Israel: Supreme Court / Independent Standing For A Company In A Shareholder Derivative Suit

Last Updated: 14 December 2017
Article by Yoram Shiv and Alex Berman

The Israeli Supreme Court ("Supreme Court") held that a company may have independent standing in a shareholder derivative suit, but only in the event that the derivative claimant's actions have a high probability of causing severe irreversible damage to such company.

The derivative suit procedure allows a claimant who is not the company (usually a shareholder) to file a lawsuit on behalf of the company where the authorized organs of the company have failed to file a claim or take other action to enforce the company's rights vis-à-vis a third party (generally an office holder or controlling shareholder of the company). The derivative claim process can be divided into two parts: (a) the certification stage of the derivative claim in which the company has independent standing to respond to the claims of the derivative claimant and may attempt to convince the court that it is unjustified to grant the plaintiff the right to sue on behalf of the company; and (b) the derivative proceeding, which occurs only if the claim certification request is accepted by the court. During this second stage, the derivative claimant steps into the shoes of the company and acts on the company's behalf without the company being actively involved in the management and administration of the claim.

In the matter at hand, the Supreme Court discussed whether at the stage of conducting the derivative proceeding, the company (the "Company") could have standing in certain situations to represent its position, or whether at this stage the Company is always represented solely by the derivative claimant.

The Supreme Court ruled that the Company could have limited independent standing at the second stage of a derivative procedure. In so far as a question relates to the management of the derivative claim, exclusive authority is vested in the derivative claimant. However, in so far as a question relates to the Company's ongoing activities, the Company's organs continue to represent the Company's interests.

The Supreme Court noted that the Company is not a typical third party with respect to a derivative claim but is generally a party interested in the claim's failure. The Supreme Court recognized that the concern that the Company might attempt to thwart a justified derivative claim but determined that this concern should not be addressed by an absolute denial of the Company's independent standing, but rather should be addressed by imposing a high threshold for the Company to meet in order to challenge the manner in which a claim is being managed by the derivative claimant. The Supreme Court explained that the focus of the derivative claimant is not usually the Company's current activity, but rather the success of his or her claim and that the derivative claimant often does not consider the damage that can be caused to the Company.

The Supreme Court ruled that at the stage of the derivative proceeding, the Company may not argue that the derivative claim per se will cause damage to the Company, but can question the impact of the manner in which the claim is managed by the derivative claimant. The Supreme Court emphasized that the Company is not granted an independent and permanent standing, but one limited to situations where the management of the claim may harm the interests of the Company. For example, where the disclosure of a document that is essential to proving the derivative claim may cause damage to the Company that exceeds the benefit that will be derived from the document's disclosure (such as where disclosure would subvert an important transaction).

Alongside the determination that the Company has independent standing at the stage of the derivative proceeding, the Supreme Court determined that for the Company to appeal the manner in which the derivative claimant is conducting the suit it must pass a high threshold. Not every concern or damage will justify judicial intervention and the Company must establish that a particular action taken by the derivative claimant will reasonably cause the Company serious and irreversible damage.

It was further determined that the Company is obligated to cooperate with the derivative claimant and that the claimant is not required to convince the Company that his or her actions are essential or relevant to the suit. The derivative claimant has exclusive discretion in this regard, and the ability of the Company to apply to the Court is limited only to when the action taken may cause harm to the Company, as aforesaid.

Finally the Supreme court ruled that it is for the Company to determine what person or organ (such as a special purpose committee) will act on its behalf in its dealings with the derivative claimant.

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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