Because of their pernicious tendency to serve as a vehicle for extracting value from firms, related party transactions (RPTs) have come to epitomize corporate governance ills. The regulation of RPTs and private benefits of control more generally is thus a focal issue in corporate governance policy making. Specialized business courts feature prominently as a potent tool in the legal arsenal for curbing inefficient RPTs. Such courts have mushroomed in the United States and around the world but Delaware’s courts remain the undisputed leaders, and the recipe for its success as the ‘corporate capital of the world’ remains secret.
This paper recounts a rapid deterioration in Israeli company law with regard to corporate actions tainted by insiders’ interest. This process took place largely after the establishment of a specialized business division in the Tel Aviv District Court, purportedly with a view to mimicking Delaware’s courts. Within just a few years, Israeli law shifted from conditioning tainted corporate actions, including RPTs, on a fully-informed-consent mechanism to apparent tolerance of such actions, provided that they appear acceptable to the court upon review of their substantive business terms or rationale. Crucially, this legal change happened notwithstanding prior case law that had adopted a strict ‘no further inquiry’ approach to potentially conflicted transactions. The establishment of a specialized business court thus engendered the opposite effect relative to the corporate governance improvement anticipated from it.
For non-Israeli lawyers seeking to design optimal regulation of corporate RPTs, the Israeli experience is puzzling. While certain individuals and interest groups could benefit from the erosion in RPT regulation, the cases provide no hint that the courts heeded to such interests. To the contrary, the courts’ stated motivation is to buttress the protection of companies and public shareholders from powerful insiders. To this end, however, they have looked to Delaware law uncritically, while ignoring important Israeli and other comparative jurisprudence and without providing any justification for this move beyond the Delaware appellation. That the result was quite the opposite of the stated goal is therefore ironic.
In assessing corporate governance reforms commentators often point to powerful forces that could thwart such reforms, like wealthy families that have a grip over the economy and politics or countries’ cultural and social institutional infrastructure. This paper adds to the literature the modest insight that sometimes, weak forces, too, can exert a significant effect. The Israeli experience provides a sobering reminder that such initiatives should be implemented with keen attention to the legal infrastructure in which business courts are to operate, and surely without any naïve expectations.
Amir Licht is Professor of Law at Radzyner Law School, Interdisciplinary Center Herzliya, Israel and a guest contributor to the Oxford Business Law Blog.