Guidelines Regarding Distribution of Dividends in Light of Recent District Court Decision


Dear clients and friends,

On May 14, 2012, the Financial Division of the Tel Aviv District Court (the Hon. Danya Keret Meir, J.), handed down a decision that has vast implications on the way companies resolve to distribute dividends and implement such resolutions (CA (Tel Aviv) 48067-01-11 A.L.A.N Baths Ltd. v. Bezeq The Israeli Telecommunication Company Ltd. (May 14, 2012)).

The board of directors of Bezeq, Israel’s leading telecommunications company, resolved to distribute dividends to its shareholders, payable in six installments. Since Bezeq did not meet the “profits test” under the Israeli Companies Law, 1999, it applied to court to approve such distribution, demonstrating (as the law required) that Bezeq could nonetheless repay its debts when due (this is known as the “repayment capability test”). Bezeq’s application was supported by a financial opinion issued by a consultancy firm that had previously undertaken work for Bezeq’s controlling shareholder. The court approved Bezeq’s request to distribute dividends, however following the payment of the first of the six installments of the dividend, the plaintiffs, creditors of Bezeq, filed an application of their own to court, arguing (amongst others) that certain events that had transpired since the approval of the dividend distribution rendered the facts underlying such approval irrelevant (such events included the raising of extensive debt financing by Bezeq). Thus, the plaintiffs contended, the approval of the dividend distribution should be revisited by Bezeq’s board of directors. Bezeq argued that once the distribution of dividends was approved and declared, such distribution is an irreversible fait accomplit; and that declared but unpaid dividends are in fact a debt owed by the company to its shareholders.

In a precedential decision, the Hon. Danya Keret Meir, J., approved the distribution of the next dividend installment by Bezeq, however set forth certain guidelines with respect to distribution of dividends. Below we have summarized those which are of special significance:

Timing of “repayment capability test”: The repayment capability test must be met both at the time of declaration of the dividend and again at the time of actual payment of the dividend (unless the payment is made promptly following the declaration and provided that between the time of declaration and the time of payment nothing out of the ordinary occurred having an adverse effect on the company’s ability to repay its debts when due). Thus, the court determined that “there is no room to permit upfront distributions of dividends in installments. A company wishing to distribute dividends without relying on the profits test must apply to court each time it wishes to make an actual payment of dividends”.

Directors’ and officers’ responsibilities: A decision by a court approving the distribution of dividends does not derogate from directors’ and officers’ responsibilities and liabilities. Thus, a change of circumstances in the period between a declaration of dividends and actual payment of dividends requires directors and officers to take the necessary measures in light of such change. The court mentioned that a board of directors wishing to avoid the consequences of a prohibited dividend distribution should determine milestones for revisiting its resolution to distribute dividends (e.g., when there is a material adverse change in the business of the company). Directors that are concerned that a certain distribution of dividends is prohibited should turn to the court for instructions.

Creditors’ right to contest the distribution: A creditor that can demonstrate a material adverse change in the company’s ability to repay its debts when due has a right to motion the court at any time in this respect, including following approval of a dividend distribution.

A declared but unpaid dividend does not create a debt to shareholders: A declared but unpaid dividend is not a debt owed by the company to its shareholders, even if the amount of the dividend is reserved against in the company’s financial statements. Thus, any declared but unpaid dividends are subordinated to the company’s debts to its creditors.

Opinion must be impartial: An opinion filed with a court in support of an application to approve a distribution of dividends must be provided by an impartial and fully independent expert, with no (direct or indirect) relations whatsoever with the company or its controlling shareholder.

Fixed fee for opinion and no indemnification of provider of opinion: In order to ensure impartiality of the expert providing the supporting opinion, the fee payable to such expert must be fixed. If the fees are hourly fees, a cap should be determined. Moreover, there can be no indemnification arrangement in favor of the expert providing the supporting opinion and such expert may only limit its liability to reliance on information provided to it.

We note that the Bezeq decision was handed by a District Court, and is therefore still subject to appeal (if filed) before the Supreme Court.

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.

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