Public Companies without a Controlling Shareholder: Amendment to the Companies Law

In recent weeks, the Israeli Ministry of Justice published a memorandum proposing an amendment to the Companies Law, focusing on the corporate governance regime in public companies without a controlling shareholder.

In the past, the vast majority of public companies traded in Tel Aviv had a distinct controlling shareholder—an individual or a group holding more than 50% of the voting rights in the company. The existence of distinct controlling parties was one of the particular characteristics of the Israeli capital market.

As a consequence, Israeli public companies’ corporate governance regime has focused on addressing the “Principal-Agent Problem” between the controlling shareholder and shareholders from the public. The Companies Law established mechanisms designed to ensure management of the company in the best interest of all shareholders and to prevent exploitation of the controlling shareholder’s status at the expense of shareholders from the public. These mechanisms include the duty to appoint external directors and the requirement to obtain consent by special majority (majority of the minority) in specific matters. These mechanisms, which put greater power in the hands of the shareholders that are not the controlling shareholders, also raised the bar and distinguished the Israeli public corporate regime from similar regimes, such as the American and British.

Recent years have seen a growing trend of controlling shareholders diluting their holdings in companies and relinquishing their control. Currently, about 18 percent of public companies traded on the Tel Aviv Stock Exchange (excluding dual-listed or foreign companies) have no distinct controlling shareholder, compared to only 4 percent in late 2010.

This process has caught the attention of the Israeli regulator, who is now proposing to amend several aspects of the existing corporate regime. These amendments are intended to fill in the lacuna in the existing corporate governance rules, in companies which do not have a controlling shareholder. In addition, the amendments are looking to address a different “Principal-Agent Problem,” the one that exists between the dispersed public of shareholders and the companies’ management, which controls the company’s ongoing matters. The concern is that in the absence of a controlling shareholder, management (consisting of the board of directors and senior management) may promote their own personal interests at the expense of the best interest of shareholders and the company itself.

In the memorandum, the Ministry of Justice proposes a set of amendments to the rules of the corporate regime. Most of the proposed changes are intended to reinforce the corporate regime of companies without control, to address the concern over the management’s power.

The trend of relinquishing control in companies should have been seen as a welcome shift rather than a threat. However, the proposed amendment does little to ease the existing restrictions, where they are less relevant to companies without a distinct controlling shareholder.

The changes proposed in the memorandum are as follows:

• Control

Currently, holding 50% or more of a company’s controlling means constitutes a presumption of control. The memorandum proposes adding a (rebuttable) presumption, whereby if no one holds over 50% of the company’s controlling means, holding 25% or more of the controlling means shall be considered control of the company.

• The Composition of the Board of Directors

Currently, there is a duty to appoint at least two external directors in every public company. The memorandum proposes doing away with the duty to appoint external directors in a company without a controlling shareholder. Instead, in such a company, the majority of directors should be independent.

• Nomination Committee

An independent committee of directors (named the nomination committee) shall take on the process of presenting candidates for serving as directors on the board of directors of the company.

• Board Chairperson Compensation

The arrangement established in the Companies Law prevents additional compensation for a board chairperson who is an independent director. Therefore, the memorandum proposes permitting an independent director to serve as board chairperson and receive additional compensation for it (in addition to his tenure as a director), as long as such compensation does not compromise the director’s independence.

• Transactions with Interested Parties and Directors

According to the Companies Law, a company’s extraordinary transaction with a controlling shareholder requires threefold approval (audit committee, board of directors, and a special majority  of the shareholders). However, a transaction between a company without a controlling shareholder and one of its significant shareholders, which could impact the board of directors, requires only the approval of the board.

The memorandum proposes establishing that a company’s extraordinary transaction with a significant shareholder (holder of 10% or more of the company’s controlling means) shall additionally require the approval of both the audit committee and the board of directors.

Moreover, currently, a transaction between a company and its director, which is not in connection with the director’s terms of employment, even when it is extraordinary, does not require the approval of the shareholders’ general meeting. Instead, the board of directors alone may approve the transaction. Therefore, the memorandum proposes establishing that a non-extraordinary transaction with a director shall require the approval of the audit committee and the board of directors. An extraordinary transaction shall also be brought for the approval of the shareholders’ general meeting, in a regular majority.

• Leading Independent Director

In companies where the board chairperson is also the company’s CEO, the memorandum proposes appointing one of the independent directors to serve alongside the chairperson, as a leading independent director. The memorandum also proposes granting the leading independent director powers to run the board’s operations and thus contribute to optimal supervision of the company’s management by the board of directors.

• Gender Diversity

Currently, if all board of director members who are not serving on behalf of the company’s controlling shareholder or their relatives, associates, or affiliates are of a single gender, there is a duty, when appointing an external director, to appoint an external director of a different gender. The memorandum proposes adding to the Companies Law’s First Addendum, which details recommended corporate regime provisions, that on the board of directors of a public company or a private company that issued bonds to the public, at least a third of the directors shall be of each gender.

• Eliminating the Requirement for Shareholders’ Approval for Compensation Policy and Compensation Agreements in Bonds Companies

Currently, under the Companies Law, even bond companies (private companies that issued bonds to the public) are required to secure the approval of the general meeting of shareholders for their compensation policy as well as for compensation agreements with the controlling shareholders and the CEO. The memorandum proposes doing away with this duty for bond companies, because it is clear the duty of securing the approval of the shareholders in a bond company is not a particularly beneficial or critical mechanism.