Taking advantage of a business opportunity by a controlling shareholder

Abstract

Taking advantage of a business opportunity by a controlling shareholder is a complex issue that has recently been discussed in courts in several separate cases. In one of the cases, within the bounds of a derivative claim (Tel Aviv-Yafo District) 36670-01-22 Oren de Lange v. Yaakov Atrakchi (Nevo 8.4.2025) (hereinafter: the “Atrakchi Case”), a motion was filed to approve a derivative claim alleging that a controlling shareholder and senior officer of the Aura Group personally exploited a business opportunity of the company and thereby violated his duty of trust.

The ruling extensively reviews a number of corporate issues which we have chosen to present in this article.

Derivative Claim Under the Companies Law

A derivative claim, as defined in Section 1 of the Companies Law 5759 – 1999 (above and hereinafter: the “Companies Law”), is a claim filed by a plaintiff on behalf of the company, for a cause of action belonging to the company. As a rule, the authority to decide on filing a claim on behalf of the company is vested in its authorized bodies. However, Chapter Three of the Companies Law creates an exception to this rule, and grants a shareholder, director, and in certain cases also a creditor, the right to file a claim on behalf of the company – where the authorized bodies have refrained from doing so, even though this serves the best interests of the company.

The need to file a derivative claim arises mainly when the cause of action is directed against the bodies themselves or against the controlling shareholder, in a manner that creates a conflict of interest between the company’s interests and their personal interests. In this context, the ruling also recognized the possibility of filing a “multiple” derivative claim – that is, a claim on behalf of a subsidiary controlled by a company in which the plaintiff holds shares.

The right to file a derivative claim is not absolute, and requires prior approval by the court, in accordance with the provisions of Section 198 of the Companies Law. In order to obtain approval, the applicant must show that prima facia three cumulative conditions are met:

1. The company has a cause of action;

2. The conduct of the proceedings is in the company’s best interest and may lead to an increase in its value;

3. The plaintiff is not acting in bad faith.

The applicant must present a minimum evidentiary basis that demonstrates an allegedly chance of success in the proceeding. However, “fragments of information” are not enough, and the burden – although prima facia – is not light, especially given the information gaps between the company and the applicant.

According to sections 194–197 of the law, a prerequisite for filing a motion for approval of a derivative claim is a prior request to the company to exhaust its rights. Only where the company has failed to take sufficient action can the motion be filed. This requirement is intended to allow the potential plaintiff to base an informed decision on a factual basis, and to allow the company to exercise independent judgment. The requirement is also intended to prevent premature or unnecessary claims and to save judicial resources.

Business Judgement Rule (BJR)

This rule was first assimilated in a ruling in a civil appeal 7735/14 Ilan Verdnickov v. Shaul Elovitz (Nevo 28.12.2016). There, three standards of judicial review of business decisions made in a company were established: the business discretion rule, the full or absolute fairness rule, and enhanced scrutiny. The ruling extensively reviews the three standards and specifies the conditions under which each of them must be included.

The business discretion/judgement rule is a legal principle intended to protect business decisions of office holders from judicial review as long as the decisions were made in the absence of a conflict of interest, in good faith, and in an informed manner. The rule is based on the recognition that business management involves risks, and that judicial review is given retrospectively and not in real time.

To the extent that the plaintiff succeeds in showing that one of the conditions is met, i.e. the decision was made in a conflict of interest, the decision was made in bad faith, and the decision was not made on the basis of a solid and reliable factual basis, then the burden shifts to the defendant to show that these three conditions are met.

If these three cumulative conditions are met, the court will refrain from examining the decision made on its merits, even if it turns out that the decision led to a less desirable business outcome for the company.

Israeli case law states that the rule does not apply where an officer is required to decide whether to file a lawsuit against himself or his associates since this is a situation that constitutes a built-in conflict of interest. This is also true with respect to the decision of a special independent committee established by independent directors to discuss the question of whether to file a lawsuit against a serving director.

Utilization of a company’s business opportunity

Section 254(a) of the Companies Law enshrines the duty of trust that an officer owes to the company, i.e. he must act in the best interest of the company and not favor his personal interests over its interests. The sub-paragraphs of Section 254(a) of the Law constitute individual manifestations of the manner in which the officer is required to act in accordance with the duty of trust that he owes. One of the sections defines the prohibition regarding the utilization of a business opportunity belonging to the company.

Among the prominent rulings, see: the Dahan,[1] Tzur,[2] Pangaea,[3] Shiloni,[4] and Hagag case.[5] The Supreme Court has not yet established a binding rule, but in some cases, it has expressed its position.

The ruling determined that the term “business opportunity” should be interpreted broadly, so that a transaction that is close in nature to the company’s business will be considered as such, even if the company was unable or did not intend to actually implement it. In the Dahan case, three alternatives were determined, one of which would result in the officer being considered to have taken advantage of a company’s business opportunity: (1) Taking advantage of the business opportunity involves using the company’s resources; (2) The information about the business opportunity reached the officer by virtue of his position; (3) There is a material connection to the company’s activities.

The Hagag case constitutes the most comprehensive ruling given on the issue, in which three tests were reviewed with the help of which it is possible to determine whether an officer took advantage of a company’s business opportunity:

1. The Consent Test: This is the main test examined on two levels:

1.1 At the first level: Examination of the company’s current field of activity as agreed upon between the shareholders and the company – the first circle includes the company’s core activity as reflected in its public reports; the second circle includes areas in which the company expects to engage in the future or related areas. The duty of the officer increases the more senior he is and is identified with the company’s activities.

1.2 On the second level: Examining the existence of an activity delimitation arrangement – an agreement made in advance between the company and the office holder that defines the areas of activity within which the office holder can operate, and which areas of activity constitute “business opportunities” for the company, within which the office holder will not operate alone.

2. Additional auxiliary tests: the competition test (whether taking advantage of the business opportunity leads the position holder to compete in the company); and the proprietary test (whether the company’s resources or information received about the business opportunity was used within the scope of the position).

Summary

The Companies Law protects the company from officers who use their power to utilize business opportunities belonging to it for their own personal gain. Alongside, it is important to design mechanisms that balance providing freedom of business action with ensuring the duty of loyalty and prudence towards the company, in order to maintain sound management and ensure its economic well-being over time.

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[1] Derived claim (Economical Civil claim) 61475-07-14 Dahan v. Dahan [Nevo] (16.5.2019.

[2] In a civil claim (Economical Civil claim) 29021-08-20 Tzur v. Empirical Hair Ltd. (Nevo 6.8.2023).

[3] Derived claim (Economical Civil claim) 20136-09-12Biton v. Pangaea Real Estate Ltd (Nevo 21.10.2013)

[4] Derived claim (Central District) 22387-05-15 Shiloni v. Weiler. Ruling 338 (Nevo 16.6.2019)

[5] Derived claim (Economical Civil claim) Hiski v. Hagag (Nevo 16.12.2021)