On business judgement and corporate transaction approval mechanism

On business judgement and corporate transaction approval mechanism

May 9, 2022

The board of directors is the organ entrusted with making most of the on-going corporate decisions. It is to be kept in mind, however, that its members are flesh-and-blood whose interests may conflict with the interests of the company and its shareholders. How is the tension between risk of stagnation and a conflict of interest of board members resolved? The answer is not a clear-cut ...

The main mechanism for preventing conflicts of interest and taking of decisions that are not for the benefit of the company by its board of directors is the requirement of special approvals for transactions in respect of which there is an apprehension that officers or controlling shareholders will exercise their power for personal benefit. Thus, for example, the Israeli Companies Law requires that any transaction is for the benefit of the company and in some cases stipulates a requirement for the approval of corporate institutions, whether it be the audit committee, the board of directors or, sometimes, even the shareholders. When a decision is duly made in accordance with the required mechanism, the board receives a kind of "immunity" known as the "business judgment rule" - a rule that when duly followed will protect the board of directors from the Court entering its shoes, even if the decision turned out to be incorrect.
However, this immunity is not complete and sometimes the Court will review the decision on its own merits by applying a standard of "entire fairness" or at least by reviewing an intermediate standard in the form of "enhanced scrutiny". It is important to note that each of the rules constitutes a flexible standard which varies according to the circumstances of the case, the conflict of interest of the board of directors and the damage to the company shareholders and is a flexible examination.

Thus, for example, a case decided by the Supreme Court in December, 2021, dealt with a transaction in which the controlling shareholder of a public company purchased most of the public shares, so that consequently the company became private. It was held that in addition to the approval of the transaction by the mechanisms stipulated by law, the negotiations in connection with the transaction were to be conducted through an independent committee. However, in that particular case, the flaws in the committee's work were minor so that the “business judgment rule” still applied.

In a case decided by the Supreme Court in August, 2021, it was held that the “business judgment rule” may be extended so that it would also apply to omissions of the board of directors. In that case, however, the Court did not apply the rule, because the board of directors breached its duty of care, as its decisions were made uniformly, and its failure to exercise caution caused the company to enter the 'preservation list' on the stock exchange and the hazard of delisting. However, it is was stated as an aside, that a breach of the duty of care by itself does not categorically suggest the loss of the “business judgment rule” protection.

In light of the above, and due to the uncertainty surrounding the field of conflict of interest transactions and the content of the various rules, as well as their scope - which varies from case to case - it is very important to be accompanied by an attorney with experience in the field of companies and contracts, who will assist the company in the decision-making process and documentation, and conduct a comprehensive examination of compliance with the conditions of the law, and in particular the articles related to conflict of interest transactions. The attorney must be involved in the full details of the transaction, the examination procedure and the approval process, in order to be able to verify that all the procedures are duly done, in a manner which may grant the officers immunity in case the transaction does not work as planned.