Legal Updates

A controlling shareholder may be compelled to return funds received from a prohibited dividend distribution

July 18, 2019

A holdings company with dual listing on the TASE and NASDAQ distributed dividends of
ILS 355M, ILS 113M of which derived from profits created by a change in the company's accounting policy and not by operational profits.
The Court allowed the minority shareholder to file a derivative action against the company's controlling shareholder. In order to distribute dividends the company must fulfil the “Profits Test” (distribution is based on company profits only) and the “Solvency Test” (no reasonable concern that the distribution will prevent the company from meeting its current and forecasted liabilities when they become due). A company may distribute dividends even if it does not meet the Profits Test, so long as it complies with the Solvency Test. However, such distribution is contingent upon Court approval. However, a company that meets the Profits Test but does not meet the Solvency Test, may not distribute dividends. The distributable amounts must derive from company's "retained earnings", as it appears in the company's income statement (and may not derive from the surplus capital item in the financial reports). Because the company suffered no damage by the distribution, the derivative action against the directors approving the distribution was rejected, but the derivative action against the controlling shareholder was approved as the controlling shareholder may be compelled to disgorge the amounts unduly distributed unless it did not know nor should have known of the prohibited distribution.