The District Court of Lod ("District Court") determined the conditions for imposing liability on a controlling shareholder for knowingly selling control of a company to a prospective controlling shareholder who will harm the company (such as a known corporate looter). The discussion was in the context of a trustee's claim that was filed against a controlling shareholder and CEO who sold his shares in the company to a group of investors that led to the company's collapse.

While Israeli corporate law imposes certain duties upon a controlling shareholder, the District Court ruled that a controlling shareholder may sell his shares to any prospective buyer, unless the controlling shareholder knows that such buyer will cause significant damage to the company. The controlling shareholder will be held liable for such a sale only under exceptional circumstances where three cumulative conditions exist at the time of the sale:

  1. High level of fault of the selling controlling shareholder, which is expressed in knowing, turning a blind eye, or indifference to the buyer's intention to act illegally in a manner that is expected to cause significant damage to the company.
  2. High level of certainty of the occurrence of significant damage to the company. Such level of certainty to be determined by objective standards.
  3. High probability of a serious deficiency or fault in the buyer's expected conduct. Usually, this would be improper profit, such as the looting of the company by the purchaser. Also possible are situations where actions are not intended to achieve improper profit, but rather violate the duty of care and loyalty towards the company such as gambling with company property or investing in a reckless manner. This condition is valid only when the intended business path of the purchaser is clearly unreasonable, and it is not sufficient that the controlling seller does not believe in the path's validity.

An examination of liability for a sale of control must be made based on the knowledge of the controlling shareholder at the date of the sale and not through hindsight. However, examination of the controlling shareholder's knowledge relates not only to what has actually occurred, but also to what is reasonably conceivable to occur as part of the transaction.

The duties imposed on the controlling seller include a duty to conduct some inquiry of the buyer's identity and motives, but the nature and scope required for such inquiry is limited and is viewed in light of the overall circumstances of the transaction. Refraining from conducting an inquiry might be seen as turning a blind eye or indifference to the harm that the buyer intends to cause and could constitute the required element of responsibility to prohibit the sale.

Under the circumstances of the case before the District Court, the controlling shareholder was held not liable, since the controlling shareholder could not have foreseen the damage that was caused to the Company as a result of the sale of control.

Additionally, the District Court exonerated the controlling shareholder for his conduct after the transfer of the control of the company, when he continued to serve as CEO and then decided after a short period to leave the company. A CEO has a duty of loyalty to the company which requires him to examine proposals presented to the company by the controlling shareholders professionally and independently, to support these proposals when they are in the best interests of the company and to oppose them when they are not. If a CEO decides to remain in his position, he must comply with validly approved resolutions of the company. When a CEO refuses to remain in office in view of policies of a controlling shareholder that are not acceptable to the CEO, the CEO does not breach his duty of loyalty to the company.

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.