Newsletter 46 – May 16 2013

Print This Page

THE LEGAL NEWSLETTER

We are pleased to present another English-language edition of our firm newsletter.  In this edition we provide a brief synopsis of recent court decisions concerning timing of distributions of court approved dividends, ex post facto exemptions of office holders from liability and whether dividend distributions are considered controlling-party transactions.

The newsletter, which our firm publishes periodically, addresses important practical developments in the field of Israeli corporate and commercial law.  The objective of the newsletter is to create awareness of these developments and of the underlying principles of the issues discussed.  We hope that you will find the newsletter informative and helpful.  Any comments or suggestions are appreciated.  If you need further information or have any questions concerning the issues discussed in this newsletter, please contact either Yoram Shiv, 972-3-607-4777, yoram@sask.co.il, or Alex Berman, 972-3-607-4777, alex@sask.co.il.

You can view previous editions of our newsletter on our website: www.sask.co.il.

Sharir, Shiv & Co., Law Offices

Supreme Court / Six-month Period Between Court Approval of Dividend Distribution and Actual Distribution Does Not Require Re-examination of Dividend Eligibility

The Israeli Supreme Court recently held that the passage of six months from a company’s receipt of court approval of its decision to distribute dividends and the date of actual distribution of dividends does not in and of itself require a reexamination or the receipt of renewed approval prior to the actual dividend distribution, provided that the company’s situation has not materially deteriorated during this period.

In this matter before the Court, a company had provided a loan to its parent company in the amount of approximately NIS 28 million. In order to facilitate the parent company’s repayment of the loan, the company distributed dividends to its shareholders. As it had insufficient profits to allow a distribution of dividends according to the provisions of the Israeli Companies Law without court approval, the company applied to the Court for permission to distribute dividends. After considering the relevant facts, the Court approved the company’s request, and six months later the company distributed dividends. The company subsequently encountered financial difficulties and eventually entered into liquidation. At the time of the initiation of liquidation proceedings, the parent company had only repaid a small portion of the loan to the company.

The liquidator of the company (the “Liquidator”) filed suit against the parent company for the return of the dividends distributed to it by the company, claiming that in light of the lapse of six-months from the time of its receipt of Court approval, and considering events in the intervening time, including the occurrence of the Second Lebanon War, the company should have reexamined the relevant facts and received a new court approval to distribute dividends.

In its claim, the Liquidator relied on a previous decision from the Court (reviewed by us in Newsletter 43), which involved a court approved distribution of dividends in the aggregate amount of NIS 3 billion in six semi-annual distributions. In that decision the Court held that a court may reexamine a company’s ability to repay its debts at each stage at which a multi-stage dividend distribution is actually made. The Liquidator claimed that based on this case the company’s ability to repay its debts should have been reexamined at the time of the dividend distribution and that the company was required to obtain a renewed court approval.

The Court rejected the Liquidator’s claim, finding that no event had occurred during the half-year between the Court’s approval of the distribution and the actual distribution that warranted a reexamination of the facts, and that therefore the company was not obligated to apply to the Court for renewed approval. Regarding the significance of the passage of time, the Court held that the passage of six months, under the circumstances, was reasonable. The Court noted that the earlier decision on which the Liquidator relied did not stand for the proposition that passage of time alone requires a company to receive renewed approval for a distribution of dividends, and that it could not be extrapolated from that case that six months is automatically an unreasonable amount of time.

The Court further held that the present case can be distinguished from the earlier decision in that in the present case dividends had already been distributed and the company’s creditors at the time of the distribution were not the same as the creditors represented by the Liquidator. In contrast, the earlier case involved a request by the company’s creditors to revoke Court approval of a planned dividend payment prior to the actual distribution on the basis that the dividend distribution would directly affect them.

District Court / Company Permitted to Exempt Office Holders from Liability Ex Post Facto When It Does Not Prejudice the Company

The District Court held that a company may ex post facto exempt its office holders from liability for breach of their duty of care towards the company as long as the decision to provide the exemption is properly approved and is for the good of the company.

In the present case, the Court approved a shareholders’ request to initiate a derivative claim against the company’s directors and CEO (the “Office Holders”) in connection with a real estate transaction. The shareholders alleged that the Office Holders breached their duty of care towards the company when they acted negligently in connection with their approval of the purchase of two parcels of land and that this negligence caused the company harm. The Office Holders responded by arguing that they could not be sued for negligence in a derivative action in the name of the company as the company ex post facto exempted them from liability in connection with the transaction.

In its decision, the Court held that in principle a company is entitled to ex post facto exempt its office holders from liability and to indemnify them in connection with harm caused to the company by a breach of their duty of care.

The Court then considered whether in the present case the ex post facto exemption was permitted by the Israeli Companies Law; specifically, whether it passed the two-pronged test of whether it had been properly approved and whether it was for the good of the company. The Court held that considering the circumstances, neither prong of the test had been satisfied. First, the exemption had not been properly approved because the company’s shareholders had not been provided with prior notice of all material information regarding the transactions. Second, under the specific circumstances of the case, the ex post facto exemption of the Office Holders held no benefit for the company and was therefore not for the good of the company.

District Court / Commercial Division / Dividend Distribution Not a Transaction with a Controlling Shareholder 

The District Court, Commercial Division recently held that a dividend distribution to shareholders, including the controlling shareholder, is not a transaction with a controlling shareholder for purposes of the Israeli Companies Law (the “Companies Law”) and is therefore not subject to the approval procedures required for such transactions.

In the present case, the controlling shareholder of a public company utilized credit lines to acquire control of a second public company. Following the acquisition, the acquired company’s Audit Committee and Board of Directors approved a dividend distribution. As was required on account of its profit position, the acquired company also sought and obtained court approval for the distribution. Following the receipt of these approvals, the company distributed dividends in the amount of NIS 1.4 billion to its shareholders. The controlling shareholder used part of the dividend that it received to repay its outstanding loans.

A minority shareholder filed suit against the controlling shareholder, who was also Chairperson of the Board of Directors, and the other directors of the company alleging that the dividend distribution had been an “extraordinary transaction” with the controlling shareholder in which the controlling shareholder had a personal interest, as described by the Companies Law. The minority shareholder argued that due to the foregoing, the Companies Law required shareholder approval of the dividend distribution and that such approval had not been obtained.

The Court rejected the minority shareholder’s arguments, holding that a distribution of dividends is within the authority of the Board of Directors and does not require shareholder approval. The Court further held that a distribution of dividends is not a “transaction” within the meaning of the Companies Law, but rather is the exercise of a shareholder right associated with its shares. The Court noted that even were a distribution of dividends to be considered a “transaction”, as dividends were distributed to all shareholders pro rata to their shareholdings, this particular distribution would not be considered a transaction with a controlling shareholder.

The Court further observed that in the case of an extraordinary transaction with a controlling shareholder a plaintiff does not have to prove the existence of a “personal interest” by the controlling shareholder; however, the company or the controlling shareholder may be able to establish that no “personal interest” was present in a particular transaction.  In the case at hand, the Court observed that the controlling shareholder did not have a “personal interest” in the dividend distribution. The Court noted that the fact that the controlling shareholder intended to use the dividends it received to repay other obligations was not determinative and does not lead to the conclusion that the controlling shareholder had a personal interest in the transaction or that the controlling shareholder placed its personal interests over the interests of the company.

This newsletter provides general information and should not be used or taken as legal advice for specific situations, which depends on the evaluation of precise factual circumstances.