DDiiggiittaall CCoommmmoonnss @@ UUnniivveerrssiittyy ooff GGeeoorrggiiaa SScchhooooll ooff LLaaww LLM Theses and Essays Student Works and Organizations 12-1-2001 CCoorrppoorraattee DDiissttrriibbuuttiioonnss ttoo SShhaarreehhoollddeerrss iinn DDeellaawwaarree aanndd iinn IIssrraaeell Anat Urman University of Georgia School of Law RReeppoossiittoorryy CCiittaattiioonn Urman, Anat, "Corporate Distributions to Shareholders in Delaware and in Israel" (2001). LLM Theses and Essays. 52. https://digitalcommons.law.uga.edu/stu_llm/52 This Article is brought to you for free and open access by the Student Works and Organizations at Digital Commons @ University of Georgia School of Law. It has been accepted for inclusion in LLM Theses and Essays by an authorized administrator of Digital Commons @ University of Georgia School of Law. Please share how you have benefited from this access For more information, please contact [email protected]. ANAT URMAN Corporate Distributions To Shareholders In Delaware And In Israel: Cash Dividends And Share Repurchases. (Under the Direction of Professor CHARLES R.T. O’KELLEY) This thesis considers the corporate legal systems of Israel and Delaware as they address the subject of corporate distributions to shareholders. The thesis reviews the significance of cash dividends and the acquisition by corporations of their own stock, in the management and survival of corporations, the effect they have on the disposition of creditors, and the extent to which they are restricted by operation of law. The thesis demonstrates how dividends and share repurchases may translate into a transfer of value from creditors to shareholders. It considers the effectiveness of the legal capital in securing creditors’ interest, and concludes that the legal capital scheme presents no real obstacle to distributions. It is further concluded that despite the recent corporate law reform in Israel, Delaware’s corporate law system continues to surpass Israel in flexibility and broad approach to distributions. Nevertheless it is expected that Israeli courts will consider Delaware’s methodology on the matter. INDEX WORDS: Debt, Distribution, Dividend, Equity, Equity cushion, Fiduciary, Greenmail, Insolvency, Legal capital, Leverage, Nimble dividend, Par value, Recapitalization, Redemption, Restrictive covenant, Repurchase, Surplus, Takeover. i CORPORATE DISTRIBUTIONS TO SHAREHOLDERS IN DELAWARE AND IN ISRAEL: CASH DIVIDENDS AND SHARE REPURCHASES by ANAT URMAN LL.B. The University of Manchester, Israel, 1998 A Thesis Submitted to the Graduate Faculty of The University of Georgia in Partial Fulfillment of the Requirements for the Degree MASTER OF LAWS ATHENS, GEORGIA 2001 ii © 2001 Anat Urman All Rights Reserved iii CORPORATE DISTRIBUTIONS TO SHAREHOLDERS IN DELAWARE AND IN ISRAEL: CASH DIVIDENDS AND SHARE REPURCHASES by ANAT URMAN Approved: Major Professor: Charles R.T. O’Kelley Committee: Fredrick W. Huszagh Charles R.T. O’Kelley Electronic Version Approved: Gordhan L. Patel Dean of the Graduate School The University of Georgia December 2001 iv DEDICATION To my parents Malka and Menachem Urman, and to Ron Kalfus. Thank you for your support. iv vi TABLE OF CONTENTS Page CHAPTER 1 INTRODUCTION…………………………………………………………..1 I. Thesis Background…………………………………………………..1 II. The Significance Of Distributions To Corporate Constituencies……………………………………………………….4 III. Israel’s Corporate Law System……………………………………...6 IV. Thesis Structure……………………………………………………...7 2 THE CONFLICT OF INTEREST BETWEEN THE SHAREHOLDERS AND THE CREDITORS……………………………...9 I. Introduction……………………………………………….…………9 II. The Conflict Between Debt and Equity……………………….…...10 III. Eliminating Investment Risks And The Function Of The Equity Cushion……………………………………………………..15 3 LEGAL CAPITAL RULES AND THE EQUITY CUSHION……………18 I. Introduction To The Legal Capital System……………….………..18 II. Distributions And Their Effect On Creditors………………………26 III. Legal Limitations On Distributions………………….……….……29 4 CRITICISM OVER TRADITIONAL LEGAL CAPITAL DOCTRINES……………………………………………………….……...45 v vi 5 MOTIVES FOR ENGAGING IN CASH DISTRIBUTIONS AND SHARE REPURCHASES……………………………………….….48 I. Introduction……………………………………………….…….….48 II. Leveraged Recapitalizations………………………………….……52 III. The Excess Cash Theory………………………………….………..56 IV. The Signaling Explanation…………………………………………56 V. The Bird-In-The-Hand Theory……………………………………..62 VI. The Takeover Defense Theory……………………………………..63 VII. Greenmail…………………………………………………………..65 VIII. Stock Manipulations And The Creditor Expropriation Theory…………………………………………………….………..67 IX. Stock Redemptions……………………………………….………...69 6 RESTRICTIONS ON DIVIDEND DISTRIBUTIONS AND SHARE REPURCHASES…………………………………………….…...74 I. Restrictive Covenants…………………………………….………...74 II. Statutory Limitations………………………………………….……76 III. Limitations Imposed By Case Law..……………………………….80 7 LIABILITY FOR IMPROPER DISTRIBUTIONS……………………...113 8 CONCLUSION…………………………………………………………..118 BIBLIOGRAPHY………………………………………………………..125 CHAPTER 1 INTRODUCTION I. Thesis Background Israel is small country with very few natural resources, facing difficult political scenarios. Despite these adverse conditions, Israel has reportedly sprouted into the world’s second most important high-tech cluster after Silicon Valley.1 In a country of only six million people, there are nearly as many Israeli companies listed on the NASDAQ (National Association of Securities Dealers Automated Quotation System) as there are European companies. The government of Israel has taken an active role in promoting the county’s technological capabilities.2 The high-tech sector has become a central element in Israel’s economy, so much so, that its continued success is central to Israel’s economy. However, it has become increasingly difficult to attract foreign investors to participate in ventures within Israel. If fact, Israel’s high-tech industry is reportedly losing its business to foreign countries.3 In the past several years, over ninety percent of 1 Roger Abravanel, The Promised Economy, THE MCKINSEY QUARTERLY, 2001 Number 4 (hereinafter The McKinsey Quarterly). Also available at, http://www.mckinseyquarterly.com/article_abstract.asp?tk=:1108:7&ar=1108&L2=7&L3=10. According to The McKinsey Quarterly, during the year 2000, Israeli high-tech start-ups attracted more investment per head than any other country in the world. Israeli high-tech start-ups attracted $3.2 billion in capital investment, most of which foreign. This amounts to a 30-fold increase in investments in a period of only three years. 2 Subsidizing and setting up labs, incubators and seed-money venture capital funds. 3 Many companies transfer their business centers and management teams out of Israel. Even when the research is performed in Israel, the development products are transferred to related companies overseas. 1 2 the new start-up companies that were formed in Israel, incorporated as foreign companies,4 many of those in the U.S., a majority of which in Delaware. Why is it then that Israel, an incubator for world-class technological innovation, is struggling to prevent companies from immigrating to Delaware? One known turnoff for choosing Israel as a jurisdiction, is its unique system of corporate law. A major source of funding flowing into the venture capital industry in Israel originates from U.S. investors who do not believe in the Israeli system. Much pressure is, therefore, placed on Israeli entrepreneurs to set up their companies in the U.S. rather than Israel. Clearly, investors are likely to choose a jurisdiction whose laws are simple and most advantageous. Indeed, we see that among worldwide systems, those that dominate are systems that have the easiest, clearest, simplest, and most worthwhile laws governing economics, securities, income tax, and companies. Such systems compete in the global market because they are compatible with worldwide leading codes. The new 1999 Israeli Companies Law, on which work commenced fifteen years ago, was intended to serve this purpose precisely. However, by introducing an innovative and revolutionary code, legislators have, in effect, set back Israel’s competitive position. The new Companies Law is widely criticized as being less clear, less simple, less predictable, and less user-friendly than its foreign counterparts. Delaware, which has become a corporate haven for many Israeli corporations, has been offering an attractive legal landscape for incorporation for over two decades. 4 Ron Tira, Bye-Bye-Tech, GLOBES ISRAEL’S BUSINESS ARENA, June 7, 2000.