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Derivative Claims - New Developments
By Adv. Yael Navon
Traditionally, a derivative claim is a claim filed by a shareholder on behalf of the company. The shareholder in such case does not claim his personal damages but rather executes the company's cause of action on the company's behalf. The Companies Law which was enacted in 1999 expanded the circle of potential claimants to include directors and - under certain circumstances - also creditors.
The derivative claim constitutes an exception to the basic rule that the authority to act on behalf of the company is granted to its organs and especially to its Board of Directors.
The main purpose of derivative claims is to serve as a tool for enforcement of legal standards on wrongdoers who have control over the company and therefore are not expected to cause the company to file claims against them.
According to the law, a party interested in filing a derivative claim must, as a preliminary condition, approach the company and demand that it take steps to exhaust its rights. Only if the company did not act as required, a derivative claim can be filed.
A derivative claim may be filed only with the Court's permission which will be granted if the Court is convinced that the claim serves the company's interest and that the plaintiff is acting in good faith.
Technically, the derivative claim is filed together with a motion to approve it, and the Court will handle the hearing of the claim in two stages: at first - it will rule regarding the motion to approve the derivative claim, and only if the derivative claim is approved, in the second stage the Court will rule as to its merit.
The Companies Law sets a monitory incentive to the plaintiff and his attorney for filing derivative claims. In addition, the Law prohibits a plaintiff from withdrawing a derivative claim which has been filed or to reach a settlement with the defendant, without receiving the Court's approval.
Recent Court Rulings
Recently two Court rulings were handed down, in which the courts referred to several aspects of a derivative claim:
1. Only in rare circumstances will a derivative claim be dismissed in limine:
In Civil Motion (Tel Aviv - District Court) 1570/07 Nitzba Settlement Co. Ltd. v. Ben-Yakar Nissim & Others (7 December 2008), several shareholders filed a motion for permission to file a derivative claim against 18 D&Os of Nitzba.
The derivative claim was based on a Court ruling handed down against Nitzba pursuant to which the Company's Board of Directors acted without authority when it negotiated the sale of control over the company. In addition, it was ruled that the company's Board caused the company (through its subsidiary) to purchase its own shares while breaching the law which was applicable at the time, and while causing the company a debt of NIS 217 million.
Pursuant to this ruling several shareholders approached Nitzba's Chairman of the Board and demanded that he files a claim against the D&Os. Since their motion was declined they filed the derivative claim.
Before the motion to permit filing a derivative claim was discussed by the Court, significant developments occurred:
- A new buyer for the company's shares was found and the Supreme Court approved the sale of the shares
- The new buyer agreed to pay the company's debt which had been created from the purchase of its own shares
- Most applicants in the claim sold their shares in the company
Consequent to these developments the D&Os filed a motion to dismiss the motion requesting permission to file a derivative claim, alleging that no cause of action exists.
The Court stated that, in general, a motion to dismiss a derivative or class action lawsuit in limine will not be discussed separately. The arguments which, under regular circumstances serve as a basis for a dismissal motion, when dealing with a derivative or class action claims, should be raised within the framework of the motion to permit filing the derivative claim/class action.
However, under rare circumstances where prima facie it is clear that there is no cause of action then the Court may dismiss a derivative claim or a class action in limine.
In our case, after the agreement with the new buyer was approved by the Supreme Court, and after the buyer agreed to pay the debt which served as the basis for the derivative claim, then no cause of action exists and the claim should be struck out in limine.
2. A Derivative Claim Cannot be Filed by a Former Shareholder
In the Nitzba case most shareholders who filed the original motion to approve the derivative claim, sold their shares in the company after the claim was filed. The Court accepted the D&O contention that a shareholder who sold its shares in the company has no right to continue handling the claim on its behalf. However, the Court stated that this contention in itself does not justify dismissal of the claim since there is no dispute that at least some of the plaintiffs are still shareholders of the company.
3. Discovery Proceedings in a Derivative Claim
In Motion (Tel Aviv) 18044/08 Azi Rafaeli v. Lev Levayev (23 November 2008), a shareholder of Bank Leumi LeIsrael Ltd. filed a derivative claim based on a transaction in which the bank sold part of its holdings in Africa-Israel Ltd. to Mr. Lev Levayev. The shareholder claimed that Levayev, the buyer, concealed from the bank material information he had pursuant to which the value of the shares he purchased was much higher than the price he paid. The shareholder argued that the bank has a good cause of action against Levayev and against the bank's D&Os who breached their duties of care towards the bank. Since the bank refused to file such claim, the shareholder filed a derivative claim.
The question discussed in the Court ruling was whether discovery of documents proceedings are possible in a derivative claim.
This question was never addressed by the Supreme Court. The District Courts which discussed the issue reached contradictory decisions. In our case the Court ruled that discovery proceedings can also be conducted in derivative actions.
The Court based its decision on the tendency of the Supreme Court to order full discovery in order to assist in exposing the truth and to make the legal proceedings more efficient.
In addition, the Court referred to a precedential Supreme Court decision which determined that discovery proceedings can be conducted within the framework of a motion to approve a class action. The Court stated that the same logic which led the Supreme Court to recognize the right for discovery in Class Actions applies also to derivative claims.
However, the Court will order discovery in a derivative claim only if the preliminary condition for filing a derivative claim, including an evidential basis for the claim, exist. Under the circumstances the Court determined that prima face, there is a basis for the claim and thus ordered Levayev to disclose specific documents which may indicate that the value of the shares he purchased were much higher than the sum he paid.
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