Retrospective grant of exemption – another step in reducing the liability of officers of a company (following the Ashash v. Atia case)

By  Adv. Michal Borovsky, shibolet & Co.

 Over the years, the obligations and duties of officers have been so significantly expanded that it often seems that officers are “split” between the desire to lead the company on to outstanding achievements – a desire that occasionally involves taking business risks and making unconventional decisions – and the concern that in certain cases there is a possibility that if they do so, they will be held personally liable.

As a result, the question of the necessity for and boundaries of “defense mechanisms” that a company is able to grant its officers today “under the auspices” of the Companies Law, i.e. insurance, indemnity and exemption from liability, has direct implications on the conduct of both officers and companies, and on how they plan their moves and assess the risks to which they are exposed.

The answer to this important question is not unequivocal, and opinions are divided. Those who argue against the various defense mechanisms believe that the simple fact of providing them could encourage negligence by officers in the knowledge that they are “protected”. By contrast, the prevalent opinion (as expressed in the Companies Law) is that the great liability that is today imposed on officers is liable to deter talented people from serving in companies, and even create a chilling effect among officeholders when it comes to taking business risks, something that is vital and even desirable in the life of a commercial company.

In this review, we will focus on the defense mechanism that some may argue has the most far-reaching consequences – exemption from liability.

The Companies Law currently allows companies to grant officers full or partial exemption in advance for damage as a result of the breach of their duty of care to the company, if the relevant provision has been included in the company’s articles of association (this is subject, inter alia, to limitations that distinguish between fiduciary duty, in which respect an officer may not be exempted from liability, and the duty of care, in which respect an officer may be exempted from liability prospectively, with exceptions, i.e. if the act was performed “intentionally” or “recklessly”).

Last June, the subject was revisited in the context of an important judgment awarded by the Honorable Judge Ruth Ronen of the Tel Aviv District Court’s Economic Department. The judgment was given in a derivative action filed against the construction company, Atia Group Ltd., its controlling shareholders, officers (which included the famous model, Moran Atias) and external consultants (35114-03-12 Ashash et al. v. Atia et al.). This case, in our opinion, constitutes another step in reducing the liability imposed on officers in a company, as it is accompanied by important statements with regard to the possible scope of exemption of officers, and also expressly recognizes, for the first time, the possibility of granting exemption retrospectively.

We will now present a brief review of some of Judge Ronen’s assertions in the above case:

 Scope of application of the exemption: Judge Ronen determines that the scope of the possibility granted to a company to exempt its officers must be broadly construed, in such manner that it will include all cases in which the officer did not act knowingly or in a conflict of interest, and even if this is a case in which the officer will not be protected by the “business judgment rule” (a rule espoused by Israeli case law, which determines that a director “who subjectively acted in good faith, was not tainted by a conflict of interest, and the action was taken in an informed manner, i.e. following discussion and inspection of the relevant data and considerations”, must be protected). In Judge Ronen’s view, a company may exempt an officer from liability for the content of a resolution as well as liability with respect to the process of its adoption, for as long as the act or omission was not performed knowingly or recklessly.

Retrospective grant of exemption: Judge Ronen argues that the fact that the legislator specifically mentioned the company’s option of exempting an officer in advance does not preclude the possibility of exempting an officer from liability retrospectively as well. Judge Ronen states that the reason that the option of granting exemption in advance was expressly stated is because this type of exemption is perceived as anomalous and problematic due to the damage it entails to the right of access to the courts. By contrast, the option of retrospective exemption is less anomalous, and it was therefore unnecessary for the legislator to expressly refer to it in the framework of the provisions of the Companies Law.

Rule of thumb for distinguishing between exemption in advance and retrospective exemption: Judge Ronen repeats the rule determined in the past in the Pacifica case by the Honorable Judge Ofer Grosskopf (11266-07-08 Stabinksy v. Pacifica), according to which the date of record for the purpose of examining whether exemption was granted in advance or retrospectively is the date of the act or omission, and not the date on which the damage was created. Meaning, if the exemption is later than the conduct in which respect liability is attributed to the officer, this is retrospective exemption, even assuming that the damage, in whole or in part, had not yet crystallized on the date exemption was granted.

Besides the spirit that arises from the ruling, we believe that it is also important to understand the position of consultancies that advise institutional entities on the subject. Thus, for example, Entropy Consultants recommends opposing the grant of deeds of exemption to directors and officers on the grounds that granting comprehensive exemption from the duty of care in advance is damaging to the desired standard in terms of the quality of corporate governance in public companies, and prevents shareholders in advance from exercising their right as far as a derivative action against officers is concerned. A similar recommendation arises from the voting policy of the consultancy, Emda Research. This position adopted by consultancies has been evident for some years now, and in the articles of association of more than a few public companies the exemption option has been eliminated.

In closing, we would like to inform readers that just recently, a decision was published, in which the court approved a derivative action against Nochi Dankner and officers of Discount Investment with respect to the acquisition of and investment in the Maariv daily. Among other things, the judge, Professor Ofer Grosskopf, discussed the respondents’ argument regarding the existence of an exemption arrangement that the company had approved for its officers. On this subject, Judge Grosskopf determined that when the court reaches the conclusion that an officer had acted recklessly or intentionally, the officer cannot argue the existence of an exemption and indemnity arrangement.

The rulings mentioned above broadly discuss these issues and others touching on the question of liability and “defense” mechanisms, and we recommend reading them. And remember – a precondition for granting officers exemption, be it in advance or in retrospect, is the existence of an appropriate provision in the company’s articles of association.