The District Court of Tel Aviv
("Court") was recently asked to find
that certain dividend distributions
("Distributions") that were approved by
the directors of a public company
("Company") were prohibited, had led to
the Company's collapse, and that the directors were personally
liable for repaying the amount of the Distributions and the value
of the Company's outstanding debts.
In coming to its decision, the Court discussed the two-fold test
that must be passed prior to the approval of a distribution of
dividends: the earnings test, which is technical and
accounting-based, and the solvency test, which considers whether a
distribution will likely affect a company's ability to satisfy
its creditors. Passing the solvency test requires more than a
simple predominance of assets over liabilities according to the
company's balance sheet; rather, it demands that a board of
directors establish, based on information available to them at the
time, that the company can meet its ongoing financial obligations.
Should reasonable doubt exist, the distribution is prohibited.
When reviewing a board decision, the court will analyze the
information available to the directors at the time of the decision
and not hold the directors responsible for additional information
available only with the benefit of hindsight.
In the event that a board of directors authorizes a prohibited
distribution, directors may be found personally liable under either
or both the laws of torts (arising from a breach of duty of care)
or contract (arising from a breach of fiduciary duty). Direct
damages would consist of the amount of the prohibited distribution.
If there is a causal link between the prohibited distribution and
future events such as the company's collapse, consequential
damages could include the sum of all company debts.
As a general rule, a director that has violated the duty of care
by failing to demand and receive adequate information prior to
making a decision carries the burden of proof with regard to
establishing that the decision was reasonable and did not cause the
In the present case, the Court held that the board of directors
had violated its duty of care in that it had considered neither the
earnings test nor the solvency test in its approval of the
Distributions, nor had the Board properly discussed the matter.
Therefore, the burden of proof lay with the Board to demonstrate
that the Distributions were reasonable under the circumstances and
did not cause the Company damage.
With respect to one of the Distributions, the Court held that
notwithstanding the Board's failure to apply the two-fold
solvency test and earnings test, as information available at the
time of such Distribution did not constitute reasonable cause to
believe that the Company would be unable to repay its debts once
they became due, the directors were not obliged to repay the amount
of such Distribution.
However, with respect to the other Distributions, as the
information available at the time of the Distributions did raise
reasonable doubt regarding the Company's solvency, the
Distributions were prohibited. The directors were therefore ordered
to repay the amount of such Distributions, an amount of
approximately NIS 20 million.
The Court rejected the plaintiff's request that the
directors also be ordered to pay the full amount of the
Company's debts, as no causal link was found between the
prohibited Distributions and the Company's collapse
The Court noted that in a public company, in which a controlling
shareholder is also director and chief executive officer, directors
serve as "gatekeepers" and are charged with avoiding
decisions whose primary intent is to serve the interests of the
controlling shareholders at the company's expense, and in such
role the directors are subject to the principle of Enhanced
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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