The issue of officers’ liability towards the company’s creditors arises mainly in a situation where the company is insolvent and is unable to repay its debts to its creditors. In most cases it is a debt originated in a contractual obligation between the company and the creditor (for a product or service provided by the creditor to the company).
The Israeli legislator has not clarified when a duty of care is imposed on an officer in the company towards its creditor thus this chore was handed to the courts. It shall be noted that the law imposes a fiduciary duty on an officer in a company, in addition to his duty of care. The court has interpreted this duty as a duty to act for the company and to its benefit in good faith, in fairness while avoiding promoting the officer’s personal interest. In this article we will focus on the officers’ duty of care and examine the array of considerations the courts exercise in an event of imposing personal liability on officers in a company towards it creditors, while focusing on small private companies.
Background
The question of officers’ liability towards the company’s creditors arises mainly in situations where the company is insolvent and is unable to repay its debts to its creditors. In most cases it is a debt originating in a contractual obligation between the company and the creditor (for a product or service provided by the creditor to the company) or a cause related to a deed (a bounced check due to insolvency).
The Companies Act explicitly states that a duty of care applies to an officer towards the company and its shareholders in accordance with Articles 35-36 of the Tort Ordinance. However, when it comes to imposing the duty of care towards third parties that Israeli legislator has not clarified when a duty of care is imposed on an officer in a company towards its creditors, and has chosen to leave the courts with the task of designing the duty of care and determining, amongst others, in which cases the duty shall be applied, and its scope.
The legal basis of imposing a duty of care to officers towards company’s creditors is negligence. Personal liability of an officer in a company towards its creditors within the framework of negligence shall arise inasmuch as it shall be proven that the creditor incurred damage, the cause for the damage is an action or omission of the officer (the causal relation) and whether the officer was negligent, namely, has acted as a reasonable officer wouldn’t have acted.
It is obvious that in the absence of an appropriate provision in the law, the courts are unable to impose a comprehensive duty of care on officers in cases where it was ruled that there was negligence, or comprehensively rule out imposing liability as stated. Therefore, and in the absence of such legislation, there is no choice but to design the duty of care in a way which balances the opposing considerations specified below.
Applying officers’ duty of care towards the company’s creditors – the array of considerations
Assuming the officer has acted in the company’s benefit, should personal liability still be imposed on him towards a creditor? A resolution on the aforementioned question is made by balancing between various considerations.
On the one hand we find the considerations of justice, according to which we should prefer the damaged party (the creditor) and ensure that the debt towards him shall be repaid (even if the company is unable to repay his debt), and the economic consideration, which aims to create deterrence against the officers so that they do not act in an unrestrained manner, especially when the company is in financial difficulties; on the other hand there is the consideration of eroding the company’s separate legal entity, which is joined by the consideration, according to which over-deterrence might prevent the officers from taking ongoing and reasonable decisions and risks, which might paralyze the company and lead it to even greater difficulties.
The court acknowledges the need to find balance in deterring officers, and therefore, when coming to impose personal liability on officers, the court exercises legal tests, when the main test is whether it is possible to establish circumstances which deviate from the officer’s regular and routine activity in the company.
In order to implement the aforementioned test in practice, namely, in order to determine whether the officer’s activity deviates from his regular activity in the company, the court resolves the question bases on factual and objective data, alongside more vague data, such as: was the officer was the “driving force” behind the company? What’s the level of the officer’s awareness of the company’s repayment capacity.
In order to impose personal liability on an officer the court does not examine what was the share of said officer in the financial deterioration of the company and the company’s inability to repay its debt to the creditor, but rather what was the share of the officer in creating the creditor’s damage.
As we can see, the data on which the court bases its decision are not clear and unequivocal, therefore it is very difficult to predict when it will impose personal liability on an officer, as well as the scope of the exposure of the officers in those cases.
The uncertainty regarding the matter of the personal exposure of officers is validated when it comes to small companies.
In most cases, small companies are characterized by a complex economic environment, which results from a number of factors: (1) the smaller the company, the higher the effect that officer’s decision may have on the company’s financial state; (2) a small company is more exposed to risks resulting from external events (for example: limiting cash transactions); (3) the “physical” distance between the officer and the creditor is much smaller than in a large company. In other words, the personal relation in a small company is greater between the officer and the creditor; (4) while a large company can insure itself from risks with insurance tools (personal officers’ insurance), a small company often foregoes the aforementioned insurances due to the high costs.
The ruling suggests that there is no specific constancy with regards to imposing personal liability on an officer in a company towards its creditors, and the court in fact examines each case by itself in accordance with each case’s specific circumstances.
Thus, for example, in Civil Appeal 407/89 Tzuk Or Ltd. vs. Car Security Ltd., the court has ruled that the company has performed a wrongdoing of passing off (imitating a commercial product which is protected by a patent) and in addition has imposed personal liability on officers for performing the wrongdoing. The court has ruled that “you do not impose liability for the very status of an organ in a company, but only for the actions of said organ with regards to the wrongdoing claimed before the court”. In this case, the court has ruled that the officers took part in the planning, the manufacturing and the marketing of the company’s products. These actions constituted passing off, and have been done by them when they were organs, directors and officers in the company, and therefore they were personally charged in torts.
In another case, discussed in Civil Appeal 313/08 Azmi Nashashibi vs. Ihab Rinrawi, a claim of negligence was rejected, having been submitted by apartment buyers against officers in a contracting company which didn’t insure the buyers’ monies paid to the company, as was required by law. The court ruled that no special relations existed between the buyers and the officers, and it was not proven that the officers have personally guaranteed the company’s debts, and therefore the court did not impose a duty of care on the company’s officers towards the buyers.
To summarize
Officers are exposed to personal liability towards the company’s creditors in the framework of the wrongdoing of negligence. However, there is uncertainty as to the scope of this exposure, which makes it difficult for the officers, who are the decision makers, to therefore make complex decisions and to plan their steps, especially when the company is in financial difficulties.
Apart from the absence of clear legislation on the matter, the courts are also not leading a uniform and clear line, and as a result rulings are made, which are sometimes too harsh and sometimes too lenient. It is obvious that uncertainty does not lead to proper results and it would be best if the Israeli legislator arrange the matter, the sooner the better.