The arrangements in Israel’s Insolvency and Economic Rehabilitation Law, enacted in 2018, include a series of special characteristics that must be taken into account when engaging with an Israeli corporation.
The relatively new law incorporates various rulings from previous years, and the legal practice deriving from it is still evolving. Thus, some uncertainty still exists regarding how the courts are likely to implement some of the arrangements prescribed in the law.
The main principle underlying Israeli insolvency law is to prefer the corporation’s rehabilitation to its liquidation. As a result, Israeli law prioritizes a recovery arrangement over business certainty and the parties’ freedom of contractual engagement.
Insolvency Tracks – Rehabilitation and Debt Arrangement Versus Liquidation and Disposal of Assets
The law prescribes three possible insolvency tracks:
- Rehabilitation of the corporation under a trustee who formulates a recovery arrangement for the corporation and the disposition of debt to its creditors.
- Liquidation of the corporation under a trustee who liquidates the corporation’s assets and distributes its assets among the creditors.
- Formulation of a debt arrangement on behalf of the company under the supervision of the arrangement administrator (a functionary with limited powers to supervise the corporation’s activities).
In 2020, in the wake of the worldwide COVID-19 crisis, an amendment to the law came into effect. The amendment prescribed an additional special arrangement allowing a corporation to propose a recovery arrangement and debt disposition, while granting the corporation (and sometimes also its controlling shareholders) a right to stay other proceedings against it for the time frame needed to approve the arrangement. This is in contrast to the rule prior to the legislative amendment, whereby, in the instance of a debt arrangement proposed by a corporation, the legal proceedings proceed as usual until the creditors approve the arrangement.
The insolvency process in Israel is characterized by centralization, with an insolvency court acquiring jurisdiction to adjudicate all of the corporation’s affairs. Corporate debt claims are decided by the trustee within the framework of a debt claims proceeding (a debt declaration is filed by the creditor and examined by the trustee) under the supervision of the insolvency court (which hears various parties’ objections to the trustee’s decisions and actions). As a result, an Israeli insolvency court acquires international jurisdiction to adjudicate a corporation’s disputes vis-à-vis foreign creditors or interested parties (customers, officers, shareholders). This also prevails over any stipulation of an agreed foreign tribunal’s international jurisdiction, if stipulated in the agreement with the corporation. Similarly, the dispute will be clarified according to Israeli law (even if otherwise decided between the parties) as an expression of the application of the principle of equality between the corporation’s creditors and, in particular, in relation to the law applying to them (Israeli law, which will be applied to everyone, equally). Therefore, a foreign corporation or individual considering engaging with an Israeli corporation must take into account that, in the event of insolvency, it must litigate its case in an Israeli court and according to Israeli law.
Infringing on Freedom of Contract to Promote Corporate Rehabilitation
Due to the legislature’s preference for the possibility of rehabilitating corporations, the Israeli Insolvency Law grants the trustee and the court broad powers to intervene in the contractual arrangements in agreements signed with the corporation. After his appointment, the trustee has time to examine the entire set of agreements in which the corporation has engaged and to decide which contracts the corporation will continue to perform and which contracts it can renounce. That being the case, throughout the contract review period, the contractual party that has engaged with the corporation cannot terminate the engagement and must continue providing ongoing services to the corporation, despite the corporation’s debt to it.
The provisions of the Insolvency Law allow an insolvency court to compel a party to an agreement with the corporation to continue the engagement, even though the corporation has breached the agreement with it (such as nonpayment for goods or services rendered), if the trustee considers the engagement essential to the corporation’s continued commercial activity. The trustee is also delegated the authority to terminate an existing agreement with a party, even if that party has continued performing the agreement, if the trustee believes that continuing the engagement would be detrimental to the corporation’s recovery efforts.
It is important to emphasize that, in relation to goods and services provided to a corporation, as soon as a trustee is appointed to the corporation, he has a personal obligation to arrange and pay these debts (from the moment of his appointment). This is opposed to a situation involving debts predating the trustee’s appointment, which will be paid (equally among the creditors) only out of the corporation’s assets, if any remain, or from the proceeds of its sale.
Imposition of Personal Responsibility on Managers and Directors to Minimize a Corporation’s Insolvency
Israeli insolvency law includes a unique cause of action that imposes direct liability on the company’s directors and managers at the stage when the company’s financial position is deteriorating, and it faces insolvency. At this stage, the directors and managers are obligated to take action to minimize the magnitude of the company’s expected insolvency and to avoid taking risks and jeopardizing the company’s assets. This is a direct liability, in addition to officers’ general duties to act skillfully and faithfully for the company within the scope of their respective roles. The law provides protections to managers and directors against this cause of action, in the form of a presumption that measures were taken to prevent insolvency, if they obtained an expert opinion (an attorney specializing in insolvency law) about what actions they need to take and they took those actions. It is important to emphasize that the imposition of personal liability pursuant to this section will also be applied to non-Israeli directors and managers, who will be required to litigate these claims in an Israeli court.
Retention of Title to Goods Stipulation
Insolvency law gives preference to creditors in terms of rights, only if they have acquired proprietary status (usually through a public register), i.e., the status of “ownership” or “quasi-ownership.” In the absence of any preference, the default is distribution of the corporation’s assets equally among the creditors (according to their pro rata of the debt out of the corporation’s total indebtedness).
Since Israel has no register for stipulating retention of title to goods, substantiating such a claim for the purpose of giving preference to the creditor during insolvency requires substantial evidence of retention of proprietary possession of the goods, and a contractual stipulation of retention of title is insufficient. In other words, even if the agreement with the insolvent Israeli company explicitly states that the supplier retains title to the goods until payment for the goods is received, a court will not recognize this stipulation as preserving the supplier’s title to the goods. Instead, it will rule, in the absence of other indications, that upon transfer of possession of the goods to the insolvent Israeli company, the goods become an integral part of the insolvent company’s body of assets (and consequently will be divided on a pro rata basis among the company’s creditors).
Moreover, even if the supplier has substantiated its ownership of the goods, by virtue of a retention of title stipulation, the law allows the corporation to continue using the goods, subject to guaranteeing that the supplier will receive the proceeds of their sale. This thereby significantly reduces the supplier’s bargaining position when attempting to collect the insolvent corporation’s debt.
Claim of Offset against an Insolvent Corporation
When a customer or supplier has claims of offset against a balance to which the insolvent corporation is entitled, unique insolvency provisions apply. These provisions not only require the filing of a debt claim, but also the delivery of a special offset notice, in conformity with the law’s requirement, as well as compliance with the Insolvency Law’s unique criteria. These criteria include a direct connection (reciprocal, according to the language of the law) between the transaction that created the insolvent corporation’s debt and the transaction that gave the insolvent corporation a right vis-à-vis the creditor (that same business system), provided the corporation’s right or its debt to the creditor arose prior to the date the corporation became insolvent.
Consequently, foreign corporations that engage with Israeli corporations must be familiar with relevant provisions of Israeli law and obtain local legal counsel in this regard. This will enable them to prepare optimally for a potential insolvency event in the course of their projects.