"Although as an external auditor, we preferred the conservative approach that immediately credits all payments to ensure future agricultural produce, but we realized that the company had taken a different approach for many years. You have to remember that they had just issued bonds at the end of 2007, which meant that they didn't meet the covenant if you throw everything at a profit and a loss. We exercised discretion as to whether the policy adopted by the company is feasible according to accounting rules in Israel and we have reached the conclusion that the company's approach is reasonable, a policy that is less conservative as stated, but in our opinion it is possible to support a policy that is possible in terms of the accepted accounting rules in Israel..."
- However, as to the claim implied in the letter of claim for "covenant engineering" on the part of the defendant, this is indeed a weighty claim, which requires a solid evidentiary basis, since it attributes to the financial statements a manipulative purpose of creating an artificial representation of compliance with the covenants (Administrative Petition (Economic) 37447-10-13 Africa Israel Industries in Tax Appeal v. Israel Securities Authority, 75 [Nevo] (August 2, 2014)). However, after reviewing all the evidence and hearing the testimonies, I did not find that the plaintiffs met the burden of proving this claim. It is not sufficient to raise suspicion or hypothesis in retrospect in order to establish a finding regarding deliberate "engineering". Moreover, and as I will explain below, the plaintiff was unable to prove that the technical violation would have actually led to the immediate repayment of the bonds or the collapse of the company. Therefore, the argument is rejected.
Was the breach of the covenant material in the accounting sense?
- Decision No. 99-4 regarding guidelines for examining the materiality of an error in financial statements (hereinafter: the "Guidelines Document"), on which Prof. Eden relies (Eden Opinion 2025, in section 2.15), defines the materiality of an error in the financial statements. The guidelines document indicate that information is essential:
"When omitted or misrepresented, may affect the way users make financial decisions based on financial statements. It is also clarified that the materiality depends on the size (a quantitative layer) and the essence ("nature", a qualitative layer) of the error, taking into account the totality of the circumstances." (Guidelines for Examining Materiality, pp. 3-4).
- With regard to the quantitative aspect, the Guidelines document establishes quantitative presumptions for a material error according to one of the following: (1) 5% or more of the net profit or loss (in absolute values) attributable to the owner of the parent company; (2) 5% or more of the total profit or loss (in absolute values), attributable to the owner of the parent company; 5% or more of the capital (in absolute values) attributed to the owner of the parent company (Guidelines Document, at p. 4). The Guidelines document further clarifies:
"The quantitative presumptions and the qualitative presumptions are not cumulative conditions, but rather alternative conditions for materiality, and therefore the non-existence of the qualitative presumptions in itself is not sufficient to determine that an error that met the quantitative presumptions is not material" (ibid., at p. 2).
- As for the qualitative layer, the guidelines document states that:
"The substantial nature of a mistake is also derived from its nature, and not only from its quantitative size. Therefore, an examination of qualitative considerations of the materiality of an error may lead to the conclusion that the error is material, even though its rate falls below the quantitative thresholds detailed above. These cases can be divided into three types: a. An error that materially affects other data (other than net and total profit or equity) in the financial statements and/or financial ratios and significant performance indicators used by investors. B. A mistake that is material due to qualitative considerations. c. An error in the information included in the annotations." (ibid., at p. 6).