ISRAEL: An Introduction to Restructuring/Insolvency
Insolvency Law - Trends and processes in Israeli law, including developments following the COVID-19 crisis
Dr. Shlomo Nass
Doron, Tikotzky, Kantor, Gutman, Nass, Amit Gross & Co.
In the legal world, it is all about balancing interests. Likewise, insolvency law must balance the interests of the various parties involved in the insolvency process while maintaining the economic stability of the market and maintaining values that are important to society as a whole.
Insolvency proceedings were previously regulated by the Bankruptcy Ordinance [New Version] 1980 as well as the Companies Ordinance [New Version] 1983, which provided partial solutions to individual and corporate legal issues. The provisions of these ordinances were enacted on the basis of principles that were relevant to the previous century, which have changed over the years. The gaps in them have been filled by the courts through creative case law and purposeful interpretation.
Currently, insolvency laws are regulated in a new law, called Insolvency and Economic Rehabilitation Law 2018, after the Israeli Legislature decided that this field needed comprehensive and up-to-date legislation. The reason for this is the understanding that this is a multi-party economic event involving complicated economic and value issues and the perception that this is not a tort or moral defect of the debtor, but rather a "necessary evil" resulting from the evolution and perfection of the credit market and from the risks in the business world today.
The change in perception has also affected the purpose and ultimate goal outlined in the law: the economic rehabilitation of the debtor (individual or corporation) while promoting financial objectives and reducing harm to the entire economy. Unlike the previous situation, where the primary goal was to streamline the debt collection process, this purpose is now secondary after the debtor has been rehabilitated.
Perceptual changes are also reflected in incorporating two tests into the definition of insolvency: the balance sheet test, which examines total liabilities versus total assets, and the cash flow test, which looks at whether debts can be paid on time, regardless of whether they have matured.
Thus, the law provides two types of procedures for a corporation in difficulty that may be rehabilitated. The first procedure under Chapter B, Part B of the law: appointment of an external trustee who assumes control and management of the company; delay of legal proceedings; prohibition of repayment of past debts and the operation of the corporation while the trustee formulates an economic rehabilitation plan. Liquidation may be ordered if there is no reasonable prospect of rehabilitating the corporation if it is clear that its operations will harm creditors, or if there are no ways to finance the costs of operating the corporation.
A second procedure under Part 10 of the Law allows the corporation to reach a binding settlement with its creditors without opening proceedings. According to this procedure, control remains in the hands of the owner and the management and accordingly, as long as an arrangement is not approved, the corporation must continue to meet its obligations to its creditors. The role of the arrangement manager is limited to managing creditors' meetings and approving the arrangement.
Although the law was innovative and adapted to the current time, it did not address businesses operating under conditions of global and extreme crisis, such as the COVID-19 crisis. There was a need to find a creative and quick solution beyond the various government decisions, including granting subsidies and compensating businesses according to the losses suffered.
For this purpose, Amendment 4 to the Law regarding the delay of proceedings for the formulation and approval of a debt settlement (Temporary Order - the new Coronavirus) was issued, which took effect on 18.3.21 and, in light of the situation, was extended until 17.9.22. As an interim outline, this amendment provides a debt settlement with the possibility of delaying proceedings (maximum up to four months), limited operations, and an arrangement manager whose mandate is extended but he does not replace the company's board of directors and serves alongside the existing management as a court supervisor. "The intention is to motivate such executives, if necessary, to take the path of rehabilitation without an order to open proceedings and without losing control of the company."
It is a new trend that can lead to improvement and general recovery in Israel because "the aforementioned protection gives a company that is in cash flow difficulty the opportunity to recover and prevent its complete collapse, and it does so proactively."
As expressed in the explanatory memorandum to Amendment 4, the starting point is that the reorganisation of the corporation's debts by the arrangement manager will allow it to return to the standard course of business from which it deviated. "As a result, Amendment 4 outlined a designated route for dealing with debtors affected by the crisis, which does not involve an order to open proceedings and the negative consequences associated with a typical insolvency proceeding."
The "Shamir Salads" company serves as an excellent example. Its sales turnover was hundreds of millions of shekels. However, due to COVID-19, its scope of operations was drastically reduced, and it found itself in great difficulties and debt. The arrangement manager appointed by the court worked with the company's representatives, and funding was found to operate the company as a "living business" throughout the delay in proceedings. The company regained its economic activity and prevented a decline in its financial performance due to this move. A lesson to be learned here is that even a company with a high sales volume and quality products can find itself in insolvency proceedings that end in liquidation if a "slippery slope" is not prevented.
According to the ruling, the interim outline is significant for companies that have been facing economic difficulties without a link to COVID-19, and the delay in the proceedings is not contingent on the financial difficulties resulting from the pandemic.
Upon granting a delay of proceedings based on Amendment 4, the court will consider, inter alia, the position of the creditors concerning the debt arrangement proposed before them, thus making it highly unlikely that the arrangement will not be approved.
Amendment 4 is positive and creative, but it is "too little, too late." It doesn't address several industries that have been severely affected by COVID-19, such as tourism, the venue industry, and the culture industry, for which this mechanism is not relevant due to the nature of their activities and the high business risks in them. It is not a magic solution to all situations. In any case, a delay in proceedings is only possible if the corporation has a real possibility of rehabilitation on an economical and practical level.
Additionally, and in the context of the company's management, there is another change in the responsibilities of the officers and functionaries in an insolvent corporation. A renewal in this matter is stipulated in section 288 of the law, which applies when the company is insolvent (instead of a formal state of filing an order to open proceedings) and while it is still in the hands of the shareholders. This requirement creates an incentive for the company's management to act at this point (of recognizing by force or in practice that the company is insolvent) in accordance with the obligation to reduce the scope of insolvency, inter alia, while taking the actions listed in section 288 (b) including "Receiving assistance from entities specialising in corporate rehabilitation".
As such, at this point, the duty of the directors and CEO changes from an obligation to the company to maximize profits to an obligation to the creditors, in the sense of reducing the extent of insolvency and therefore benefiting them.
Directors and CEOs will be liable for actions or omissions that occurred while they knew or should have known that the corporation was insolvent and failed to reduce the scope of insolvency, which would have constituted a breach of their duty under section 288 of the Act. Only after an opening proceeding order has been issued can this be done.
An interesting recent example this context, in the care of our firm, when directors of Goatilav Ltd. (which has indirect corporate ties to the NSO Group) and which holds shares in Convexum Ltd. and Wayout Ltd., initiated insolvency proceedings to appoint a trustee to take over the businesses and their assets. Considering that both companies were insolvent, the directors, who were in a position of informational disadvantage, sought to act in accordance with the information available to them. The court ruled that a trustee can be appointed who will operate the companies and undertake any measure they deem necessary to maximise the profit that can be generated through the company rehabilitation process.
In conclusion, we can observe the changes and trends that have taken place in the area of insolvency in recent years, in general, and following the COVID-19 crisis in particular. By smartly and appropriately using the tools the legislature has provided, according to which the ruling is applied, the corporate entity can move forward in the right and appropriate direction.