Case Number

CA 817/79

Date Decided

7-9-1984

Decision Type

Appellate

Document Type

Full Opinion

Abstract

The appeal is centred on the question of the liability of shareholders of a bank who sold their shares knowing that the bank's funds would be used to finance the acquisition of the shares and that it would endanger the existence of the bank, and on the question of the liability of the directors of the bank, who allowed the aforesaid sale of the shares.

Held by the Supreme Court:

A. (1) The director is the "brain" and "nerve center" of the company's activities. He acts in its name towards outsiders and manages its affairs internally.

(2) For some purposes, the director is an organ of the company. For other purposes, he is its agent; he may sometimes be treated as an employee.

(3) The principles of penal law, which are part of general law, specify norms of proper conduct which must be followed by directors. Thus, for example, there are "friendly relations" (within the meaning thereof in section 36 of the Penal code [New Version]) between the director and the company, and the director must take all measures that a reasonable director would take under the circumstances (in accordance with the provision of section 35 of the Penal Code [New Version]).

(4) The general legal system is incapable of dealing directly with the problems arising from the power of control wielded by the director. The solutions of these problems are found by applying the duty of loyalty to the holder of the power.

(5) The principle of loyalty has broad application. It is applicable to any case in which someone wields power and control over someone else. The list of situations to which the duty of loyalty is applicable is not a closed list, and it pertains in a wide range of legal relationships.

(6) The duty of loyalty is a general duty which is incumbent upon the holder of the power. The content of the duty is that the person holding the power must act in good faith, honestly and for the good of fulfilling his function. It is a general rule inherent in our system, and its practical implementation requires concretization.

(7) The fundamental principle of the duty of loyalty of a director has been accepted by case law and has been developed by it according to our needs. as part of the Israeli equivalent of common law.

(8) A director must act loyally in conducting the affairs of the company. He must act honestly in his dealing with the company. Should there arise any substantive suspicion that he is not acting in good faith and for the good of the company, the burden to disprove it rests upon him.

(9) The standards of conduct by which a director is bound are not those of the marketplace, and they are not the result of a struggle between equal forces. Therefore, a director may not be in a situation of conflict of interest between the good of the company and his or someone else's good.

(10) The duty of loyalty is a personal duty, and it incorporates the duty to prevent other directors from breaching their duty.

(11) The list of situations to which the duty of loyalty is applicable is not a closed list. The duty was intended as a solution to the changing problems of life with which we are constantly confronted. With the development of commercial life, new secondary rules are created, in order to protect the intent of the fundamental principle.

(12) In our case, the directors breached the duty of loyalty they owed the bank in that they approved the financing by the bank of the acquisition of its shares in contravention of the law and with the knowledge that it would lead to the insolvency of the bank.

B. (1) In parallel to the development of the various duties of loyalty which are incumbent upon a director, the remedies available to a company for breach of those duties have also developed. The relief must suit the duty, and the remedy must suit the breach.

(2) A director must make available to the company all the monies that it expended as a foreseeable result of the breach of his duty towards it, even if those monies were not received by him but by a third party.

(3) If each of several directors breached his duty and thereby caused the company to part with sums of money, then the aforesaid obligation of indemnity rests upon the directors "jointly and severally."

C. (1) The fact that a director did not act because of a personal interest and sought no benefit for himself is insufficient in itself to entitle him to the forgiveness specified in section 90(a) of the Companies Ordinance [New Version], 5743-1983; a condition for the exemption of a director in accordance with this section is that the director must have acted honestly and reasonably.

D. (1) A holder of controlling shares who wishes to sell his shares owes a duty of loyalty to the company with regard to such sale, and he must act towards it in good faith and honestly. He will be in breach of his duty if he sells his shares to a purchaser who to the best of his knowledge will strip the company of its assets and lead it to insolvency.

(2) In this regard, if the transaction consists of several stages, which in commercial terms could be viewed as a series, then the whole may also be interpreted as a single entity in legal terms. It is therefore possible to attribute a breach of loyalty to a shareholder because of actions which are to take place in the future, provided that they are foreseeable and constitute a part of the entire entity.

(3) This duty is based on the fundamental principle that the holder of power over a company is under a duty to prevent the abuse of that power. From this well-known fundamental principle we may infer new secondary duties to suit our needs.

(4) The content of the duty of loyalty is not identical in all the legal relationships to which it is applicable. The duty of loyalty of a director is not identical to that of a shareholder.

(5) A shareholder is the owner of property, and according to the general law of title he is entitled to do whatever he wishes with his property. This freedom is not unrestricted, since one of the restrictions stems from the fact that ownership of the shares gives him control of the company, and this control necessitates honesty, good faith and acting for the good of the company. The content of the conduct -which belongs to the general realm of the duty of loyalty - is a product of an appropriate balance between the right of ownership on the one hand and control of the company on the other hand.

(6) The term "control" means different things in different contexts. As for the applicability of the duties of loyalty relating to the sale of shares, it is sufficient that the shareholder belongs to the controlling group, and he need not necessarily be the holder of control himself.

E. (1) A holder of controlling shares who sells his shares to a purchaser who leads to the insolvency of the company is liable to repay the company all the monies it parted with as a foreseeable result of his breach which caused the said insolvency.

(2) This relief consists first and foremost of the monies of the company which came into the possession of the holder of the controlling shares himself, but it is not limited thereto. The liability for repayment also extends to monies received by third parties, be they the company's money which was used to finance the purchase or the company's money which it parted with as a foreseeable result of the transfer of control.

F. (1) The knowledge of an agent is attributed to the principal, if such knowledge is related to his function as an agent.

(2) Where an agent serves two principals, his knowledge with regard to one is not automatically attributed to the other.

(3) Where the agent's knowledge is attributed to his agency on behalf of both principals, it is attributable to both.

Keywords

Agency, Corporations

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