Corporate opportunity in venture capital industry – Israeli perspectives

Can investors who wish to invest in competing Israeli companies rely on the Delaware court’s reasoning?

By NADAV TIOMKIN
Nadav Tiomkin (photo credit: OSNAT ROM)
Nadav Tiomkin
(photo credit: OSNAT ROM)
The Israeli technology sector continues to grow at a dizzying pace, while investors do not miss the opportunity to get on board. According to Start-Up Nation Central, in 2018 alone, Israeli hi-tech companies raised $6 billion in 681 funding rounds led by hundreds of local and foreign investors.
The phenomenon of specialization, which is steadily spreading through all areas of employment, has not skipped the venture capital industry. Such specialization leads to an increasing number of investors that invest only in specific verticals, and accordingly to an increasing number of portfolios that include competing ventures. This development raises questions about potential conflicts of interest between the investors and their portfolio companies in the form of exploitation of corporate opportunities – since the investors tend to appoint a representative to the board of directors of the companies in order to monitor their investments, even if the investors operate according to the highest standards of loyalty, they may be exposed to potential conflicts of interest due to the confidential information to which their representatives are exposed.
In the United States, in order to deal with this situation, the market practice is to adopt provisions in the governing investment documents that authorize the investors to invest in competing ventures. The power of such provisions was recently brought to the test when Alarm.com Holdings, Inc. (Alarm) filed suit against ABS Capital Partners, Inc. (ABS), alleging that ABS misappropriated Alarm’s trade secrets and confidential information by investing in its competitor. A few months ago, a Delaware Supreme Court order affirmed the Court of Chancery’s ruling granting ABS’s motion to dismiss Alarm’s claim because of the existence of corporate opportunity waivers in the governing investment documents. Most significantly, Alarm’s certificate of incorporation included a provision pursuant to section 122(17) of the Delaware General Corporation Law (DGCL) eliminating any obligation of ABS and its representative to refrain from pursuing corporate opportunities that might belong to Alarm.
Can investors who wish to invest in competing Israeli companies rely on the Delaware court’s reasoning?
The Israeli perspective
Like in the United States, in Israeli transactions the question of how investors will handle the target company’s confidential information frequently arises. However, the Israeli Companies Law does not include a comparable provision to section 122(17) of the DGCL. In fact, the Israeli Companies Law explicitly prohibits the company from exempting in advance its directors from their duty of loyalty, while allowing the company to insure and commit to indemnify its directors in advanced only if the breach was made in good faith.
While considering such differences, it is important to remember that there is a close connection between the Delaware courts’ rulings and the manner the Israeli courts address contemporary business situations. Such connection regularly affects the way Israeli companies operate. In light of the above, it is advisable for investors that wish to invest in competing Israeli companies to consider the following:
· Avoid Dual Designation. By nominating different representatives to the boards of competing companies, investors can steer clear from giving a representation of misappropriation.
· Carefully Draft the Investment Documents. Despite the differences between the governing regimes, it is advisable to include corporate opportunity waivers in the investment documents. Such waivers should be carefully drafted to address a specific situation in which the investors wish to invest in competing ventures, while  too broad or general language should be avoided.
· Adopt Communication Carve-Outs. The governing investment documents should not prohibit communication of the company’s information among the investor’s representative, the investor itself, and the investor’s affiliates.
· Execute an Indemnification Agreement. Subject to the investor’s representative being held as one who acted in good faith, a well drafted indemnification agreement will reduce the representative’s exposure.
This article is intended for general information purposes only and does not constitute legal advice.
The author is an attorney at Gross, Kleinhendler, Hodak, Halevy, Greenberg, Shenhav & Co. (GKH).