Israeli company law for founders:what to know before you incorporate

You have an idea and partners, and you have decided to set up a company. This article covers the essentials of Israeli company law for founders: what to agree before incorporation, how a company is run, and which mechanisms protect shareholders.

Before you set up the company

Settle the relationship between the founders from the start, even if the company will only be incorporated later. Topics include:

• How the shares are divided between the partners.
• Protections in future deals and share allocations.
• Who does what.
• The board of directors.

The articles of association

The articles set the rules by which the company operates. Some of those rules come straight from the Companies Law.

The law contains mandatory provisions, which cannot be overridden, and non-mandatory ones, which the articles can change. If there is a founders agreement and the partners agreed that the articles would reflect it, the articles adopt its terms.

The company's organs

A company has three main organs:

• The general meeting.
• The board of directors.
• The CEO.

The board of directors

The Companies Law lists many matters within the board's authority, as part of its role in setting company policy and overseeing the CEO. Among other things, the board may:

• Set the company's plans of action.
• Set principles for financing the company's activities and the priorities between them.
• Review the company's financial position and set the credit limit it may operate within.
• Appoint and dismiss the CEO.
• Decide on issuing bonds or allotting shares, up to the company's registered capital.
• Decide on distributing dividends.
• Decide on actions and transactions that require special approval, such as interested party transactions.

The board is also responsible for preparing the company's financial statements and for reporting to the annual meeting of shareholders on the company's position and business results.

These powers cannot be delegated to the CEO.

Directors' duties

Board members carry real responsibility for the company. The Companies Law therefore imposes two duties on them: a duty of care and a duty of loyalty.

The duty of care means each director must act as a "reasonable director" would. The company may sue a director in tort for negligence in performing the role.

The duty of loyalty means each director must act in good faith and in the company's interest, and advance its affairs even where that conflicts with personal interest. Under the Companies Law, the company may sue a director who breaches this duty. Examples of a breach:

• Acting where the director's personal interest conflicts with the company's interest.
• Taking part in an activity that competes with the company's business.
• Using a business opportunity of the company that came to the director's knowledge through the role.

The general meeting

The general meeting is the meeting of the company's shareholders. Subject to the Companies Law, a company may give it various powers. How powers are divided is usually set out in the articles or the founders agreement.

Examples of powers held by the general meeting:

• Amending the articles of association.
• Exercising the board's powers in its place when the board is unable to act.
• Appointing the company's auditor, setting the terms of engagement and ending it, as set out in the Companies Law.
• Appointing external directors.
• Approving actions and transactions that the law requires the general meeting to approve, such as transactions in which officers have a personal interest.
• Increasing or reducing the company's registered share capital.
• Approving a merger of the company.

The CEO

A public company must appoint a CEO and may appoint more than one. A private company may appoint one or more CEOs. If it appoints none, the board runs the company.

Unless the articles say otherwise, the board appoints and dismisses the CEO. The general meeting has no power to interfere in the appointment, except by amending the articles.

The CEO runs the company day to day, within the board's policy and subject to its instructions.

Tag along

This right usually protects minority shareholders. When a shareholder offers shares for sale and the other shareholders have not exercised their right of first refusal, they may join the sale and sell their own shares on a pro rata basis.

Drag along

This is the reverse mechanism. It allows a major shareholder to sell the whole company, even if other shareholders object.

An example from an agreement: if a shareholder holding more than 70% of the company wants to sell all its holdings to a third party, and the buyer insists on buying the entire issued share capital, the other shareholders must, if asked in writing, sell all their shares to that buyer at the same time. The threshold is agreed in each agreement.

The BMBY clause

BMBY stands for Buy Me Buy You. Under this mechanism, the initiating party may notify the other party at any time that it wants to buy all of the other party's rights in the company. The notice is given in writing and states the initiator's valuation of the company.

It is a way to separate, usually when the parties cannot agree or decision-making has reached a deadlock. It is generally recommended for a company with two shareholders, or two main camps.

Registering the company

To register the company with the Registrar of Companies you file, among other things:

• A declaration by the first shareholders.
• A declaration by the first directors.
• The articles of association.

This article is general information, not legal advice. For advice on your situation, contact the office.