Founders' Agreement for an Israeli Group Developing a Project Abroad: Decision Matrix, Capital Calls, Deadlock and Exit

Most projects of Israelis abroad do not start with a single developer. They start with three friends, two brothers, an investor and a developer, or a group of five partners, each bringing something different: money, construction experience, connections in the target country or time to manage. At this stage everyone agrees on everything, so it seems possible to make do with the standard articles of association of the local company and a handshake.

This guide explains what should be in the founders' agreement, or by its professional name the shareholders' agreement, of an Israeli group developing a real estate project abroad. It is general and does not refer to a specific country, because the logic is similar in Romania, Greece, Cyprus, Bulgaria or the USA. Every country has local rules that override the agreement, and these are checked with a local lawyer.

1Why do you need a shareholders' agreement when the company has articles of association?

Because the articles of association and the shareholders' agreement do different jobs. The articles are the company's public document, registered with the local companies registry and limited to what local law allows to be written in them. The shareholders' agreement is a private contract between the partners, more detailed, and is not disclosed to third parties.

The problem starts when the two documents do not speak to each other. If the agreement provides that a decision to take a loan requires the consent of all the partners, but the articles authorise the director to sign alone, the local bank will rely on the articles. The partner who did not agree will be able to sue the other partners under the agreement, but the loan has already been taken. So the key mechanisms, such as a special majority, restrictions on share transfers and appointment rights, are also anchored in the articles, to the extent local law permits.

There is also a question of governing law. In the European Union, the Rome I Regulation, which determines which law applies to contracts, does not apply to questions governed by company law, such as incorporation, the internal organisation of the company and its winding up. In simple terms: you can agree that the contractual relationship between you will be subject to Israeli law, but how a valid general meeting resolution is adopted, and what is required to issue shares, will be determined by the law of the country where the company is registered.

2Who decides what? A decision matrix

The short answer: every decision in the project needs an address and a majority defined in advance. A decision matrix is a table that sets out, for each type of decision, who may make it and by what majority. It is a simple tool for preventing disputes, because it settles most arguments before they arise.

Pay particular attention to the row on related-party transactions. In Israeli groups it is common for one of the partners to also be the contractor, the marketer or the project manager, receiving management fees or an extra share of the profit. There is nothing wrong with this, but the agreement should set out in advance the remuneration, the performance metrics and the way to replace that partner if they are not met, and exclude that partner from voting on all of these.

3What happens when a partner does not transfer their share in a capital call?

This is the question on which groups break apart, so the answer should be written down before it is asked. In a development project, additional money will almost always be needed: a delay in the permit, rising material costs, a bank's equity requirement. If the agreement only says "the partners will transfer funds as needed", you have no tool against a partner who does not transfer.

A reasonable capital call mechanism includes four components: who is authorised to issue a call and by what majority; a cumulative cap on each partner's commitment, so that no one commits to an open-ended amount; written notice with a defined transfer date; and what happens to whoever has not met it. The last component has several options, which are sometimes combined:

• Dilution. The partners who transferred receive additional shares, and the share of the partner who did not transfer shrinks. The critical question is at what value. Dilution at nominal value or at a discounted value is designed to make the partner transfer on time, but you need to check that local law permits it and that it will not be considered an unreasonable penalty.
• Priority loan. Another partner makes up the amount as a loan to the company or to the defaulting partner, at a defined interest rate, and it is repaid before any distribution of profits.
• Suspension of rights. The defaulting partner loses voting rights or appointment rights until they make up their share.
• Purchase option. The other partners may buy that partner's shares at a discounted price set in advance.

4What is the difference between a right of first refusal, drag-along and tag-along?

All three deal with the same question: what happens when someone wants to sell shares. A right of first refusal protects the group from an outside partner, a drag-along right protects the majority from a minority blocking a sale, and a tag-along right protects the minority from a sale that leaves it behind.

In a project financed by a bank loan, every share transfer is in practice also subject to the loan agreement. Banks customarily require their consent to a change of ownership or control, and sometimes also a pledge over the company's shares. So the mechanisms in the shareholders' agreement should be drafted so that they do not contradict what you sign with the lender.

5How do you break a deadlock between partners?

Deadlock occurs when two equal partners, or two groups, cannot reach a decision the project needs. The agreement needs a tiered path: first escalation between the management teams, then mediation or expert determination, and only at the end a separation mechanism.

6What happens when a partner leaves, dies or divorces?

A development project lasts years, and during those years life happens. A good agreement addresses these events in advance, so that the project does not stop because of them:

• Death. Whether the heirs step into the partner's shoes, or the partners have an option to buy the shares at a value determined by an agreed mechanism.
• Divorce. Shares registered in the name of one spouse may be considered joint property under the law that applies to the matrimonial property regime. It is worth providing that a transfer to a former spouse is subject to a right of first refusal.
• Insolvency of a partner. A partner's creditors may try to enforce against that partner's shares. The agreement can give the partners a purchase option in such a case.
• A managing partner who leaves. When the partner managing the project leaves, the distinction between leaving in justified circumstances (Good leaver) and a breach (Bad leaver) determines whether that partner keeps the extra share of the profit.

7Which governing law and which forum should you choose?

For the contractual relationship between the partners, you can usually choose the governing law, and Israeli groups often choose Israeli law and arbitration in Israel. This is convenient, but it has two limits worth knowing.

The first limit is corporate law, already mentioned: questions such as the validity of a general meeting resolution or the issue of shares are determined by the law of the company's country. The second limit is jurisdiction. In the European Union, Regulation 1215/2012 gives the courts of the country where the company has its seat exclusive jurisdiction in proceedings concerning the nullity, dissolution or winding up of a company, and the validity of the decisions of its organs. In these matters, arbitration in Israel will not replace the local court.

For everything else, arbitration is an effective tool. Israel, Romania, Greece, Cyprus, Bulgaria and the USA are all parties to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, so an arbitral award given in Israel is generally enforceable in these countries, subject to the exceptions in the Convention. In the arbitration clause, set the seat of arbitration, the language, the number of arbitrators, the institutional rules if any, and the option to apply to a local court for urgent interim relief.

8What should you check on the Israeli side?

Israeli residents who hold shares in a foreign company may be required to report to the Israel Tax Authority, for example on Form 150, a declaration of holding in a foreign resident body of persons. In addition, you should check with an accountant how dividends and profits from the sale will be taxed in Israel, and how credit will be given for tax paid in the project country under the relevant tax treaty. It is worth doing this check before deciding whether the partners hold the shares directly or through a company.

9Checklist before signing the founders' agreement

1. An agreed business plan, including the capital each partner commits to and a cumulative cap on capital calls.
2. A full decision matrix, and a check that the special majorities are also anchored in the articles to the extent local law allows.
3. A capital call mechanism with a clear consequence for a partner who has not transferred, after a local check that it is enforceable.
4. A right of first refusal, drag-along and tag-along, and a lock-up period coordinated with the lender's requirements.
5. A tiered deadlock mechanism that fits the actual distribution of liquidity among the partners.
6. Provisions for death, divorce, insolvency and the departure of a managing partner.
7. Rules for related-party transactions and for the remuneration of a managing partner.
8. The order of distribution of funds on exit: repayment of shareholder loans, return of capital and profit.
9. Choice of law, an arbitration clause, and a prevailing language if there is a Hebrew version and a version in the local language or in English.
10. An Israeli check of reporting and taxation before deciding on the holding structure.

10How do we accompany a founders' group?

We start with the conversation nobody wants to have at the beginning: what will happen if something goes wrong. From it we build the decision matrix, the capital mechanism and the exit mechanisms, and then coordinate them with the articles and with local law together with lawyers licensed in the project country. It is better to finish this work before committing to the land and before approaching the bank.

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