Personal Liability Imposed by Liquidation Court on Directors and Officers for Breach of Corporate Duties

Dear clients and friends,

Sections 373 and 374 of the Israeli Companies Ordinance, 1983 (the “Companies Ordinance”) enable liquidators to make a claim for payment against officers of a company in liquidation.  Section 373 permits the court to apply unlimited personal (and criminal) liability to directors and officers who ran a company’s business fraudulently. Section 374 enables the retrieval of funds from any person that made improper use of any of the company’s assets or funds or who acted improperly or in violation of applicable law.

The question brought before the District Court of Haifa (the Hon. Adi Zarnakin) in Liquidation Proceeding 272-98 Galrad Industries (1992) Ltd. v. David Sheinin, was whether the respondents were liable for the debts of Galrad Industries (1992) Ltd. under Section 373 or 374 of the Companies Ordinance.

In its ruling, the District Court drew a distinction between Sections 373 and 374 of the Companies Ordinance.  Whereas the implementation of the former requires proof of fraud, implementing the latter requires only proof of breach of the fiduciary duty or duty of care of such director or officer.
The company’s liquidator argued that the controlling shareholder of the company’s parent company, together with another officer of the company, conducted the business of the company in a fraudulent manner, transferred company funds from its accounts to companies affiliated with the controlling shareholder, and breached their fiduciary duties and duties of care.

The controlling shareholder of the parent company argued that he did not serve as an officer of the company and thus, he does not owe a fiduciary duty or duty of care towards the company.  The District Court rejected this argument and ruled that in the present case the controlling shareholder should be deemed an officer due to his influence over the company’s operations, his managerial – albeit informal – position in the company, the authorities and powers granted to him in practice and the level of influence he had on other officers of the company.

The District Court ruled that the evidence presented to it was insufficient to determine that the actions committed by the respondents amounted to fraud and therefore, Section 373 of the Companies Ordinance did not apply. The District Court did however accept a few of the liquidator’s claims and ruled that the respondents breached their fiduciary duty and their duty of care as once they thought that the company would not recover from its dire financial situation, they withdrew assets and funds from the company, thus depriving the company and its creditors of value. The District Court therefore invoked Section 374 of the Companies Ordinance and ordered them to return certain amounts to the company.

We note that this ruling may be subject to additional review and appeal, and may therefore not be the final word on this matter.

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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