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Board Members? 7 Keys to Protecting Your Company and Your Self During the Pandemic

Opinion

Board Members? 7 Keys to Protecting Your Company and Your Self During the Pandemic

When a company is on the verge of insolvency directors and CEOs become subject to more enhanced scrutiny under Israeli law

Asaf Nahum & Seffy Zinger | 09:29  18.05.2020
The surprising emergence of the coronavirus (Covid-19) pandemic in 2020 caught many companies by complete surprise. Boards of directors of companies, of every size and from all industries, who had just recently approved their budget for 2020, fell into a new reality — suspension and occasionally complete cessation of business activity. The economic effect of the deadly virus is yet to be fully realized, however, it is safe to assume that many companies and business entities who suffer from liquidity issues during the crisis, may face insolvency or quasi-insolvency proceedings.

It is within the general duties of the directors to observe, supervise, and take precautionary measures to protect and advance the business of the company. This becomes imperative in the time of a pandemic that may have a destructive economic effect on the company and its business activity.

A board room. Photo: Shutterstock A board room. Photo: Shutterstock A board room. Photo: Shutterstock

Israeli law takes these duties into account. Generally, directors are subject to heavy duties of care and loyalty. Under the duty of care, an Israeli officeholder must “act diligently in a manner in which a reasonable officeholder would have acted in the same position and under the same circumstances, and generally shall take, subject to the circumstances at hand, reasonable measures to obtain information relating to the business worthiness of any action brought to approval by the Board or that is made by the officeholder in his or her capacity as such, and to receive all information relevant to said action.”

When a company is on the “verge of insolvency,” however, directors and CEOs become subject to more enhanced scrutiny. Section 288 of the Israeli Insolvency and Financial Rehabilitation Law, 2018 (the “Israeli Insolvency Law”), imposes personal liability on directors and CEOs who knew or should have known that the company is insolvent and did not take reasonable measures to reduce its impact. The Israeli Insolvency Law stipulates that “insolvency” is measured both based on the balance sheet test and the cash flow test. The liability under the Israeli Insolvency Law applies towards the company in relation to damages caused to creditors of the company due to acts or omissions of the directors or the CEO.

The Israeli Insolvency Law does provide a safe harbor for officeholders. The law prescribes that directors or CEO who have taken measures to assess the financial status of the company and have exercised any one of following precautionary actions, shall be presumed to have acted properly – (a) consulting insolvency and rehabilitation specialists, (b) negotiating with the creditors of the company towards a creditor arrangement or (c) initiating insolvency proceedings (i.e., liquidation or stay of proceedings).

The law further provides protection to those directors or CEOs who have proven good faith, reasonable reliance on information evidencing that the company is not insolvent.

It is important to note though that companies may expand their directors and officers (D&O) liability Insurance coverage to apply to breaches similar to those, but that they cannot provide any waiver from liability or to indemnify officeholders for breach of such duties.

In addition to these expanded duties, one must take into account that corporate actions made on the verge of insolvency may be classified as a preference of creditors or assets smuggling in case the company eventually becomes insolvent. Directors and management should be wary of these as well.

So, what should the Board and management do in times of a pandemic?

From the above-mentioned duties, we can draw a few general guidelines:

1. Assessment - Firstly, the directors and management should take all reasonable measures to assess the current and anticipated economic status of the company as a result of the pandemic. For such purposes, it is essential to examine the solvency status of the company and whether it is, or is expected to be, financially insolvent based on the balance sheet test and the cash flow test. Note – The Board is not expected to foresee the financial impact of the pandemic on the company with complete certainty but rather on a reasonable basis.

2. Budget Changes - Directors and management should also consider changes that may be required to the existing in-effect budget of the company and the budget for the foreseeable future. Changes can be made moderately and in phases. Compliance with the new budget and under the evolving pandemic should be inspected from time to time and also immediately upon the occurrence of material events.

3. Funding Alternatives - Directors and management must consider relevant alternatives to fund any shortfall expected under the new budget.

4. Mitigating Measures - In case there is a reasonable concern that the company is insolvent or is on the verge of insolvency, directors and the CEO should take reasonable measures to mitigate the damage, such as consulting with insolvency specialists, negotiating with creditors or, if worse comes to worst, initiating insolvency proceedings.

5. Procuring D&O Insurance - As aforementioned, although companies cannot waive liability or indemnify officeholders for breach of duties under Section 288 of the Israeli Insolvency Law, companies can (and should) procure D&O insurance for such actions and omissions.

6. Conducting a Process - It is essential that the course of action taken by the directors and the management in the case of a pandemic shall be well-organized and properly documented. It is advisable to form a manual containing guidance to the directors and management. The process should include information gathering, presentation of meaningful alternatives for a proper course of action, compliance with decision-making, periodic review of the financial status of the company, and more; and lastly

7. Legal and Financial Advice - It is imperative that the directors and management rely on solid legal and financial advice in times of a pandemic. Soliciting appropriate advice can be deemed a reasonable measure protecting officeholders from wrongdoing, but more importantly it may mitigate the risk of unnecessary insolvency.

The operative measures to be taken by each company naturally derive from its specific current and anticipated financial status and circumstances and so there is no rule of thumb but rather general principles that directors and management should follow.

 

The authors are partners at Herzog Fox & Neeman Law Firm

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