Officers’ Liabilities in the Age of COVID-19

During the COVID-19 crisis, many startup companies enter into the unfortunate zone called the “insolvency zone”. “Insolvency zone” is the time period during which the company’s financial condition deteriorates, but before the company becomes insolvent. During the insolvency zone, the tension between the company and its offices on the one hand, and the company’s creditors on the other hand, becomes apparent: While the company’s offices might prefer to take risks in order to rescue the company from its financial distress, the creditors might prefer to reduce the risks in order to decrease their losses.

The new Israeli Insolvency and Rehabilitation Law, entered into effect in September 2019, first introduced the special liability of the company’s officers during the insolvency zone. The law provides that if a director or the chief executive officer of a company knew or should have known that the company is insolvent, and did not take reasonable steps to limit the scope of insolvency, such director or chief executive officer will be personally liable towards the company for the damages caused to the company’s creditors by virtue of their failures. In other words, the law imposes a special duty of care on the company’s directors and chief executive officer that will encourage them to take reasonable steps to protect the interests of the company’s creditors. Note that the director or chief executive officer of the company is not responsible for the fact that the company becomes insolvent, but for not taking reasonable steps to minimize the losses caused to the company’s creditors.

While the special duty of care arises only once the company is insolvent, it should be noted that insolvency is defined very broadly, and hence, the duty might arise also in the solvency zone. The law sets out two alternative tests for insolvency: First, the debtor is unable to pay its debts when due, whether or not their maturity date has arrived (the cash flow test); and second, the debtor’s obligations, including its future and conditional obligations, exceed the value of its assets (the balance sheet test).

A company is prohibited from exempting the liability of a director or the chief executive officer from such special duty of care. The company is also prohibited from including a provision in the company’s Articles of Association that allows an indemnification of such officer due to such officer’s breach of such special duty.

So, what can one do in order to make sure that they are safe from personal liability? The law provides a rebuttable presumption, pursuant to which if the relevant director or chief executive officer took steps to evaluate the financial condition of the company, and also acted for the company to take at least one of the following steps, it shall be deemed as if he or she took reasonable steps to reduce the scope of the company’s insolvency:

1. Receiving assistance from bodies who specialize in corporate rehabilitation;
2. Negotiating with the company’s creditors in order to achieve debt reconstruction;
3. Initiating insolvency proceedings.

It is very important to take these steps in good faith and genuine will to minimize the losses caused to creditors.

In addition to the aforementioned rebuttable presumption, to the extent the relevant director or chief executive officer can show his or her reasonable good faith reliance on information that the company is not insolvent, he or she will be protected.

In times like these, it is important for the company’s officers to be aware of their personal liabilities, not only towards the company and its shareholders, but also, and even more so, towards the company’s creditors.