Israeli Insolvency Law Moves to Encourage Reorganization

Israeli Insolvency Law Moves to Encourage Reorganization

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In 1988 Koor Industries Ltd., like many other Israeli companies, was in dire economic distress as a result of the hyperinflation years of the mid-1980s. Koor, one of the largest conglomerates in Israel, employed more than 30,000 people and was involved in diversified industries ranging from food to pharmaceuticals and from steel to newspapers. Koor's debt obligations totaled more than $1.3 billion. In 1988, the company defaulted on its loans to banks and bondholders. Bankers' Trust, owed $25 million by Koor, filed a motion for the liquidation of Koor with the Tel-Aviv District Court. The possibility of Koor's being liquidated and of the resulting shutdown of its operations presented disastrous consequences for the Israeli economy as a whole.

 

Pursuant to §§257 and 258 of the Israeli Companies Ordinance, [New Version] 5743-1983, a creditor's motion to liquidate a company will be granted if it is proven to the court that the company is insolvent. Pursuant to §268 of the ordinance, any transaction with a company subsequent to the filing of a motion to liquidate such company could be declared null and void in the event that an order of liquidation is eventually given. In addition, the Israeli insolvency laws at the time did not permit a company to obtain a stay of proceedings against it that enabled it to continue operating while formulating a scheme to pay creditors.2 Since Koor was insolvent, such an order of liquidation seemed therefore inevitable. Thus, Bankers' Trust's motion to liquidate Koor could completely paralyze Koor's ability to conduct business. As might be expected, the motion to liquidate Koor alarmed the heads of the Israeli economy.

Hon. Judge E. Winograd heard the motion to liquidate Koor. After reviewing the potential damage to the Israeli economy that could result, Judge Winograd decided that the court has an inherent power to give any relief or order, if justice is served thereby. On that basis, the court ruled that Koor would be able to carry on with its business as if a motion to liquidate was not filed, that Koor could continue negotiations with its creditors for a creditors' arrangement, and that during such process proceedings against Koor would be stayed. The court so ruled, notwithstanding the absence of explicit statutory authority for such relief.3


...the Israeli legal system favors concise yet flexible codified authorities.

Koor had a very successful creditors' arrangement and is now a thriving business, attracting foreign investors into Israel. Yet its plight shed an important light on the significance of the absence of a statutory solution for a company that suffers from a temporary financial hardship and needs a short respite from creditors to get back on its feet.4 As a result of Koor and other similar cases, the Israeli legislature has recently reformed Israeli insolvency law to foster company reorganizations. The evolution of Israel's reorganization laws and its current key provisions are addressed below.

Pre-Amendment Israeli Law

Section 233 of the ordinance contains the reorganization provisions of Israeli insolvency law. Specifically, §233 contains the mechanism and governs the procedure for debtor's schemes of arrangement with creditors (akin to U.S. plans of reorganization). The aim of §233 is "to enable the rehabilitation of companies, be it by way of reorganizing the company, or be it by way of a settlement or arrangement, as an alternative to liquidation."5

A debtor company can propose a scheme of arrangement to its creditors and move the court for an order to convene creditors' meetings to vote on the scheme. Each class of creditors has a separate meeting and vote. A creditor, shareholder or liquidator (if the company is already in liquidation) can also propose an arrangement. The arrangements must be approved by a vote of a majority in number and 75 percent in amount of creditors at each creditors' meeting. A trustee is usually appointed in order to decide who qualifies to be a creditor and what the amount of each creditor's claim is for purposes of voting on the scheme of arrangement. The court must approve the scheme of arrangement. The execution of the arrangement is monitored by the trustee, with or without a creditors' committee.

However, prior to 1995, the ordinance did not offer a stay of proceedings to a company that desired to continue operations while attempting to negotiate a scheme of arrangement with its creditors. A stay of proceedings was technically only available where a debtor company had been placed into formal liquidation proceedings or where a temporary liquidator has been appointed6 (although pursuant to the Koor case and others, some courts began to order stays of proceedings in certain circumstances on the basis of their "inherent powers"). As a practical matter, this legal rubric severely limited the ability of companies to reorganize. In order to obtain a stay of proceedings, the law required that a company's management be replaced by a liquidator in the context of a proceeding predisposed to liquidation. Outside of a liquidation proceeding, a company remained vulnerable to attacks by creditors, particularly foreclosure actions by secured creditors. The Koor case and other similar cases highlighted the importance to the reorganization process of affording companies the protection of a stay of proceedings while they both continued operations and negotiated an arrangement with their creditors. The Israeli legal community responded by amending §233 to foster and facilitate reorganizations.

The 1995 Amendment

In April 1995, subsections A1-A4 were added to §233, thus amending §233.7 The amendment provides for the following:

  1. The express authority for the court to stay proceedings against a company for a period of up to nine months, if the court deems such necessary to assist the company in creating or approving a scheme to rehabilitate the company.
  2. The stay of actions by secured creditors (with fixed or floating charges) is conditioned upon the existence of adequate protection of such creditors' rights in respect of their collateral.
  3. A court may order a stay of proceedings on an ex parte basis, although, in such a case, any motion by a creditor to vacate or alter such a stay must be heard within 30 days after the stay was given.

The Experience with the New §233

The amendment has been widely utilized since its enactment. The addition of the stay of proceedings, although not an automatic stay, has proved to be very useful in many cases, benefiting both debtors and creditors. For example, in the Gali case, a large shoe manufacturer and retailer was in financial difficulty. The company moved the court for a stay of proceedings in order to create an arrangement. A short stay was given during which the retail stores kept functioning regularly. Eventually this enabled the operations of the company to be sold as a going concern. Under the old regime before the amendment, it was almost impossible to keep such a chain of stores operating as a going concern, either in the absence of a stay of proceedings or with a stay but under a liquidator's governance.

The proliferation of stays of proceedings afforded companies in financial difficulty has promoted successful schemes of arrangements. Concomitantly, the expertise of the professionals in reorganizing companies has grown. Also increasing is the body of reorganization case law, providing parties with insight into how courts will apply the relatively laconic language of the amendment. The amendment constitutes a major step forward for companies attempting to reorganize and has helped numerous companies accomplish that goal.

Subjects Not Covered by §233

Section 233 does not cover certain other matters that are relevant to the reorganization process. Among the subjects not covered by §233 are:

  1. Debtor-in-Possession: Although in most cases the court appoints a trustee to be in charge of the arrangement, creditors' meetings, etc., it is possible for the debtor company to remain in possession. However, it is not clear under what circumstances and in what fashion a debtor may be permitted to remain in possession.
  2. New Money: Section 233 has no specific provisions addressing how and under what conditions a company can obtain new money, both to finance its reorganization and its day-to-day affairs.
  3. Onerous Assets: Under §§360 and 361 of the ordinance, in a liquidation proceeding a liquidator can repudiate onerous assets, such as contracts without profits. There is no parallel arrangement for a company in a §233 reorganization context.
  4. Vital Suppliers: Section 233 does not address issues concerning a debtor company's capability to pay its vital suppliers in order to allow the orderly operations of the company (such as utilities, special raw materials, etc.) to continue.

Conclusion: Evolution Continues

Although the State of Israel has existed for only 50 years, its legal system benefits from well-developed and diverse roots. Some Israeli law (the ordinance being a good example) is British in origin, introduced during the British mandate. Some Israeli law (the majority of the civil law) has been enacted by the Israeli Knesset based upon European civil law models. Finally, the Israeli law is also inspired by the Jewish heritage and law as it evolved over two millennia in the Diaspora and in the land of Israel before its independence.

As a result of these diverse roots, the Israeli legal system favors concise yet flexible codified authorities. Accordingly, Israeli courts both apply statutes as written and interpret them, filling lacunae where necessary, by virtue of their inherent powers to do justice. Therefore, the Israeli judiciary will continue to apply existing Israeli reorganization law as it has been updated with the amendment, and will interpret and adapt Israeli reorganization law to do justice even where specific statutory authority is presently absent. What is virtually sure is that Israeli reorganization law will continue to develop to better promote the reorganization of companies.


Footnotes

1 Mr. Silverman is a partner with Bingham Dana LLP, the successor by merger with Hebb & Gitlin PC. Return to article

2 A stay of proceedings was only available where a temporary liquidator had been appointed or an order of liquidation had been given. Either of these scenarios foreclosed the ability of a debtor to continue operations while protected by a stay of proceedings. Return to article

3 Cf. (T.A.) 1901/88 In re Koor Industries Ltd. Return to article

4 Over the years, not all judges agreed to apply their "inherent powers" to permit a debtor company to remain in possession while staying proceedings against it, as was done in the case of Koor. The Supreme Court of Israel did not have the opportunity to deal with the issue. Return to article

5 C.A. 217/88 Bank Hapoalim Ltd. v. The Trustee of the Arrangement of the Encyclopaedia Publishing Company Ltd., P.D. Mem Dalet (2), p. 698, on p. 703. Return to article

6 Section 267 of the ordinance. Return to article

7 B.L. 1521, 5755 (April 12, 1995) p. 204. Return to article

Bankruptcy Code: 
Journal Date: 
Thursday, July 1, 1999