Liability of Officers and Functionaries in an Insolvent Corporation

In March 2018, the Knesset enacted the Insolvency and Economic Rehabilitation Law, 5778 – 2018, which is designed to update the insolvency laws that today apply in Israel.

Until now, insolvency laws were regulated under old-fashioned, outdated, and spotty legislation that was detrimental to the debtors, the creditors, and the entire economy. The law approved in 2018 is designed to rectify this situation and provide the Israeli economy with modern insolvency legislation.

This law has three principal objectives: first, to prioritize the debtor’s economic rehabilitation; second, to increase debt repayments to creditors and to distribute the repayment fund more equitably between strong and weak creditors; and third, to increase the certainty and stability of the law by streamlining proceedings and reducing bureaucracy.

The law is scheduled to come into effect on September 15, 2019.

Chapter 8 of the new law addresses the liability of officers and functionaries (i.e., the corporation’s promoter, as this term is defined in the Companies Law, 5759 – 1999, officers, trustees or any party acting on its behalf, and receiverships) in a corporation that becomes insolvent. The law’s main innovation is that – beyond liabilities toward the corporation, which already existed prior to the enactment of the law, such as fiduciary duty and duty of care – special liability will also be imposed on the corporation’s officers and functionaries in respect of the period that preceded the corporation’s official entry into insolvency proceedings.

The law prescribes that in the event a director (and the intention is also to anyone who actually fulfilled the role of director, i.e. also “shadow directors”) or the CEO knew or should have known that the corporation was insolvent and failed to take reasonable measures to minimize its scope, the court may rule, at the request of the trustee or the administrator, after having issued the order to open proceedings against the corporation, that the director or the CEO must bear liability toward the corporation for the damages caused to the corporation’s creditors as a result of his or her failure.

The law also prescribes that a company is not allowed to grant a release and/or to indemnify a director and a CEO in respect of breach of said duty. However, the law prescribes that the director or CEO will not be held liable in respect of the aforesaid if he or she can prove that he or she reasonably and with bona fides relied on information that indicated the corporation was not in a state of insolvency. Furthermore, the law prescribes a presumption that a director or CEO will be deemed as having taken reasonable measures to reduce the magnitude of the corporation’s insolvency if he or she took steps to assess the corporation’s economic situation and took action for the corporation to institute one of the following measures:

1. obtain assistance from experts in corporate rehabilitation;
2. conduct negotiations with creditors in order to reach a debt arrangement; or
3. open insolvency proceedings.

The repercussions of an officer’s breach of duty are as follows: if the court finds that a functionary in the corporation breached his or her duty toward the corporation in a manner that justifies adjudicating compensation, payment, or the return of an asset to the corporation, the court may rule, at the request of the trustee or the administrator, after having issued the order to open proceedings against the corporation, that that functionary must compensate, pay, or return said asset to the corporation.