Background
Two companies entered into an investment banking agreement (the “Agreement”) in which it was agreed that one company (the “Investment Banker”) would provide investment banking services to the second company. Subsequently, all shares of the second company were purchased in a transaction in which it was the second company that located the purchaser and negotiated the deal with the purchaser and implemented the deal without any involvement from the Investment Banker.
Nevertheless, the Investment Banker claimed that according to the Agreement, it was entitled to a commission from the acquisition transaction proceeds. The second company refused, and the Investment Banker filed a lawsuit against the second company for payment of its commission for the transaction according to the Agreement in the amount of US$ 1.43 million plus VAT. Our firm represented the company that was sued in the case (the “Defendant”), although the firm did not draft the Agreement.
The Judgment
The Tel Aviv-Jaffa District Court (Judge Gershon Gontovnik) denied the claim in its entirety and ruled, in accordance with the Defendant’s position, that the Agreement should not be interpreted as entitling the Investment Banker to a commission for a transaction that it did not initiate and on which it did not work. The court based its judgment on the language and structure of the Agreement, exchanges between the parties before it was entered into, commercial logic, and the parties’ conduct during the contractual period.
Although the court interpreted the Agreement restrictively in light of its economic purpose, it is suggested that in order to avoid expensive and lengthy litigation, investment banking agreements subject to Israeli law should clearly address the issue of exclusivity and entitlement to commissions. Such agreements should explicitly state whether they are exclusive or exclusive only with respect to certain parties mentioned in the agreement, together with a clear statement that in any event a commission will be paid even if the investment banker does not perform certain actions detailed in the agreement; if the agreement is not exclusive, this should be stated together with a clear statement that in cases in which the investment banker does not perform certain actions detailed in the agreement, no consideration will be paid to it.
Key Rulings in the Judgment regarding Investment Banking Agreements subject to Israeli Law
Parties entering into an investment banking agreement subject to Israeli law should take note of the following determinations in the judgment:
- Success Fee Definition: The meaning of the term “success fee” in the agreement refers to the success of the investment banking service provider and not of the service recipient, where the term ‘commission’ refers to the labor and effort of the party receiving the commission.[1]
- “Possible Transaction” Terminology: The term “possible transaction” in the agreement in question, which was mentioned in proximity to the term “success fee”, clearly links the Investment Banker’s services to a transaction that will ultimately be concluded with a third party, thereby requiring the Investment Banker’s involvement in the successful transaction.
- Deviation from Clear Language: To deviate from the clear linguistic meaning of “success fee” and “possible transaction”, the Agreement would have had to have stated that the Investment Banker would be entitled to its commission regardless of who was responsible for the success of the transaction, and this silence speaks volumes when the parties did not agree that the Investment Banker’s services would be exclusive.
- Market Practice Claims: The court ruled that the Investment Banker did not substantiate its claim that it is common for investment bankers to be entitled to transaction commissions even when they were not involved in bringing the investor/purchaser; the Investment Banker did not prove its claim that in the past there were “quite a few” situations in which it was not “directly” involved in a client’s transaction and nevertheless received its full fee – the Investment Banker failed to specify the quantity of such occurrences and did not present any witnesses or documents to support this assertion beyond its own interested-party testimony.
- Fixed vs. Contingent Payments: The language of the Agreement distinguishes between a one-time payment that is not conditional on anything (the fixed fee component due to the Investment Banker for the services it provided and the efforts it invested to study the Defendant’s business and seek investors, which the Defendant undisputedly paid) and the success fee which was contingent on the Investment Banker’s success.
- Agreement Termination Mechanism: The Agreement’s termination mechanism stipulates three conditions that must be met in order for the Investment Banker to be entitled to a post-termination success fee, including that it was the Investment Banker who introduced the investor with whom the transaction was ultimately concluded to the Defendant during the term of the Agreement. This termination mechanism is designed to protect the Investment Banker and prevent the Defendant from evading the obligation to pay a commission simply by terminating the Agreement prior to performance of a transaction with an investor introduced by the Investment Banker.
- Causal Connection Requirement: The Agreement’s termination mechanism reflects the parties’ general agreement that the Investment Banker would be entitled to a commission if there is a causal connection between its actions and the transaction. Insofar as things occur during the contractual period, the Investment Banker’s entitlement would be self-evident, and the entitlement extends to cases where the transaction crystallizes at a later stage if all provisions of the triple termination condition are met, but for this purpose clear provisions are required and the parties formulated them.
- “Tail” Mechanism: The Investment Banker called the triple condition the “tail” mechanism, but one must remember that the tail is connected to the body, and just as in the body (the contractual period) the Investment Banker must be involved in promoting the transaction, this requirement also applies for eligibility under the tail, and certainly the triple condition should not be seen as turning the essence of the success fee on its head and negating the need for the Investment Banker to have been involved in the success of the transaction with the third party.
- Pre-Agreement Negotiations: The Defendant’s interpretation is also supported by pre-agreement exchanges in which the parties negotiated the success fee and the Investment Banker did not receive exclusivity from the Defendant. The court referred to the pitch that the Investment Banker presented prior to the signing of the Agreement, email communications between the parties before the first draft of the agreement was sent, and the first draft of the Agreement that the Investment Banker sent to the Defendant in which the neither the word “exclusivity” nor any other equivalent term appears.
- Commercial Logic: Commercial logic also supports the Defendant’s interpretation, especially when exclusivity was not granted to the Investment Banker in providing its services. There is no business logic in the Defendant agreeing to pay the Investment Banker a handsome commission when the Investment Banker had no part in developing the business opportunity at issue. The Investment Banker’s interpretation leads to an absurd result lacking any business logic whereby immediately after signing the Agreement, the Investment Banker could sit idle and do nothing but still be entitled to a commission.
- Brokerage Commission Analogy: The success fee in the Agreement is a type of brokerage commission. The court cited Section 14(a)(3) of the Real Estate Brokers Law, 1996 and Sections 223(a) and 223(b) of The Monetary Law Bill Draft, 2011, ruling that the legislator had in mind the basic principle that one should be entitled to a brokerage commission only when one is the factor that brought about the conclusion of the transaction.
- Correspondence During the Term of the Agreement: The correspondence between the parties during the term of the Agreement and the Defendant’s contacts with several investment entities without the Investment Banker’s involvement also strengthen the conclusion that it was clear in real time to the Investment Banker that it had no exclusivity in providing services to the Defendant and that its entitlement to a commission was conditional on its success; it was clear to the Defendant that it had not given the Investment Banker exclusivity in commission.
- No Obligation to Involve Investment Banker: Since the Defendant was not bound by exclusivity, it was naturally not obligated to involve the Investment Banker in negotiations that the Defendant conducted with a third party whom the Defendant located on its own, and the court therefore rejected the Investment Banker’s claim that the Defendant excluded it in bad faith from the negotiations that it conducted with what turned out to be the purchaser.
Additional Matters
The court noted that since it ruled that the Investment Banker is not entitled to a success fee due to its non-involvement in the transaction, there was no need to decide additional disputes between the parties regarding whether the Agreement was breached; whether the Agreement applies at all to types of transactions that do not bring direct income to the Defendant’s coffers; and whether the engagement between the parties was terminated approximately nine months after the Agreement was signed.
Costs Award
After considering the scope of litigation that lasted approximately six years, the court awarded what are by Israeli standards very high costs in the amount of ILS 650,000 plus VAT for the Defendant’s legal fees and ILS 50,000 for the Defendant’s expenses.
The court noted, among other things, that the Investment Banker was already informed early in the case of the difficulties in its statement of claim and that the amount of costs awarded reflects the Defendant’s need to incur costs as a result of the rejection of its position in various motions during the case – a motion it filed for summary dismissal of the lawsuit and a motion to strike paragraphs from the Investment Bankers rebuttal to the Defendant’s response.
[1] In Hebrew, the words “commission” and “effort” share the same root.
