|
On 19th April 1999, a new Companies Law was enacted by the Israeli Parliament (hereinafter: “the Companies Law”). This law entered into force on 1st February 2000 and replaced the Companies Ordinance - 1983 (hereinafter: “the Ordinance”).
1. Strfuctufre of Israeli Corporate Entities
As far as D&O insurance is concerned, three types of Israeli corporate entities are relevant:
(a) Companies:
Legal entities with limited liability of shareholders:
Public Companies -companies whose shares are traded on the Stock Exchange, whether on the Israeli Stock Exchange or on foreign ones. Israel is the second largest “foreign country” whose companies’ shares are traded on the various stock exchanges in the U.S.
119 Israeli companies, mainly in the field of hi-tech, are traded today in the U.S.
Private Companies - companies whose shares are not traded on the Stock Exchange. The Companies Law increases the liability imposed on a private company’s directors and officers.
Accordfing to the Companies Law, in certain circumstances, wfhere the Court finds it just and appropriate to do so, the Court is permitted to pierce the corporate veil, and hold the directors and officers, as well as the shareholders responsible for the company’s obligations
(b) Cooperative Societies - A significant segment of the industrial activity in Israel is performed by cooperative societies. Most of the public transportation companies are incorporated as such corporations. Also the “kibbutzim”, world known Israeli communal villages, are incorporated as cooperative societies. Many of the kibbutzim are owners of industrial plants which require directors and officers coverage. The cooperative society, like a corporation, is a separate legal entity from its members and its rights and obligations cannot be attributed to its members. The officers of the cooperative society are also subject to the duties of care and trust.
(c) Non-for-Profit Organizations
Non for profit organizations, are incorporated within the framework of the Associations Law - 1980. Most of these organizations are active for the purpose of promotion of social, cultural and educational objectives.
Since these organizations represent the public interests, the officers of such organizations are often exposed to public criticism and hence - to claims.
2. Who are the Directors, Officers and Managers?
Israeli law uses the term “office holder” which pertains to directors, officers and managers. This term is defined as follows:
Director, general manager, chief business manager, deputy general manager, vice general manager, a manager who is directly subject to the authority of the general manager, and any other officer who fulfills a function mentioned above, even if his title is different.
In other words, all these office holders who are directly subject to the authority of the general manager or the board of directors, are actually deemed to be “directors, officers and managers”.
According to the Companies Law, an internal auditor is not defined as an officer. Therefore, the policies issued to Israeli companies after 1st February 2000 should include a special extension if cover is to apply to the liability of the internal auditor.
3. Legal Basis of Directors, Officers and Managers Liability in Israel
(a) The legal basis of liability in Israel derives from both statutory law and court precedents.
The Ordinance was based on the English Companies Law - 1927. As a result, until 1992, the Ordinance specifically prohibited a company to indemnify or to insure its directors and officers. In 1992, the Ordinance was amended to allow insurance and indemfnification by the company.
(b) The said amendment imposed extensive duties on the directors and officers: duty of care and duty of trust towards the company itself, its shareholders and any other third party. The law also established that where the company’s business was carried out by fraudulent trading, the directors may be personally liable for the company’s debts in case of liquidation.
The Duty of Care - The Companies Law established that the duty of care of the directors and officers of the company is based on the principles of negligence in the Torts Ordinance.
The level of precautionary measures and degree of skill required from the directors and officers is the degree that a “reasonable” director and officer holding the same position and acting under the same circumstance, would have applied while ascertaining that all relevant information regarding the viability of the transaction in question is known to him.
The Duty of Trust - The Companies Law imposes on the directors and officers the general duty to act in good faith and in favour of the company. In particular, the Law states that the directors and officers must avoid actions which constitute conflict of interests, competition with the company business, and taking advantage of business opportunities of the company for personal profit. The directors and officers are also obligated to disclose to the company any information received by them in the capacity as directors or officers, which relates to the company’s affairs.
A further expansion of the directors and officers liability, which is incorporated into the Companies Law, relates to the piercing of the corporate veil in order to hold the directors and officers liable for the company’s obligations, not only during its liquidation, but also during the company’s life-time.
The Israeli Supreme Court, which is the highest judicial instance in Israel, and whose judgements serve as binding precedents, handed down a few judgements which imposed substantial liability on directors and officers. For example:
* C.A. 817/79 Kossoy v. Feuchtunger Bank Ltd ., PDI 38(3)253: The subject matter of this case was the liability of the directors of a bank who approved the financing for the purchase of the bank’s shares by using the bank’s money, even though such purchase posed a risk to the bank’s capital.
The legal question was - what are the duties of a company’s directors and officers towards the company?
The Supreme Court ruled that a director is the master-mind and the nerve centre of the activities of a company, and acts on its behalf towards the outside world, and is also engaged in running the company’s internal affairs. In view of the power which the director holds, his relationship with the company should be dealt with within the framework of the duties of trust.
The principle of duty of trust has a wide scope and it applies whenever one has the control and power over another. The duties and obligations imposed as part of a trust relationship are not a closed list. The essence of this duty is that the holder of the power has to act fairly and in good faith in execution of his duties.
The fact that a director does not act for his own private interest and does not request personal benefits for himself, cannot release him of the duty of trust towards the company.
In the said case, the knowledge of the director, that use of the bank’s funds for purchase of its shares may risk the bank’s stability, imposed on the director a substantial duty to avoid such a situation.
* In C .A. 7/81 Penidar v. Castro, PDI 37(4) 673, the Court found a construction company’s manager personally liable for the company’s breach of contract with the purchaser of an apartment. The Court ruled that the manager had acted in bad faith during the negotiations with the purchaser by not disclosing that the land on which the apartment was to be built, was not owned by the company. The Court decided that the manager was personally obliged to compensate the purchaser.
* The change in awareness of Israeli directors and officers to their duties as such and to the risks to which they are personally exposed, came to light on December 1993, when the District Court of Jerusalem rendered its decision in a lengthy judgement in the case of C.A. 400/89 The Official Receiver as the Liquidator of North America Bank Ltd. v. Zussman et al, P.M. 1993 (2), p.3. The judgement imposed liability to the extent of millions of dollars on directors who failed to control and supervise the affairs of a bank where its general manager and the manager of its head office embezzled the bank’s clients’ money. The decision was equivalent to an earthquake in the culture of directors in Israeli companies. Until this judgement was handed down, the position of a director was considered an honorable and profitable position, which does not impose any risks. This state of mind has obviously changed.
(c) The US Business Judgement Rule was not adopted per se by Israeli Courts. However, similar ideas were accepted by the Supreme Court, which held that not every mistake in business judgement constitutes a breach of the duty of care on the part of the directors and officers and that the court would not interfere in the company management’s considerations, as long as they were taken in good faith and in favour of the company.
This concept is also reflected in the specification in the Companies Law regarding the level of the duty of care required from a director or officer, as specified above.
(d) see above.
(e) The Law specifically imposes the duty of care and trust of the directors and officers towards the company and “any other person”.
Claims lodged against the directors and officers by minority shareholders as well as by creditors often invoke the above described Companies Law provisions. Such claims can also be based on breach of the Securities Law or other laws by the director or officers.
(f) The Companies Law provides that in any case of liquidation, the Court will check whether the collapse of the company was caused due to fraud in the conduct of its business.
“Fraudulent Conducting of Business” was interpreted by precedents as commercial unfairness in conducting business, e.g. a director or officer who had ordered merchandise knowing that the company will not be able to comply with its obligation, will be considered as acting fraudulently.
In many of the liquidations which took place after the enactment of the Companies Law, the liquidators filed suits against the directors and officers based on their investigations.
(g) The tax, labour and environmental laws include specific clauses which impose criminal liability on the directors and officers of companies, following infringement of these laws.
The Israeli Authorities are making substantial fuse of these laws in cases of safety in working place, i.e. in every case of death of employees in a work related accident, an investigation is carried out and the officer in charge is prosecuted.
With regard to other types of laws, the Authorities use their right only in extreme cases.
(h) The Companies Law allows indemnification of a director or officer who was indicted only in case he was acquitted. The only exemption to the said rule is where the director or officer was convicted of a crime which does not require proof of intent.
4. Statute of Limitation
In general, the limitation period for filing a civil claim under Israeli law is seven years from the date the cause of action was created. There are certain exceptions to that rule, for example: the limitation period for filing a claim based on a misleading particular in a prospectus in accordance with the Securities Law - 1968 is two years from the date of the transaction or seven years from the date of the prospectus, whichever is earlier.
5. Who Can Sue?
(a) The Company itself -for breach of the directors’ or officers’ duties towards the
company;
namely, duty of trust, duty of care (usually these elements are excluded from the D & O
policies by a Company v. Director exclusion). A derivative claim can be filed by any
shareholder or by a director of the company. The filing of a derivative claim requires the
court’s approval. Such claims are infrequently filed.
(b) Shareholders for breach of duty of care and duty of trust towards them. In public
companies, shareholders may file class actions (which also require the court’s approval.
Class actions can be filed for breach of several laws, such as the Securities Law, the
Companies Law, the Business Restriction Law, and Consumer Protection Law.
Shareholders class actions are recently growing in frequency.
(c) Third Parties - A Third Party can be anyone who has dealings with the company, including creditors. According to the Ordinance the duty of trust of the directors and officers is towards the company and any other person.
The Israeli Court specifically stated that such duty is extended to creditors and to anyone who is in contact with the company.
(d) Regulatory Authorities - Several laws impose duties on officers of the company even if they were not the wrongdoers. For example:
The Safety in Working Place Ordinance - 1970 imposes duties on officers of the company for any breach of safety regulations.
The Securities Law - 1968 imposes duties on both directors and officers for fulfillment of many of the obligations included in the law, such as liability in respect of misleading particulars in the prospectus, liability for failure to disclose information in the quarterly and annual reports of the company.The Business Restrictions Law - 1988 imposes obligations on directors and officers of the company to refrain from activities that can amount to creating a monopoly in a certain area.
Breach of the said laws can lead to both criminal and civil liability, and the relevant authorities have the right to conduct inquiries into the matter. Usually such an interrogation is a short one, and only on rare occasions do the directors and officers use the services of attorneys.
(e) Insolvency Administrators/Trustees in Bankruptcy - Pursuant to both the Ordinance and the Companies Law, during the liquidation of the company, the liquidator or the Formal Receiver may, in special circumstances, request the court to impose personal unlimited liability for the company’s obligations on a wide range of office holders who participated in conducting the company’s business. In fact, in most recent liquidations, the liquidator found ways and means to blame the directors for the collapse of the company.
Moreover, in almost every case concerning the collapse of a public company, a class action was lodged by the shareholders against the directors.
(f) Employees -- The Israeli labor laws are very protective towards employees rights. Most of the employees in Israel are members of strong labor unions and only a small portion of the employees have personal employment contracts with their employers. Claims between employees and employers are exclusively in the jurisdiction of the labor courts. In most cases, employees’ claims are filed against the company and not against its directors or officers.
There is a list of laws prohibiting work related discrimination in Israel, the most significant one being the Equal Opportunities at Work Law - 1988. A civil claim under this Law can be filed only within one year after the cause of action was created. In 1998 a new law was enacted: The Law for Prevention of Sexual Harassment. This Law provides that sexual harassment is both a civil tort and a criminal offence, and allows the Court to award plaintiff up to NIS50,000 without proof of damage. It also imposes on the employer the duty to prevent sexual harassment and specifies certain measures which should be taken for that purpose.
6. The Enforceability of Foreign Judgement on Israeli Directors and Officers and Managers
under Israeli Law
The Israeli Law of Enforcement of Foreign Judgements - 1958 provides for several
conditions specified in the Law in order for the judgement to be enforceable. The
judgement has to be final, with no possibilities of future appeal, the judgement must not
contradict public policy and should be executable under the foreign law. The Law also
requires reciprocity.
7. Can the Directors, Officers and Managers be liable for Punitive Damages and Are Punitive
Damages Insurable under Israeli Law ?
The concept of punitive damages does not exist under Israeli law. Furthermore, fines or
penalties imposed on the director or officer due to a criminal offense are uninsurable
under Israeli law.
8. Can the Company indemnify its Directors, Officers and Managers under Israeli Law
and Under Which Conditions?
The Companies Law enables the company to indemnify an officer, a director or a manager in respect of:
(a) A Court judgement awarding monetary relief to a third party.
(b) Reasonable legal costs including attorney’s fees incurred in defence of a claim initiated against him by the company or a third party or in defence of criminal proceedings in respect of which he is acquitted.
Pursuant to the Companies Law directors and officers’ costs in defending a criminal accusation are reimbursable even in case of a conviction - so long as the offense in question does not require intent.
The Companies Law prohibits a company from insuring or indemnifying in any other way, a director or an officer with regard to:
(a) breach of duty of trust which was not done in good faith, or which the officer knew might prejudice the company (i.e. intentional acts);
(b) breach of duty of care which was carried out intentionally or with indifference to the circumstances of the breach or its results;
(c) an act which was done with the intention of receiving improper personal gain;
(d) a fine or penalty imposed on the officer or the director as a result of a criminal offense.
In order to insure or indemnify an officer or director, a company must include in its Article of Association a specific clause allowing the indemnity and/or insurance.
9. Is Directors, Officers and Managers Insurance Legal?
According to the Ordinance and the Companies Law, the following are events which can be covered by insurance:
(a) Loss or damage which derive from breach of duty of care on the part of the director or the officer towards the company or any third party.
(b) Loss or damage deriving from breach of trust on the part of the officer or director against the company, provided that such breach of trust was carried out in good faith while the director or officer had reasonable basis to believe that such an act would not prejudice the interests of the company.
(c) Monetary liability to a third party as a result of an activity in his capacity as an officer of the company.
The legal restrictions in respect of directors and officers insurance are identical to the restrictions applicable to indemnification, as detailed in the previous Section.
Who pays the premium/insurance?
According to the Ordinance and the Companies Law, the company is allowed to pay the premium for the benefit of the directors and officers.
Must the D&O Insurance Policy be issued by a local admitted insurer?
No. An Israeli insured is not prohibited from the purchase of a policy from a foreign insurer.
Issues of tax allocation of local premium for local D&O insurance policy
Since there is no prevention to acquire a policy from a foreign insurer, no issues of tax allocations arise.
10. General Comments
The two main items of legislation that influence the exposure of directors and officers are:
a) The Companies Ordinance which was influenced primarily by English Law, but was developed more along the thinking of American rulings.
b) The Securities Law - which was based on The American Security Act - 1933.
The main differences between the situation in Israel and the U.S. are the amounts of the awards granted to plaintiffs by the courts, as well as the amounts incurred in legal defence which are low in comparison to the U.S. For example, defence costs against a class action in Israel may amount to “only” $300,000-$400,000, including appeal proceedings.
One of the main reasons is the fact that there is no jury system in Israel. In addition, the Israeli legal system did not adopt “the duty to defend” approach, nor the “bad faith” threat.
In the last couple of years the tendency of the Israeli courts has been to impose greater difficulties on plaintiffs who file class actions for breach of the Securities Law. The courts have become aware of the danger that such claims may become a means of extortion from the company and have refused to cooperate with abuse of court proceedings.
In fact, most of the claims which were recognized as class actions related to fraudulent acts committed by directors and officers, or claims where irreversible damage was caused which could not be explained by the business judgement rule.
As a result of the above, in general, the D&O market has been a profitable one throughout the years, with a positive loss ratio.
|
Home
