Corporate control agreements – cooperation or coercion?

Corporate control agreements – cooperation or coercion?

October 3, 2020

Two entrepreneurs incorporated a company and want to ensure their control over it even after the entry of investors. The way to ensure this may be through a ‘control agreement’ or a ‘voting agreement’, in which the parties may undertake to agree between them on any vote before casting it. But then it may turn out that, as in many cases, it is much easier to get in than it is to get out ...

Control agreements create a state of de facto ‘joint holding’. In the case of a public company, Israeli Securities Laws, as is the case in other countries, stipulate that when two or more shareholders cooperate under an agreement, whether in writing or orally, they are considered a single shareholder for the purpose of defining ‘personal interest’ upon voting. A review of preliminary decisions of the Israel Securities Authority demonstrates, for example, that in 2015, the Securities Authority gave a pre-ruling with respect to Inbal Orr's query, that in the event of the revocation of a shareholders agreement which results in the joint holding of more than 5% of the company's capital, the shareholders will no longer be considered ‘joint holders’ under law. But how can a control agreement be revoked? While the law takes a wide approach to entering into a control agreement so that there can even be an oral agreement, as far as the cancellation of such agreements is concerned there is no guidance under law.

In a case decided by the Tel Aviv District Court in August, 2020, a party to a control agreement terminated the agreement due to its breach by the other party. The Court held that as to termination for breach, a control agreement may be terminated as any other contract. This means that in the event of a breach, the injured party has three options: Demanding enforcement, termination or damages. An agreement may be terminated immediately for a material breach, i.e. a breach which had a party to the agreement anticipated such breach, it would not have entered into the agreement in the first place. In the case of a non-material breach an agreement may be terminated only after giving time to remedy the breach. A party is not required to wait for the other party to breach the agreement and sometimes an agreement may be terminated on the basis of an ‘anticipated breach’ - a situation in which it is clear that the other party does not intend, or can not, meet the terms of the agreement. For example, when two shareholders have an interest to appoint a director to represent their common interest in the company, but one of them declares that he will not vote pursuant to the agreement. In the aforementioned Court case, the basis of the control agreement was the joint appointment of directors and when one shareholder systematically voted in contrast to the provisions of the agreement, this justified its termination by the other shareholder.

As the termination of a control agreement, such as termination of any other agreement, may be considered a breach of agreement, insofar as the termination is not duly made, it is very important to consult a lawyer with expertise in the field of contracts and corporate law before making such a move. Similarly, given the importance of such agreements, it is certainly important to consult such a lawyer before entering such an agreement, as every comma in the agreement may have substantial consequences over time.