cross border transactions

The Implications of Israel adhering to the OECD’s Convention for the Prevention of Bribery – Recommendations for Future Steps

Posted by: Gadi Ouzan  & Dani Rinot

A few months ago it was widely reported in the press that a foreign government had frozen engagements with seven international companies, including an Israeli security company, in the wake of suspicions of bribery and corruption of a senior official in such country. It is especially interesting to follow these reports in the context of the recent legislative amendments in Israel, addressing the prohibition to bribe foreign public officials. These amendments are reviewed, for your convenience, below:

On March 11, 2009, Israel joined the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions of the OECD (the Organization of Economic Cooperation and Development), and in doing so, joined 37 other countries that already signed the Convention. Israel’s accession to this Convention constitutes an important stage in the process of Israel becoming a member of the OECD, a process that began in May, 2007.

As part of Israel’s accession to the Convention and its efforts to be accepted to the OECD, the Israeli legislator initiated several legislative amendments in order for the Israeli internal legislation to conform to the Convention’s principles and the OECD’s requirements, similar to the restrictions imposed on US companies under the US Foreign Corrupt Practices Act (FCPA).

1. Bribing a Foreign Public Official – a Criminal Offense – in the framework of an  amendment to the Penal Law, the offense of bribing was expanded such that “bribing a foreign public official for an act associated with his position to ensure business activity or another benefit regarding business activity”, constitutes a criminal offense, the punishment of which can reach up to 3.5 years imprisonment, and the court is entitled to impose a fine in an amount of up to NIS 202,000 or up to four times the value of the benefit received due to the payment.The consequences  of this amendment is that Israeli citizens and Israeli companies shall now be exposed, inter alia, to criminal charges in Israel for giving benefits to foreign public officials abroad.
2. Payment of Bribery Abroad is not a Recognized Expense – A proposed legislation to amend the Income Tax Ordinance, so that deduction of payments made in violation of any law shall be prohibited for tax purposes, is currently pending. The said amendment was proposed, among other reasons, to comply with the OECD’s requirements, pursuant to which it is necessary to forbid deduction of bribery payments to foreign officials, as income-generating expenses.   

Recommendations for Future Steps
In the framework of corporations’ preparation for the new legislation and rules, it is advised, among other things, to consider taking the following measures: 

1. Review Agreements – In light of the accession to the Convention and the amendment of the Penal Law, we advise Israeli companies that engage in export activity to review their agreements with consultants, agents, distributors and business partners, and incorporate in the agreements detailed provisions addressing the prohibition to give illegal payments to foreign public entities.
2. Adopt Internal Compliance Program – although the law does not determine a special director offense, it is recommended that Israeli companies operating abroad consider adopting a voluntary compliance program addressing this matter. Such a compliance program would generally include preparing a plan determining the organization’s guidelines  and policy; internalizing such guidelines  within the organization; allocating resources for an internal training program for employees and business partners; appointing a senior compliance officer within the company to supervise  the matter; encouraging employees to freely report any suspicion of an offense to the compliance officer (a “hotline”); conducting due diligence examinations  regarding business partners’ activities, etc.

   In the United States (where similar legislation has been in effect for many years), the existence of an internal compliance program is taken as a factor by the enforcement authorities when determining whether to initiate legal proceedings against a corporation and its directors, and when considering the penalties to be applied.

   It is likely that also in Israel, adopting and implementing an internal compliance program will assist in providing a better defense for directors and officers of companies accused of such offenses.

Posted By: Moty Ben Yona

The recent financial crises, on one hand, and the growth of private funds, on the other hand, have raised numerous calls for reduction of management fees and more efficient investor protection. Moreover, in order to reach such objectives there have been recently discussions in the U.S and in Europe about the need for regulation of private funds, primarily hedge funds.

Without addressing the question whether regulation of private funds is indeed necessary, it is obvious that a more efficient protection for the interests of the Limited Partners can be achieved by incorporating certain terms and conditions to the limited partnership agreements and the ancillary documents, which govern the relationships of the Limited Partners, the General Partner and the fund managers.

While the typical limited partnership agreements tend to be very long and contain hundreds of clauses, it is important to make sure that these agreements include certain terms and conditions, which are designated to align the interests of the Limited Partners and the General Partner. It is also important to make sure that the fund provides the Limited Partners with adequate transparency.

Below is a short outline of some of the issues required to be addressed prior to executing a subscription agreement by which a Limited Partner will make a solid commitment to invest in a private equity fund:

What is the term of the Fund?
It should be confirmed what is the term of the fund, as throughout such term management fees will be paid to the General Partner (subject to certain adjustments within such term). It is also advisable to take into account that the General partner is usually entitled to extend the fund for additional 1-2 years, at its sole discretion. Also, in most cases the term of the fund may be further extended with the consent of a majority in interest of the Limited Partners. In addition, it is advisable to confirm what is the duration of liquidation and whether the General Partner or the liquidator of the fund will be entitled to fees throughout such period of liquidation.  

What is the Capital Commitment provided by the General Partner?
It is recommended that the General Partner of the Fund will have a substantial capital commitment and a substantial equity interest in the fund. Naturally, while the General Partner invests its own money in the fund a strong alignment of interest with the Limited Partners can be reached. It is also suggested that such investment shall be made by the General Partner in cash rather than by means of waiver on management fees.

What is the method of the calculation of the Carried Interest?
Carried Interest is the share of profits that the General Partner receives as compensation. Traditionally, the amount of Carried Interest is set at around 20-25% of the fund’s annual profit. However, it is necessary to confirm how the Carried Interest is calculated. For instance, it is advisable to confirm whether the Carried Interest is calculated based on net profits or gross profits and whether the carried interest is calculated on an after tax basis.

What is the Structure of Management Fees?
It is advisable to ensure that the Management Fees are not excessive and that they are based on reasonable operating expenses. Also, it should be confirmed whether the management fees cover all the overhead and staff compensation as well as travel and other administrative expenses. It should be confirmed which expenses are not covered by the management fees and whether such expenses should be borne by the Partnership or by the General Partner. For instance, it should be discussed whether the general partner’s insurance will be borne by the Partnership or the General Partner itself. In this context it should be also confirmed whether the Limited Partners’ Advisory Committee has any rights to review the Partnership’s expenses on a periodic basis. It is also advisable to confirm whether the Management Fees are decreased significantly once the investment period is over.

Is there a Clawback Obligation?
A clawback obligation of the General Partner ensures that the General Partner will not keep distributions in excess of a certain percentage which was agreed upon in the Limited Partnership Agreement. The clawback provision will require the General Partner to repay the Limited Partners such amounts which were distributed in excess. To secure the clawback repayment by the General Partner, it is possible to require that the General Partner will maintain a “carry escrow account” with significant reserves to cover potential clawbacks.  

Are there any “No Fault” Clauses?
No fault clauses provide the Limited Partners with the right to demand changes in the operation of the fund upon majority in interest vote. “No Fault Divorce Clause”, for instance, provides the Limited Partners with the right to remove the General Partner of the fund and either terminate the fund or otherwise appoint a new General Partner. Such clause can be activated even if the General Partner is not in breach of the Limited Partnership Agreement, provided that the resolution for the removal of the General Partner was adopted by a special majority of the Limited Partners. Other “No Fault Clauses” provide the Limited Partners with the right to demand the suspension or the termination of the “Investment Period”, during which the General Partner invest the fund’s commitments.