In a recent ruling by the Judge of the Economic Department of the Tel Aviv District Court, Ruth Ronen, a guideline was given in relation to the application of the Business Judgment Rule doctrine to decisions taken by the officers of a company in the context of dividend distribution.
In the case, an application to approve of a derivative claim (47621-07-16 Horev v. B Communications Ltd. et al), the petitioner alleged the approval by the board of directors of an unlawful dividend distribution in the amount of NIS 113 million. According to the Israeli Companies Law, 1999, a company may distribute profits to its shareholders if two tests are satisfied: the “Profit Test” and the “Solvency Test”. Notwithstanding, distribution of dividends may also be permitted in circumstances that a company does not satisfy the profit test, though the court will hold that the company does meet the solvency test.
The board of directors of B-Communications Ltd. (“B-Com“) decided to distribute dividends and determined that both, the profit and solvency criterion, had been met. In the ruling, Judge Ronen held that the profit test had not been satisfied, since the source of the profits presented in the company’s books under the retained earnings component is merely an accounting surplus. It follows from this premise, that the company’s board of directors had made a dividend distribution which is contrary to a statutory provision (known under the Companies Law as a “prohibited distribution”).
The question that then arose is whether the distribution could be “protected” under the Business Judgment Rule.
The Business Judgment Rule was adopted in Israel from the American legal system in a number of judgments (the first of which was 7735/14 Verednikov v. Elovitz), and states that the action or decision of an officer, made in the absence of a conflict of interest and in good faith, in an informed manner, enjoys a presumption of propriety even if it had caused a loss or damage. The degree of care and diligence required is one that a reasonable person would exercise if they were a director or officer in those same circumstances.
In the B-Com case, interestingly, Judge Ronen ruled that the Business Judgment Rule, as its name implies, is intended to apply to business decisions, in which directors must exercise business judgment. The rule cannot, however, be applied to protect directors who violated a statutory provision. The question of whether a particular distribution meets the profit test or not is a question of law, to be interpreted by the court.
This ruling, although continuing the course of similar decisions recently made by the Economic Department of the District Court, may have an adverse effect on officers and company legal advisers when attempting to differentiate “business decisions” from “legal decisions”, when only the former will, if taken properly, enjoy the presumption of defense afforded by the Business Judgment Rule.
Bearing in mind the number of decisions taken by a board of directors which are business in nature, though simultaneously and invariably also containing legal aspects, such a classification may very well prove artificial in real life.