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Special report: Israel – Law in a war zone
4 August 2014 | By Jonathan Ames
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Israel’s conflict with Hamas-controlled Gaza is escalating. Is this a place where lawyers can still do international business?
The only certainty around Israel is that nothing is certain – the geo-political picture is evolving by the day. As one Israeli lawyer comments when asked to forecast practice trends for the next six months, “In some parts of Israel, looking six minutes ahead counts as significant forward planning”.
There has not been much to smile about in Israel or Gaza over the past month. The conflict with Hamas – which the Israeli government is still describing as an “operation” – has caused horrific carnage, with more than 800 Palestinians and 35 Israelis (mostly soldiers) losing their lives at the time of writing. While the death toll of Israeli civilians remains low, there is a growing fear that the conflict could mushroom.
The big fear is that the relatively localised battle in the Gaza Strip will cascade into something like the second intifada, which dragged on for more than two years in the early 2000s. During that conflict airline insurers withdrew cover for passenger travel to Israel, resulting in the country’s national carrier, El Al, being the only option, and that only thanks to the government effectively underwriting the risk.
As one lawyer summarises the concern, “People don’t invest and do business in jurisdictions to which they can’t travel.”
But for the time being Israel’s cadre of business law specialists is putting on a brave face, with several relating stories to illustrate that international clients retain confidence in the jurisdiction.
Alan Sacks, head of international practice at Herzog Fox & Neeman had a meeting several days ago in Tel Aviv with executives from a large Chinese state-owned investment bank.
“We were on the 22nd floor of an office building with a breathtaking view of the city and the sea,” he recalls. “Then the air raid siren sounded for an imminent rocket
attack. Our host encouraged us to move to the safe room, but the Chinese insisted on staying. They all moved to the window with their cameraphones to photograph a plume of smoke from the rocket, which was destroyed by the Israeli ‘iron dome’ defence system. They were enthralled. When it was all over I suggested we should temporarily move from our discussion of banking to whether they’d be interested in our missile technology.”
Simon Jaffa, founding partner of Barnea & Co, describes US clients as “particularly robust” in the face of rocket attacks.
“I was at dinner at a restaurant the other night with some Americans and they asked where to go in the event of an air raid. I pointed to a multi-storey car park opposite. Sure enough, there was a siren in the middle of dinner; we went to the car park and waited five minutes for the all clear, and then returned to finish our meal. Their view was that they would continue to do business in Israel.”
However, others suggest they are seeing signs of frayed nerves on the part of international clients. Erdinast Ben Nathan partner Roy Caner points to a Canadian company involved in a significant acquisition that postponed a Tel Aviv meeting owing to the conflict. But, says Caner, the client is adamant the deal will go ahead.
“The timeframe for the transaction remains the same,” he says.
Business must go on
Indeed, the overriding view among lawyers remains positive. They point out that at least three similar conflicts have flared with Hamas over the past eight years, yet the Israeli economy remains strong.
“None of those incidents has had long-lasting material impacts on the business community,” maintains Ronald Lehmann, a corporate partner at Fischer Behar Chen Well Orion & Co. “And there’s every reason to believe that will be the case again, barring a major disaster. Historically, for better or worse, there hasn’t been much of a link between the geopolitical and business environments.”
Epstein Rosenblum Maoz partner Simon Marks agrees, but adds a note of caution.
“At this stage we’ve not seen any effect on business,” says Marks. “The deals are still ongoing, but there’s a caveat over the question of time. The last relatively recent event that had an economic impact was the second intifada – from the end of 2000 to 2003. That went on for longer and created a real sense of a lack of security in the country.”
The outbreak of hostilities with Hamas interrupts a boom period for business generally, and the legal sector specifically. Israel is arguably the most lawyered country on the planet – putting even the litigious US in the shade. Estimates vary, but it is generally accepted that there is one lawyer in Israel for every 170-200 people (while the US boasts a lawyer per capita ratio of 1:290-300).
Israeli lawyers have been doing well in recent years – even during the 2008 global financial crisis that caused so much pain in other developed jurisdictions. The Israeli economy continued to grow during the worldwide downturn, essentially the result of two key factors.
First, tight conservative central bank policies were imposed by then governor Stanley Fischer, now vice-chairman of the US Federal Reserve. The Israelis learnt lessons from their own banking crisis of the early 1980s, and Fischer had ensured that Israeli banks were not involved in sub-prime lending.
Jaffa explains: “Israeli banks are now conservative and cautious. When I bought my first flat in London I got a 90 per cent mortgage from the bank; in Israel, the most you’d be able to borrow is 60 per cent – and that’s pushing it.”
The second plank of Israel’s recent economic success has been the creation of a vibrant technology sector, with start-up businesses attracting foreign investment and overseas buyers.
“Israel has become a mini-Silicon Valley,” says Jaffa. “There’s an entrepreneurial culture – every university graduate wants to found a tech business. And that has drawn the attention of the international tech companies. They all have a massive presence in Israel, looking for the next big thing.”
M&A activity – while still involving US and European companies – is increasingly being driven by Chinese buyers. They are on the march to acquire top-drawer Israeli technology start-ups which, says one Tel Aviv lawyer, the Chinese reckon they can pick up on the cheap.
Perhaps the biggest recent deal for the region was cut in May, when China’s Bright Food paid London-based private equity house Apax Partners $960m (£565m) for a 56 per cent stake in Tnuva, Israel’s biggest food producer, in a bid to help expand the Chinese dairy market.
That may well be part of the stated rationale, but Israeli lawyers see another motive.
“The Chinese aren’t interested in dairy per se,” argues Jaffa, whose firm advised on Israeli law aspects of the deal. “They haven’t got an insatiable appetite for cottage cheese and yoghurt – they are interested in Tnuva’s technology. The Chinese want to use that technology in their domestic market.”
Jaffa maintains that as recently as two years ago, deals involving Chinese parties “were unthinkable” but, he says, “there has recently been a marked increase in Chinese business activity in Israel”.
The soaraway tech sector
The creation of a hotbed of technological innovation in Israel is an ironic benefit of years of military conflict.
“The brightest kids are trained by the military in the use of ultra-sophisticated computers and electronic warfare,” maintains Sacks, “and that’s then spun off into civil technology.”
A recent example is Waze, a geographical navigation application for smartphones that Google bought last year for $1.3bn. The internet gaming sector is also growing in Israel, but perhaps more important, according to Caner, is foreign interest in cyber security businesses in the country.
That trend was highlighted back in March, when US private equity business Francisco Partners scooped up Israel’s NSO Group Technologies for $120m. Caner, whose firm acted for NSO, describes the move as Israel’s biggest private equity deal of 2014 so far.
“We envisage many more deals like this over the next year,” forecasts Caner, “with foreign investors picking up Israeli start-ups after they have increased their business a bit.”
In addition, he predicts a general increase in cross-border M&A outside the technology area. And outbound investment is healthy, with Israeli companies having the cash to acquire US and European companies.
Contributing significantly to Israel’s booming M&A market has been recent domestic legislation aimed at smashing the historic stranglehold of several mega-conglomerates on the country’s economy. Last December saw implementation of the Law for the Encouragement of Competition and Reduction of Concentration, which is essentially monopoly-busting legislation combined with a prohibition on multi-layered public companies.
Israeli conglomerates have a grace period to meet the legislation’s requirements by divesting elements of their businesses. Indeed, the Tnuva-Bright Food deal is a high-profile illustration of the impact of the new law.
“The legislation gives companies four years or so to divest and flatten their pyramid structures,” explains Caner. “That will create a lot of legal work – we’re advising clients not to wait until the last minute to have a rushed fire sale.”
But it is not just the law that is fuelling the M&A market. Lawyers suggest that piles of debt have also contributed to the rush by conglomerates to sell elements of their business.
“These businesses borrowed heavily to create their corporate mountains,” says Sacks.
He points to the historic informal cartel around Israel’s telecoms sector as an example. There were three major mobile phone operators in the country, which were effective cash cows for the groups owning them. But in the past two years the communications ministry has introduced much wider competition, causing consumer rates to plummet.
“The companies suddenly found themselves without the cash they needed to service their debts,” says Sacks. “They had artificially propped themselves up and quickly had to divest assets.”
Apart from the obvious benefit to the legal profession from the boost to M&A business caused by a dismantling of Israeli conglomerates, lawyers generally take the view that wider choice in the market is a positive.
“Historically, the Israeli economy has been thought of as a club,” adds Sacks. “The major players – the banks and industrialists – met at cocktail parties twice a week. It’s a cliché but one that has a large element of truth behind it. So it is good to shake up that situation.”
A potentially bigger and longer term factor making an impact on the Israeli economy and legal profession is the discovery five years ago of the Leviathan and Tamar gas fields, which lie 50 to 80 miles off the coast of Haifa in the Mediterranean.
Their discovery is already being touted as a game-changer, not just because the reserves will turn Israel from an energy importer to a significant exporter, but also because it could potentially have an impact on the role and influence of the Persian Gulf countries, which until now have had the Middle East fossil fuel market sewn up.
Tamar – the smaller of the two fields – contains an estimated 8.5 trillion cubic feet of natural gas, while Leviathan lives up to its name by containing an estimated 18 trillion cubic feet.
“These discoveries have got every-one excited,” comments Marks. “We’ve had a strong energy practice at this firm, which has historically focused on renewables. But now it’s shifting towards conventional energy as well. There’ll be a lot of activity in the sector in the coming years.”
But renewables are not being completely sidelined, according to Caner.
“A lot of what we are doing is in the clean energy sector,” he says, pointing out that large foreign companies such as France’s EDF remain active in the sector.
There is no denying that the big gas field discovery has played a significant role in whetting the appetite of foreign law firms for the jurisdiction. Until about 18 months ago that hunger would have been only partially sated by forming close referral relationships with local Israeli firms.
Those firms have essentially stuck to the representative office model. However, the biggest international presence on the ground in Israel comes in the form of Greenberg Traurig. The Miami-based firm has allocated some 11 lawyers – many of whom are Israeli-qualified and recruited locally – to its Tel Aviv outpost.
Meanwhile, there are at least two firms that fit neither model. Asserson was launched in 2005 as an overseas firm based in Tel Aviv, providing English and US law services. It now has 20 lawyers on board. Then last year – in a further indication of increasing Chinese interest in Israel – that country’s second largest law firm, Yingke, took over local practice Eyal Khayat Zolty Neiger & Co.
For the time being, local lawyers maintain the creeping influx of English and US law firms has a neutral or positive influence on the
Israeli legal profession.
“They haven’t changed the market dramatically,” maintains Gross Kleinhendler Hodak Halevy Greenberg & Co capital markets partner Shachar Hadar. “When we analyse the competition we still mostly focus on the other big domestic firms. We don’t really see the foreign firms as real competitors.”
Sacks typifies the more positive outlook on the presence of global practices.
“The international firms that have set up shop in Israel are now providing far more work to local firms than they used to,” he says.
He dismisses suggestions that the global players will eventually start to nibble into local law firm profits.
“It doesn’t make economic sense for them to try to compete with us on Israeli matters,” he says. “If you look at what Israeli banks expect to pay for an hour’s legal advice, London lawyers wouldn’t get out of bed for that.”
Others are more cautious.
“The jury is still out on how the reformed rule will affect the relationship between local firms and global practices,” comments Lehmann. “At the moment everyone is painting it as a mutually beneficial opportunity. The foreign firms have been open in approaching the Israeli firms, looking to present themselves as potential partners and not as competitors. They’ve been upfront about not appearing in Israeli courts and not being able to do local real estate transactions. Where there’s potential friction is over outbound transactions.”
Local firms acting for Israeli clients in transactions abroad have usually taken the role of deal counsel, co-ordinating the instruction of foreign counsel. But now some of those foreign firms are in Israel, they potentially offer a one-stop service to Israeli corporate clients.
“They might start to argue that having two teams at two firms on the same deal is not efficient,” says Lehmann. “That’s an issue people have so far trod fairly lightly around. The foreign firms are sensitive to that point because those that are here are looking to build relationships with the local firms as a source of work. We’ve not yet seen how that potential friction will play out. And that’s partly because those foreign firms that are here are here in relatively small numbers.”
But some already see early signs of growing antagonism.
“We’re beginning to see a little friction between the foreign and local large firms,” maintains Marks. “The foreign firms are pitching for large outbound work done by large Israeli corporates with an international footprint. Relations have strengthened between the foreign firms that have offices here and local Israeli businesses. Those corporates don’t necessarily need an Israeli lawyer involved on a large outbound deal. So it isn’t necessarily a case of things being better for everyone.”
Pain or petrodollar darling?
However, geopolitics could again play a role, as it so often does in the region. International firms have spent much of the past decade building significant practices in the Persian Gulf area, not least because of that region’s still-prominent position in the world’s petrodollar economy. Promoting a large presence in Israel could cause firms difficulties with Arab rulers from Riyadh to Abu Dhabi to Doha, so they may be happy to keep a low profile in Tel Aviv for the time being.
Of course, if Israel becomes a global energy superpower on the back of Leviathan, that reluctance could quickly evaporate.