Newsletter 49 – February 15 2014

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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 regarding the use of a person’s name without consent as a keyword in connection with sponsored advertisements and the application of the Business Judgment Rule and the meaning of Inside Information in a potential takeover context.

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.

Sharir, Shiv & Co., Law Offices

District Court (Commercial Division) / “Profit Test” for Dividend Distributions

The District Court (Commercial Division) accepted an application to approve the filing of a derivative action against a company’s Board of Directors alleging that the Board had improperly approved a distribution of dividends.

The Companies Law provides that prior to approving a dividend distribution, the Board must apply two tests: the Profit Test, in which the Board considers whether, based on the company’s latest published financial statements, adequate profits exist from which to distribute the dividend; and the Solvency Test, in which the Board makes reasonable assumptions about potential future events to help determine whether a distribution will affect the company’s solvency. Dividends may be distributed only from profits (unless specific court approval is obtained) and a distribution is prohibited if it will cause insolvency.

In the present case, in applying the Profit Test the Board had limited its analysis to data appearing in the company’s published financial statements. This was notwithstanding that the Board had been aware of unpublished information concerning events subsequent to the date of the financial statements (a decrease in the value of the company’s holdings) that created a high probability that at the time of the dividend distribution the company would not be in compliance with the Profit Test. The Court held that under the circumstances, where there was a change in the company’s situation between the date of the published financial statements and the date of the Board’s decision, the Board should have considered such unpublished information in its deliberations regarding whether the Profit Test had been met.

In light of the foregoing, the Court approved the application to file a derivative claim.

District Court (Commercial Division) / Service as a Director in Competing Entities

R. was founder, shareholder, director and CTO of an Israeli start-up company. The Founders Agreement to which he was a party provided that he would not compete against the company or the company’s other founders for a period extending until two years after he ceased being a shareholder. Notwithstanding this restriction, R. began working at another company in a similar position while still a shareholder and director of the first company. Shortly after beginning such engagement, the second company began competing with the first company.

The first company and its shareholders applied to the Court, requesting an injunction against R. and the competing company, proscribing them from soliciting the first company’s customers and employees, as well as an injunction prohibiting R. in his capacity as director from taking part in Board meetings of the first company or appointing a proxy to take his place. The first company and its shareholders alleged that R.’s engagement at the second company amounted to a breach of his fiduciary duties as a director towards the first company and of his contractual obligations under the Founders Agreement.

The Court accepted the first request for an injunction but not the second. The Court held that although the two companies had not entered into a non-compete agreement, the fact that the second company began its competing activities contemporaneously with R.’s engagement justified the issuance of a temporary injunction prohibiting R. from contacting customers and employees.

Regarding the decision not to issue the second injunction, the Court recognized that a director owes a fiduciary duty to the company in which it officiates, which includes, inter alia, the requirements that the director not act in conflict with its obligations towards such company or exploit such company’s business to achieve personal gain. However, a concurrent appointment in a competing entity in and of itself does not evidence a breach of this fiduciary duty. Therefore, an injunction prohibiting R. in his capacity of director from participating in Board meetings or appointing a proxy was not justified.

Supreme Court / Assumption by the General Meeting of the Authority of the Board of Directors

Shares of a private company were held by two families: ordinary shares in a 70:30 ratio and management shares divided equally, with one representative from each family holding a single management share. Notwithstanding that the company’s articles of association did not outline special powers associated with the management shares, in practice the Board of Directors had been comprised of the two holders of the management shares.

As time progressed, a dispute arose between the two families regarding decision making in the company; whether it should be based on the proportionate holdings of management shares (50:50), or relative holdings of ordinary shares (70:30). Following the Board of Directors’ failure to reach agreement, the family holding the majority of ordinary shares succeeded in having the General Meeting, by vote of the ordinary shareholders, assume the Board’s authority.

Following this assumption of power, the minority-holding family applied to the Court for a declaration that only holders of management shares, and not ordinary shares, were authorized to appoint directors to the Board, and that the General Meeting’s assumption of power amounted to unlawful oppression of minority shareholder rights.

The Court denied the application, holding that the company’s articles of association were silent regarding the rights of the management shares and that the evidence demonstrated that the company had de facto been managed by the holders of ordinary shares. The Court further held that the Companies Law permits the assumption of power by the General Meeting (by declaration of the General Meeting) if necessary for the proper management of the company, such as when the Board is incapable of exercising its powers. Board incapacity can arise from different circumstances, including when the Board is divided and cannot reach agreement.

The Court held that in the present case, the General Meeting had assumed power legitimately after considering the Board’s ongoing division and the failure of mediation.

The Court rejected the claim regarding oppression of minority shareholders and held that the allegation was based upon the erroneous understanding that the company was to be managed in accordance with the allocation of the management shares.

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.