Israel — Termination of international business

Not what you would expect 

When can you terminate, how should you terminate, and how much are you exposed?!

The outcomes of termination of a business relationship with an Israeli counterpart in Israel arise again and again as a question in many disputes between International corporations and Israeli counterparts, such as distributors or franchisees.

This is mainly because Israeli law does not include specific laws regulating or regarding distribution or franchising or other kinds of business ventures (except a relatively new agency law – referring in a limited manner to specific kinds of agency only) – and thus disputes in said regards are determined based on the general principles of contract law, the contractual and factual bases – obviously resulting in considerable uncertainty as to specific matters.

However, substantial case law, such as in the matter of Johnson & Johnson International that ended up paying compensation in the equivalent to over 1.5 Million US$, indicates the basics and threshold of what can be expected in such disputes, and, if implemented wisely, may assist in planning the disengagement or termination of a business relationship, in a manner that would be the least costly for the terminating party and minimize its exposure to a lawsuit.

In many cases, domestic parties invest many years and/or fortunes, in order to penetrate the domestic market with the foreign service or products, and to promote sales in the subject region, for the benefit of both the international corporation and the domestic party.

Nevertheless, often the international corporation decides for various reasons (such as establishing an «in-house» operation» in the target location or substituting the distributor/franchisee) to terminate the oral or written contractual relationship.

What are the legal foundations involved in such termination as per due notice of termination and corresponding compensation — if at all?

Generally, this issue arises in cases in which the contract does not specify a period of the business relationship, and, as a principle of law, contracts may be terminated by reasonable notice and subject to the fundamental good faith principle.

Contracts are not perceived as binding upon the parties indefinitely. The question is always what is the reasonable time for termination notice, and is the termination done in good faith (which is always a tricky and vague issue). Compensation is commonly awarded in accordance with what the courts find as the due notice period that may also entail compensation for damages related to said breach.

As always, there are exceptions, such as breach of trust toward the manufacturer/franchisor, that may have great impact on any due notice obligations, as far as justification for immediate termination that can be deemed immune to breach of due notice or good faith obligations.

The truth is the reasonability of the due notice varies from case to case!

However, Israeli case law is extremely sensitive to the actual reasoning of termination and how genuine it is, as opposed to asserting a tactical breach argument in an attempt to «justify» avoiding a due notice period or adequate compensation.

In this respect, in many cases simple «non-satisfaction» was denied as a legitimate argument for breach of contract, while safeguarding the freedom of contracts and the right to terminate an ongoing contract with due notice and good faith.

There are various common parameters referred to in the case law, to determine the adequate time of due notice, including, for instance, the magnitude of investment; the time required for rearrangement of business towards the new situation (including time required to find an alternative supplier product which can be marketed); the magnitude of the product/service out of the entire distributor’s business, etc.

Time and again, although not as binding rule, the due notice period seems to be in the range of around 12 months, as a balance between the right of termination and the reasonable time for rearranging the business in light of the termination. There were, however, cases in which due notice for termination was deemed as short as three months and as long as two years — but these are rather exceptional.

Another guiding point in the case law is the factor of exclusivity or non-exclusivity, as well as the concept that the longer the business relationship, the less the distributor/franchisee may expect compensation/reimbursement for investment – based on the concept that he has enjoyed the fruits of the investment.

The outcome of not providing such adequate due notice might result in actual compensation reflecting the loss of profit of the business in the last year before the termination, or for the whole term the court finds a due notice was in place, or, in cases of bad faith, even a longer period reflecting the damages.

In conclusion, given the legal regime in Israel, such exposure might be extremely considerable for any international or foreign business. It would, therefore, be vital and as a consequence of real value to plan the strategy of disengagement/termination of the business with the domestic counterpart in Israel, in advance and prior to executing it, and there are, indeed, adequate and wise strategies that may be implemented for the best result.