The Court Orders Controlling Shareholders to Stop Payment of Executive Remuneration

There have been cases where bonuses have been paid by a controlling shareholder of a public company out of his own pocket to officers as remuneration for their work in the company. This raises the question as to whether a controlling shareholder is allowed to personally guarantee additional remuneration to officers of the company that is inconsistent with the company’s remuneration policy.

This question was considered recently during the economic court’s ruling in the Da Langa vs. the Israel Corporation Ltd. et al. case.

The petitioner filed a motion for permission to file a derivative suit on behalf of the Israel Corporation Ltd. against officers of the company. The petitioner’s principal allegation was that the controlling shareholders of the Company, Mr. Idan Ofer, and a company under his control, awarded bonuses to members of the company’s senior management totaling approximately NIS 55 million. The bonuses were made contingent upon the officers ensuring the completion of a spin-off, whereby five corporations held by the company would be transferred to a new subsidiary, Kenon Holdings Ltd., which will be listed for trading in the United States and in Israel under a dual reporting regime.

Initially, the company had examined the possibility of providing incentives to the officers in relation to the spin-off within the scope of its remuneration policy, but, in light of comments received, the wording of the company’s remuneration policy was revised, so that the remuneration committee and the board of directors would be authorized to award a special bonus to officers, based on their contribution to the promotion and completion of the spin-off.

The spin-off process was approved by a 99% majority of the shareholders having no personal interest in approving the spin-off. The company had issued a disclosure about the incentives to officers, but they were not approved by way of a separate resolution and, in effect, the incentives were submitted as one bundle in the proposal to approve the spin-off.

The court approved the filing of the derivative suit and stated that, when it comes to the manner of deciding officers’ remuneration in a reporting corporation (public company or any company who issued bonds to the public), a detailed arrangement is prescribed in Amendment 20 to the Companies Law that obligates every reporting corporation to implement officer remuneration in accordance with a policy document that must be approved by a general meeting by special majority once every three years. The court recognized the importance of an officers’ remuneration policy and that, to a great extent, it sets the company’s “agenda” and serves to reflect the company’s priorities and how it divides resources among its officers. Therefore, remuneration being paid directly by a controlling shareholder to officers of the company disrupts the balance that Amendment 20 sought to achieve and, as a result, causes officers who are promised a future bonus to be in a state of conflict of interests between their desire to receive the contingent benefit that was promised to them, and their obligation to work according to the company’s remuneration policy.

The court proposed that, in these instances, when the controlling shareholder has a strong personal interest in an important resolution being submitted for approval (such as a spin-off), the proper way to approve the related resolutions is  to obtain approval by a majority of the shareholders who also have no personal interest in these related proposed resolutions, or by specifically including this possibility in the remuneration policy, which shall be approved by the shareholders (in the case at hand, the Israel Corporation had originally tried to do this, but the relevant clauses in the remuneration policy were rejected by the investors).

This ruling by the court makes a clear statement about the way in which officer remuneration in a reporting corporation must be examined and approved. However, this ruling also is very interesting as it pertains to private companies.

The Israeli Companies Law does not differentiate between officers in public companies and officers in private companies on the matter of the obligations imposed on them. In the absence of transparency and a formal document such as a remuneration policy, private companies constitute more “fertile ground” for various arrangements like this between a controlling shareholder and officers in cases where material transactions are being closed.

Another decision reached by the court in the Da Langa case is that a board resolution not to file the lawsuit on behalf of the company is not protected under the business judgment rule, since the company failed to prove that it had fulfilled the criteria for applying the business judgment rule and, mainly, that it failed to prove that the resolution not to file a lawsuit was passed in an informed manner and without conflicts of interest.