The Business Judgement Rule in Derivative Actions


In a recent judgment of the Israeli Supreme Court, a significant precedent was handed down by Judge Yoram Danziger, setting out that the Business Judgment Rule applies to a company’s board of directors when it is deciding whether to file a derivative action.

The case brought before the Supreme Court dealt with a dispute between Uvision Air Ltd. (the “Company“), represented by Adv. Erez Dar-Lulu and Nir Menahem of our firm, and a shareholder of the Company.

The dispute stemmed from the shareholder’s demand that the Company file a claim against one of its customers for an alleged breach of contract.

Following the Company’s refusal to file the claim, the shareholder petitioned the Tel Aviv District Court to allow him to file a derivative action on the Company’s behalf.

Put simply, a derivative action enables directors and shareholders of a company to exercise a cause of action which the company may pursue but has failed to, by means of filing a claim on the company’s behalf.

According to the mechanism prescribed in the Israeli Companies Law, the right to file a derivative action is not automatic. As a general rule, the plaintiff (in this case – a shareholder) is required to first demand that the company exercise its rights by way of filing an action addressing the relevant matter. If the company does not accede to the demand and declines to file the action at issue, the plaintiff is then required to obtain the court’s approval to file an action on the company’s behalf, i.e. a derivative action.

Approval by the court to file a derivative action is conditioned on the following: (1) the existence of cause of action on the company’s behalf; (2) the lawsuit and the conduct thereof are in the company’s best interests; and (3) the plaintiff is not acting in bad faith.

In its ruling, the Supreme Court deliberated the question of whether and to what extent the court should intervene in the decision of a company’s board of directors to not file a derivative action against a third party and, in this context, if the Business Judgment Rule protects a decision of this type.

In a nutshell, according to the Business Judgment Rule, a decision of a company’s board of directors is presumed to be correct and immune from judicial review when (a) it is informed; (b) does not involve a conflict of interest; and (c) was taken in subjective good faith. Put differently, under this doctrine, the court will defer to the business judgement of a company’s executives.

In upholding the lower court’s decision, the Supreme Court accepted our client’s position and set a precedent by ruling that a company’s decision to not file a lawsuit is, for all intents and purposes, a business decision like any other business decision made by the company’s board of directors.

It was further held, that in deliberating a demand made to a company to file a derivative action, its board may consider matters other than the direct “benefit of the company”, such as the cost of conducting the legal proceedings (compared to the potential reward), the effect the proceeding might have on the company’s reputation and other considerations in which a company’s board of directors has an advantage over the court.

Consequently, one can presumably foresee a reduction in judicial intervention in decisions of this type which, in turn, is expected to contribute to the reduction of frivolous and meritless claims.

This newsletter is provided for informational purposes only, is general in nature, does not constitute a legal opinion or legal advice and should not be relied on as such. If you are seeking legal advice, it is essential to review the specific facts of each case in detail with a qualified lawyer.

The review was written by Adv. Gary Copelovitz, Partner and Head of the International Department and Adv. Gad Keren, Associate in the International Department