Recently, a four month proxy fight over control of an Israeli incorporated NASDAQ traded company was settled, following a series of proceedings held before the Tel Aviv District Court. At a crucial juncture, the Tel Aviv Court was asked to issue a temporary injunction over a transaction initiated by the board, which included a highly dilutive (24.9%) issuance of shares. In reviewing the transaction, the Court found that that the “enhanced scrutiny” standard should be used in analyzing the actions of the board, and issued the requested injunction. Subsequently, a settlement was reached, the board resigned and a new board was elected in its place.
The company in question, Arcturus Therapeutics Ltd. (formerly, Alcobra Ltd.; the “Company”), is Israeli-incorporated, with its operations in the USA and shares traded on NASDAQ. Despite its strong USA nexus, as with all other Israeli incorporated NASDAQ listed companies, the Company is subject to the public company corporate governance rules of the Israeli Companies Law, 5759-1999, and the regulations promulgated thereunder (the “Companies Law”).
The recent proxy fight commenced in January 2018 when four of the then six directors on the Company’s board resolved to remove the fifth board member and Company’s founder, Mr. Joseph Payne, from his position of President and CEO of the Company.
In response, Mr. Payne, the founder and terminated CEO, chose to fight to regain his position and in February 2018 he invoked his shareholder rights under section 63 to the Companies Law, and demanded that the board convene an Extraordinary General Meeting with an agenda to remove the four directors and appoint a new slate in their place.
The board proceeded with the removal of the Company’s sixth director, co-founder and CSO, through a transaction involving inter alia the transfer of control over the voting of the terminated CSO’s shares to the newly appointed Company interim President.
In response, the terminated CEO filed a claim with the Tel Aviv District Court against the Company and the four directors and interim President, and submitted a motion seeking an injunction to prevent the board’s attempted takeover of the voting rights in the CSO’s shares, arguing the directors were tainted by “personal interest” (within the meaning of the Companies Law) and had failed to follow the requisite corporate governance rules of the Companies Law – specifically, that they had not brought such interested party transaction to the shareholders for their approval.
The Tel Aviv District Court granted an ex parte injunction, ordered the suspension of the transfer of the voting rights in the shares and required maintenance of the status quo in the Company.
In defense against the terminated CEO’s bid, the board refrained from convening the Extraordinary General Meeting, and in April 2018 it brought forward, for an overnight approval, a new investment transaction with a German business partner of the Company. The proposed transaction included a highly dilutive (24.9%) issuance of new shares at a 10% premium over the Company’s depressed share price, having fallen drastically since the dismissal of the CEO.
In response, the terminated CEO filed an emergency motion with the Tel Aviv Court, seeking to enjoin the transaction. This motion was based on two arguments – the first being that the injunction already in place prohibited the proposed transaction. The second argument, based on section 267 to the Companies Law, was that the four directors are conflicted (having a “personal interest”) when considering and approving the transaction, as the transaction was intended to influence the outcome of the vote at the Extraordinary General Meeting and protect their continued service on the board. With such conflict of interest the transaction should not be allowed to proceed, in the absence of compliance with the corporate procedures and approvals required under the Companies Law, including obtaining shareholder approval.
In a first decision the District Court ruled that the first injunction indeed prevented the proposed transaction, and did not proceed to consider the second argument. In response, the Company sought to remove the injunction and allow the transaction to proceed, inter alia arguing that the board members were not conflicted and that it was in the best interest of the Company to allow the transaction to proceed.
On April 29, 2018, following a hearing, the honorable Judge Ruth Ronen of the Economics Affairs Division of the Tel Aviv District Court handed down a detailed decision, which kept the injunction in place. After determining that the scope of the first injunction did not contemplate the subsequent investment transaction, Judge Ronen proceeded to review the second argument. In her reasoned opinion, Judge Ronen determined that there is a prima facie chance that the burden to prove that the new transaction is in the best interests of the Company would be transferred to the Company, and that such transfer leads to the conclusion that the applicant’s chances of success in his claim regarding the new transaction exceed those of the Company.
Judge Ronen resolved that it is a reasonable assumption that the four directors, whose positions were at stake, have a personal interest in the resolution regarding the engagement of the Company in an agreement that might change the balance of powers in the general meeting.
Once it was determined that the directors’ decision involved their personal interests (related to their desire to maintain their positions as directors of a company), the Judge proceeded to consider whether these interests were the only or dominant considerations of the directors. In making such examination the Court considered the application of the “enhanced scrutiny” standard, which originated from Delaware case law, and cited the guiding case law of the Supreme Court of Delaware, Unocal Corp. v. Mesa Petroleum Co., where it was determined that the prohibition on the directors relates to a situation in which their actions are “solely or primarily out of a desire to perpetuate themselves in office”.
The Court held that though at this stage it is difficult to determine whether the consideration of keeping their positions was the only or the dominant consideration of the directors, the clear existence of this consideration is sufficient in order to reinforce the potential concern about the directors’ considerations when they made the decision regarding the new transaction. That was sufficient to determine, if only prima facie, that this is not a decision to which the business judgment rule applies, but rather is a decision that might be examined in accordance with the enhanced scrutiny standard.
After the injunction was confirmed, the Tel Aviv District Court proceeded to order that the Company convene the Extraordinary General Meeting in accordance with the terminated CEO’s demand.
Following the court rulings, a number of subsequent proceedings followed, and on May 27, 2018 a settlement agreement was signed. According to the agreement, the four directors and the interim President resigned from the Company, and the new slate of four directors, nominated by the removed CEO, was elected to the board. The settlement agreement was validated by the Tel Aviv District Court on May 28, 2018, and shortly thereafter the terminated CEO was reinstated as the President and CEO of the Company.