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Claims Against D&Os Upon Liquidation
By Adv. Yael Navon
The Companies Ordinance grants the liquidator the authority to investigate the reasons which led to the liquidation, and to file personal claims against its directors and officers.
1.1 The Authority to Interrogate D&Os Upon Liquidation
Section 288 to the Companies Ordinance provides that upon the appointment of a temporary liquidator or the issuance of a liquidation order, the Court may order any director or officer to provide information regarding the company's establishment, business or assets and to interrogate such director or officer verbally or in writing. It is common practice for the Court to authorize the company's liquidator to execute the interrogation of the directors and officers and to act in this respect as the Court's "long arm".
The purpose of the interrogation is to enable the liquidator to examine whether there is a basis to file claims against the company's directors or officers or against other third parties. The interrogation is not intended to provide the liquidator with tools against a director or officer whom he has already sued or is about to sue. Therefore, the Court will not permit the execution of an interrogation in cases where the liquidator's claim against the directors or officers has already been filed or is very like to be filed in the near future. (M.C.A. 8997/07 Itzhak Zeller v. Ofer Gavrieli handed down by the Supreme Court on 22nd December 2008).
1.2 Possible Claims Against D&Os Upon Liquidation
Two provisions in the Companies Ordinance refer to potential claims against directors or officers during liquidation:
1.2.1 Claims arising from fraudulent acts perpetrated by the D&O
The first is section 373 to the Companies Ordinance which states:
"When the Court issues a liquidation order, it shall schedule a hearing to discuss whether the company's business was handled with the intent to defraud its creditor's or another person's creditors or for any other fraudulent purpose. If it was discovered in such hearing or afterwards during the liquidation of the company that its business was handled as mentioned above, the Court may, pursuant to an application made by the official receiver or the liquidator or any creditor or contributory of the company, and if it seems to the Court justified to do so, determine that every director or officer who was knowingly involved in the management of the business, will bear unlimited personal liability for the company's obligations, fully or partly, as ordered by the court..."
According to the provision, if the Court finds that a director or officer of the company was knowingly involved in the fraudulent management of the company, it can hold him personally liable for all of the company's obligations.
Under section 373 liability may be imposed on directors or officers. The definition of "director or officer" for the purpose of this section is broad and includes present and past director or officer and any person who the directors or officers normally acted in accordance with his orders. The sanction set in section 373 is severe. The director or officer may be forced to pay all of the company's debts including those debts which were not created as a result of their fraudulent acts.
No causal connection is required between the director's or officer's acts and the extent of the debts imposed on them.
In addition, the Companies Ordinance determines that a director or officer who was knowingly involved in the fraudulent management of the company as set above may be subject to criminal liability.
1.2.2 Claims arising from the D&Os breach of their duty of care or trust
The second provision, which refers to the directors and officers liability in liquidation, is set in section 374 of the Company Ordinance which states as follows:
"If it was discovered during the liquidation of a company that a person who participated in its foundation or establishment or who was or is a director or officer therein or a receiver, liquidator, or temporary liquidator unfairly used money or an asset of the company ... or acted improperly or unlawful in a negotiation which concerns the company, then the court may, pursuant to an application made by the official receiver, the liquidator or a creditor investigate this person's behaviour and force him to return the money or asset or part thereof in addition to interest at a rate it may consider appropriate or force him to pay the company money as the court will consider appropriate as compensation for his actions ..."
Liability under section 374 can be imposed on a shareholder, director, officer, receiver or liquidator without the need to prove a fraudulent act. The liability may arise from the breach of duty of care or the duty of trust of a director or officer or any of the above officials toward the company. According to court judgements, section 374 is not intended to set a new standard of liability, but is rather meant to provide a procedural framework for claims against directors or officers due to the breach of their duties.
A claim against a director or officer based on section 374 must point out a specific legal duty which was breached by the director or officer and which can base the applicability of section 374.
Contrary to section 373, imposing liability according to section 374 requires the existence of causal connection between the director's or officer's wrongful act and the damage for which he is liable.
1.3 Procedural Aspects
Claims against directors and officers which are made according to sections 373 and 374 are usually subject to a special procedure conducted in the bankruptcy court. This procedure is shorter and faster than the regular one, the discovery stage is very limited (if at all) and the defendants are not entitled to file third party notices without receiving the court's approval. In this respect, the Supreme Court stated: "By setting this fast procedure, the legislator preferred the importance of the public interest to expedite the liquidation proceedings - for the benefit of the various creditors, for the benefit of the liquidated company and for the benefit of the public in general - over the personal interest of the officeholders mentioned in the section that their liabilities should be discussed according to the regular proceedings". (M.C.A. 294/88 Rechter v. the Liquidator Chaim Shechter, PD 46(1) 362).
Although section 374 refers specifically to liquidation, the Supreme Court recently ruled that the right to file a claim according to this section is granted not only to a liquidator, but also to a trustee appointed within the framework of a creditors' agreement. (M.C.A. 9983/06 Clal Insurance Co. Ltd. v. Shlomo Ness - handed down on 19th August 2008).
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