Israeli Justice Ministry Proposes Amendments to Governance Rules for Non-Controlled Companies

On March 10, 2021, the Israeli Ministry of Justice (MoJ) published (Hebrew) a draft amendment to the Israeli Companies Law primarily affecting corporate governance rules for non-controlled corporate issuers. As part of an ongoing consultation, interested parties are invited to submit comments here (Hebrew).

The MoJ outlined seven main issues that would be addressed in the revision of the Companies Law:

  1. The definition of ‘control’ over a public company,
  2. Board independence at non-controlled companies,
  3. The process of appointment and nomination of candidates to the board of directors,
  4. Compensation of an independent board chair in a non-controlled company,
  5. Related party transactions,
  6. The role of a lead independent director in a non-controlled company, and
  7. Gender diversity on the board of directors.

Background

In the Israeli capital markets, the majority of publicly traded companies have a ‘controlling’ shareholder with at least 25% of the issued share capital. Due to the predominance of concentrated ownership structures, the instructions for corporate governance of Israeli publicly traded companies are strongly focused on minority shareholder representation issues that can arise in controlled companies. However, in recent years a growing number of publicly traded companies have seen a shift towards decentralized ownership structures, which in some cases have led to different issues relating to the representation of minority shareholders.

In most cases shareholders do not have the same deep knowledge and familiarity with companies in their portfolio as the management teams of those companies. In addition, smaller shareholders may have weakened legal abilities to actively oversee company management due to their smaller holdings, and less of a financial incentive to do so. These features cause agency issues that differ between controlled and non-controlled companies.

The current Companies Law governance rules are aimed at dealing with board oversight in relation to the “horizontal” agency problem that exists between minority shareholders and the controlling shareholder, in a way that attempts to prevent the expropriation of public companies and their minority shareholders by a controlling party. At non-controlled companies, the MoJ set itself the task of crafting governance rules intended to prevent management from furthering its own interests at the expense of the company and its shareholders (a “vertical” agency problem).

Proposed Changes to the Companies Law

The following are the key changes proposed in the draft law:

  • It is proposed to define any shareholder of 25% or more of a company as a controlling shareholder, if no other shareholder of the company holds 50% or more. The new proposed threshold of 25% matches the de facto definition of a controlling block in the Israeli Companies Law. Where a holder of 25% or more of a company claims to have no control over a company, the burden of proof will be on that person/entity.
    • Currently, the definition of “control” in the Companies Law includes two parts: the first part is a (quantitative) power or holding of at least 50% of the company, and the second part is a qualitative test which is focused on the ability to direct the operations of the corporation in practice.
  • Non-controlled companies would be required to have a majority independent board; the requirement of two external directors would be removed. Further, directors’ affiliation with one another would be scrutinized closely for the purposes of determining independence, in an expansion of the current law.
    • The Companies Law currently requires publicly traded companies to appoint at least two external directors who must serve three-year terms. Currently, at non-controlled companies, directors with an affiliation with the board chair may not be considered independent.
  • It is proposed that non-controlled companies would be required to have an independent nomination committee with similar rules of composition to the audit committee. Holders of 1% of the voting rights of the company would still be eligible to propose candidates at general meetings. It is proposed to cap directors’ term lengths at three years, limiting issuers from appointing directors to terms longer than that without a shareholder vote on their re-election, as well as to prevent inordinate use of staggered boards.
    • Nomination of directors is currently done by the board as a whole, unless boards voluntarily convene a nominating committee. Shareholders of 1% or more can nominate candidates.
  • It is proposed to allow the payment of additional compensation to the board chair beyond regulated board fees, as long as this would not affect the independence of the chair.
    • The current law restricts independent directors, including those serving as chair, from receiving any compensation beyond the legal caps for external directors
  • It is proposed to amend the law so that exceptional transactions between directors and shareholders who hold 10% or more of the company would require approval of the audit committee and the board. Additionally, it is proposed that transactions considered “non-exceptional” with a director would require the approval of the audit committee and the board, while “exceptional” transactions would require the approval of the audit committee, the board, and then a majority of votes cast at a general meeting (similar to the current state of affairs).
  • Similar to other markets, and in order to increase the independence of boards in non-controlled companies, it is proposed to add a recommendation (not a binding law) that boards with a combined chair and CEO should appoint a lead independent director that would serve alongside the chair with responsibilities for leading the board and supervising management that are clearly outlined in the law and its recommended provisions.
  • It is proposed to add a recommendation relating to gender representation on publicly traded companies, so that at least one-third of board members be of each gender.

Questions Unanswered

The proposed changes cover most of the key themes raised by Glass Lewis and other stakeholders in the lead up to the draft law. To our knowledge, the following issues are not yet contemplated under the current or proposed versions of the law:

  • What amount or type of “additional compensation” for a board chair would be considered to impede their independence?
  • While the proposed law would include a recommendation that boards with a combined chair and CEO appoint a lead independent director, what about cases where the chair is affiliated to the company or management in some other way, but is not the CEO?

Going Forward

The MoJ is taking further comments from the public until April 9, 2021. If the draft legislation is accepted by the next Knesset (parliament), which may not be guaranteed given that Israel is about to undergo its fourth national election in two years, it would be unlikely to come into force until 2022.

See here for our past coverage on these rule changes and our comment to the MoJ submitted on November 11, 2019.