1.1 Background
In September 2002 the Trade Bank collapsed due to an embezzlement perpetrated by a clerk in the credit department. The embezzlement involved an amount of $60 million.
The special manager who was appointed by the Bank of Israel, investigated the matter and concluded that the Bank's D&Os had failed to detect the embezzlement and/or to prevent it.
Following the investigation report, the State of Israel announced its intention to instigate criminal proceedings against nine of the Trade Bank's former D&Os due to their alleged failure in managing and supervising the Bank in a manner which allegedly jeopardized its ability to comply with its obligations.
Although at this point only draft indictments have been filed and a hearing will take place prior to the State's decision regarding the filing of the criminal indictment, the said decision has already been criticized by Israeli scholars who claim that imposing criminal liability on D&Os due to their decisions relating to the everyday management of the company might prevent people from accepting a director's position or from other D&Os to fulfill their duties fearing that each decision they make will expose them to criminal proceedings in due course.
In two recent judgement handed down by the District Court of Tel Aviv the court discussed the implication of placing criminal liability on directors and officers and reached contradicting conclusion:
1.2 A D&O Who Reasonably Relied on Information Presented by the Controlling Shareholder shall not be subject to Criminal Liability
In C.C. 40162/05 The State of Israel v. Aviv Elgor and Others criminal charges were raised against the company's two controlling shareholders, one of whom also served as a director and officer of the company, as well as the company's general manager and against its legal advisor.
According to the indictment, the controlling shareholders wanted the company's general assembly to approve two transactions: firstly to approve an agreement granting them management fees and secondly to approve the purchase of a D&O Liability policy and provide an undertaking to reimburse the company's D&Os.
These two transactions between the company and its controlling shareholders regarding the terms of their employment required the approval of the majority of the company's shareholders, who had no personal interest in either transaction.
Unfortunately, the company's public shareholders objected to the transactions, hence in order to overcome this obstacle, the controlling shareholders came up with a "plan": they contacted a third person and financed the purchase of the company's share by him, and during the general assembly, categorized him as an uninterested party for the purpose of the approval of both transactions.
Consequently, both transactions were approved.
The Court convicted the controlling shareholders of deceitfully receiving the general assembly's approval and went on to discuss the liability of the company's general manager.
The Court determined that the general manager was led to believe that the third person was an innocent investor to whom the company's controlling shareholders aided in purchasing the company's shares rather than a "straw man" whose sole duty was to assist them in approving the transactions. The Court went on to discuss whether the general manager suspected the true state of affairs, but chose to ignore the signs.
In this respect, the Court stated that when the company's professional organs are exposed to partial information which should raise their suspicion, but they choose to ignore it, then it is doubtful whether liability should be placed on them.
The Court stated that placing criminal liability in such cases might paralyze a public company's everyday activities, since the professional officers exposed to partial information might rush to report such information in order to avoid future criminal proceedings, thus endangering the company's trade secrets and preventing quick business decisions from being taken.
The Court concluded that under the circumstances of this affair, no liability should be imposed on the general manager and she was acquitted.
1.3 The Agreement of an Unqualified Person to be Appointed Director May Lead to Criminal Liability
C.C. (Tel Aviv - District Court) 40213/05 The State of Israel v. Rachel Toledano and Others is one of a series of civil claims and criminal proceedings which were initiated upon the collapse of a group of companies which were controlled by two businessmen, Givony and Peled.
In July 2005 an indictment was filed in the Tel Aviv District Court against nine defendants due to their acts in one of the companies in the Peled-Givony Group, Feuchtwanger Industries Ltd. ("the Company").
The indictment included severe accusations against the controlling shareholders and their financial advisor concerning funds they unlawfully withdrew from the Company. However, these severe accusations were not directed against three members of the Company's Board of Directors, who were sued in the indictment for one reason only: their failure to ensure that the Company files its financial reports in a timely manner.
The three directors reached a plea bargain with the District Attorney, pursuant to which they filed a list of agreed facts to the Court and these served as a basis of the Court's judgement without the necessity of hearing any evidence. On 13th March 2007 the District Court of Tel Aviv handed down its verdict.
1.3.1 The Qualification to Serve as a Director
The District Court criticized the practice of appointing individuals who have no qualifications to serve as directors in public companies repeating a statement made by the Supreme Court in another case: "Indeed, being a director is not only a matter of honour or respect. It is not only a reward for services provided in the past to the State or to the society. It is not a respectful way to retire."
Knowledge, expertise and experience are the basic tools of a director who is required to consider and examine the issues presented to the Board. A director should have knowledge regarding the operation of corporations in general, and of the company in which he or she serves in particular.
Under the circumstances, the three directors were not qualified for the job: one had no academic training, was without any experience in economics or finance and had no idea of the requirements of a director; the second had political experience in the Municipality of Haifa, however no knowledge about the Company; the third had some experience in media and political science, however he admitted that he did not know when an entity was required to publish its financial report.
The Court therefore ruled that although there is some difference between the three directors, all three of them were not qualified to serve as such.
1.3.2 The Standard of Care Imposed on a Director
The District Court repeated the Supreme Court precedent pursuant to which: "Each director must incur all the precautions which a reasonable director would have incurred under the circumstances ... a reasonable director must be interested in the Company's affairs and be familiar with them. He must be aware of the company's financial position. A director cannot fulfill his obligations on the Board of Directors if he has no idea of what is happening in the Company or if his interest is superficial".
In our case, when the directors became aware of the Company's problem in publishing its financial report on time, they took no steps to understand the problem, to consult with professional experts and to keep updated as to the actions taken to overcome it. The directors should have taken an active role in trying to prevent the Company's failure, including taking drastic steps such as taking over the authority for active management of the Company. None of these steps were taken. The gatekeepers of the Company failed to perform their job.
1.3.3 The Directors' Sentence
The District Court imposed a criminal fine on the Directors and determined that due to the nature of their crime, they are not suitable to serve as directors of a public company for the next few years (according to Section 226 of the Companies Law - 1999). The Court stated that the agreement of the Directors to be appointed as such, although they were not qualified, constitutes a breach of their duty of care.
The Court wished to send a clear message to board members: "Every director should know that he can serve as such only if he has suitable qualifications. The appointment is not a prize for services he provided in the past, is not a reward for loyalty to someone or for knowing him and is not for the purpose of experiencing a new field. And he should also know that if he sins in this respect and fails to act like a reasonable director, he might be brought to justice for problems he caused or in which he participated."
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