On June 15, 2015, the Israel Securities Authority published a summary report on the findings of a sampling audit conducted at six reporting corporations on the subjects of dividend distributions and buy-backs of shares. The emphasis during the horizontal audit was on examining the decision-making process when approving a distribution and on its method of disclosure to the public, rather than on the content of the resolution. The Companies Law prescribes that a company may execute a distribution if two criteria are fulfilled: (a) the distribution will be executed from surpluses (the profit test); (b) there is no reasonable concern that the distribution might prevent the company from being capable of paying its existing and foreseeable debts (the solvency test).
While the profit test is a retrospective quantitative test that is relatively easy to perform, the solvency test is a prospective qualitative test whose performance is subject to the sole judgment of the company’s board of directors.
The ISA’s audit report focuses on the method of performing the solvency test, and relies on a projected cash flow. According to the report, a board of directors that is considering a dividend distribution must insist upon receiving a projected cash flow covering a period of more than two years, must take into account long-term cash-generating potential and must apply economic models such as the adjusted NAV model (net asset value or the economic equity of the company).
The board of directors must also examine sensitivity analyses of various scenarios, including events external to the company, which, if or when they materialize, are likely to impact the company’s solvency. Thus, and solely as an example, the board of directors of a stable company must examine the possibility that relations with one of its material customers might deteriorate, even if there has been no indication of this. The report also refers to another standard of responsibility, which requires boards of directors to at least take into account numerous additional variables, such as a change in overall product profitability, a delay in the activation of production lines, shifts in customer tastes and preferences, etc.
It seems that the report is proposing high barriers to the ability and willingness of boards of directors to pass future resolutions regarding dividend distributions. We will have to wait and see whether this position of the ISA is adopted as a mandatory standard of conduct by directors of companies. If so, it will likely be difficult for directors to weigh ‘risks and prospects’ when deciding to approve a distribution. Further, a significant amount of management’s valuable time will be taken up in preparing the data for the board of directors