A significant precedent was handed down recently by the Israeli Supreme Court on the subject of the judicial audit that should be performed in relation to companies' business resolutions.
The judgment officially adopts the Business Judgment Rule prescribed in Israeli law with regard to the auditing standard that should be applied to board resolutions. The judgment further prescribes that it is also warranted to adopt the Enhanced Scrutiny Rule under circumstances when the Business Judgment Rule does not provide an adequate solution. The judgment also engages in subjects not yet addressed by the court, including issues pertaining to dividend distributions, leveraged buyouts, officers' duties in a company and the relation between them.
The judgment was handed down within the scope of a derivative suit filed against Bezeq and officers of Bezeq, alleging that the acquisition of Bezeq's control core in 2010, at the inclusive sum of about NIS 6.5 billion by corporations controlled by Mr. Shaul Elovitch, was carried out by way of an LBO (leveraged buyout) (equity totaling approximately NIS 1.4 billion; financing totalling about NIS 1.5 billion). The petitioners alleged that Bezeq's capital recruitment policy and the subsequent distributions had exacerbated Bezeq's capital structure and were used mainly to service the debt incurred by the company's controlling shareholder in order to finance the acquisition and was at the expense of the company's best interests.
The District Court rejected the motion filed to certify the derivative suit and ruled that all of the resolutions passed by Bezeq's board of directors are sheltered under the BJR (the Business Judgment Rule). An appeal of the District Court's ruling was filed with the Supreme Court.
Following are the Supreme Court's key rulings
The court notes that an LBO is a legitimate and even desirable tool, provided that it is employed with all due responsibility, adding that generally, board resolutions of companies undergoing a leveraged buyout, just like any other resolution affecting a company's financial structure, are sheltered under the Business Judgment Rule.
An officer, who is not in a conflict of interest and who makes a subjective decision with bona fides and in an informed manner will be protected under the "immunity from judicial review" and the "presumption of propriety" prescribed in the Business Judgment Rule.
The court will refrain from examining the business action itself, but rather, will examine the decision-making process in the company. However, one must keep in mind that the Business Judgment Rule is a rebuttable presumption and, in some circumstances, the presumption will be rebutted. The court further ruled that it is warranted to adopt an intermediate standard of Enhanced Scrutiny, under circumstances when the Business Judgment Rule does not provide an adequately suitable response, due to the concern that reliance solely on the Business Judgment Rule might lead to a failure to identify violations of the fiduciary duty imposed on officers of the company.
Another issue elaborated on in the judgment is whether a dividend distribution can be considered a "transaction" with a company's controlling shareholder (which, as such, is subject to the provisions of law prescribed in the Companies Law regulating procedures for approving transactions). The Supreme Court ruled that a dividend distribution is not deemed a "transaction" (and not even an "exceptional transaction") and that, due to the principle of equality in dividend distributions, the controlling shareholder cannot have a "personal interest" in a distribution. In this regard, the court ruled that a judicial review of a dividend distribution will be carried out according to the procedural mechanisms for distributions prescribed in the Companies Law (the profit test and the solvency test) and while considering the directors' duties, and not according to the mechanisms for approving transactions with interested parties.
Furthermore, the judgment differentiated between the various duties imposed on officers of a company. Alongside the duty of care and the fiduciary duty imposed on officers is the duty of fairness that is imposed on the controlling shareholder, which is solely vis-à-vis the company and not vis-à-vis all the other shareholders. The court ruled that the controlling shareholder's support of the dividend distribution does not suffice to constitute a breach of the duty of fairness imposed on him.
The Supreme Court's judgment in the Bezeq case is one of the most important corporate law judgments handed down in the State of Israel. This judgment constitutes a precedent that directly impacts business resolutions being passed by companies' boards of directors, including companies with a control core. We invite you to consult with us in relation to the implications of this judgment; we are at your service to answer any question in this regard.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
