Overview (August 2001)

Origins of Israeli Law
Liquidation
Reasons for Liquidation
Priority Ranking
Concealing Assets
Bankruptcy
Receivership

Israeli insolvency laws are not homogeneous and different legal mechanisms exist for the liquidation of various legal entities. The Bankruptcy Ordinance 5760-1980 and the Execution of Court Decisions Law 5727/1967 govern bankruptcy of individuals. The liquidation of companies is dealt with in the Companies Ordinance (new version) 5743/1983.

Certain legal corporations are unique to Israeli law, such as cooperative societies (like kibbutzim) and Ottoman organizations, fellowships and registered partnerships. The liquidation of such corporations is found in specific orders detailed in the general law.(1)

Cross-references exist between the different legislation. For example, issues such as provable debts and the rights of secured and unsecured creditors of companies are referred to the Bankruptcy Ordinance.

This Overview focuses on the directives regarding the liquidation of companies and the bankruptcy of individuals in which most insolvency activities are centralized, and in which foreign entities may be involved.

Origins of Israeli Law

Israeli law is comprised of three types of statutory directives:

• Israeli legislation;

• British mandatory legislation; and

• Ottoman (Turkish) legislation.

Most of the British legislation originates from the British Mandate over the Land of Israel (1918-1948).(2) The Israeli insolvency laws are based on the British aspect of the Israeli legislation. The Companies Ordinance is based on the Companies Ordinance 1929 that was enacted during the British mandate. The ordinance was based on the British Companies Act 1929 (with minor changes). Although the Israeli legislator enacted a new Companies Law in 1999, this law does not include directives regarding the liquidation of companies, and the relevant provisions of the Companies Ordinance thus remained in effect. The Bankruptcy Ordinance is based on the Mandatory Bankruptcy Ordinance of 1936, which is a copy of the British Bankruptcy Law 1914.

Many Israeli judicial decisions regarding company law have deviated from the strict letter of the law and have created new premises that were not stipulated in the written law. One example concerns the establishment of creditor arrangements and freezing of proceedings (similar to Chapter 11 of the US Bankruptcy Code), which was created by court decisions and later enacted in the Companies Ordinance.

Liquidation

The Companies Ordinance stipulates three ways in which a company can be liquidated:

• liquidation by court;

• voluntary liquidation (with or without directors' declaration of solvency); and

• voluntary liquidation under the supervision of a court.
  

Court liquidation
The liquidation of most companies results from financial problems that prevent the company from fulfilling its daily commitments. Usually, a creditor petitions for the company's liquidation by a court.(3) Most liquidation proceedings are conducted under court supervision. All of the court's major decisions are taken after consultation with the official receiver(4) and the creditors committees.

After the court renders a liquidation decree, the official receiver is nominated as the company's temporary liquidator until the nomination of a permanent liquidator. The official receiver publishes the liquidation decree and provides the court with a report on the company's business status. Then the company's creditors' committee is convened and the permanent liquidator is chosen. The court then appoints him or her. The permanent liquidator gathers the assets of the company, liquidates them and distributes the funds between the creditors in accordance with priority ranking. The permanent liquidator is entitled to determine the scope of the company's debts and to represent the company in any matter. Once the court renders the liquidation decree, all proceedings against the company are frozen.(5)

Voluntary liquidation
Voluntary liquidation by shareholders is a procedure performed voluntarily by the company and without the involvement of the court. The general meeting of the company's shareholders decides to liquidate the company; thereafter, the company publishes the decision and nominates a liquidator, who acts in accordance with the shareholders' directives. In contrast to the liquidation by court, voluntary liquidation does not include automatic freeze procedures; rather the company must serve an appropriate petition to the court.(6)

This liquidation procedure is conditioned upon a directors' declaration stating that the company will be able to pay all of its debts within 12 months of commencing its liquidation. If the directors do not submit such a declaration, then the company's creditors shall undertake the liquidation of the company rather than its shareholders. In this case the creditors committee or a committee of inspection nominated by the creditors committee shall nominate the liquidator, who shall act in accordance with its directives.

Voluntary liquidation with court supervision
During a voluntary liquidation of a company, the court is entitled to rule that the liquidation shall be performed under its supervision. In this case the liquidation decree shall have the same effect as a liquidation decree rendered under a liquidation by court, including freezing of procedures.

Any entity and/or person entitled to petition for the liquidation of a company by court remains entitled to petition for this during a voluntary liquidation.(7)

Reasons for Liquidation

Israeli law contains many reasons for the liquidation of a company, which are subject to the discretion of a court. The main reasons are as follows:

• in the case of company insolvency. Section 258 of the Companies Ordinance sets out the following events as reasons for insolvency: (i) the company did not pay an undisputed debt to a creditor within three weeks of payment falling due; (ii) the company did not adhere to a verdict or a decision of court in favour of one of its creditors; (iii) it was proven to the court's satisfaction that the sum of the company's assets would not be enough for the payment of its present and future liabilities;

• if the court believes that it is right and justified to liquidate the company. To date, the courts have used this clause where: the company was established in an attempt to deceive its investors; (ii) the purposes of the company were unlawful; (iii) the general meeting of shareholders and the board of directors of the company did not function lawfullly; and (iv) minority shareholders were oppressed in a way that could not be resolved.

• if a majority of the registered shareholders of the company decides to liquidate the company by court; and

• if the company has not commenced trading one year after its incorporation or has not traded for at least one year.
  

Priority Ranking

The assets and/or proceeds of the corporations are divided in accordance with priority ranking in the following order:

• guaranteed creditors. The assets are divided among them in accordance with priorities concerning tax debts of the company's real estate, holders of lien rights against the company and owners of encumbrance by power of an agreement or law;

• liquidation expenditures;

• priority debts. The assets are divided to pay (i) employee salaries up to approximately $1,800 per employee per month (the court is entitled not to render priority for an employee's salary if it finds it just to do so); (ii) monies lent to the company for the purpose of salary payment (the sum shall not exceed the abovementioned amount); (iii) income tax the company should have paid for its employees; and (iv) the past year's rent and taxes to governmental authorities that are not guaranteed creditors;

• creditors that hold a floating charge which crystallizes upon the company's liquidation; and

• non-guaranteed creditors.
  

Any remaining assets are divided in accordance with the company's articles of association.

Concealing Assets

During liquidation and bankruptcy proceedings creditors can track assets that were sold or assigned before the beginning of the process and, in certain circumstances, can add them to the total dividable assets of the company. For example:

• fraudulent transfers of assets made three months before the beginning of the liquidation or bankruptcy process can be nullified;

• transfers of assets for no consideration made two years before the beginning of the bankruptcy process are automatically nullified; and

• transfers of assets for no consideration made 10 years before the beginning of the bankruptcy process can be nullified in certain circumstances.
  

Together with the aforementioned civil actions, extensive criminal sanctions exist for directors and officers of a company who fraudulently manage a company, or use a company's assets unlawfully, or conceal them. The company's directors and officers can be criminally liable if they try to interfere with the liquidation process, do not fully disclose all of the company's assets, or do not deliver all of the company's books to the liquidator. Similar sanctions exist for bankruptcy proceedings.

Bankruptcy

The insolvency of individuals is governed by two parallel legal systems: the bankruptcy laws and the Execution of Court Decisions laws. The two systems differ in that a successful bankruptcy ends after the court hears the objections of the creditors, approves a creditors' arrangement and issues a decree that discharges the debtor from all of his or her liabilities (after the same has paid all of the monies under the arrangement). By contrast, the debtor under the Execution of Court Decision Law must pay all of his or her debts and, if unable to do so, the proceedings continue.

Originally, under the Execution of Court Decisions Law, an individual could be imprisoned if he or she did not pay the outstanding debts. This threat proved to be an effective deterrent. However, in 1992 Parliament promulgated a Basic Law: Freedom of Men and Dignity. This law forms part of the Constitution (which has not yet been wholly formulated) and its status is greater then other laws. In light of the Basic Law and as result of criticism of imprisonment for non-payment of debts, the Supreme Court has ruled(8) that an individual cannot be imprisoned if it is clear that he or she is unable to pay. In light of this ruling, the Execution of Court Decisions Law was amended to diminish the ability to petition for the imprisonment of a debtor and, in most cases, the court is content when a debtor pays modest monthly payments.

Many people are reluctant to petition for bankruptcy under bankruptcy laws (as they have to pay a considerable portion of the debt in order to receive a discharge) and, given the revised Execution of Court Decisions Law, most insolvency procedures are now facilitated through the execution of court decisions system.

Receivership

Generally, a receiver is appointed on behalf of a creditor over a defined group of assets of the debtor (company or person). The receiver collects, manages and in most cases sells the assets on behalf of the creditor.

Different laws exist (including the Companies Ordinance and the Execution of Court Decisions Law) that enable a creditor to appoint a receiver over a debtor's assets. There are different directives and powers of the receiver for each procedure. Generally, a receiver under the Companies Ordinance is appointed from the power of a bond for the assurance of a floating charge(9), whereas a receiver under the Execution of Court Decisions Law is appointed as a result of a pledge over a certain asset.

For further information on this topic please contact Yechiel Kasher at Yuval Levy & Co by telephone (+972 3 5172303) or by fax (+972 3 5164185) or by e-mail ([email protected]).

Endnotes

(1) Paragraph 7 of the Associations Law 5760/1980, Paragraph 5 of the Partnerships Ordinance (new version) 5735/1975, Sections 46-48 of the Cooperative Societies Ordinance, and Section 14 of the Cooperative Societies Law 121.

(2) In addition to the mandatory legislation, until 1980 Israeli law stipulated that legal matters not settled under Israeli law would be settled in accordance with British law and in accordance with Section 46 of the Order in Council 1922-1947. Through this directive, Israeli law 'imported' later British statutory principles and verdicts. In 1980 the Law Foundations Law 5760/1980 was enacted, stipulating that deficiencies in Israeli law would be settled by way of analogy or in light of the freedom, justice, integrity and peace principles of Israeli heritage.

(3) In accordance with Section 259 of the Companies Ordinance, the company or its shareholders can also petition for liquidation by court.

(4) The official receiver is an Israeli governmental authority that handles liquidations and receiverships on behalf of the state. Among other things, the official receiver considers the interests of parties that are not directly involved in the liquidation or receivership procedures but that could be influenced by it (eg, small creditors).

(5) Section 267 of the Companies Ordinance. According to Section 264 the court is entitled to freeze proceedings against the company immediately after the liquidation petition is served.

(6) Sections 267 and 335 of the Companies Ordinance.

(7) Section 262 of the Companies Ordinance.

(8) BGZ 5304/92 Amutat PRCH v The Minister for Justice, PD 47(4) 715.

(9) As a result, most of these receiverships handle the majority of the company's assets.