda for the general meeting shall be set by the board of directors, or shareholders with at least one percent of the voting rights may request a certain appropriate matter be included in the agenda, and only resolutions regarding matters set out in the agenda may be passed by the general meeting.[25]
The general meetings of private companies may pass resolutions without invitation and without convening a meeting, provided that it is passed unanimously by all voting right holding shareholders.[26] Private company general meetings may also be held using any means of communication where all shareholders can hear each other simultaneously, unless the articles of association provide otherwise.[27]
The Board of Directors
Duties/Role
The board also has residual power and may, therefore, exercise any power of the company not granted to any other organ by law or by the articles of incorporation.[28]
Powers of the board of directors (the board) are set out in Part III Chapter 3, Article A of the Act. Accordingly, the board has the power to act on behalf of the company, unless otherwise provided for in the company’s articles of association. More specifically the board shall determine: the company’s plan of action; funding, financial status, set credit limits, organizational structure, preparation of financial reports, company reports for the annual general meeting; appointment and removal of the general manager, allocation of shares and securities; and opinions on special tender of actions of the company.[29]
The board is prohibited from delegating certain powers to a committee such as powers relating to determining the company’s general policy; distribution; allotting shares; approval of financial reports, and so on.[30]
Generally, the board cannot delegates its authorities to the general manager.
Board Meetings
Board meetings shall be convened according to the needs of the company, at least once a year, and at least once every 3 months for public companies.[31] The chairman of the board shall determine the agenda and direct board meetings.[32] Public companies must elect one of the members of the board to act as chairman.[33] Private companies do not have to elect a chairman, and where none is elected each member of the board has the power to convene a meeting and determine its agenda.[34] And meetings may be held using telecommunication so long as all participating directors can hear each other simultaneously.[35] Board resolutions may be passed without convening a meeting so long as all directors entitled to participate in discussion and vote agree thereto unless otherwise prohibited in the articles of association.[36]
Resolutions of the board shall be passed by ordinary majority. In the case of a tied vote, the chairman shall have the casting vote unless otherwise provided for by the articles of association.[37]
Where the board is precluded from exercising its essential powers, the general meeting may exercise such powers in its place.[38]
Duty of Care and Fiduciary Duty
Directors and other office holders such as general managers owe a duty of care to the company as provided by the Torts Ordinance and must act with the standard proficiency with which a reasonable office holder would act in the circumstances.[39] A fiduciary duty is also owed by such persons to act in good faith and for the benefit of the company.[40]
Qualifications/Restrictions
There are no nationality restrictions on regular directors, however, external directors must be Israeli residents, except, in the case where public companies are traded on a stock exchange outside of Israel, there are no such rules for outside directors.[41] Also, depending on the industry, limitations on the ability of non-Israeli citizens or residents may apply according to other relevant laws. For example, such limitations apply to companies which are engaged in certain security matters, as well as certain infrastructure and utility companies.
Persons who have been convicted of certain criminal offenses may not serve as directors of public companies until the lapse of 5 years from the date of conviction. Persons who have been declared bankrupt are also prohibited from acting as a director for so long as they remain undischarged.[42]
Furthermore, persons in relation to which a conflict of interest might arise are also prohibited from acting as an external director.[43]
Appointment and Removal
Unless indicated otherwise in the articles of association, directors are appointed by the general meeting of shareholders and serve until the end of the next one. [44] The initial directors are appointed by the founders of the company and will cease to hold office at the end of the first annual meeting unless the articles of association provide otherwise.[45]
As indicated in the table above, public companies must have at least two outside directors,[46] and private companies must have at least one director.
Outside directors in public companies are usually appointed for a term of 3 years and may be reappointed for two additional terms of 3 years each thereafter.[47]
Termination of office shall occur in certain circumstance according to the Act, including where the director has been convicted by final judgment of an offence; becomes bankrupt; or breaches one of their duties to the company.[48]
General Managers
Duties/Role
The general managers of a company are responsible for managing the day-to-day business. They can exercise all managerial and executive powers unless otherwise granted to another organ by the Act or articles of association. They shall be subject to supervision by the board of directors.[49] They have a duty to report to the board any extraordinary matter which is of significance to the company, and any other matters at the times and extent determined by the board.[50]
General managers as office holders also owe a duty of care and have a fiduciary duty to the company similar to directors.[51]
Qualifications/Restrictions
For private companies, there may be one or more general managers. Where none are appointed the company shall be managed by the board of directors.[52]
Appointment and Removal
General managers shall be appointed and dismissed by the board of directors unless indicated otherwise by the articles of association.[53]
Auditors
A company must appoint an auditor to audit its annual financial reports and express an opinion on them. This is referred to as “the act of audit” by the Act.[54] Several auditors may also be appointed at once as joint auditors.[55]
Public companies must keep accounts and prepare financial reports pursuant to the Securities law.[56] Private companies must keep accounts and prepare financial reports according to the Act.[57]
Auditors have a duty to report to the board when they become aware of substantial defects in the inspection of company accounts. They must also give an opinion on financial reports for which they are liable.[58]
Auditors must be independent of the company, both directly and indirectly and in accordance with the necessary provisions prescribed by the Minister of Justice.[59] Furthermore, where dependence exists the auditor’s employment must be notified immediately and a general meeting convened in order to determine termination of service at which time the auditor will have a reasonable opportunity to make their position known.[60]
Appointment of company auditors, as well as their conditions of employment and termination in accordance with the Act, is determined by the general meeting, [61] except in the period prior to the first annual meeting the shareholders, where the board may appoint the company’s first auditor.[62]
Private companies that have elected in their articles of association in accordance with the Act not to hold an annual general meeting may appoint an auditor for a single act of audit, or if specified according to the articles of association.[63]
Audit Committee
An audit committee must be elected in the case of public companies, and is optional for private companies,[64] the function of which is to locate defects in the company’s business administration by consulting the internal auditor or auditor to make proposals to the board in relation to corrections, defects etc, and to decide on acts and transactions requiring the audit committee’s approval.[65]
For public companies, the board must elect from its members, including all outside directors, an audit committee. The chairman and employed directors who provide services on a permanent basis, as well as a holder of control or relative of such, are prohibited from being a member of the audit committee.[66]
Dividends
Pursuant to section 302 of the Act, a company may distribute dividends only from its profits (a “profit criteria”) and provided that there is no reasonable suspicion that such distribution might prevent the company from meeting its existing and anticipated liabilities when the time comes for the fulfillment thereof (a “solvency criteria”). The Act further includes the following definitions:
“Profits” for the purpose of the profit criteria – the balance of surplus or the surplus accumulated over the past 2 years, whichever is the greater, in accordance with the latest adjusted financial reports, audited or surveyed, after reduction of prior distributions of the company if not previously reduced from the surplus, provided that the date in respect of which the reports were prepared is no earlier than six months prior to the date of the distribution by the company.
“Adjusted financial reports” – financial reports adjusted to the index or financial reports which replace or will replace such reports, all in accordance with accepted accounting principles.
“Surplus” – sums included in a company’s equity originating from the net profit of the company, as determined according to accepted accounting principles, and other sums included in the equity under accepted accounting principles, other than share capital or premiums, as prescribed by the Minister.
Furthermore, the Minister has prescribed certain rules with respect to when positive or negative sums included in the company equity due to changes in the fair value of investments in capital instruments will be regarded as surplus.
The company may also distribute a dividend which does not comply with the profit criteria as long as such distribution has been approved by the court after the court was convinced that the company complies with the insolvency test.[67]
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Other Notes:
Transparency
The board as a whole is responsible for transparency and disclosure, such as preparing financial reports. Public companies are also subject to other reporting requirements, such as: isclosure of prospective offerings to the public; annual and quarterly reports, such as financial statements; and other business activity reports.
Footnotes
[1] *Please note: in addition to the Act and the articles of incorporation there several other regulatory sources in relation to corporate governance including: the Companies Ordinance 1983, which deals with issues relating to liquidation, encumbrances and creditor rights; the Tel Aviv Stock Exchange Listing Rules; the Torts Ordinance (formerly the Civil Wrongs Ordinance – updated March 2015) and the Securities Law 1968.
[2] Meir A. Fuchs Adv., A Practical Guide and An Overview of the Israeli Companies Law as to Privately Held Companies, 2010, p1.
[3] Companies Law, Section 11 (a)
[4] Ibid, Section 11 (b)
[5] Ibid. Section 46, 47
[6] Ibid, Section 53
[7] Israel Company Laws and Regulations Handbook World Law Business Library Int’l Business Publications, 2008, p 73
[8] Ibid
[9] Ibid, Section 219 (c), *At least two outside directors shall hold office in a public company.
[10] Ibid, Section 219(b)
[11] Ibid, Section 119 (a)
[12] Ibid, Section 119 (b)
[13] Ibid, Section 154
[14] Ibid, *Section 154(c)
[15] Ibid, Section 114, 115
[16] Ibid, Section 60
[17] Ibid, Section 61, *Note: Section 62-65
[18] Ibid, Section 57
[19] Ibid, Section 58
[20] Ibid, Section 59
[21] Ibid, Section 52(a)
[22] Ibid, Section 50
[23] Ibid, Section 82
[24] Ibid, Section73
[25] Ibid, Section 66
[26] Ibid, Section 76
[27] Ibid, Section 77
[28] Ibid, Section 49
[29] Ibid, Section 92
[30] Ibid, Section 112
[31] Ibid, Section 97
[32] Ibid, Section 99, 96
[33] Ibid, Section 94(a)
[34] Ibid, Section 94(b)
[35] Ibid, Section 101
[36] Ibid, Section 103
[37] Ibid, Section 107
[38] Ibid, Section 52(a)
[39] Ibid, Section 252, 253
[40] Ibid, Section 254
[41] Ibid, Section 240
[42] Ibid, Section 227
[43] Ibid, Section 226
[44] Ibid, Section 221, 222
[45] Ibid, Section 220
[46] Ibid, Section 219, 239
[47] Ibid, Section 245
[48] Ibid, Section 228-234
[49] Ibid, Section 121
[50] Ibid, Section 122
[51] Ibid, Section 252-254
[52] Ibid, Section 119 (a)(b)
[53] Ibid, Section 250
[54] Ibid, Section 154
[55] Ibid, Section 156
[56] Ibid, Section 171(a)
[57] Ibid, Section 171(b),172
[58] Ibid, Section 169, 170
[59] Ibid, Section 160
[60] Ibid, Section 163, 164
[61] Ibid, Section 57, 162, 165
[62] Ibid, Section 155
[63] Ibid, Section 154(c)
[64] Ibid, Section 114, 118
[65] Ibid, Section 117
[66] Ibid, Section 114, 115
[67] Ibid, section 303
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