By Adv. Efrat Dayagi, Shibolet & Co.

 

An undertaking by an officer or shareholder in the name of a corporation to parties who have entered into a contract with the company may, in certain cases, be considered a personal, independent obligation that establishes cause of action against the officer or shareholder, in addition to the cause of action in respect of breach of contract by the corporation toward the third party.

The Supreme Court’s judgment in the appeal in the case of the Kachtan brothers, given last January[1], raises issues regarding the question of imposing personal liability on officers and shareholders of a corporation in light of the principle of the company’s separate legal personality.

Judge Danziger, of the majority opinion, outlined the principle according to which, in order to impose personal liability in respect of breach of contract not only on the company but also on its organ or officer, it must be proven that this is an exceptional case that comes within the bounds of “rare cases such as fraud”, or a case in which “personal (subjective) culpability for acts or omissions” rests with the organ or the officer.

According to this principle, the majority opinion of the court reached the conclusion, albeit not without deliberation, that personal liability should not be imposed on the Kachtan brothers for breach of the undertakings of the companies they owned, in which they also served as officers, to register in the apartment buyers’ names the apartments they had bought in a building project in the city of Ashdod.

In 2009 apartment buyers in the project, who had signed contracts with companies owned by the Kachtan brothers, filed a claim with the Tel Aviv District Court against the Kachtan brothers and the companies they owned, in which they argued that despite repeated requests to the companies, and although many years had passed since the project had been completed and occupancy had been taken up, the residential buildings in the project had not yet been registered as a condominium, and consequently the rights in the apartments had not been transferred to the buyers’ names. As a result, the apartment buyers requested that the court instruct both the companies and the Kachtan brothers personally to register the apartments, and to charge them with payment of compensation.

The District Court determined that despite the fact that nothing had been done to further the registration proceedings, the Kachtan brothers had made a representation to the claimants that they were supposedly furthering and working to arrange for the registration in a manner that amounted to mala fides and breach of the duty of good faith by the brothers. Consequently, the District Court accepted the claim in full and asserted that the companies and the Kachtan brothers must be obliged to register the rights in the apartments in the claimants’ names, and ruled compensation in a total amount of NIS 140,000 in their favor.

The companies and the Kachtan brothers filed an appeal with the Supreme Court against the obligation to register the apartments in the claimants’ names and to pay them monetary compensation.

The Supreme Court’s judgment focused mainly on the dispute surrounding the question as to whether a personal dimension in the information communicated or a representation made to the parties engaging in a contract with a company through an officer or shareholder of the company is able to impose personal liability on the officer or shareholder, even in the absence of a personal undertaking to the contractual creditor.

The majority opinion, as expressed in the judgment, reflects the approach that had been customary in the rulings until then, i.e. that use of the imposition of a contractual obligation on officers of a corporation in respect of breach of a contract of the corporation must be reserved for exceptional cases only, given that the company is the party to the engagement, and not its shareholders or officers. According to the ruling as it was given in Judge Danziger’s verdict, in order to also charge the shareholder or officer with personal liability for breach of contract by the company, even though he did not undertake to personally assume the company’s liabilities in the contract, another dimension must be proven – subjective mala fides – which contains elements of deception or fraud by the shareholder or officer.

“If the court does not apply a stringent test such as this”, Judge Danziger ruled, “and applies the principle of good faith to the shareholder or officer, who is not a direct party to the contract, in the same way as it applies it to the company, which is a direct party to the contract, this will in practice be tantamount to overlooking the principle of the company’s separate legal personality and to creating a quasi-contract between the claimant and the shareholder or officer, despite it not having been proved that there was a personal undertaking by the shareholder or officer.”

Although his position on the fundamental-legal aspect was decisive, in the specific case before him Judge Danziger ruled that although this was a “grey” case in terms of its circumstances, it was not an exceptional case that justified the imposition of personal liability on the Kachtan brothers.

By contrast, Judge Barak-Erez, the minority, was of the view that although the imposition of personal liability on an officer in a corporation is meant to be reserved for exceptional cases, these cases should not be limited only to situations in which there were “indications of misleading or fraud”, and the possibility of imposing personal liability in other cases as well should not be ruled out.

Judge Barak-Erez criticized Judge Danziger’s ruling, which, in her opinion, added to the stringency of the tests prescribed in the rulings, and emphasized that although one should indeed beware of a “slippery slope”, care should also be taken that activity in the framework of a corporation should not become a “safe haven” for poor conduct. Nevertheless, in regard to the specific case before her, the outcome she reached in the circumstances also reflected Judge Danziger’s fundamental approach as expressed in the majority opinion, as in Judge Barak-Erez’s humble opinion, in the case at hand the Kachtan brothers had acted toward the apartment buyers in subjective bad faith that amounted to deception.

Make a real effort

Alongside the central dispute surrounding the question whether subjective bad faith to the point of deception is required in order to impose personal liability on an officer or shareholder of a corporation due to breach of contract by the corporation, it is actually the obiter dictum of the judgment that contains interesting statements on the breach of the obligation of an officer or shareholder in the corporation to make every effort so that the corporation will fulfill its undertakings, and the possible implications of such a breach on the officer or shareholder.

In the context of her opinion Judge Barak-Erez gave an example of a situation in which “the officer creates a representation that he is handling a certain subject, while he knows that in actual fact he is doing nothing and is thus misleading the parties engaging with the company and causing it damage”. In this situation there are indications of deception, and therefore, in the opinion of Judge Danziger of the majority opinion as well, personal liability will be imposed on the shareholder or officer of the corporation. This situation, which involves conduct that reaches a high level of bad faith, can be identified as one of those cases in which personal liability may be imposed on an officer of shareholder of the company.

Another case which Judge Barak-Erez mentions in her judgment is based on the creation of a personal commitment by the officer to make every effort so that the corporation will fulfill its obligations, while it transpires, in retrospect, that the same officer made no attempt at all to accomplish this. According to Judge Barak-Erez, this is a case that is distinct from the course of imposing liability in respect of a “personal undertaking” mentioned in the majority opinion, and it relates to an undertaking to make an effort that is personal in nature and bad faith conduct by the officer, and it is the combination of the two that justifies the imposition of personal liability on the officer in fitting cases.

Ostensibly, the case suggested by Judge Barak-Erez is able to justify the imposition of personal liability on a shareholder or manager of the company according to Judge Danziger’s position as well, as the undertaking to attempt to achieve fulfillment of the corporation’s contractual obligations to the counterparty is accompanied by indications of deception or fraud. At the same time, however, in his comments in response to Judge Barak-Erez’s opinion at the end of his judgment, Judge Danziger did not refer to the second situation raised by Judge Barak-Erez and to her position that at least in some of the cases mentioned, there would be room to impose personal liability on the officer.

In fact, on the basis of Judge Danziger’s comments on Judge Barak-Erez’s words a third situation can be discerned, in which a shareholder or officer has undertaken in good faith to try or to make an effort to procure fulfillment of the corporation’s undertakings to the counterparty, without this undertaking being accompanied by any indication of deception or fraud as described above, and it ultimately transpires that he did not try hard enough and did not make any such real effort. However, in this situation, Judge Danziger emphasized that he does not believe that it would be fitting to impose personal liability on the officer or shareholder in this respect. Judge Barak-Erez, for her part, did not address this point in her opinion.

“Everything will be fine”

The statements by the Supreme Court judges in the verdict give rise to reflection on the boundaries of the acts of officers and shareholders in companies in a manner that would justify defense against the imposition of personal liability on them, especially in cases where they had undertaken to make an effort or try to fulfill the corporation’s undertaking.

As Judge Barak-Erez aptly explained, the creation of a personal relationship between the managers or shareholders of a company and parties engaging with the company tends to strengthen the decision of some parties to engage with the company or to maintain the engagement with it, on basis of the shareholder’s or manager’s “word”. “But”, according to Judge Barak-Erez, “this is clearly a mixed blessing. When the day of reckoning comes, this dimension is likely to lead to a personal obligation on the part of those managers and shareholders.”

If so, what is ideal and what is real as far as the conduct of officers and shareholders in companies toward parties engaging in a contract with the company is concerned?

In her opinion, Judge Barak-Erez mentioned criteria that can be of assistance in deciding whether liability should be imposed in a particular case in which an officer or shareholder had given an undertaking to try or to make an effort to bring about fulfillment of the corporation’s commitment. However, as one recalls, according to the case described by Judge Barak-Erez a personal dimension is also required – a false representation or bad faith conduct by the officer. The toughest question that arises from the considerations outlined by Judge Barak-Erez is whether personal liability will be imposed on the officer or shareholder who undertook in good faith to attempt or to make an effort to procure that the corporation would fulfill its undertaking, while in actual fact he did very little or gave the shakiest of assurances, even without making false promises or creating a false impression that he would do otherwise. An answer to this cannot be found in the judgment.

It seems that to avoid the risk of imposing personal liability in a case of breach of contract or misrepresentation by a company, particularly in a “family” company or a small one, it would be preferable for managers and shareholders to refrain from expressing or committing in the company’s name in a manner that is able, in certain circumstances, knowingly or unintentionally, to impose a personal obligation that pierces the corporate veil between the officer/shareholder and the company.

If a promise or a representation has already been made by a shareholder or officer that he will try or make an effort to achieve fulfillment of the company’s undertaking, care should be taken that he performs his actions in a timely manner and in the best manner possible, so that no gap is created between the promise made or the information communicated by the shareholder or officer to the party engaging with the company, and the actual state of affairs.

Additionally, the recommendation is to act and to personally commit to customers of the company in writing only, and to document how each undertaking or agreement given to customers by a shareholder or officer in the company was handled or implemented, in real time and in the most accurate and detailed manner.

It is undisputed that each case must be examined on its own merit and that there are “grey” cases where it will be hard to determine if certain statements or promises by an officer or shareholder will grant protection against personal liability being imposed on them, similar, perhaps, to the case of the Kachtan brothers. One way or another, thought should be given to the possible implications of actions, promises or representations by managers or shareholders to the company’s contractual creditors, particularly against the backdrop of the “trust me” culture that is typical of Israeli society.


 

[1] Civil Appeal 3807/12 Ashdod City Center KA Ltd. v. Shmuel Shimon et al., given on January 22, 2015.