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Israeli Law Update - January 2010

JANUARY 2010

Wildes, Perry , PARTNER

Hodak Committee Publishes Interim Report

The Hodak Committee, appointed by the Israeli Commissioner of Capital Markets, Insurance and Savings in May 2009 and chaired by GKH’s chairman, David Hodak, recently published its interim report, following months of discussions and deliberations.

The Hodak Committee was appointed in response to the global financial crisis and in response to risky investments in corporate debt securities by Israeli institutional investors. The Hodak Committee’s mandate was to propose quantitative and qualitative parameters and procedures for institutional investors when investing in non-governmental Israeli debt securities.

Currently, there is no Israeli regulation addressing the information that a private company issuing debt securities must provide to institutional investors. The underlying assumption was that institutional investors have the ability to properly negotiate terms directly with private debt issuers. The committee focused on two main problems: first, the lack of means to ensure the rights of the institutional investors with respect to repayment of the debt, and second, the concern that in many cases there was no proper ratio between the level of risk of a debt security and the interest rate paid by the issuer of the security.

The Hodak Committee therefore made proposals aimed at providing a set of tools to improve the institutional investment process based on two general principles: (i) improving the process of review and approval of an investment in debt securities by institutional investors prior to the investment, and (ii) recommending that certain terms and conditions will be included in debt instruments.

The interim report proposes that an institutional investor take the following steps and meet the following requirements prior to investing in debt instruments:

1. Prepare a written analysis of the relevant debt security based on the borrower’s financial statements for a period of at least three years, including a recommendation whether to invest in the debt security.

2. Where the principal amount of the debt security to be purchased by the institutional investor or its affiliates exceeds certain specified levels, a specific resolution of the investment committee would be required.

3. The institutional investor would be permitted to invest only if it had received all relevant information at least seven business days prior to the date of its purchase offer or commitment.

4. Where the issuer is a non-reporting entity (i.e., not required to file reports with the Israel Securities Authority), an institutional investor would be required to receive from the issuer a specially prepared issuance memorandum, including financial reports and other detailed information required for assessing the investment and evaluating the issuer.

5. Non-tradable securities would be required to be subject to a registration requirement in a special registrar to be formed for such purpose.

6. An issuer would be required to undertake to bear all the issuance costs and reasonable legal costs should a trustee will be required to commence legal proceedings on behalf of the holders of the securities.

7.Terms of the debt instrument would include certain covenants with respect to change of control of the issuer, sale of all or substantially all of the issuer’s assets, in which case a redemption right will apply. Alternatively, the institutional investor’s investment committee can determine a set of financial parameters and covenants that the issuer would need to satisfy, in which case the right to redeem would not apply.

All of the Hodak Committee recommendations can be waived by the institutional investment entity in its discretion.

The Hodak Committee recommendations do not apply to foreign issued debt, although the committee did suggest that institutional investors deal with such debt in the same manner proposed in the committee’s conclusions and report.

The final report is expected in the coming months.

Securities Law

Increasing Companies׳ Internal Controls And Enhancing Disclosure Requirements

A recent amendment to the Israeli Securities Regulations aims to increase companies’ internal controls over financial reporting and disclosure procedures. The purpose of the amendment is to improve the quality of financial reporting and corporate disclosure and to provide senior management with reasonable assurance regarding the accuracy of the financial reports and their compliance with the law.

Under the amendment, effective for annual reports for the year ending December 31, 2010, companies will be required to attach to their annual and quarterly financial reports (i) an additional report of the company’s directors and management evaluating the effectiveness of the company’s internal controls over financial reporting, (ii) personal CEO and CFO certifications confirming the statements in the board and management reports, and (iii) a report by the company’s comptroller addressing the company’s internal controls.

In their annual report for the year ended December 31, 2009, companies will be required to state their progress in implementing the internal controls and disclosure requirements and procedures with respect to financial reporting.

Patents Law

Israeli Patent Commissioner Announces New Classification And Priority Treatment For ״Green״ Patent Applications

In an effort to participate in the worldwide struggle to protect the environment and to encourage research and development in the field, the Israeli Patent Commissioner (the ״IPC״) has recently announced a new type of patent application classification, called ״Green Applications״.

As of December 27, 2009, patent applications regarding inventions that assist in protecting the environment, for

example by delaying the causes for global warming, decreasing air or water pollution, advancing non-polluting agriculture, among others, will be classified as Green Applications.

The IPC further stated that Green Applications will receive priority in the examination process by the Israeli Patent Office and the examination will begin no later than three months from the date of classification as a Green Application. Such classification will assist the applicant in by-passing the “first-come-first-served” basis on which patent applications are typically examined by the Israeli Patent Office.

An applicant who wishes for an application to be classified as a Green Application must attach a letter shortly describing how the invention serves to advance the protection of the environment. The Israeli Patent Office will inform the applicant if the application is classified as a Green Application, as well as when the examination process will commence. A request for classifying an application as a Green Application may be submitted also with respect to applications filed prior to the introduction of this new policy.

Litigation

New Policy Regarding Participation In Arbitration Procedures In Which The State of Israel Is One of The Parties

The (now former) Israeli Attorney General, Mr. Menny Mazuz recently published a new directive pursuant to which the State of Israel may participate in arbitration procedures. This guidance constitutes a change in the policy in place since 2003 according to which generally the State of Israel did not settle its disputes through arbitration. This change was made possible as a result of an amendment to the Israeli Arbitration Law, 1968, which allows the parties to appeal to a court with an arbitration ruling, subject to certain limitations.

According to the new directive, only the Attorney General has the authority to execute an arbitration agreement. His approval is also required in order to include an arbitration clause or to refer a dispute to an arbitration procedure. The exercise of an arbitration clause also requires the approval of the Attorney General and of the relevant authorized department or unit after consulting with the Attorney General.

According to the directive, there are certain considerations that should be taken into account before referring a dispute settlement to arbitration or including an arbitration clause in an agreement with the Israeli government.

Such considerations include, among others: the business or professional-technical nature of the dispute; the nature of the dispute is such that affords an advantage to settlement in non-public procedures (such as where open court proceedings may disclose information that may harm the public safety or external/diplomatic relations of Israel); considerations relating to the identity and character of the parties to the dispute (such as a dispute that involves a long lasting relationship); efficiency considerations; the scope and financial consequences of the dispute. Nevertheless, this is not a closed list of considerations, but rather general guidelines and each case will be assessed based on its particular circumstances. Pursuant to the directive, certain considerations would generally weigh against the use of arbitration in an agreement or dispute with the government, such as: the dispute or agreement raises a fundamental legal question, a question of precedential value or another sensitive issue; dispute concerning the broader public or the decision in which may affect a large segment of the population; and in the event that the ruling may affect third parties who are not party to the arbitration procedure.

Tax Law

Reduction Of Corporate And Individual Income Tax Rates

The corporate tax rate has been reduced to 25% in 2010 (26% in 2009). The corporate tax rate is scheduled to be gradually reduced to 18% by the year 2016. The top individual marginal tax rate is reduced to 45% in 2010 (46% in 2009) and is scheduled to be gradually reduced to 39% by the year 2016.

Increase Of Monthly Income Amount Subject To Social Security And Health Tax

For the period between August 1, 2009 and December 31, 2010 the monthly income amount subject to social security and health tax was increased to 10 times (instead of five times) the “average income” (currently NIS 79,750).

Reduction Of The Vat Rate

Effective January 1, 2010 the VAT rate in Israel was reduced from 16.5% to 16%.

Reduction Of The Tax Rate Imposed On Certain Dividends

Dividends distributed during the period between October 1, 2009 and September 30, 2010 to individuals or to a “Family Company”, as defined in Section 64A of the Israeli Income Tax Ordinance, from retained earnings accumulated until December, 31 2002 will be subject to a reduced tax rate of 12%, provided certain conditions are met.

Labor Law

A Company’s Failure To Transfer Social-Benefits Deductions From The Employee’s Paycheck To Their Designated Purpose Serves As A Sufficient Reason For Piercing The Corporate Veil

In the case of Ofir Stratugo, an employee sued her employer company for certain benefits accrued during the period of her employment, claiming that the corporate veil should be pierced and that the CEO and owner of the company should be personally liable for the company’s debts to her. The company had been shut down and all the employees were dismissed, including the employee suing the company. The company had not transferred the deductions from the employee’s paycheck for certain benefits to their designated purpose. The court held that the company’s failure to transfer such deductions from the employee’s paycheck to their designated purpose served as a sufficient reason for piercing the corporate veil of the company. The court further held that the establishment by the CEO of a new company that essentially continued the business of the company that had been shut down and in effect emptied the previous company of its assets, was also a reason to pierce the corporate veil and hold the defendants personally liable for the previous company’s debts to the plaintiff.

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