Economic Court Restores Certainty to Profit Test for Dividend Distributions

The Tel Aviv District Court (Economic Department) has restored certainty to directors in relation to the profit test for dividend distributions.

The court ruled that the profit test is a retroactive technical test, unless the directors are aware of a major event that could materially change the company’s accounting position.

Pursuant to the Companies Law, in order for a company to be able to distribute a dividend, it must pass two “distribution tests”: the profit test and the solvency test.

The profit test is a retroactive technical test that examines a company’s accumulated profits over the last two years.

The solvency test is a forward-looking test in which the board of directors is required to ascertain whether a reasonable concern exists that a distribution may prevent the company from paying its existing and expected liabilities.

A ruling Issued by the court in 2013 (the Lahav case) prescribed that, even though the profit test is a technical test, under certain circumstances, a company’s board of directors is required to analyze and take into account updated information in its possession when performing it. (This includes information contained in financial statements not yet signed.)

The ruling in the Lahav case led to uncertainty with regard to the profit test and, to a certain extent, also expanded it toward its “technical” extremes. As a result, directors of public companies became more anxious and cautious and often refrained from approving a dividend distribution even though the company had met the retroactive technical conditions of the profit test.

Restoration of certainty

The court handed down a ruling recently within the framework of a motion to certify a derivative suit against Discount Investments Ltd. This ruling reiterated and stressed that the profit test is merely a technical test.

The ruling further stated that the profit test will be expanded beyond its technical limits solely in cases where developments occurred in a company prior to passing the resolution to distribute a dividend that caused the company’s accounting position to change materially from the position it was in when the financial statements forming the basis of the resolution to distribute were published.

This ruling brings more certainty to directors when passing a resolution to distribute a dividend. It also eliminates the heightened restraint that existed to date in this regard.

***

Adv. Ron Shuhatovich a partner in the capital market department of the firm. He advises public and private companies, directors, and leading institutional entities. Ron and the team are at your service if you need any advice or guidance in this regard.