Special Committees Confidentiality in Transaction With Controlling Shareholder

Special Committees Confidentiality in Transaction With Controlling Shareholder

Written by

Gilad Bar-Ami
September 4, 2023

A public company seeks to transact with another company, a simple matter that usually requires approval at the management levels of the various companies but what if both have a common controlling shareholder? Unlike a simple conflict of interest situation, in a transaction involving a controlling shareholder the managers may find themselves, naturally, acting for the benefit of the shareholder who appointed them, or may influence their continued employment, and not for the benefit of the company and thus the company and the other shareholders will be harmed.

The Israeli Companies Law ("Law") requires in such a case a "triple approval", i.e., the approval of three bodies unrelated to the controlling shareholders is required to approve the transaction - the audit committee; the board of directors; and the general meeting. This is a prerequisite procedural mechanism without which the transaction will not be valid but another material condition which is that the transaction that is "for the benefit of the company". These prerequisites are intended to deal with the complex situation (impossible from the point of view of the company managers), in which the controlling owner is actually transacting with himself (on the expense of company and the other shareholders). However, it was not always sufficient to apply the triple test to face the concerns arising from such a transaction and in particular the concern that the terms of the transaction are biased to the detriment of the company and to the benefit of the controlling shareholder. A voluntary solution that was sometimes chosen was the formation of an independent committee (in addition to the audit committee) to oversee the procedure. The legislator chose a similar path in a 2014 amendment to the law for the promotion of competition which imposed on the audit committee the obligation to establish a competitive procedure in transactions of this type. However, the establishment of a committee, in addition to and beyond what is required and without a legal arrangement, raises the question - what are the duties of the members of this committee?

In a case decided in the Supreme Court in July, 2023, the question of leaking materials from the special committees formed by Bezeq in its transactions (via a subsidiary -“Yes”) with Eurocom and Space-Communication Ltd. - a "leak" allegedly made by a member of the committee to the controlling Shareholder, Mr. Shaul Elovitz. The Supreme Court found that although there is no explicit source in the law for the duty of confidentiality in the committee's hearings, the existence of the mechanisms established by law regarding contracting with interested parties and the nature of the institution of the special committee as a whole formulates a normative rationale for the existence of such a duty, beach of which, in that case, was decided to be a criminal offence. This case is different from a previous case heard by the Supreme Court in 2021 in which the transfer of the information was made by the special committee itself and the question was an examination of the quality of the special committee's work and not whether criminal norms were violated by leaking confidential materials to the controlling shareholder – in that case it was found that the transfer of the materials to the controlling shareholder does not invalidate the transaction.

Transactions between companies with a common controlling shareholder, and in particular when it comes to a public company, is a complex matter and it is obvious that both the legislature and the Courts work towards closing the "loopholes" and gray areas in order to neutralize the influence of the controlling shareholder. Therefore, in any case of a transaction with an interested party, and especially with a controlling shareholder of a public company, it is vital to consult a lawyer with expertise in the field both before and on an ongoing basis during the execution of the transaction and the receipt of the required approvals.