Validity of a Contract made for Appearance Sake Only

Validity of a Contract made for Appearance Sake Only

Doron Afik, Esq.
October 13, 2016

An Israeli company wished to penetrate the European market and for that purpose contracted a Belgian company and agreed on fees for such services. However, because at that time one was entitled to receive state incentives by way of reimbursement of rental expenses and office expenses, the parties signed an agreement for the lease of offices and receipt of office services in Belgium. After a conflict broke out between the parties the Belgian side filed a financial claim in respect of rent and office services. Can the Israeli company deny the contract it signed?

The Israeli Supreme Court defined a contract sake of appearances as a contract in which there is an intentional discrepancy between the declarations of the intentions of the parties to the transaction, and their true intentions. While outwardly, the parties agree on a certain legal structure to apply, their real intention is different. The Israeli Contracts Law provides in section 13 thereto that a contract for appearance sake only is invalid.

Contracts for appearance only are in many cases made to hide an illegal act, such as an illegal receipt of state incentives, evading of taxes (e.g., a land sale contracts recording a low transaction amount in order to reduce the tax exposure) or concealment of assets (e.g., a contract for the sale of property to a third party the sole purpose of which is evading creditors of the “seller”). For this reason, the Courts demand a very high burden of proof from a party to a transaction arguing that the transaction is void as it is a mere contract for appearance.

Thus, for example, in an inheritance dispute an argument was raised that the deceased mother was not really the owner of shares in a company but in fact was recorded as such only under a gentleman agreement or for appearance purposes only. The Supreme Court held that because that high burden of proof was not lifted, the shares belong to the estate and will be distributed under to the rules of succession.

In some cases, a contract for appearances only may have implications on third parties. For example, if a person sold an asset to a second person, who sold it to a third party. An argument of the original seller that the contract was for appearances only means that the purchaser could not have sold it to the third party. For this reason, it was determined that a contract for appearances only on which a third party relied in good faith will not be voided if the result will jeopardize the rights of the third party.

Even ignoring the criminal implications of a contract for appearances only, it is important to remember that because of the high burden of proof required to prove a claim that a contract for appearances only, such a contract may in future be valid in all respects despite the original intention of the parties. For this reason, it is best not to enter into agreements of this type, but if such was done, it is important to terminate the agreement by mutual assent as soon as possible to prevent a situation where in case of a dispute between the parties is will not be possible to prove that the parties never intended the provisions of the contract to be valid.