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Director Obligations under Israeli Law


General Obligations and Duties

The company Director has an obligation to set the policy guidelines for the company and to supervise the performance and activities of the Managing Director.

Amongst its duties a Director must prepare and confirm the financial reports of the company. Before presenting these reports to the shareholders, the Director must convene a shareholders’ meeting and establish the proposed agenda for the meeting. The Director must implement the shareholders decisions and ensure that shareholders resolutions are agreed upon.  The Director must generally supervise and ensure that the company fulfills its requirements under the law.

Standard practice indicates that a Director must delegate responsibilities. However it must be emphasized that parts of the Director’s official duties cannot be delegated. Examples of duties that cannot be delegated include:  Determining the general policy of the company, determining the distribution of profits, granting options and confirming the financial reports of the company.

Trust Obligations – Fiduciary duty (Article 254 of the Companies Law) orders a director as well as any other company manager to exercise its power and to act in good faith in relation to the company’s interests. Such a duty require the company’s director not to act in a way that may result in a conflict of interest between the company and himself or between the company’s business and the director’s own private matters. An example of a violation of fiduciary duty is when a director has holdings in a third party in which the company intends to invest money.  The director must not compete with the company business and he is prohibited from gaining a personal advantage through business opportunities presented before the company. Further, the director must transfer to the company any information and documents that have connection to the company’s business in circumstances were he received those in the frame of his role in the company.

Duty of Care Obligations – The obligation to act with a duty of care is an obligation not to be negligent. A director must act in a way in which a reasonable director would have acted in similar circumstances. Further, any omissions must also be in line with what a reasonable Director would omit in similar circumstances. The Company Law requires a director to fulfill his duties with appropriate skill and diligence.

Relationship between the Company and the Director – The relationship between the company and the director is in essence a contractual one.  Nevertheless, in the absence of a formal written document between the parties, all the requirements under the law will be brought to such a relationship.

Criminal Sanctions – In some cases the violation of the duty of care that a director owes to the company might lead to criminal sanctions.  Some examples include: theft of company assets, forgery of documents with intent to deceive and fraudulent registration of the company’s documents.

Director’s Rights – For the purpose of setting the Policy Guidelines for the company and supervising its activities, any director may examine the documents and records and receive copies thereof. The director may also examine the assets of the company and receive professional advice at the expense of the company.

In general the director is entitling to use all of their authority and power to carry out any actions bested in it by law or by the Company Articles of Associations. This includes the right to appoint one or more persons as Managing Director or another manager of the Company, and to dismiss and replace those appointed directors. A director may determine the remuneration of the Auditor of the company in respect of the audit.

Insolvency. The rule on the separate legal status of a company with regard to its shareholders and officers also applies where the company enters into liquidation.  The Israeli courts usually avoid lifting the corporate veil and/or imposing personal liability on officers in connection with the company’s business: under the ‘business judgment’ rule, a court will not retroactively judge the correctness of decisions made by company officers as long as they applied reasonable judgment at the time.

However, in case of insolvency in Israel, a number of causes of action are available where company officers are found to have failed to exercise their duties properly.

Directors may also be criminally liable for misuse or withholding of information before and during liquidation, as well as for failing to keep proper accounts during the two-year period preceding liquidation.

Further to Section 373 of the Israeli Companies Ordinance, if it becomes evident during liquidation that the company’s business was managed in a manner intended to deceive its own or other creditors, or for any fraudulent purpose, the court may, at the request of the Official Receiver, the liquidator, a creditor or a shareholder, order that any director who knowingly participated in the management of the business bear unlimited personal liability for all or part of the company’s debts, as instructed by the court. The court may also impose criminal sanctions on that director, and even disqualify him from serving as company director or being directly or indirectly involved in the management of a company without court permission.

For such purposes, the term ‘director’ also covers a person who has not served as a formal director, if in practice the directors acted on that person’s instructions or guidelines.

Further to Section 374 of the Companies Ordinance, if it becomes clear in the course of liquidation that an officer made improper use of money or assets of the company, or committed an improper or illegal act in a negotiation related to the company, the court may, investigate the behavior of that officer and order him to return the money or asset, in full or in part, or to compensate the company for his actions.

Financial Reports. Further to section 171 of the Companies law, Israeli companies are required to keep accounts, and also to prepare financial reports. The financial reports are to be approved by the board of  directors and signed in its name. Further to section 172(a) of the Companies Law, a company shall prepare financial reports for each year, which shall include a balance sheet as of 31 December, as well as a profit and loss account for the period of a year ending on that date, and other audited financial reports, in accordance with the requirements of accepted accounting rules. Further to section 173(a) of the Companies Law, the board of directors of a private company shall present the financial reports approved by it to the annual meeting of shareholders of the company.

Israeli Court’s Ruling

In regard to the rulings that had accumulated since the enactment of the Companies Act, attention must be paid to the multiple claims that arrived to the courts.

This multiplicity of claims indicates a dramatic change has taken place in Israeli law. In the past, the Israeli legal system did not significantly enforce liability duties of directors and managers.  The principle of “non-intervention” which instructed the court in England, and later on in Israel, reduced the willingness of the court to perform significant supervision on decision-making process within the company.

This situation began to change gradually, after the “Beisky report” published in 1986 which followed the affair of the bank shares.  This affair reinforced the concept that, there is room to expand the duties of trust and personal responsibility for directors and managers of companies. In this context, it also expanded the responsibility of accountants and internal supervisors of companies.
The change in this matter took place in several stages:

The first phase developed a model regulation. The Beisky report, and then after the ruling of the ruling in Buchbinder v. Official Receiver in his role as liquidator of the Bank of North America anchored the role of the board of directors to be in charge of decision-making process within the company. This ruling widened the directors’ personal liability for damages caused to the company as a result of its breach of the duty of supervision.
In the second stage, a correction in the Companies Ordinance was legislated: Amendment No. 4 reshaped the fiduciary obligations of directors and company managers. The amendment procedures set standardization of decision-making in the company in any case where there is a conflict of interests.  This ensures that no conflicts of interest in advance will cause harm to the company’s favor.

In the third phase, the Companies Law was passed. This further extended the fiduciary obligations of directors and managers. The law adopted the arrangements of Amendment No. 4. It also determined the personal responsibility of managers to situations such as: prohibited distribution to the shareholders (Section 311 of the Companies Law), approval of a merger that affects the repayment capacity of the merging company (section 315 of the Companies Law) and defensive tactics that lead to scuttling of a tender offer (Article 330 of the Companies Law).
In the fourth stage, Amendment 3 was passed, which increased the standardization of the decision-making process within the company in order to ensure the effective enforcement of these obligations.