Yakov Vilenski

When an institutional investor in Israel invests in an investment fund, it must comply with regulations set in the Supervision of Financial Services Regulations. In particular instances, the manner funds manage their affairs contradict these regulations.

Holding Units in an Investment Fund

A clear instance of such a contradiction is the case of full and complete proprietary and control rights. According to Regulation 21(a), “An institutional investor shall hold an asset only if its right in it is a proprietary right, including the perpetual lease right, its control over the asset is direct, full and complete, and there is no lien or mortgage on the asset.” In practice, this regulation states that an Israeli institutional investor may hold its units in an investment fund only if these units are under its full and complete ownership and control.

However, the typical documentation of investment funds is inconsistent with this requirement. Investment funds tend to make transfers of units of these funds to third parties contingent upon the approval of fund managers, because fund managers reserve the right to determine the identities of investors in their funds. This practice by investment funds of restricting transfers of units in funds may cause an institutional investor to violate the regulations, since the regulatory requirement of “full and complete control” can be interpreted as requiring Israeli institutional investors to ensure their right to sell their units in the investment funds and not to agree to grant fund managers the power to prevent them from transferring their units to third parties.

Interpreting the Regulation

According to this interpretation of the regulation, there must be no restriction on the rights of Israeli institutional investors to sell their units in a fund, since, if an Israeli institutional investor is the owner with full and complete control over these units, it must also hold the right to sell its units in a fund at any time. In other words, the regulatory authority may consider fund managers’ power to prevent the sale of units in the fund as detracting from the “full and complete ownership” within the context of the regulation.

The Court’s Position

This interpretative approach is not merely theoretical. Support for it can be found from inferences in case law. In a 1991 District Court (Tel-Aviv) ruling, the court held that the legislative authority’s objective in the regulation is to ensure the liquidity of a financial entity’s assets so that, when necessary, if the financial entity encounters cash flow difficulties, it may dispose of these assets. Therefore, and in light of the fact that restrictions on transfers may make it difficult for institutional investors to liquidate their units in the funds, Israeli institutional investors must not be subject to these restrictions on transfers.

The Pragmatic Solutions

Normally, managers of private equity funds have considerable interest in assisting their investors to effectuate transfers of units. This is in order to maintain good relations with investors and support the value of the fund’s units in the secondary market. For this reason, it is usually quite easy for fund managers to agree to undertake not to refuse approval of such transfers for unreasonable reasons. This undertaking, included in the side letters to Israeli institutional investors, provides some degree of a practical transfer right. This is one of several solutions to reconcile between the understandable desire of fund managers to determine the identities of investors in their funds and the provisions of the regulatory regulation as interpreted by some institutional investors in Israel.

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Barnea Jaffa Lande’s investment funds team is at your service if you have any question in this regard.

Adv. Roy Engel heads the firm’s investment funds practice.

Adv. Yakov Vilenski is an associate on the team.

Israeli investment funds are incorporated as limited partnerships under the Israeli Partnerships Ordinance. Investors are “limited partners” and the fund manager (or another corporation acting on its behalf) is the “general partner” of these limited partnerships.

The document that establishes a limited partnership is the limited partnership agreement. This agreement prescribes the legal and commercial terms and conditions of the limited partnership.

However, many investors and fund managers are unaware that a simple reading of the relevant partnership agreement is not sufficient to get the “full picture” of the legal conditions that apply to their specific limited partnership.

Dispositive Arrangements

The Partnerships Ordinance defines several arrangements pertaining to the relationship between the limited partner and the general partner. These include arrangements called “dispositive” arrangements, which constitute default arrangements that shall apply unless otherwise agreed upon in the contracts between the parties. This differs from “cogent” arrangements in various laws, which apply to contracts regardless of the wishes of the parties.

Section 63(d) of the Partnerships Ordinance is very important in this regard, since this section addresses several dispositive arrangements. It is important to familiarize yourself with the contents of the list below because, if the limited partnership agreement does not stipulate any other arrangement, these provisions apply as if they had been expressly included in the limited partnership agreement.

The Five Arrangements

1. The first arrangement is that limited partners have no veto power in relation to the addition of additional limited partners. This means that if you are a limited partner in the fund and your specific agreement does not stipulate otherwise, the general partner may add additional limited partners to the fund even if they are not to your liking, and you have no right to object to this.
2. The second arrangement is that limited partners are unable to dissolve the partnership by issuing notice of dissolution. This arrangement means that, unlike the situation whereby a partner may withdraw from a partnership by way of issuing notice of its dissolution, if your specific partnership agreement does not stipulate otherwise, a limited partner may not dissolve the partnership.
3. The third arrangement ensures a limited partner’s right to transfer its share of the partnership to another party (which in legal lingo is called an “assignment”), in a manner that entitles that party to the same rights held by the original limited partner. In other words, let’s assume you are a limited partner in a partnership and you want to transfer your rights in the partnership to another party. You are entitled to do so even if the partnership agreement does not specifically address such assignments.
4. The fourth arrangement is that a lien imposed on a limited partner’s share as a result of that limited partner’s personal debts does not constitute justified grounds for dissolving the partnership. Here, too, if you are a partner in a limited partnership and prefer another arrangement, you must stipulate this explicitly in the agreement.
5. The fifth and final arrangement addresses the requisite majority for passing resolutions if there is more than one general partner in the partnership. The Partnerships Ordinance prescribes an arrangement whereby, unless otherwise agreed, a majority vote of the general partners shall settle differences of opinion. Naturally, if you want some other arrangement (such as the majority being according to the general partners’ ratio of the total investments in the partnership), you must stipulate this in the agreement.

Considering the various provisions in the Partnerships Ordinance and the precedents set in case law, it is not enough to read the relevant limited partnership agreement, since it does not reflect all of the legal conditions that apply to your limited partnership. You should also consult with an attorney specializing in partnerships.

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Barnea Jaffa Lande’s investment funds team is at your service if you have any questions in this regard.

Adv. Roy Engel heads the firm’s investment funds practice.

Adv. Yakov Vilenski is an associate on the team.