INTRODUCTION
The Israeli M&A market, which is heavily reliant on foreign investment and on its local high-tech market,has not been immune to the global slowdown in M&A activity in 2022. After several years of record-breaking deals in terms of both deal size and company valuations, the cautiousness of buyers has increased due to international trends of inflation and rising interest rates. Additionally, local factors, such as the Israeli government’s plan to overhaul the judiciary, which has sparked strong public protests, have added uncertainty to the market. As the Tel Aviv Stock Exchange indices lag behind other stock markets, some investors have recognized the potential opportunities amidst the crisis. Over the past year, there has been a growing interest in going private transactions, where publicly traded companies become privately owned, delisting their shares from the exchange.
Going private offers several benefits to companies, including increased flexibility, reduced regulatory requirements, and the potential for higher long-term profits by prioritizing long-term growth over short-term shareholder interests and market pressures. These transactions are appealing to investors seeking to focus on long-term growth and strategic changes. While most Israeli publicly listed companies are registered on the Tel Aviv Stock Exchange (TASE), others are traded on NASDAQ and other global exchanges (or dually listed). However, the corporate laws governing a going private transaction of an Israeli company will always be Israeli law. In this article, we will outline the main Israeli corporate law implications of a going private transaction.
There are two primary alternatives for effecting a going private transaction of an Israeli company. The most common method is a reverse triangular merger, in which the acquiring company forms a new Israeli entity (NewCo) that merges with the target company (Target), with the Target surviving the merger. Another option, though less common, is a full tender offer, in which the purchaser acquires all of the shares of the Target. Both methods result in the same outcome.
According to annual summaries published by the TASE, in the five-year period between 2018-2022, 45 companies were delisted from the TASE through a transaction – 26 of them have done so through a merger and 19 through a full tender offer (not all where “going private” transaction per se, as some of them were with another public company). The data from 2021 and 2022 presents a trend of preference to the merger alternative: of the 14 companies that were delisted during that period, only three have done so through a tender offer and 11 of the delisting transactions were effected through a merger.
REVERSE TRIANGULAR MERGER
Structure: Under this structure, the purchaser establishes NewCo, a wholly owned company, which then enters into a merger agreement with the Target. NewCo then merges with and into the Target, resulting in the Target surviving the merger. After the merger, the Target’s shareholders receive the agreed-upon per-share merger consideration (usually cash), and the purchaser, previously the sole shareholder of NewCo, becomes the sole shareholder of the Target.
Corporate approvals: The merger requires approval from the board of directors and shareholders of both merging entities. The Target’s board of directors must ensure that the merger will not jeopardize the Target’s ability to meet its obligations to creditors. In fulfilling their fiduciary duties, the Target’s board members should conduct a thorough review of the transaction, consider alternative options to maximize value for public shareholders, and engage a reputable accounting firm to conduct a valuation analysis of the Target. A fairness opinion may also be sought to confirm the adequacy of the offered per-share merger consideration.
In a merger of two unrelated companies, the approval by a majority of the shareholders (50.01%) in each of the merging entities will suffice. The approval process becomes more complicated where the controlling shareholder of the Target has a personal interest in approving the merger. Israeli case law commonly defines “personal interest” as the existence of a material “excess interest” that a controlling shareholder (or any other person in which such controlling shareholder has an interest) possesses, compared to the common interest of other public shareholders. The most common circumstances of personal interest are transactions in which a controlling shareholder attempts to “squeeze-out” the minority shareholders and become the sole-shareholder of the Target. Where a controlling shareholder has a personal interest, the merger will require a set of three-level approvals: (i) approval by the Target’s audit committee, (ii) approval by the Target’s board of directors (acting on the recommendation of a special independent board committee formed for this purpose as further set forth below), and (iii) approval by a super-majority of the Target’s shareholders, which consists of either the affirmative vote of the majority of the shareholders who are not controlling shareholders and have no personal interest in the transaction (the “Disinterested Shareholders”), or that the votes of such Disinterested Shareholders do not exceed 2% of the aggregate voting rights of the Target.
A going private transaction involving a squeeze-out by the controlling shareholder that is effected via a merger transaction is generally viewed by Israeli courts as inherently suspicious and subject to increased scrutiny. This type of transaction is usually challenged in court by dissenting minority shareholders, arguing that the directors who approved the merger have done so not in the best interest of the Target, but for the benefit of the controlling shareholder. Because of the inherent conflict of interest, the directors would not benefit from the “business judgment rule”. The courts would rather review such a transaction by applying the “entire fairness” standard, which reviews the three main aspects of the transaction: full disclosure, due process and fair value of the consideration. As part of that review, the court would examine the process by which the board approved the transaction and its implementation of due process and would also apply its own discretion as to the sufficiency of the considerations. In scrutinizing the sufficiency of the considerations, the court would rely on expert opinions submitted by the parties and may also rely on market indicators. For example, if some of the Disinterested Shareholders who voted in favor of the merger were sophisticated institutional investors, this would be an indication that the consideration was reasonable.
In order to alleviate the court’s increased scrutiny, it is of utmost importance that the board of directors of the Target forms a special committee, comprised solely of independent directors unrelated to the controlling shareholder, to examine the transaction, negotiate the terms of the transaction, and recommend to the board of directors whether to enter into the merger agreement and whether the merger consideration proposed to the shareholders is reasonable and fair. An effective and comprehensive process by a special independent committee would imitate an arms-length negotiation between the Target and its controlling shareholder and would ease the concerns of conflict of interest. In a recent Supreme Court opinion, the court ruled that if the approval of the merger was based on the recommendation of a special independent committee which acted effectively, the decision of the board of directors would be scrutinized according to the “business judgment rule”, meaning that if the directors made an informed good faith decision, with no personal interest, the decision itself would not be subject to scrutiny. This standard would apply also if there were minor immaterial defects in the conduct of the special independent committee. If, on the other hand, the special independent committee breached its fiduciary duties, acted for the benefit of the controlling shareholder or simply neglected to apply due process (e.g. did not retain advisors or did not review alternative transactions or structures), the transaction would be scrutinized according to the “entire fairness” standard, and the court would review all the terms of the transaction to ensure that they are fair to all shareholders. In intermediate cases, where there were substantial defects in the process of the special independent committee which do not rise to the level of breach of fiduciary duty, the court would apply an “enhanced scrutiny rule”, an elastic standard of review, which is adjusted to the magnitude of the defects in the conduct of the special independent committee. In applying the “enhanced scrutiny rule”, the court would review the terms of the merger to ascertain whether they were reasonable. The more serious the defects in the conduct of the special independent committee, the wider this review would be, and vice versa.
Case law provides guidance on how to ensure that the process at the special independent committee be adequate enough to ensure that its decision is warranted the “business judgment rule” treatment. The special independent committee must be constituted of independent board members and must be authorized to retain its own independent legal counsel, who will participate on its behalf in all related discussions and negotiations between the controlling shareholder and the Target, alongside other economical advisors and experts on its behalf. Moreover, the committee must be authorized to negotiate the terms of the deal proposed by the controlling shareholder, to examine alternatives, and protect the interests of the company and its minority shareholders. The committee is required to keep its deliberations confidential and not to reveal its business strategy to the controlling shareholder or its advisors. Furthermore, all its meetings must be properly documented, and the minutes of such meetings should properly reflect the discussions. Additionally, the committee must act based on complete information, especially information which relates to the determination of the fair value of the company.
Creditors’ rights: Creditors also have a position to challenge a merger. The creditors of a merging company have the right to apply to the court and request to hold or delay the merger, or to request other protections of their rights. A creditor must show the court that there is a reasonable concern that, following the merger, the surviving entity will not be able to pay the debts of the surviving entity when they become due. Upon the application by a creditor of either party to the proposed merger, the court may delay or prevent the merger.
Procedure: The merger is effected through a formal process conducted by the Israeli Registrar of Companies. In order to effect a merger, the parties are to submit to the Registrar, a Merger Proposal – a form signed by both parties which outlines the terms of the merger and includes a declaration of each of the board of directors of the merging entities that the merger does not give rise to a reasonable concern that the surviving entity will not be able to meet its debt obligations towards creditors as a result of the merger, the rationale for the merger and a description of the merger consideration. The merger may not occur unless at least 50 days have elapsed from the submission of such Merger Proposal to the Registrar and at least 30 days have elapsed from the approval of the merger by the shareholders of each of the merging parties. Taking into consideration, in addition to the abovementioned waiting periods, the 35 days period needed for summoning a general meeting, the minimal waiting period between the signing of a merger agreement and its closing is 65 days. Once these waiting periods have elapsed, the Registrar of Companies will issue a merger certificate, which would mark the closing of the merger.
FULL TENDER OFFER
Structure: A controlling shareholder holding more than 45% of the issued and outstanding share capital of an Israeli company may acquire additional shares in the company, so long as its holdings do not exceed the 90% threshold. In the event that the controlling shareholder wishes to reach 100% holdings (i.e., effect a going private transaction as a result of which such entity would become wholly owned by the purchaser and its shares would be delisted from the exchange), the shareholder would have to launch a full tender offer for all of the Target’s share capital. Such an offer would be addressed directly to the shareholders and published on the applicable exchange. Because this is an offer to the shareholders, the approval of the board of the Target would not be required.
Under this alternative, a full tender offer will be deemed accepted if either (i) the shareholders who did not positively accept the tender offer hold less than 5% of the issued and outstanding share capital of the Target, and more than 50% of the shareholders that do not have a personal interest in the tender offer, have accepted the tender offer; or (ii) the shareholders who did not accept the tender offer hold less than 2% of the issued and outstanding share capital of the Target.
If the tender offer is accepted as set forth above, then all the shares of the Target (even those held by shareholders who voted against the tender offer) will be transferred to the purchaser by operation of law. If the tender offer is not accepted, the purchaser may not acquire additional shares from shareholders who accepted the tender offer if, following such acquisition, the purchaser would hold over 90% of the Target’s issued and outstanding share capital.
Appraisal rights: A shareholder that had its shares transferred to the purchaser as a result of a successful full tender offer, may, within three months following the tender offer acceptance date, petition the court to determine that the tender offer was not made in fair value and that the purchaser must pay the fair value, as shall be determined by the court. The offeror (i.e., the potential purchaser) may, under the terms of the tender offer, limit the right of appraisal only to shareholders who refused to accept the full tender offer, thereby hedging its potential exposure to only the 5% (or less) dissenting shareholders. This hedge would not be applicable if the consenting shareholders prove that the disclosure provided by the offeror in the tender offer was insufficient, which in such case, the appraisal rights may be granted also to shareholders who accepted the tender offer.
According to case law, the appraisal will generally be done by using the DCF (Discounted Cash Flow) valuation model, which values the company based on the discounted cash flow of its current assets, as well as the discounted cash flow that its future investment opportunities would have generated. The appraisal should also consider information available to the offeror regarding the future investment options in the company as they are known to it at the time of purchase, and thus eliminating its informational advantage over the minority shareholders.
PROS AND CONS OF EACH STRUCTURE
Effecting a going private transaction under the full tender offer alternative does not require board approval of the Target and can be done unilaterally, without negotiating the terms of the deal and without support from the board of the Target. However, the requirement to obtain the affirmative support of at least 95% of the shareholders makes it not feasible in many cases. In some companies, especially those with a longer history, it is a challenge to locate all shareholders and a shareholder who did not respond to the offer would be practically viewed to have objected to the offer. From an economic standpoint, obtaining such a high percentage of support would often require the purchaser to offer a very significant premium. Even if the full tender offer is successful, the purchaser remains at a risk of the court awarding appraisal rights and increasing the consideration.
Effecting a going private transaction by way of a reverse triangular merger will provide a higher certainty for consummation of the transaction, since only the approval of shareholders holding a majority of the voting rights is required (if the transaction involves a controlling shareholder, the majority should be of the Disinterested Shareholders). A reverse triangular merger requires engagement and often negotiation with the board of the Target. A going private merger with a controlling shareholder would be viewed by the courts as suspicious, but the formation of a special independent committee and adherence to strict due process at such committee would minimize the risk of the court intervening in the deal.
Author: Dan Sella, Partner, Erdinast, Ben Nathan, Toledano & Co. With Hamburger Evron