Had it not had three sides it wouldn’t have been my duck!

Had it not had three sides it wouldn’t have been my duck!

February 18, 2019

It is said that every story has three sides: your side, my side, and the truth. Sometimes transactions also have three different sides/stories: the story written in the agreement, the story the parties actually intended to write, and the story that the Court later decides to be the real story. Like any good novel (especially when the agreement is not well drafted and caused the intent of the parties to be construed differently by the Court in the future), any relation between the stories is completely coincidental. Like any good novel, the ending may come as a complete surprise to the parties…
The concept is sometimes referred to as the “duck test.” If it walks like a duck, it quacks like a duck, it is a duck. If an agreement looks like a sale of an apartment, for example, but the seller has the right to repurchase the apartment at a higher price and at a set time, the Court may later decide that, in fact, the parties intended to create a mortgage agreement. A person needed a loan. The lender refused to settle for a mortgage on the asset and demanded it to be transferred to its name, but if the borrower repays the loan with interest, the borrower can receive back the asset. If the parties, however, did not register the mortgage as required under law in order to effect it, the lender/purchaser might find itself without a security, especially if the borrower/seller goes bankrupt.
Similarly, in a case decided by the Israeli Supreme Court in November, 2018, a property in Germany was financed by selling the asset and then leasing it back (a sell-leaseback transaction) when upon payment of full rent on time, the asset will revert to the lessee. The transaction was also structured in a complex manner involving corporate shares, maybe to make it harder to understand the real intent, maybe for tax purposes, and maybe for other reasons. The fact that the transaction was a repurchase agreement (“repo”), a legitimate economic transaction, but with a sell-leaseback transaction, another legitimate economic transaction, raised suspicion that it is in fact concealing a different economic transaction and it was held that in fact it was a loan transaction with the asset used as security. Was this indeed the original intent of the parties? Maybe…
In any case, Israeli law enables recording of a pledge even when the transaction is in fact not a pledge, while adding a note that the recording does not attest the real character of the transaction. Sometimes it is better to do so, just in case the Court will later construe the intent of the parties differently from their original intent.
Because transactions can sometimes become complex due to real economic grounds (e.g. ad hoc financial distress with the belief that in the future the asset may be repurchased – a real repo transaction, legitimate tax considerations or other reasons), it is important that the agreement will be drafted by lawyers experienced in the field, in order to minimize the potential exposure to future construction that is not necessarily fitting the original intent of the parties.