Legal Updates

A board of directors of a profitable company that has knowledge of future negative data that will cancel the profitability cannot distribute dividends

January 12, 2021

A company approved distribution of dividends two months prior to publication of its yearend financial reports, under to which the company expects a negative balance, but only after examining the company's profit forecasts for the next four quarters after the distribution.
The Court held that the distribution of dividends is permissible because the unpublished financial reports do not contain material information that could affect the company's profitability. In order to maintain a balance between the distribution of company resources to its shareholders and the risk to the "safety cushion" of its creditors, Israeli law stipulates that when a company board of directors decides on dividends, in order for such distribution to be deemed a "permissible distribution", it must meet the distributions tests: The Profit Test and the Solvency Test. The Profit Test is a retrospective technical test that enables distribution only from the higher of the surplus and the accumulative profits of the last two years. If the company does not meet the Profit Test but does meet the Solvency Test, which substantially examines whether such distribution may make it difficult for the company to meet its obligations, the company may move the Court to authorize the distribution. If, at the time of distribution, the company meets the Profit Test but the board of directors has material information suggesting an imminent possibility to affect the company profitability, the distribution no longer meets the Profit Test. Here, the unpublished reports do not materially affect the company's position, particularly when the decision was made two months before the reports were published, when additional data on future profits was presented to the board and when the losses appear to be due only to the passage of time. Thus, the distribution is permissible.