The Company’s articles of association serve as a contract for all intents and purposes, and it sets the relations and rights. A ruling that was recently granted in the matter of Wave Guard illustrates the disputes that may arise following changes made to the articles of association, and the danger of relying upon oral agreements and status quo. The things that are important to be set down in the articles of association and what to watch out for

12.10.20 | Efrat Neuman

One of the first things that entrepreneurs do when establishing a startup is to draw up the articles of association.  This legal document is a contract between the company and its shareholders and between the shareholders themselves –  which determines the company’s conduct and activity.  Later down the road, the company is entitled to change the articles of association in a decision voted in with a simple majority in a general assembly (or another type of majority, if such is set down in the articles of association), and this should be notified to the Registrar of Companies.

A case that recently reached a ruling, dealt with the interpretation of the articles of association between the widow of one of the founders of Wave Guard and the company and its shareholders.  The crux of the dispute stemmed from the fact that the articles of association were changed several times over the years.  Throughout all the years of the company’s activity, one of its founders, Haim Shaked, served as a director; and over the years, due to medical problems, he appointed a director to function in his stead (an alternate director).

After his death, his widow requested to appoint a director on her behalf.  However, the articles of association, which were last amended in 2012, did not include such a right – even though such a right had existed in the past and was actually granted to her husband until his death.

The term has ended, who can appoint a director?

Wave Guard was established in 2009 by David Shaul, Gavriel and Lior Nave and Shaked, and it is engaged in the development of technologies in the field of cellular monitoring and tracking.  Upon its establishment, the company submitted a short and generic articles of association to the Registrar of Companies, which included only mandatory paragraphs, as required by the Companies Law, including the name of the company, its goals, information regarding the registered shares capital and information regarding limiting the liability of the shareholders.

At the beginning of 2010, the founders decided to amend the articles of association, such that a shareholder with 13% or more of the shares is entitled to appoint a director on his behalf, including himself.  According to this agreement, the founders appointed themselves as directors.

In subsequent years, additional investors entered the company; and consequently, the articles of association were amended.  The articles of association granted Investors Victor Medina and his son Eitan the right to appoint a director as long as they owned at least 10% of the shares.  It also determined that any appointment of a director or termination of his term should be conducted pursuant to a decision of a majority of the shareholders.  Businessman Avraham (Miko) Gilat, who joined as an investor at a later date, was also granted the right to appoint a director under certain conditions.   The last amendment to the articles of association was in 2012; and at this stage, the articles of association no longer included the paragraph that grants anyone with 13% of the shares the right to appoint a director. 

In 2014, when Shaked’s condition deteriorated, he appointed Ronen Shahar as an alternate director on his behalf.  Shahar’s term elapsed upon the death of Shaked.  After his death at the end of 2018, the widow asked to appoint Shahar as a director on her behalf, but she was refused.  She was notified that Shaked did not have the right to appoint a director on his behalf; and consequently, his heir did not have any such right either.

The widow turned to the Court through Adv. Ya’ara Freund, claiming that the founders never intended to abolish the right granted to each of them in the articles of association in 2010 – of appointing a director on their behalf, as long as they owned 13% of the shares.  She claimed that the intention of the amendments made to the articles of association during the following  years was to make equal the rights of investors in the company (the Medina Group and Gilat) to the founders’ rights, so the founders’ rights would not be hurt.

Judge Yehezkel Keinar of the Central District Court rejected these claims, and ruled that the last articles of association were very clear in its assertions:  except for the two exceptions of the Medina Group and Gilat – the other appointments would be made with a vote by a majority of the shareholders.

Judge Keinar mentioned the ruling given by the Supreme Court in 2019, in the matter of Bi-Bi Roads, in which three members of the panel of justices agreed that they must stick to the language of the contract.  “As for the company’s articles of association, there is special importance in giving priority rights to the language of the articles of association.  The articles of association are also a forward-looking contract, in which clarity, transparency and full disclosure are of the utmost importance.  Additionally, the articles of association do not only impact the rights of the shareholders, but also can impact the rights of various types of third parties,” wrote Judge Keinar.

The Court ruled that the petitioner had not proven that the new investors – the Medina Group and Gilat – knew that the founders had the right in the past to appoint a director on their behalf and agreed to retain this right.  “The petitioner’s claims against the very clear verbal interpretation that arises from the company’s articles of association, as if there was some type of ‘insertion’, in its common usage, by anyone, cannot stand against such a clear situation and because the language of the articles of association is unequivocal,” wrote Keinar.  

Moreover, the Judge ruled that even if the founder’s widow would have succeeded in proving that the subjective intention in the rules of association was to retain the right to appoint directors in the hands of the founders – it would be overruled by the first reason.”   In other words, it would not have helped her claim, because of the precedence that must be given to the contract’s language.  The company and its shareholders, Naveh, the Medina Group and Gilat were represented by Adv. Yoav Zatoresky and Adv. Yisrael Feffer.

To anchor the oral agreements and norms in writing

The case of Wave Guard illustrates the disputes that may arise between founders and investors with regard to their rights.  Inevitably, the judge examined only what was written in the articles of association; and therefore, the founders must understand that even if there are oral agreements, and even if in actually there is a status quo – this is not binding, as long as the explicit language of the articles associations determines otherwise.  

The petitioner claimed that her late husband was actually a director in the company, and even appointed an alternate director when he was sick and this can indicate that this was his legal right, and that no one thought that the founders’ right to appoint directors no longer existed.  The judge did not accept this claim and ruled that the company and its shareholders can decide whether or not to use the directors’ appointment paragraph – and it is optional rather than mandatory.

Adv. Achai Gomeh, Partner and Head of the Capital Market, Securities and Venture Capital Department at Hamburger Evron & Co. explained the things that are important for the founders to focus on in the articles of association.  In the case of appointment of directors, the default in the law is that they are appointed once a year by the general assembly, with a simple majority.  However, Gomeh noted that in private companies, a different type of appointment is set, and it is important to regularly compare the articles of association with the status in the company in terms of the ownership of shareholders and balance of power – in order to avoid what happened at Wave Guard.

Gomeh explained that with a lack of another explicit assertion in the articles of association, if 80% (or more) of the company’s shareholders decide to sell their shares, the sale can also be forced upon the minority (on condition that it is executed with the same terms).  “It is best for the entrepreneurs to ensure that if they hold at least 20%, then there should be a provision in the articles of association that raises the rate from 80% to a higher rate – because it is not always possible to obtain the investors agreement to this in subsequent negotiations.”

Another important issue is the vote in the board of directors:  Each director has one vote regardless of the number of shares he owns.  In small companies, the shareholders may be mistaken and think that the rate of their possession of shares affords them the same voting power in the board of directors (as in the shareholders assembly).  However, this requires an explicit provision in the articles of association.  This is particularly important in cases in which the board of directors has exclusive authority.