Corporate Governance Manual for

Palestinian Family Firms

Prepared by a technical team commissioned by the Palestine

Governance Institute

March 2014

معهد الحوكمة الفلسطيني

Palestine Governance Institute (PGI)

PGI was established in April 2011 as an independent non-governmental

organization, registered at the Palestinian Ministry of Interior. PGI's mission is

aimed at promoting commitment to modern corporate governance, both in business

firms and relevant public and private sector institutions. Compliance with

prevailing Palestinian corporate governance codes and over-riding legal

frameworks is expected to improve the investment climate, raise the

competitiveness of Palestinian firms, and foster higher business ethics.

PGI does not engage in political debates, nor advocate the agendas of any political

groups.

Board members (by alphabetical order)

Dr. Atef Alawneh

Dr. Akram Daoud (Chairman)

Mr. Hani Dajani (Treasurer)

Mr. Jamal Jawabreh (Secretary-General)

Mr. Omar Hashem

Mr. Mohammad Hassouneh

Mr. Jamal Hourani

Ms. Abla Ma'aya'a

Mr. Asma'a Masri

Mr. Rami Sabe'

Mr. Faisal Shawwa (Deputy Chairman)

PGI Director

Dr. Hisham Awartani

Primary contributors of material in the Manual

Dr. Gassan Khaled Professor of Commercial Law at An-Najah National

University - Nablus

Dr Sameh Al-At'out Professor of Accounting at An-Najah National

University - Nablus

Reviewers of the Manual during various phases

Dr. Amin Dawwas Professor of Commercial Law at the Arab American

University

Dr. Othman Takrouri Professor of Commercial Law at Al-Quds University

Mr. Jamal Melhim Country Director, Talal Abu Ghazaleh Office in

Palestine

Mr. Mohamad Arafat Certified Auditor - Arab Consultants Office - Nablus

Mr. Tareq Raba'iah Legal advisor – Companies' Supervision Dept. -

Ministry of Economy

Dr. Hatem Sarhan Director–General, Companies' Supervision, Ministry

of Economy

General Coordinator

Dr. Hisham Awartani Executive Director, Palestine Governance Institute

Sponsors of this Activity

Center for International Private Enterprise (CIPE)

Arab Fund for Economic and Social Development

Contact information

Palestine Governance Institute (PGI)

P. O .Box 443 - Nablus, Palestine

University Str. – Abu Ra’ad Blg. (3rd Floor)

Tel: (00970) 9 2385405

Fax: (00970) 9 2338218

E-mail: info@pgi.ps

Website: www.pgi.ps

Palestine Governance Institute

Contents Page

1. Introduction …………………………………………………………………….

2. Governance during the registration phase of General Ordinary Companies…..

3. Legal framework relative to General Ordinary Companies……………….…..

4. Legal framework relative to Limited Ordinary Companies……………………

5. Legal framework relative to Private Shareholding Companies………………….

6. Regulatory provisions relative to the establishment of Private Shareholding Companies..

7. The relative merits of different types of companies…………………………….

8. Prospects of transformation in the legal framework…………………………….

9. Governance rules associated with administrative affairs………………………..

10. The General Assembly of an Ordinary Company ………………………………

11. The Board of Directors of an Ordinary Company……………………………….

12. The advisory committee of a Family Company…………………………………

13. The executive management of an Ordinary Company………………………….

14. Management of a Private Shareholding Company………………………………

15. Transfer of equity and senior management………………………………………

16. Sustainability of the Company…………………………………………………..

17. Interests of other stakeholders……………………………………………………

18. Governance in the financial management of a Family Company………………..

19. Internal control system…………………………………………………………..

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20. Human resources management………………………………………………….

21. Assignment of tasks and responsibilities………………………………………..

22. Petty cash………………………………………………………………………..

23. Disbursement mechanisms………………………………………………………

24. Internal audit……………………………………………………………………..

25. External audit…………………………………………………………………….

26. Audit Committee…………………………………………………………………

27. Profit distribution policy…………………………………………………………

28. Personal withdrawals…………………………………………………………….

29. Documentation Chain ……………………………………………………………

30. Risk management………………………………………………………………..

31. Transparency and disclosure…………………………………………………….

32. Evaluation………………………………………………………………………..

33. Enforcing accountability…………………………………………………………

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1- Introduction

Since its inception in 1994, the Palestinian National Authority has witnessed

material transformations in the social and ideological values prevailing in the

Palestinian society, especially in the aftermath of its transition from an armed

resistance movement in to a civilian and democratic regime governed by rules,

regulations and accountability for all. These transformations have reflected

significantly and progressively on all sectors of livelihood, especially with regard

to transparency and integrity in the legislative system, local elections, freedom of

press, freedom of expression in conferences and workshops. The democratic

environment has also reflected positively on the accessibility to form civil society

institutions which are able to communicate directly with various international

entities in order to acquire necessary funds to finance their activities.

One of the most important aspects of success in the democratization process is the

growing attention given to issues of governance, whether in government

institutions or in civil society organizations. This interest has been manifested in

many ways, most importantly in the commitment to fostering rule of law,

regulations and behavioral codes. This includes institutions operating in the

political, social, educational fields, as well as those operating in the economic and

financial fields.

This manual relates to governance in all types of commercial firms except for

public shareholding companies, especially those listed on the Palestine Stock

Exchange. Such companies are subject to legal and organizational frameworks

other than those applicable to other forms of business entities.

1-1 Transformations in corporate governance and economic institutions

The size of the transformations which occurred in the area of corporate

governance within the business community has been one of the most

practical manifestations of the democratic transformation in Palestine. This

shift has been apparent in different shapes, the most important of which is

the formulation of modern laws which have replaced some of the old laws

inherited from decades ago, the establishment of regulatory and service

institutions focusing on private sector affairs, as well as the formulation of

behavioral codes related to various aspects of governance.

One of the most important steps that Palestine has witnessed in relation to

modernizing corporate governance in its firms and private sector at large,

was the preparation of the Corporate Governance Code governing companies

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listed on the Palestine Stock Exchange (2009). This step was succeeded one

year later by the preparation of the directory of rules and best practices

relating to corporate governance in commercial banks (2010). Since then,

these two codes have contributed significantly towards a qualitative shift in

the culture of governance, especially for those entities targeted by the two

codes.

In practical terms however, these two codes appear to have had no

significant tangible impact on the level of governance in companies and

other targeted entities which are not listed on the Stock Exchange. The main

reason for that is probably the unavailability of a well defined package of

regulations and instructions which would provide the owners and managers

of these companies with the required actions to do or not to do for the

purpose of modernizing governance practices in their organizations. Hence,

the urgent need to fill this gap, especially in relation to family–owned

businesses (FOB), has become of paramount significance to the Palestinian

economy.

1-2 Objectives of the Manual

The main objective of this Manual is to provide a package of regulations and

instructions which are believed to have a cumulative effect in the upgrading

of commercial entities not covered by the Palestinian Corporate Governance

Code and the Banking Governance Directory. Targeted entities include sole

proprietorships, ordinary companies (general and limited) and private

shareholding companies. It is well understood that the above-mentioned

entities are of extreme significance to the Palestinian economic and social

structure, as they account to more than 98% of the total number of

commercial entities. As such, they are the biggest employer of labor force

and the largest contributor to Gross Domestic Product. Notwithstanding the

variance in the legal framework of these entities, they do share a common

feature in that they are mostly family structured, whether in terms of

ownership or executive management.

In view of the huge differences between entities targeted in this manual,

whether in size, type of work, number of equity holders or legal standing, it

is more likely that the top executives in most of these entities may feel that

some or most of the provisions of this Manual are not pertinent to them for

various reasons. Indeed, this may appear to be true in certain cases, such as

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in a small firm where the size of business does not permit the adoption of

some or most of the provisions of this directory.

There is certainly no definitive answer to such perceptions, yet business

leaders are strongly advised to acquire deeply–entrenched convictions that,

at least in principle, the long term interests of their firms require that they

exert every possible effort to apply the provisions herein, and not to seek

excuses for postponement for reasons which may prove to be inaccurate.

Specifically, the small size of the company should not be taken as a

conclusive excuse for its owner not to modernize governance in his firm.

1-3 Distribution of business firms by type of legal entity

From a legal standpoint, there are several types of commercial entities in

Palestine. The following table presents the relative significance of these

types in terms of their numbers as at the end of January 2014.

Distribution of Firms by Legal Classification

(End of January 2014)

Type of company Number

Sole Proprietorships* 108,200

Local companies-total** 20,392

Private shareholding 12,996

Ordinary -general liability 7,146

Odranidr -limited liability 27

Public shareholding 100

Non-profit 103

Civil 20

Companies on the folding list 6000

Foreign companies-total** 246

Private shareholding 200

Public shareholding 27

Ordinary- general liability 16

Non-profit 3

Sources:

* Palestinian Central Bureau of Statistics

** Companies Registration Department-Ministry of Economy

Despite the fact that it would be difficult to identify the exact nature of the

family firms, yet it is certain that the absolute majority of sole

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proprietorships, ordinary companies and private shareholding companies are

all of a family dominated nature, whether in terms of equity or management.

It should be noted, however, that the family nature of a company as per these

criteria can also exist in public shareholding companies, including those

listed on the Palestine Stock Exchange. Yet the provisions of this manual do

not apply to such companies, as they are liable to other legal frameworks, as

stated earlier.

1-3 Legal basis for the provisions of this manual:

There are three sources for the provisions listed in this manual, namely the

following:

1. Jordanian Companies Law No. (12) for the year 1964, and amendments

thereof.

2. Companies Regulations Ordinance No. (13) for the year 1965.

3. Palestinian Corporate Governance Code issued in 2009.

2- Governance during the registration phase of General Ordinary Companies

The General Ordinary Company is a company composed of a minimum of two

persons, operating under a given address and engaged in commercial activities. The

partners of the company are fully liable in their personal and joint capacity to the

full debt of the company. In such a company, a partner's share is transferable only

by approval of the partners.

The vast majority of commercial entities are often initiated by a single founding

family member, often in cooperation with one or more of his sons, brothers or

relatives. Hence, the strong bonds among owner/relatives do not make them

apprehensive of the underlying risks of their mutual and unlimited liability.

Hereunder are the most important legal and organizational procedures associated

with this stage:

2-1 The registration application and the contract of association are presented to

the Companies Registrar. It is advised that the contract of association be

signed in front of the notary public or the companies' registrar.

2-2 In case the companies' registrar refuses to register such a company, the

applicants may appeal to the Minister of Economy, who is required to decide

on the registration application within a period not exceeding 30 days. Should

the Minister reject the application, such a decision can be contested at the

Supreme Court of Justice within 60 days from the date of rejection of the

application by the Minister.

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2-3 If the Companies Registrar does not respond to the registration application

within one month, then the application is considered rejected. It is possible

however, to challenge the rejection decision at the Supreme Court of Justice

within 60 days of expiry date of the one month period of submittal of the

application.

2-4 The contract of association of the General Ordinary Company must be in

written form, or else it becomes null.

2-5 The contract of association of the General Ordinary Company must include

the following minimum information:

Name of company, company's Head Office, objectives of the company,

names of partners, their addresses, nationality, equity holding of each

partner, names of authorized signatories on behalf of the company, and

duration of the company if it is of a limited timeframe.

2-6 In addition to the information mentioned under item 2-5, it is advisable to

attach a statement explaining the repercussions on the company in the event

of the demise of a partner.

2-7 According to the prevailing Law, it is permissible for a legal (non-personal)

entity e.g. another company, to be a partner in the General Ordinary

Company, provided that it operates in the same business sector. However, in

view of the unlimited liability nature of the partners, companies are not

advised to venture with personal entities in such companies.

2-8 It is possible for the founders of the company to identify the name of the

executive manager of the company in the contract of association.

Alternatively, they could agree to appoint the manager in a subsequent

agreement between them outside the context of the contract of association.

2-9 If the contract of association or any subsequent agreement does not specify

the name of the person authorized to manage the company, then any partner

is authorized to act on behalf of the other partners in running the company's

business affairs in order to achieve its objectives. In this case, the other

partners retain the right to object to his action before it happens; otherwise

all partners will become liable for such actions.

2-10 Upon paying of the registration fees and registering the company in the

special register for such type of companies, the companies' registrar should

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publicize the announcement of registration of the company in the Official

Gazette. It is advisable that the announcement includes all important

information stated in the contract of association. The company may not

commence its activities before the declaration of its contract of association in

the companies' register held by the companies' registrar.

2-11 Any amendments to the contract of association should be processed through

the same aforementioned procedures, where an application to that effect

should be presented to the companies' registrar within one month of the

occurrence of such amendments.

2-12 Upon the approval of the companies' registrar, any concerned party may

have access to the register upon payment of the approved legal fees.

2-13 The aforementioned provisions are applicable to the registration phase of the

Limited Ordinary Company with consideration to its characteristics of

privacy.

3- Legal framework relative to General Ordinary Companies

3-1 The partners are personally and jointly liable for all company debts. This

means that in case the company fails to repay its debts, any creditor has the

right of recourse to all partners in their personal and joint capabilities in

order to claim debts owed to him by the company.

3-2 Recourse to the partners to settle the company debts is not permissible

before recourse to the company, and can only be enforced if the liquidated

assets of the company were determined to be insufficient to repay its debts.

3-3 The partner who settles the debts of the company has the right of recourse to

the other partners proportionate to the amount he paid on each behalf. If one

of the partners is illiquid, the other partners shall share the burden in

proportion to the equity share of each one of them.

3-4 In the case of a demise of a partner, his heirs become jointly liable for his

debts within the limits of their inheritance.

3-5 Any provision in the contract of association relieving the partners from their

joint liability to others is considered void.

3-6 Any withdrawing partner shall remain liable for the company debts up to the

date of his withdrawal unless there a different agreement is arrived at

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between the creditors, the incoming partner, and the withdrawing partner,

provided that the incoming partner replaces the exiting one.

3-7 The new partner shall be liable only for the company debts which accrued

since his joining date, unless there is clear agreement to the contrary.

3-8 The equity holdings in a partnership company are not negotiable by way of

commercial transactions. Therefore, it is not permitted for a partner to

transfer his equity to someone else except by approval of all partners.

3-9 An exception to the above provision is allowable if the articles of association

provide for the transfer of equity by approval of the majority of the owners.

3-10 A creditor to one of the partners of the company may, by means of court

order, block the partner's (debtor) share in order to secure the repayment of

his debt. It is also permissible to place a pledge on the partner's share upon

liquidation of the company.

3-11 The partner acquires the state of a merchant upon entry to the company.

There are several repercussions to that, one of which is that the death of a

partner or the declaration of his bankruptcy leads to the dissolution of the

company, except where the partners have agreed to the contrary.

4- Legal framework relative to Limited Ordinary Companies

The Limited Ordinary Company is one which includes two types of partners: those

who are personally and jointly liable for the debts and obligations of the company,

and those who have a limited liability to the extent of their equity holding in the

company. There are several legal reflections to that:

4-1 The limited liability partner does not have the right to participate in the

management of the company; otherwise he will be liable for all its debts

during the period of his participation in its management.

4-2 The limited partner is allowed access to the books of the company and to

inquire and discuss the affairs of the company with the other partners.

4-3 The transfer of the equity holding of the limited liability partner or the entry

of new partners is carried out by approval of the general liability partners or

a majority of them (if the contract of association of the company permits

that), without conditional consent of the limited liability partners.

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5- Legal framework relative to Private Shareholding Companies

A private shareholding company is one in which shares are not offered to the

public. The liability of the partners in such a company is limited to the extent of

their equity in the company.

5-1 The contract of association and the internal memorandum of association of

the private shareholding company should comply with the following:

The number of its members must not be less than two and not more than

fifty.

The right to transfer its shares is subject to certain conditions.

Subscription to its shares is not made through public offerings.

5-2 Precaution against the possibility of a drop in the number of partners to less

than the minimum permissible could be defined, possibly by adding the

following text in the contract of association and the internal memorandum:

"If the number of partners in the company drops to less than the minimum

required, then the remaining partner should rectify the discrepancy within a

maximum period of one month from the date of occurrence of the shortage;

otherwise, the company is considered to be dissolved by law".

5-3 In order to handle the possibility of an increase in the number of partners

above the maximum permissible, it is advised to add the following phrase in

the internal memorandum of association:

"In case of the death of one of the partners and the transfer of his share to his

heirs result in excess of the maximum permissible number of partners, the

heirs should rectify the situation in accordance with the Law by choosing

from within them the heir(s) to whom the share of the deceased shall be

transferred in order to keep the number of partners within the required legal

limit".

5-4 The liability of the partners shall be limited to the value of their subscribed

shares.

5-5 The Companies' Registrar does not have the right to conclude the registration

procedures before verifying that the partners have actually paid at least 25%

of the company's declared share capital.

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5-6 It is not permissible to establish a private shareholding company through

public offering, nor the company is allowed to issue commercially

negotiable shares and bonds.

5-7 The capital of the private shareholding company is divisible into shares of

equal value. These shares are non-negotiable commercially, subject to the

restrictions stipulated in the internal memorandum of the company.

5-8 The transfer of shares between the partners does not require any one's

approval, unless the contract of association specifies otherwise. The

restrictions stipulated on the transfer of shares to non-partners on the other

hand, need to be observed.

5-9 The company is not dissolved upon the death of a partner or the declaration

of his bankruptcy, since the financial liability of the company is independent

from the financial liability of the partners.

6- Regulatory provisions relative to the establishment of private shareholding

companies

The registration of a company as a private shareholding company has many

advantages which are mostly connected to the separation of management from

ownership, albeit to a limited extent. This in fact opens the door to a wide range of

improvements in the level of the company's governance, enhances its growth

potential, and ultimately improves its competitiveness. In addition to these

advantages however, the transformation into a private shareholding company could

be a consequence of the progressive increase in the number of partners due to death

and transfer of shares to an increasing number of heirs. This type of company has

the following legal characteristics:

6-1 The capital of a private shareholding company is the only security for its

creditors, hence the liability of the partners is limited to the extent of their

share in the capital.

6-2 The Companies Law No.12 for the year 1964 requires that the minimum

capital of the private shareholding company is ten thousand Jordanian Dinars

or its equivalent. However, in view of the fact that the real value of this

amount has depreciated significantly over the years, it is advisable that the

Companies' Registrar stipulates a higher minimum capital, possibly

commensurate to the actual requirements for the operation of the company.

Otherwise, he has the right to reject the company's registration application.

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6-3 In accordance with the Law, a minimum of 25% of the capital should be paid

upon its registration, and the remainder is to be paid within a maximum of

four years. The Companies' Registrar may require that the remainder capital

be paid within a shorter period of time, or that it is fully paid upon

registration.

6-4 The Companies Registrar is expected to exercise his right to monitor the

withdrawal transactions in the company's bank account in order to verify that

the management of the company does not withdraw the deposited capital

within a few days from commencing operations.

6-5 The Companies Registrar has the right to inspect the capital distribution

pattern between the partners in order to ascertain that one partner does not

control the companies resources. This may happen in the event that the other

partner's shares are small enough not to give them an effective role in the

management of the company, which represents a material violation of

governance principles. Furthermore, this will unveil any attempt to establish

a fictitious company under the cover and protection of a limited liability

company.

6-6 The name of the private shareholding company should reflect its objectives.

The phrase "Private Shareholding Company" must be added to the name in

order to alert the public to the nature of the partners liabilities.

6-7 The contract of association of a private shareholding company should

contain the following information:

Name of the company and its objectives.

Limited liability nature of the partners.

Nominal capital value divisible into shares of equal value, each not less

than one Dinar and not more than 10 Dinars.

Specifying the number of partners, which should range from 2-50

persons.

Restricting the right of transfer of shares.

Duration of the company (if that is fixed).

Address of head office of the company.

Method of payment of installments, in case payment of shares is by

installments.

Method of distribution of dividends.

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Number of shares needed to qualify a partner for board membership.

Any other data reinforcing governance and transparency.

6-8 The process of registration of the private shareholding company passes

through the following phases:

6-8-1 Submittal of an application accompanied by contract of association and

internal memorandum of association. The contract of association and the

internal memorandum of association must be signed by the founders in front

of a lawyer, while the application must be signed in front of the Companies

Registrar or a notary public.

6-8-2 Submittal of proof of deposit of the required percentage of cash shares of the

capital of the company at one of the banks in Palestine, and providing an

estimate of the shares in kind, and stating that in the contract of association

and in the internal memorandum of association.

6-8-3 Upon presentation of the capital in-kind, the Companies Registrar is obliged

to assign an appraiser or more, paid for at the expense of the company, in

order to appraise the money value of the assets in-kind.

6-8-4 The Companies Registrar studies the application and submits his

recommendation in this connection to the Minister.

6-8-5 Before approval of the registration of the company, the Minister has the right

to ask the founders to introduce specific amendments to the contract of

association and the internal memorandum, as deemed necessary by him.

6.8.6 The Minister is supposed to decide upon the registration application within

two months of submittal; otherwise the application is considered rejected.

6.8.7 The name of the registered company is publicized in the official gazette; the

announcement includes all basic information stated in the contract of

association.

7- The relative merits of different types of companies

Every type of the legal status of companies has specific features which would make

it most appropriate for incoming partners. In general, it is assumed that the

following remarks are taken into consideration upon selection of the legal status of

the company at the foundation stage.

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7.1 The risks associated with "general ordinary companies" are the highest

amongst all other types of companies, on account of joint and unlimited

liability of the partners'. On the other hand, it is this feature which avails this

type of companies the distinguished confidence they enjoy amongst traders

and banks.

7.2 The Ordinary companies enjoy tax advantages by law, as each partner is

allowed a personal tax exemption amounting to NIS 30,000.

7.3 The presence of joint and personal partners in a limited ordinary company

enhances the credibility of such companies with other associated parties.

This type of company, however, may include limited liability partners;

accordingly, it possesses a greater potential to solicit investments.

7.4 The private shareholding companies are characterized by the limited liability

nature of their partners to the extent of their equity in the company, without

the diminution of their right to participate in its management. Furthermore,

the establishment of this type of company does not entail complicated

procedures as those required in public shareholding companies. The limited

liability nature of the partners, on the other hand, may undermine the

confidence level in this kind of companies and reduces its credit worthiness,

especially that its minimum required capital (ten thousand Jordanian Dinars

or its equivalent) is relatively low when compared to public shareholding

companies (amounting to two hundred and fifty thousand Jordanian Dinars

or its equivalent). This reflects negatively on the confidence level towards

this kind of companies.

8. Prospects of transformation in the legal framework

Most of the family companies get exposed, especially in later stages of their

operations, to complex changes in the structure of their ownership and

management. Such developments may necessitate corresponding changes in their

legal structure in order to reinforce their competitiveness and productive capacity.

The management of the company is therefore advised to consider taking necessary

measures in order to meet the requirements for such a change in a manner that

fulfills the interests of their owners. The following are some thoughts in this

regards:

8.1 There are strong reasons and motives which may require the transition from

a Sole Proprietorship to an Ordinary Company, where partners could be

family or non-family members. Therefore, one of the most important pillars

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of governance is to formulate an internal memorandum of association for the

company, in line with the guides mentioned earlier in this manual relative to

the type of company selected.

8.2 Likewise, there could be strong interests for the Ordinary Company to

transform into a private shareholding company. However, there are

important caveats which may occur due to the likelihood of a substantial

increase in the number of equity holders as a result of the transfer of

shareholdings to a relatively large number of heirs in the case of death of one

of the owners. In such cases, the number of partners may exceed 50 partners,

thereby constituting a clear violation of the Law.

8.3 The transition into a Public Shareholding Company could be one of the best

options for some of the family companies, assuming of course that the

requirements stipulated by law are met. It is important to note here that the

transition into a public shareholding company does not necessarily nullify

the family nature of the company, as evident from the practical experience in

Palestine and other countries.

9. Governance rules associated with administrative affairs

The major factor leading to the delinquency or non-performance of family

companies is perhaps the mistakes undertaken by senior management with respect

to appointment and promotion of employees. The most important mistake lies in

the excessive weight given to family ties with respect to hiring, salary scale and

other financial bonuses. What makes this phenomenon even more risky is that the

senior management of the company does not, in many cases, attend to proper

practices when monitoring and evaluating staff from among family members. In

order to avoid the above shortcomings, the management of the company should

exhibit a clear commitment to the following principles and provisions:

9.1 It is in the family company interest to appoint employees on professional and

competitive grounds. This should apply in particular to senior positions in

the company.

9.2 It is very important for all partners to abide to the set principles of salary

determination and annual increments, and in accordance with market norms

rather than merely fulfilling the financial needs of respective family

members.

9.3 All employees must be equally held accountable upon negligence, or when

committing offenses against the company's interests and assets. It is

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advisable that the employees are also informed about the measures taken

against violators, including family members.

10. The General Assembly of an Ordinary Company

The Companies Law states that the General Assembly of the company is the

ultimate source of authority for its administrative bodies, especially the board of

directors and its committees. The existence of a General Assembly in all types of

companies is therefore a very important step towards achieving administrative

stability and enhancing commitment towards good governance. The importance of

this role increases in the light of the increase in the number of partners (by way of

inheritance), such that it becomes impossible to reach a consensus on major

company decisions.

In view of all of this, the senior management of the company is advised to take the

following necessary precautions:

10.1 It is advisable to include in the internal memorandum of the family

company, regardless of its legal form, sufficient details with respect to

conditions and qualifications of membership, and the regulations which

govern voting mechanisms. It is also helpful in this case to refer to the

Companies Law and the Governance Code.

10.2 One of the main issues relating to the administration of the General

Assembly meetings is the treatment of the consequences relating to probable

variances in the partners' share in the capital of the company. In accordance

with the provisions of the Law, it is assumed that the number of votes

enjoyed by the equity holder is commensurate to the number of shares (i.e.

equity holding) in the company. This principle should also be observed in

relation to voting rights for the selection of board members.

11. The Board of Directors of an Ordinary Company

One of the most important pillars of modernizing governance in all types of

companies is the activation of the role of the Board of Directors in the company,

rather than allowing the dominance of a single individual or party on its

management. It should be noted that the prevailing Companies Law does not

necessarily require the existence of a Board of Directors, except in public

shareholding companies and in private shareholding companies in which the

number of partners exceeds 20. In spite of that, however, the Law does not ban or

discourage the set-up of board of directors in ordinary companies. It is therefore

15

assumed that some of the basic issues relating to the board of directors are dealt

with in the internal memorandum of association as follows:

11.1 Number of members of the Board

It is advisable that the minimum number of members is set at three, regardless

of the size of the company. The number should be increased to around five in

large family companies.

11.2 Acquiring membership

The best method to acquire board membership is through elections in the

general assembly, where it is assumed that all members participate, regardless

of the size of their shares or family ties. It is obviously understood that the

election process at the early stages of the company is done by means of

acclamation, most probably due to the fact that the number of participants is

few and does not allow real elections. Nevertheless, it is better to include a

clear text in the internal memorandum fostering the principles of democracy in

the elections of the board of directors of the company.

11.3 Specialized committees emanating from the Board of Directors.

There are no specialized committees emanating from the board of directors in

the vast majority of family companies. However, due to the sensitive role

which they could play, forming such committees is considered as one of the

requirements for the modernization of governance in family companies. It is

specifically advised to form an audit committee emanating from the board of

directors, and that it be assigned the responsibility to supervise the activities of

the internal and external auditors.

11.4 Documentation of the Board meetings.

In order that the Board of Directors and its committees fulfill their role, it is

important that they comply with accredited procedures with respect to some of

the main indicators, especially as follows:

Preparation of the business agenda of the meeting in advance and upon

the consent of the other members.

Dispatching the invitations at the appropriate time and in a manner which

guarantees the receipt of the invitations by all members.

Administering the meeting in a democratic manner where freedom of

expression is guaranteed for all members.

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Preparation of minutes inclusive of all the issues discussed and the

decisions taken, and distributing copies to all members.

11.5 Number of board meetings

The number of the Board meetings should not be less than four per year.

12. Advisory committee of the family company

The existence of an advisory committee in the family company is one of the

significant elements in its governance structure. However, in order for this

committee to function efficiently and to carry out its duties, it should take into

consideration the following factors:

12.1 The committee should comprise qualified persons in the relevant field, and

should earn the trust of the board of directors.

12.2 It is assumed that the advisory committee is consulted before decisions are

taken and after providing sufficient data to its members.

13. The executive management of an ordinary company

In cases where the number of partners is few, it is possible for all of them to

participate in its management in accordance with certain arrangements agreed upon

in the internal memorandum of the company. In this case the company and the

partners bear responsibility for actions taken by each one of them. However, in

cases where the number of partners is more than three, It is advised to assign

management to one of them or to an external party.

The existence of a company manager with adequate qualifications, experience and

integrity is one of the company's most important success factors, whether it is a

family or non-family company. It is essential therefore that the mechanism of

appointment of the manager and the duties assigned to him comply with the

following provisions:

13.1 The company manager is appointed by means of a decision by the board of

directors, based on professional grounds relating to his qualifications and

integrity. Although family ties may have some weight in the selection

process, yet this should not be at the expense of professional competence.

13.2 It is assumed that the manager's authorization limits, duties, salary and

remuneration are specified in the appointment contract.

13.3 If the manager is appointed as per the company's contract of association,

then the termination of his services is possible only in accordance to this

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contract, except where there exists a clear text in the contract by which a

certain quorum is needed in order to terminate his services.

13.4 The termination of the services of the manager who has been appointed later

by means of a separate contract is carried out by means of a board decision,

except where the contract of association states otherwise.

13.5 It is assumed that the authorization limits of the manager, his permissible

activities and provisions and restrictions thereto, are specified in the contract

of association.

13.6 The manager is not permitted to delegate his duties to others, unless he is

authorized to do so.

13.7 If the management of the company is assigned to several managers then the

contract of association should specify the methodology of their work, the

manner by which they take their decisions, and the authorization limits for

each one of them.

13.8 If the manager is a partner in the company, he is not permitted to receive any

remuneration without the approval of the remaining partners.

13.9 The manager of the company is obliged to avoid anything which may lead to

conflicts of interest between him and the company, like contracting with the

company for his own benefit, or engaging in activities similar or competitive

to the activities of the company, unless by written approval of the partners.

13.10 The partners are entitled to sue the manager criminally if he presents a fake

balance sheet to the partners, or conceals information relating to the financial

position of the company or commits any similar action.

13.11 The company bears responsibility for all actions of the manager, whether he

is a partner or not, as long as these actions were carried out within the

manager's area of specialty, and under the company's name and for its

account.

13.12 The Board of Directors should appraise the performance of the managers and

senior officials annually. The evaluation should be taken into consideration

upon renewal of their contracts and approval of their salaries and bonuses.

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14. Management of a Private Shareholding Company

14.1 If the number of shareholders in a private shareholding company is less than

twenty persons then its management is conducted in the manner agreed upon

between the shareholders similar to that of an ordinary company.

14.2 If the number of shareholders in a private shareholding company exceeds

twenty persons then its management is entrusted to a Board of Directors

whose members are not less than three and not more than five.

14.3 The members of the board of directors of a private shareholding company

are elected by means of elections held in the annual general assembly

meeting of the company.

14.4 The invitation to the convention of the General Assembly is sent to all

shareholders, regardless of the numbers of shares that they own.

14.5 The invitation should be sent by registered mail at least 14 days before the

date of the meeting, and also by means of an advertisement in a daily

newspaper, at least one week before the date of the meeting.

14.6 Every member should be provided with explanatory notes and data relating

to the meeting's business agenda within a reasonable period prior the date of

the meeting. That includes copies of the company's balance sheet and the

auditor's report. It does not suffice to ask the shareholders to obtain such

documents from the company's office.

14.7 It is permissible for a shareholder to issue a proxy in favor of non-

shareholders in order to represent him in the meeting of the General

Assembly in whatever rights he owns commensurate to his number of

shares. However, it is not permissible for a proxy holder to represent a total

of shares exceeding 5% of the paid-in capital of the company.

14.8 Votes for the election of the Board of Directors are casted by secret ballot.

14.9 In cases where amendments to the contract of association and the internal

memorandum of association are to be discussed, it is assumed that the

suggested amendments to the shareholders are attached with the invitations.

14.10 It should be emphasized that the minutes of the meetings of the Board of

Directors should be accurately recorded and reviewed. The names of absent

members should not be listed as present in the meeting.

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14.11 It is not permissible to take decisions by soliciting signatures on a circulated

draft which was not subject to actual deliberations.

15. Transfer of equity and senior management

The existence of a carefully thought out plan for the transfer of equity holdings,

shares and the administrative responsibility in the company is a basic requirement

for guaranteeing the continuity and growth of the company and the avoidance of

shocks upon transfer of ownership from one generation to the other. It is assumed

that such a plan is put in writing and approved by the board of directors. Such a

plan is also assumed to take the following into consideration:

15.1 No preferential treatment amongst the offspring is exercised on the basis of

gender.

15.2 The abilities and intentions of the offspring and their willingness to assume

responsibilities should be considered when filling administrative and

technical positions.

15.3 Appropriate academic education for the offspring should also be provided.

15.4 Assigning of roles for the offspring should be on the basis of actual

capabilities of each.

16. Sustainability of the company

The founding generation of the company could play a definitive role in supporting

the continuity of the company through the following procedures:

16.1 Formulating an administrative, organizational and financial structures for the

company which give the highest priority to achieving profits, the

achievement of profits, reinforcing the stability of the company, its

continuity and facilitating vibrant growth.

16.2 The delegation of authority to officials should be based on clear and well

understood basis.

16.3 Identifying the objectives and mission of the company, and insuring the

understanding and commitment of family members to such objectives and

mission.

17. Interests of other stakeholders

Irrespective of the type and the legal standing of the entity, it is imperative that the

interests of other stakeholders, like employees, customers and creditors are duly

observed. The success of the company in managing such relationships requires

attention to the following:

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17.1 The executive management formulates a financial and administrative system

approved by the board of directors.

17.2 All parties of interest are subject to the prevailing laws and regulations, such

as the Labor Law with respect to the employees, and the Commercial Law

with respect to company dealers. The relationship with other stakeholders is

subject to special contracts reached with them.

17.3 The management of the company formulates clear instructions regarding

employee incentives in order to strengthen their allegiance to the company,

such as providing health insurance, bonuses, as well as comfortable and

healthy working conditions.

17.4 The administrative regulations of the company are supposed to include clear

sanctions applicable to various types of violations.

18- Governance in the financial management of the family company

The issues relating to financial management occupy a predominantly significant

role in the success of commercial entities, especially in light of increasing

segregation between ownership and management, which makes transparency and

credibility in the company's financial and administrative reports more significant. It

should be further noted that one of the most important basics of modern financial

management is the existence of an effective system for audit and risk management.

There are many technical details with respect to the financial management of the

company, and this chapter will focus on the requirements to modernize governance

within that area.

19- Internal control system

19-1 All financial transactions should be entered in the financial system by an

accredited accountant. The required proofing documents for all financial

transactions entered into the financial system are supposed to be attached.

19-2 All financial transactions are audited periodically by the financial manager.

Audit dates are specified in accordance with the size and nature of work.

19-3 Cash and credit sales vouchers, receipts, disbursements and all other books

are audited by the financial manager.

19-4 External vouchers, such as purchasing and disbursement bills, are audited by

the accountant before entry is made in the financial system. Such documents

should be approved by the financial manager and the general manager.

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19-5 All activities and financial transactions are documented by means of an

approved periodical reporting system and sound documentation.

19-6 Compliance with taxation laws and relevant regulations and instructions is

mandatory.

20- Human resources management

One of the major weaknesses in the governance of family companies is associated

with giving excessive weight to family kinship in decisions relating to

appointments, promotion and non-performance. Such practices often entail serious

negative consequences. The following recommendations should therefore be

considered very seriously, especially in relation to employees working in the

financial affairs.

20-1 Staff are selected on the basis of competence and capacity to perform the

required tasks. This requires holding proper academic qualifications and

relevant experience.

20-2 An effective control and evaluation system for performance should be

formulated. This system should apply to all employees regardless of their

family ties.

20-3 It is advisable that employees consume their prescribed annual vacations,

and that senior management should exploit this opportunity to solicit new

insights regarding the prospects of improving performance in respective

jobs.

21- Assignment of tasks and responsibilities

The tasks and responsibilities should be clearly defined for all positions within the

company. This requires observing, to the extent possible, the following principles:

21-1 Separation of functions between the employee reviewing the suppliers'

vouchers and the one issuing the checks to suppliers.

21-2 Separation of the function of the entry recording in the accounting system

and the function of keeping and maintaining the assets.

21-3 Separation of the function of the cashier and the customer accounts section,

where cash collections are recorded in the customer's subsidiary accounts.

21-4 Separation between the section which prepares employee checks and the

section which maintains and records employee working hours.

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22- Petty cash

22-1 It is advisable that the petty cash does not exceed 1% of the company's paid-

in capital, or US$ 1000 as a maximum limit.

22-2 Petty cash management should be separate from the functions of recording

financial transactions.

22-3 Any petty cash disbursements should be accompanied with documentary

evidence.

22-4 It is necessary to audit and count physically the petty cash by comparing the

actual balance with the book's balance. The cashier bears the responsibility

to cover any deficit in the petty cash balance.

23- Disbursement mechanisms

23-1 Disbursement mechanisms and procedures are unified and centralized.

23-2 Disbursement is made after securing all relevant documents, which includes

the following:

Attaching and auditing the suppliers' vouchers by the accountant before

disbursement is made. It is assumed that the audit includes the

reconciliation between the dispatch voucher and the voucher issued by

the supplier before payment is made.

It is also assumed that these vouchers are approved by the financial

manager and the general manager before they are disbursed.

Attachment of the suppliers' statement of account with the disbursement

transaction.

Performing final check of the disbursement transaction by the

accountant and the financial manager before disbursement is made.

23-3 Regulations specifying the required signatures on the issued checks should

be put in place. The check limits may vary from one company to another due

to various reasons, but in general it is advisable that the required signatures

be according to the following limits:

Checks up to US$ 5000 are signed by the financial manager and the

general manager.

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Checks from US$ 5001- 10000 are signed by an authorized board

member in addition to the financial manager or the general manager.

Checks exceeding US$ 10000 are signed by the general manager and

the Chairman of the Board.

24- Internal audit

Internal audit is considered as one of the pillars of modern governance. The

functions and the authority limits of the internal auditor have expanded in a manner

which requires the appointment of a specific employee for this purpose, or perhaps

the creation of an internal audit department consisting of one or more auditors. It is

possible, on the other hand, to use the services of an internal auditor from outside

the company.

The principles of governance associated with internal audit are the following:

24-1 The appointment of the internal auditor and the determination of his salary

requires a Board resolution based on a recommendation by the audit

committee, if there is one.

24-2 The internal auditor must hold a Bachelor degree in accounting, and

experience in the field of accounting and audit of no less than three years.

24-3 From an administrative standpoint, the internal auditor is accountable to the

general manger, yet he performs his duties independent of the executive

management, and submits his reports directly to the Board of Directors,

through the audit committee if there is one. The internal auditor is expected

to discuss his reports with the respective departments before submitting them

to the Board.

24-4 The duties and responsibilities of the internal auditor are as follows:

Monitoring the effectiveness of operations.

Ensuring the validity of account balances and the authenticity of

financial reports.

Performing random audit of receipt and payment vouchers and entries,

and ensuring compliance with the relevant supportive documents,

administrative decisions, and sound accounting procedures.

Performing surprise and periodic physical count for main and subsidiary

cash boxes.

Preventing embezzlement and investigating suspected cases.

Participating in the annual physical assets count.

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Ensuring the safekeeping of fixed assets and inventory control

procedures, including surprise inventory counts of warehouses.

Reviewing to tender documents and inspection of contracts with other

parties.

Reviewing of the documentation system periodically, in coordination

with the financial department, and providing remarks and

recommendations thereto.

Monitoring compliance with prevailing laws and regulations, and with

the decisions taken by the board of directors and the executive

management.

24-5 The internal auditor may have access to any information or contact any

employee, and he has the authority to perform his duties in a satisfactory

manner.

24-6 The internal auditor submits a report every three months, inclusive of his

remarks and recommendations with respect to the audit process and findings.

He also submits a report at the end of the year, inclusive of his main remarks

on audit operations and his recommendation in that regard.

24-7 The internal auditor keeps a special file containing copies of all documents

which relate to any conclusions he draws and recommendations he makes.

24-8 The internal auditor keeps a file of all policies and procedures and samples

used in the internal audit programs and plans, in addition to information

relating to internal control systems, and copies of audit reports submitted to

management.

24-9 The internal auditor takes into account all remarks of the external auditor

concerning the internal control system, the accounting and documentary

systems, and the internal audit procedures. The internal auditor should also

develop control systems based on the external audit report and in

coordination with the legal advisor of the company (if exists).

25- External audit

25-1 The selection of the external auditor and the definition of his scope of work

is made by the General Assembly in its annual meeting, and upon

recommendations from the audit committee (if available). The appointment

is for one year, open for extension for a maximum of five continuous years.

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25-2 The external auditor should be keen on maintaining his autonomy, hence he

should refrain from providing other services which may impact that

autonomy.

25-3 The external auditor is supposed to immediately inform the Board of

Directors about any embezzlement, tampering, or what appears to be an

intention for tampering in the financial management of the company.

25-4 The external auditor reports to the board of directors through the audit

committee if available, or directly to the chairman of the board or his deputy

if an audit committee is not available.

26- Audit Committee

26-1 The board of directors is advised, depending on the size of the company, to

form an audit committee composed of three of its members, where at least

one of whom is an expert in accounting and financial affairs. The audit

committee's task is to supervise all matters relating to administrative and

financial affairs, including the tasks performed by the executive team, the

external auditor and the internal auditor.

26-2 The audit committee prepares a clear work program, which is discussed and

approved by the board of directors. The program is assumed to include a

definition of the committee's goals, authorization limits, meeting dates and

remuneration accruing to its members

26-3 The audit committee acts as a communication channel between the board of

directors and each of the external and the internal auditor. However, the

responsibility of the audit committee does not overrule the responsibilities of

the board of directors and the executive management of the company with

respect to the efficiency of the internal audit system.

26-4 The audit committee monitors the autonomy of the external auditor and

reports to the Board on all information and remarks relative to the relations

between the external auditor and senior officials in the company.

27- Profit distribution policy

The policies and procedures relating to profit distribution and financial withdrawals

made by partners constitute one of the most sensitive issues in family companies,

and they might entail serious negative repercussions on such companies in the

future. Hence, the internal memorandum of the company is supposed to include all

26

main provisions relating to this subject, and in compliance with the following

considerations:

27-1 At least 10% of net profits are allocated to the general reserve (compulsory),

in addition to 5% to a special reserve (optional).

27-2 The board of directors recommends to the General Assembly on the

percentage of profits for distribution after allocating all reserves, and in the

light of the annual financial results after they are reviewed by the external

auditor.

27-3 Cash distribution of profits is made in the period between the months of

March and April. Distribution is made by means of checks issued by the

company or through bank transfers to partners' banking accounts.

27-4 Final decision on the percentage of profit distribution is taken by the General

Assembly in its annual meeting. The board of directors has the right to

withhold some or all of the profits for valid reasons, such as the need to back

up liquidity or for expansion and development purposes. The final decision

in this case rests with the General Assembly.

28- Personal withdrawals

The procedures for withdrawals made by partners and employees should be based

on the following rules:

28-1 In the case when the partner is also an employee in the same time, he may

withdraw from the company up to his monthly salary.

28-2 Withdrawals should be in accordance with the disbursement mechanisms

specified in the internal memorandum, or in accordance with approved

financial procedures.

28-3 When the partner is not an employee, he may withdraw cash from the

company provided that the sum does not exceed 5% of his equity, and that it

is made for one year only. Such a withdrawal should be settled from the

profits distributed at the end of each year

28-4 Regarding the partner who is also an employee, settlement is made from his

salary on a monthly or quarterly basis, and he is treated in the same manner

like other employees.

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29- Documentation chain

29-1 The financial system is assumed to make available all documents which

control the financial transactions and all business affairs of the company.

29-2 The documentary chain of the company includes the following types of

documents:

Transaction vouchers

Entry vouchers

Output ( counter) vouchers

Purchase vouchers

Purchase returns

Sales vouchers

Sales returns

Debit

Credit advise

Disbursement bills

Receipt bills

29-3 In addition to conforming to the documentary system, it is very important for

the accounting system to ensure actual compliance with the following

procedures:

Reconciliation of the petty cash at least on a monthly basis.

Reconciliation and verification of bank accounts at least monthly.

Reconciliation and matching of accounts receivable on a monthly basis.

Reconciliation and matching of Accounts Payable on a monthly basis.

30- Risk management

30-1 The Board of Directors and the Internal Auditor should assess the risk

exposure of the company and formulate a clear risk management policy in

order to achieve profitability, growth and continuity of the company.

30-2 The internal auditor shall present to the company a risk report explaining all

internal and external risk exposure, risk management means, and risk

mitigation methods.

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31- Transparency and Disclosure

Transparency and disclosure relating to the financial and administrative

information are considered among the basic components in the company's

governance strategy. It is advised that this process be made in the light of the

following guidelines:

31-1 Disclosure should be made at the appropriate time, ensuring fair access to

information to all partners and other parties of interest. It is necessary to

guarantee equal accessibility of the information to all owners.

31-2 The company should, in accordance with the provisions of the Law, disclose

promptly a balanced assessment of its position and expectations, and all

other information which may affect the decisions of the owners and other

parties of interest.

31-3 The financial information disclosed should contain at least the following:

Financial statements and the auditor's report.

Profit and loss statement and the balance sheet.

Changes in owners' equity.

Cash flow statement

Explanatory notes to the financial position.

Comprehensive income statement.

31-4 Non-financial information should also be disclosed, especially the following:

Ownership structure relative to owners of more than 10% of shares.

Privileges and bonuses received by each member of the board of

directors.

Number of meetings of the board of directors, and a list of attendants

and absentees in each meeting.

Details of loans extended to members of the board of directors and

related parties.

Factors relating to material risks.

Details concerning social responsibility.

External auditor's report.

Sufficient information on the performance of the company and any

deliberations thereto.

Policies and procedures concerning other parties of interest.

31-5 The management of the company should prepare authentic, audited and

periodic financial reports as per the following timeframe:

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A quarterly report published before the end of April of each year.

A semi- annual report published before the end of August of each year.

A report for the third quarter of each year reflecting the financial period

from the beginning of the year up to the month of September.

Annual report reflecting the period from 1 Jan. to 31 December.

31-6 The data published in the financial reports should be accredited by the

internal and the external auditors of the company before publication. The

owners and the members of the board of directors should be provided with

such reports.

31-7 It is recommended that all periodic reports are prepared on the basis of

accredited financial standards, especially Standard #34 relating to the

preparation of periodic reports.

31-8 The company is supposed to disclose its social responsibility, with special

emphasis on the following aspects:

Net social responsibility of the company, which does not only include

costs and benefits accruing to the company but also the costs and

benefits borne by other sectors of the society.

Identifying whether the strategy and objectives of the company coincide

with the social priority of the company on the one hand, and with the

company's main goal of achieving profits on the other land.

Disclosure of the impact of the company's activities on the health of the

employees, environment pollution and usage of resources. Achieving

this objective requires providing the appropriate data on the social

performance of the company, and the extent to which such an objective

is reached.

31-9 Confidentiality of financial and administrative data should be maintained. It

is therefore prohibited under legal penalty for the financial department,

internal audit department, or the external auditor to publish any internal

financial and administrative information, except that permissible by law.

31-10 It is preferable to use websites and all available media in the disclosure

process, including daily newspapers.

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32- Evaluation

One of the basic pillars of governance modernization in family firms is to reinforce

the conviction amongst their work force that they belong to a profit oriented entity.

Hence, there is a compelling priority to perform an objective and periodic

evaluation of all workers in order to achieve this objective. The evaluation process

is supposed to be based on the following principles:

32-1 The key performance indicators for each employee should be specified.

These indicators should be clear and agreed upon for each employee.

32-2 The extent of adherence to working hours is an important tool for monitoring

discipline, especially among family employees.

32-3 The results of the performance evaluation process are supposed to be

documented by means of periodic reports prepared by the employees at all

levels (e.g. weekly, monthly and annual reports).

32-4 The evaluation process relates to all levels of employees in the company,

including senior management and members of the board of directors. This

process is performed by specialized committees composed of members of

the executive staff and members of the board of directors.

32-5 The performance of the board of directors as a whole and individually has to

be evaluated at least once a year. It is also recommended that the assessment

process relative to the board and the senior management be performed by a

qualified external party every two or three years.

33- Enforcing accountability

Practicing accountability at all administrative levels is one of the main pillars of

governance. Enforcing this principle requires commitment to the following basics:

33-1 Defining of quantitative performance indicators. Such indicators should be

agreed upon and circulated to all those concerned.

33-2 Practicing accountability requires the formulation of an objective oversight

system. This is accomplished through the application of a control

mechanism, as described under item 32-1

33-3 Formulating and enforcing relevant penalties in relation to violations of

laws, regulations and board of directors resolutions. The penalty regulations

should be clear and binding to all workers in the company, including those

with family ties to the major owners.