Company response strategiesPreparation
What are the fiduciary duties of directors in the context of an activist proposal? Is there a different standard for considering an activist proposal compared to other board decisions?
The directors are bound by their duty of care and fiduciary duty towards the company and there is no difference in the context of an activist’s proposal. Any steps taken by directors in the course of and in relation to shareholder activism, shall not derogate from their duty to act for the benefit of the company.
The director’s response to shareholder activism will usually be scrutinised by the business judgement rule (BJR). Judge Ruth Ronen, in the Altman v Gazit case, made the BJR applicable to a standstill agreement with an activist, ruling that: ‘The desire for a truce among the company shareholders may in some cases be consistent with the benefit of the company and that of its shareholders.’
What do we mean when speaking of ‘the company’s benefit’ that directors and office holders must uphold? Section 11 of the Companies Law provides that
the purpose of the company is to act in accordance with commercial considerations for making profits, and as part of these considerations one may take into account, among other matters, the interests of its creditors and employees and those of the public; the company is also permitted to contribute a reasonable sum to a worthy cause even though such a contribution does not stem from commercial considerations, if such is laid down in the provisions of the articles of association.
A long line of scholars has attempted to get to the bottom of this broad definition, and there are several different views and constructions of how it should be interpreted. The accepted conception in the Israeli legal arena has for many years been that the essence of the company is first and foremost to act in the pursuit of profits, especially for the shareholders. This traditional conception fails to deal with the difficulty in those cases where the interests of the company and its shareholders do not coincide. Israeli case law expressed each one of these interpretations - the one enabling the benefit of the company to be jeopardised for the sake of the shareholders, and the other indentifying the right of the company as a distinct right from the shareholders.
What advice do you give companies to prepare for shareholder activism? Is shareholder activism and engagement a matter of heightened concern in the boardroom?
A company may take a variety of measures to prevent or mitigate potential confrontations with activists.
One of the methods is open communications. A key issue is to maintain an ongoing communication with the company’s key investors. Open communication can create a strong trusting relationship with the company management, and can result in support of such investors in case an activist raises allegations against the leaders of the company. Although this may be difficult to maintain and may be inconvenient at times, in the long run, it can be beneficial and minimise crises.
It may be beneficial to be aware of the investors’ positions and concerns, including the company’s key shareholders (usually the institutional investors) for example, on issues such as the dividend distribution policy, capital investments and executive compensation, and not be first familiarised with them in times of crisis with an activist.
Another method is self diagnosis - identification of vulnerabilities of the company in advance regarding corporate governance and operative aspects. Following its identification, the company should act to mitigate the vulnerabilities. Many companies have updated their corporate governance practices to be in line with market standards. Thus, awareness may keep potential activists away from the company.
Additional method is ‘activist thinking’. Here too, similar to self diagnosis, it is important that directors would try to adopt ‘activist thinking’ and as such would identify and handle existing weaknesses, such as constant evaluation of the company’s business strategy and its alternatives. These actions are likely to keep activists away and turn to other companies.
What defences are available to companies to avoid being the target of shareholder activism or respond to shareholder activism?
The Israeli Securities Authority objects to extreme controlling entrenchment mechanisms in Israeli public companies, such as staggered board of directors for many years and poison pills of various types, in view of the Israeli Securities Authority’s position regarding the importance of maintaining a market of efficient corporate control. The Israeli Securities Authority is not opposed to mechanisms for staggered boards as long as the period set between director replacements does not exceed three years.
It is doubtful that instruments provided in the articles of association - in particular, defence mechanisms against hostile takeover (such as staggered boards, special majority for amending the terms of the articles of association, etc) are appropriate when dealing with activism - since the aim of the activist is usually not to take over the control of the company. Institutional investors as well as their advisory firms also object in principle to controlling entrenchment mechanisms in the articles of association.
There remain less drastic mechanisms to be considered - for instance, amending the articles to hold that a director may only be elected at the annual general meeting and not at a special meeting. This mechanism presents stability to the company and prevents frequent changes in the composition of the board at every whim of the shareholders.
The board of directors is also able to publish a position statement or a response to a position statement of an activist.
In addition, a company can turn to the court to classify the vote of an activist as having a negative personal interest (ie, the shareholder has a personal interest in the failure of the transaction).
Also, some of the companies turn to institutional investors before they convene a meeting to appoint an external director for the purpose of examining whether the candidate proposed by the company will receive the institutional investor support, or that they wish to suggest another candidate.
There are also certain anti-takeover defences determined in the Companies Law - see questions 10 and 13.
Reports on proxy votes
Do companies receive daily or periodic reports of proxy votes during the voting period?
During the period preceding the general meeting, companies receive proxy votes from shareholders not physically attending the meeting. Shareholders may also vote electronically and the company is accessible to these votes six hours prior to convening the meeting. In addition, advisory bodies to institutional investors, such as Entropy, provide their position on items on the agenda at a reasonable period in advance, which indicates the manner in which institutional investors receiving the services of the advisory body intend to vote.
Is it common for companies in your jurisdiction to enter into a private settlement with activists? If so, what types of arrangements are typically agreed?
Settlement agreements with activists are becoming more and more common, usually including: a stand still provision for a specified period of time; support of the company’s nominees for board membership and support of one or more of the activist’s nominees for membership of the company board of directors as long as the activist holds certain minimal ownership position in the company. Settlement agreements between the public company and an activist may be required to be disclosed in accordance with the reporting requirements under the Securities Law and regulations.
A question arises as to the enforcability of settlement agreements in view of the fact that, in such agreements, the company grants significant rights to specific minority shareholders and not to other shareholders. This preference may be found in court to be unlawful or not enforceable.