Dear colleagues and friends,
In a recent decision, the Israeli Supreme Court (the Hon. Miriam Naor, Salim Joubran and Esther Hayut) determined the circumstances in which refraining from distributing dividends constitutes deprivation of minority shareholders in private companies.
Prat Metal Industries Ltd. is a private company with three shareholders: two shareholders are siblings that together own 60% of the company; and a third unrelated shareholder owns 40% of the company. In the course of about 20 years since the third shareholder joined the company, the company did not distribute dividends (other than once). During such period, the controlling shareholders (and related parties) acted as directors and officers of the company, and were paid generous salaries and other benefits.
The minority shareholder filed suit against the company and its controlling shareholders in the District Court of Tel-Aviv – Jaffa. The claimant’s principal argument was that by the systematic refusal to distribute dividends, the company and its controlling shareholders were depriving him of his legitimate rights and expectations.
District Court Ruling
The District Court found in favour of the minority shareholder and determined that the continued refusal of the company to distribute dividends, while its cash balance was positive, amounts to deprivation of the minority shareholder’s rights. The District Court based its ruling, among others, on the controlling shareholders’ systematic opposition to distribute dividends, no business justification to support such opposition, and the payment of high salaries and other benefits to the controlling shareholders over the years (such that they received compensation from the company while the minority shareholder received none).
The District Court decided that the appropriate remedy would be to force the controlling shareholders to acquire the shares of the minority shareholder; however, since the controlling shareholders contended that they were unable to acquire the shares at their current valuation, the District Court instructed the company to distribute 50% of its profits as a dividend and to enforce a resolution of the company’s board of directors from 2012 to distribute 30% of the company’s profits as dividends every year.
Appeal and Supreme Court Ruling
The controlling shareholders appealed the District Court’s decision before the Supreme Court claiming (among others) that: (i) the plaintiff did not prove that the company’s dividend distribution policy was unreasonable, and therefore the District Court should not have intervened; (ii) the District Court did not determine that the controlling shareholders were paid excess salaries, and should have therefore not taken such considerations into account with respect to its decision relating the distribution of dividends; and (iii) the District Court should have ordered a distribution of dividends at a rate of 30%, rather than 50%, which coincides with the resolution of the company’s board of directors in 2012 that the court instructed to enforce.
The Supreme Court upheld the District Court’s determinations. The Supreme Court noted that according to the Israeli Companies Law, 1999, unequal allocation of resources by a company may constitute deprivation of a minority shareholder’s rights. Although courts generally do not interfere with decisions that are within the authority of a company’s board of directors, such as the manner of use of company profits and distribution of dividends, under certain circumstances, a company’s refusal to distribute dividends could be considered as deprivation. The Supreme Court noted that minority shareholders in private companies may find themselves unable to effectively receive a return on their investment, due to majority shareholders’ weak incentive to distribute dividends, as in many cases the majority shareholders, as opposed to minority shareholders, receive salaries and other benefits. Moreover, minority shareholders in private companies are usually unable sell their minority stakes at market value.
In the Prat matter, the Supreme Court determined that the minority shareholder established reasonable grounds for a claim of deprivation of rights, indicated by the company’s longstanding refrainment to distribute dividends, coupled with the high salaries and benefits that were paid to the majority shareholders, the company’s extensive investments over the years, and other indications of excluding the minority shareholder from company business. The Supreme Court noted that the aggregation of all such actions established the claim while each such action alone may not have been sufficient.
The Supreme Court rejected the majority shareholders’ line of defense, which was based on the company’s policy to save its profits “for a rainy day” and for the benefit of the company’s creditors, stating that such arguments are not supported by the company’s actions.
With respect to the District Court’s decision to distribute 50% of the company’s profits as dividends, the Supreme Court noted that the Companies Law permits courts flexibility in deciding suitable remedies in cases of deprivation of minority shareholders’ rights. The Supreme Court ruled that the District Court’s ruling did not justify its intervention, and that such ruling reflects the years of deprivation suffered by the minority shareholder.
This publication provides general information and should not be used or taken as legal advice for specific situations, which depend on the evaluation of precise factual circumstances.