Unlike other governance systems where, as the residents of Animal Farm (George Orwell, 1945) discovered, everyone is equal but... some are more equal than others, one of the cornerstones of democracy is absolute equality before the law. But, what about voting rights in a company's board of directors - will it be possible for one director to have preferential rights over another director and is there a limit to the scope of privileges that the shareholders of the company may grant?
Contrary to other laws which seek to form a clear and exclusive path for conduct with regards to the matters regulated therein, alongside several instructions and guidelines set as default options, the Israeli Companies Law provides the shareholders of a company extensive freedom in setting the structure of the company and the manner of its conduct, under the principle of freedom of contracts and its application onto the company's articles of association. However, there are non-dispositive provisions in the law, including those concerning the powers and duties of the board of directors.
An example for one such provision, which exemplifies the aforementioned tension between contractual freedom and the non-dispositive corporate governance rules, is the director’s duty to exercise independent judgment in his vote on the board. At first glance, this is a directive that is only relevant for voting according to instructions from a third party or in accordance with a voting agreement contrary to his discretion but what is the law where a director votes according to his independent discretion, but due to the provisions set forth in the articles of association, his vote expressing that discretion has no weight in influencing the decision that will be made and ultimately the conduct of the company. Can it be contended that the articles of association enabled him to vote according to his discretion and are therefore in compliance with the law or is a substantial compliance with the duty to exercise discretion is required, hence a decision absent the potential to affect the company's activity should be deemed noncompliance? In a case heard at the Israeli Supreme Court in November, 2009, the Court discussed the right of a director to exercise an articles of association set veto right and its was found that granting a veto right on certain decisions of the board of directors does not prevent the board from exercising its discretion, but rather that the resulting decision is subject to additional approvals. However, in a case heard in the Supreme Court in August, 2022, the Court (whilst differentiating between the reality of unequal voting power or even a right of veto and a situation in which the directors’ discretion is completely nullified by the decision-making power given to a single director) held that although the provisions of the law allow for a reality in which the external directors constitute a minority on the board of directors, they do not allow their influence on decision-making in this company to be completely eliminated. In that case, a company that functioned as a general partner in a public limited partnership stipulated in its articles of association that the decision-making in professional matters rests in the hands of a specific person – an action that due to the fact that the law requires a public company to appoint external directors, is illegal, as it nullifies the discretion of such directors. However, it should be noted that contrary to the clear rule that was set by the Court regarding nullification of the external directors’ discretion, the Court did not set a similar rule in relation to directors who are not external directors and contented itself with harshly criticizing such nullification.
Thus, while at first glance the law grants shareholders unlimited contractual freedom to regulate the management of the company by drafting the articles of association, further consideration shows that this freedom is subject to many limitations and non-compliance may lead to the disqualification of the articles of association and even dissolution in fact of the company. Therefore, even at the incorporation stage, it is essential to retain the services of a lawyer who is knowledgeable in companies law and is well versed in drafting articles of association.