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 company damage.
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 Scrutiny.
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