Israel might be the only modern nation state engaged in perpetual, internecine warfare to see its capital markets unaffected by bullets and tanks.
In fact, the data suggests that conflict and its markets have an inverse relationship. During the Second Intifada between 2001 and 2005, Israel recorded the fastest GDP growth in its young history. For a long time, investors have found sanctuary in the chaos, comforted by Israel’s world-leading startup ecosystem and liberal democratic commitment to the rule of law, at least at company level.
However, investors are now spooked as the Netanyahu Government announced that it will create an “override clause,” allowing a simple plurality in parliament to overturn any Supreme Court decision. Israel’s Supreme Court is the most activist in the world, seen by detractors as left-wing and overzealous and without constitutional basis. Still, foreign investors fear that such a drastic shift of power from judiciary to executive will threaten their contracts, undermine their power to dispute the actions of general partners of funds they invest in, and ultimately their portfolio companies.
Disruptive, a venture capital firm with $250 million in assets under management, claimed it will withdraw all of its funds from the country if the bill goes ahead. “Assuming the reform, which is a judicial coup, will happen, this will create economic instability in Israel,” said Disruptive co-founder Tal Barnoach.
It’s not just investors either. Two Israeli Unicorn CEOs, Tom Livne of transcription firm Verbit and Eynat Gutz of payroll firm Payapa, announced that they would withdraw all funds from Israel if the law was passed. Livne even went as far as to say he would emigrate from the country and stop paying taxes, while Bezalel Smotrich, leader of the Religious Zionism party and proponent of the law tweeted him “we are brothers, hope you come back.” Whether a pithy remark or not, it remains to be seen whether the accused “liberal elite” in the “startup nation” will follow through with their threats — or indeed if the government will stay on course.
There are two key questions that emerge here. First, does the override clause represent a constitutional coup, given that Canada and New Zealand also have one? Second, would its passing really threaten the contractual agreements of Israel’s startups and investors?
Supreme Court of Israel
To tackle the former, we must understand the role of the Supreme Court in Israel’s inchoate constitution, while comparing it to other liberal democracies. There have been multiple attempts to draft a constitution since the formation of the state in 1948, to no avail. In its place, a provisional solution of 11 basic laws that enjoy semi-constitutional status pertaining to some of the legal rights of the functions of the state such as the president, Supreme Court, and the Military, among others. It was only in 1995 that the Supreme Court themselves interpreted that the basic laws had some sort of constitutional standing.
Under the leadership of Aharon Barak, the court essentially allows itself to strike down legislation. It also created a “reasonableness test” as part of its judicial review process to prevent new or strike down existing legislation based on vague, subjective criteria. Arguably the current debate arises from a recent decision on these grounds too; Aryeh Deri, a convicted tax evader and leader of the Shas party was barred from being a minister in Netanyahu’s Government, despite being strategically essential to Bibi’s coalition. Yet despite the questionable processes in Israel’s messy attempts at parliamentary democracy, the outcomes generally produced by the activist Supreme Court are the last veneer of the rule of law. Equally, it is easy to see how the right feels angered by an emboldened “liberal elite” striking down laws at their whim, with self-interpreted power to do so.
Still, the rule of law serves as an anchor for banks and investors looking to enter the region. The fact that Israel is the only country in the Middle East with an independent judiciary has long been one of its major attractions as a hub for investment. It provides the basis of property rights and contracts being upheld, which is often stipulated as a requirement by LPs in funds in managers’ mandates. Its breakdown could see capital haemorrhage from the country, threatening its global status in markets.
Western Parallels
Israel, however, would not be alone in having an override clause. One might point to Canada’s “notwithstanding clause,” introduced by Pierre Trudeau in the 1980s that allows provincial or federal legislatures to override certain sections of the Charter of Rights and Freedoms. It has often been used by Quebec, yet in contrast to Israel’s proposition, its use can only last for five years before review by the electorate.
Moreover, Britain’s system is governed by the principle of parliamentary sovereignty, yet it also has the Human Rights Act and multiple international treaties enshrined in law. Indeed, there are limits to executive power in practice, as Boris Johnson found out in 2019 when his prorogation of parliament to push Brexit through was deemed unlawful. The UK has long-established processes and case law for judicial review, with grounds far beyond mere “unreasonableness.” In addition, it has a second chamber to review and delay legislation, further adding to oversight. Israel cannot boast such entrenched processes or constitutional clarity, which is why investors fear a slippery slope towards the breakdown of their contracts. Last week, 270 economic experts wrote to Netanyahu warning that Israel’s credit rating would decline, with foreign investments shrinking if the changes went ahead. JP Morgan further emphasised these risks in a recent paper.
Danger to the Start-Up Nation?
It might seem that the political ramifications of an override clause are more imminent than the potential breakdown of business contracts. But it’s easy to imagine the risks for investors and founders as the political stakes become higher for judicial decisions.
Israel’s political system is delicately poised by weak, adversarial coalitions where the defection of a single member of Knesset can bring down an entire Government, as we saw with the Lapid-Bennett coalition. So if you were to imagine a contractual dispute between a founder of a fintech startup, which overstated its revenues prior to an exit, the impetus of both the acquirer and the acquired would be to “get to” a critical mass of politicians, rather than focus on legal arguments. In the past, this kind of dispute would have gone all the way up the courts, before the Supreme Court made a final decision on whether the startup owes investors compensation, for example. Yet theoretically, the CEO of the startup could build a coalition of 61 MKs to support this decision’s overturning, leaving the defrauded investors with nothing.
This and many other scenarios represent a plausible fear for investors and counterparties — if an unlikely one, since the clause will likely be used for Human Rights decisions. Still, since many Israeli startups sell to US markets, and have US subsidiaries, it’s possible that capital flight could see them relocate to the states should the American Government acquiesce.
Constitutional Chaos
Israel needs a constitution. It simply cannot survive with its labyrinthine quasi-constitution any longer. Yet the shifting of power from the judiciary to the legislature would be disastrous for its financial and tech sector. An override clause that only requires a one-vote majority to overturn a judicial decision is a recipe for “tyranny of the majority.”
Appropriate checks and balances must be agreed upon if Israel wants to maintain its position as the Startup Nation. Today’s environment is too unstable and polarised to do so though. The clause is driven by one thing only: Netanyahu’s desire to avoid jail for the three corruption charges against him. He seems willing to undo all the financial and technological progress to do so. Perhaps Israelis can dream of a post-Bibi world where the courts’ powers can be finalised once and for all, but for Benjamin Netanyahu being “down and out” is simply not in his vocabulary.
Author: Tal Feingold
#Israel #MiddleEast #Netanyahu #Bibi #StartupNation
