New York’s Plaza Hotel: Who gets first crack at the deal?
New York’s Plaza Hotel: Who gets first crack at the deal? Photo by Bloomberg
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Avi Scharf
Israir plane comes in for a landing. Photo by Avi Scharf

Sweetheart deals have made headlines over the past few years, prompting legislation to deal with the phenomenon.

One example is the sale of Israir by Nochi Dankner's privately-held Ganden Holdings. The cash-guzzling airline went to the public IDB group under Dankner's control, sparking a lawsuit.

But there are other ways for tycoons to rake in profits at the expense of public shareholders, if they hold privately-owned companies in the same business as the public companies under their control.

A hypothetical example is Delek Real Estate, a public company controlled by Yitzhak Tshuva, who also owns Elad Group, another real estate investing company.

How would Tshuva decide where to channel property deals he came across?

Corporate law requires controlling owners to disclose business opportunities to their public companies, but only when the owner is listed as a corporate officer. So the law doesn't necessarily apply to Dankner, Tshuva and Lev Leviev, who don't always play an official role in the companies they control.

"A controlling owner who isn't a corporate officer could be required to avoid exploiting a company's business opportunities if his involvement and influence over the board's actions is enough for him to be considered a shadow director," says attorney Ziv Preis, a founding partner of the P&B law firm.

How can you tell if a certain transaction falls within the purview of the public company?

Preis: "One of the tests in the U.S. is the expectations test, whereby the business opportunity is considered the company's opportunity when it is expected to operate in the field in question. Or there is a test of its normal business activity under which any accepted business opportunity leading to competition or cutting into its profits can be considered exploiting its business opportunity. In Israel the lines defining a company's business opportunities haven't yet been clearly set."

Can the company approve the controlling owner's exploiting the business opportunity?

Preis: "For the officer to exploit the company's business opportunity, he needs the company's approval for the transaction after disclosing the opportunity and his personal interest ... along with confirmation that the approval doesn't hurt the company."

Attorney Ophir Nave, an expert on corporate law, notes the differences between Israel and the United States.

"The handling in Israel of exploiting business opportunities is based on U.S. law, ignoring the unique characteristics of Israeli companies. Whereas ownership of U.S. public companies is diffuse and control is held by management, Israel has many public companies controlled by owners with the financial means to conduct business activities on their own. Sometimes these operations parallel those of the public company - and this creates a problem."

Nave says business opportunities are often brought directly to the attention of a controlling owner, and it isn't always clear if this occurs within his role in the public company or as a private businessman. A conflict of interest is created when he has to decide whether to split the risk and potential profits with public shareholders or hoard the opportunity for himself, and a great deal of value is transferred from the public to the controlling shareholders over time.

Pox on the capital market

Unlike Preis and Nave, attorney Michael Barnea thinks this is much less of a problem than the interested party transactions he claims are a pox on Israel's capital market.

"The problem is that from the moment shareholders approve [a deal] it is deemed valid," says Barnea, who heads his own law office. "The courts see the special majority requirement as the final word on it becoming a fair deal."

There are countless ploys for interested parties to achieve the necessary majority approval even if public shareholders end up harmed, says Barnea. "An intractable Gordian knot results, since derivative suits aren't effective in Israel," he says.

Regarding tycoons taking advantage of a company's business opportunities, Barnea says the problem exists - Tshuva being a prime example. But it isn't widespread.

"Most leveraged controlling owners aren't particularly wealthy on their own and direct their operations via public companies - not from any love for the public but from a lack of choice, and to leverage their limited equity," he says.

Even so, the question remains how owners who control companies through pyramids decide which company to assign the business opportunity. Why, for instance, did Dankner buy Maariv using Discount Investment Corporation and invest in Credit Suisse through Koor Industries?

According to Barnea, controlling shareholders whose companies are undertaking initial public offerings often delineate the activities of the company being floated in its prospectus to calm investors. The owners pledge to avoid taking personal advantage of the company's business opportunities.

The August 2010 prospectus for Elad Canada, for example, part of Tshuva's privately held real estate arm Elad Group, outlined a mechanism for arranging dealings of the two companies within the same market. "The right of Elad Group to buy or develop ... income-generating assets in the provinces of Ontario and Quebec is restricted," says the prospectus.

Then there is the 2006 prospectus of Hagag Group Real Estate in which the primary owners undertook to restrict all their real estate operations in Central and Western Europe to the public company alone.

Sometimes, though, the controlling owner makes it clear that no restrictions apply. Africa-Israel's 2007 prospectus contains the following declaration: "To the best of the company's knowledge, its controlling owner Lev Leviev operates and invests in Israel and abroad ... in areas of activity in which the group companies operate and/or invest, and/or in areas tangential to some of the company's operations."

Clauses delineating operations are often required by institutional investors before the public offering or are proposed by the controlling owners themselves. Barnea, however, says he doesn't think the institutional investors are aware enough of the problem and are therefore not vigilant enough.

Nave says the extensive focus on corporate governance shifts attention from the problem. "Since one characteristic of business opportunities snatched from a company is that these opportunities don't reach discussion by the company's boards or a shareholder vote, the issue is absent from the current debate in Israel," he says.

What are the odds of discovering that the controlling owner took advantage of a business opportunity that should have gone to the company? Very slim indeed.

"The possibility of supervising the implementation of an agreement is limited," says Preis. "The chances of supervision improve when the controlling owner runs his affairs publicly or the media frequently covers his other dealings."

Preis adds that commitments in a prospectus only apply to the initial buyers of securities and hold no validity for anyone buying them in the secondary market.

Nave proposes amending the Companies Law to force controlling owners to give their public companies a chance at every offer that reaches them. "The owner could make use of the business opportunity privately only if the company rejects it first," he says.