A guide to negotiating US-lsraeli business transactions
Having worked on M&A transactions in both Silicon Valley and Tel Aviv for the last 20 years, I have observed at close hand the legal and cultural differences between the US and Israeli markets. I find that approaching a transaction with an understanding of these legal and cultural differences is key to guiding the transaction to a smooth and successful conclusion. Israeli transactions often take place in an uncertain legal environment, they often lack uniformity, and often involve government agencies to a greater extent than comparable transactions in the U.S. Anticipating these differences allows me better to explain to my U.S. clients the particularities of the Israeli marketplace, and to explain to my Israeli clients why U.S. investors find some aspects of doing business in Israel so unusual.
Despite the differences in temperament and in the legal environment, it should not be difficult for U.S. investors to carry out transactions in Israel. The objective should always be to reach the finish line in a manner satisfactory to all parties. I believe that we as lawyers can assist in bridging cultural gaps. Let us look at some of the key issues.
LANGUAGE AND TONE
A major client once remarked to me, “Americans and Israelis both speak English, but they do not speak the same language.” Many readers who have done business both in Israel and the U.S. will relate to this. It begins with “tone.” At the risk of generalization, while American investors often prefer a more subtle tone, Israelis almost take pride in being blunt. And these different approaches may lead of confusion. Take for example the simple statement “That’s interesting,” which when expressed by an American investor may be understood as a polite dismissal, but may be taken by the Israeli entrepreneur as an invitation to pursue the matter further.
Cultural and linguistic differences are often coupled with important distinctions surrounding legal terms of art. Take for example, directors’ fiduciary duties. In Delaware corporations, in the ordinary course of business and when no personal interest is involved, directors need to follow the Business Judgment Rule and are subject to a duty of care. Israeli directors are subject at all times to a fiduciary duty, and while courts recognize the concept of the Business Judgment Rule, directors may also be required to show that they acted in good faith and in the company’s best interest.
A lot of the seed and early-stage VC financing transactions in Silicon Valley are structured to reduce transaction expenses by using standard documentation with which all market players are familiar. This uniformity reduces time and legal fees, as the parties are not bogged down by negotiating language that has already been rehashed, and are able to address the core elements of the transaction. This practice frees the VC from repetitive explanations and negotiations and speeds up the entire transaction, allowing startups to concentrate on promoting their business.
Israeli practioners have thus far been unsuccessful in implementing this uniformity. While we rely a great deal on NVCA model documents and Series Seed documents as market term guidelines, these forms require significant adaptation to the Israeli legal environment, and have not yet gained broad acceptance. Because of this, we often spend more time negotiating VC financing transactions in Israel than one would in an equivalent U.S. transaction.
Israeli lawyers practice in a legal environment where many key issues relevant to corporate transactions are not addressed within our company legislation or have yet to be the subject of judicial decision. This is in stark contrast to the vast body of case law available for Delaware corporations, and the DGCL that is updated bi-yearly so as to address and codify developments in corporate practice.
For example, Israel’s Companies Law, which came into effect in the year 2000, contains a chapter dealing with corporate mergers. However, there is no mention of the possibility of a “reverse triangular merger,” a technique used often in U.S. acquisitions. The reverse triangular merger was imported into Israel more than ten years ago by practitioners familiar with U.S. practice, and since then the technique has been used in most public company acquisitions. It was not until recently however that Israeli courts acknowledged this form of merger as a means to effect an acquisition in Israel.
I mentioned earlier that board members of an Israeli company are subject to similar fiduciary duties to directors of Delaware corporations. However, there is almost no case law that describes the content of this duty in the context of the sale of a company. Virtually all agreements for the acquisition of Israeli public companies include a “fiduciary out provision,” but there is no case law which outlines whether this is required, and whether provisions such as “matching offers” and “force the vote” are valid. Discussions among practitioners quickly turn to what would be the result of a specific provision in Delaware, but we can only speculate to our clients how an Israeli court might decide on the issue.
Similarly, the Companies Law includes a forced sale provision for private companies similar in nature to contractual bring-along provisions in voting agreements of Delaware corporations. Here too there is no case law delineating whether the statutory language (which requires treating all shareholders equally) permits taking into account any “liquidation preference” of investors in distributing the proceeds of sale. The case law also does not address whether the notice periods described in the Law are mandatory or whether other periods can be specified in the Articles of Association (by-laws) of a company.
U.S. investors may be surprised by the number of occasions on which it is necessary to obtain regulatory approvals within the context of corporate investments or acquisitions. The term “merger” is widely defined in Israel’s Restrictive Trade Practices Law, and as a result the approval of the Antitrust Commissioner (or at least notification to the Commissioner) will be necessary in a large number of transactions. Particular attention needs to be given to restrictions and conditions imposed on Israeli companies that have received funding from the Office of the Chief Scientist (OCS) at Israel’s Ministry of Economy. OCS funding is generally given subject to limitations and restrictions regarding the transfer overseas of, or the granting of rights in, know-how that has been funded by the OCS. Regulatory approval will be necessary for investment (other than insignificant investment) in regulated sectors such as the finance sector, telecommunications and so on. In addition, there is a variety of controls over the use and export of regulated technologies and related services and knowhow in defense-related industries. Israeli law prohibits trade with certain enemy countries.
The peculiarities of the Israeli tax system, and in particular the taxation of cross-border payments, often perplexes U.S. investors. The taxation of cross-border payments is effectively “policed” by Israeli banks, which are required to withhold tax at source in Israel unless they receive an appropriate withholding tax certificate from the Israeli Revenue Authorities. So, for example, if a U.S. corporation acquires an Israeli company, Israeli tax advisers will explain that there is an withholding obligation on the U.S. corporation with respect to payments to Israeli shareholders. Common problems that arise include the treatment of any founder shares repurchase arrangement and payment holdback arrangements for key employees, all of which are familiar arrangements with VC investors and technology acquirers. The treatment of payments to founders and key employees (are the payments capital or income in nature?) will affect the obligations towards the Israeli Revenue Authorities of the U.S. investor making these payments.
Even if a U.S. corporation acquires another U.S. corporation with significant operations and assets in Israel, withholding obligations may still apply.
In short, Israel’s elaborate withholding tax system means that any U.S. investor must receive appropriate tax advice. More often than not, it will be necessary for the local tax advisers to approach the Israeli Revenue Authorities for withholding tax exemption certificates for those shareholders that are not subject to tax in Israel, and generally to obtain clarification on the tax obligations of the U.S. investor in Israel.
In this short article I have barely scratched the surface of the differences between M&A activity in Israel and in the U.S. However, as we have seen in recent years, many successful transactions have been completed, with U.S. investors investing heavily in Israeli companies at all stages of their development. The important thing for legal practioners is to help their clients come to a transaction with an awareness of the differences between the legal systems in Israel and the U.S.*This article originally appeared in the October, 2015 edition of ‘The American Lawyer’ magazine.