Israeli Insolvency Law: It is Time for a Change

In recent years Israel harnessed its intellectual resources for financial gain by exporting technology. A steady stream of Israeli technology startups have mushroomed, with many of those startups finding significant success. Through the combination of shekel devaluation and the growing worldwide demand for better technology, the Israeli economy has grown. This change demonstrates how Israel casted-off the traditional socialist-Zionist/ Kibbutz/agricultural model in favor of the current capitalistic/corporate model. Surprisingly, the Israeli insolvency regime seems to cling to the old model, which likely impedes economic growth.

The U.S.’s insolvency regime is very pro-debtor. Filing a Chapter 11 bankruptcy petition shields a debtor from pre-petition debt, known as the automatic stay, which allows the distressed company breathing room to reorganize. (18 U.S.C. 362) Bankruptcy also grants the debtor the right to reject certain agreements, which can advantage the debtor by reworking long-term labor contracts and leases. For instance, to keep competitive with other airlines, a solvent American Airlines filed for Chapter 11 bankruptcy protection, allowing American Airlines to stay collection of all pre-petition debt, reject labor agreements, and renegotiate with its unions.

Another significant advantage of the U.S. system is post-petition financing, or D.I.P. (debtor-in-possession) financing. That is, a creditor who provides a debtor financing during bankruptcy has priority over other creditors, thereby rewarding creditors who provide working capital to bankrupt debtors. Often this financing provides a debtor the necessary lifeline to continue its business during and emerge from bankruptcy.

To finalize a bankruptcy plan the debtor can employ a cramdown, which forces some creditors to accept modified loaned terms. (18 U.S.C. 1129) A cramdown crams a plan down the creditors’ throats. Creditors debate the merits of a proposed plan and vote on that plan. If the requisite creditors vote to adopt the plan, the plan is crammed down the dissenting creditors’ throats, binding all parties. This tool allows a debtor to emerge from bankruptcy with modified obligations to satisfy creditors. The preceding shows some examples how the U.S. bankruptcy regime is debtor-friendly.

The U.S. bankruptcy regime is debtor-friendly because there is a belief that keeping a business as a going concern is ultimately the best for all parties. The business remains as a going concern that, under the circumstances, allows creditors to collect the maximum. Being debtor-friendly disincentives a distressed company from acting reckless because the distressed debtor knows that it has a strong likelihood of remaining intact. For the same reason this promotes an efficient bankruptcy process.

In contrast, Israeli insolvency law is pro-creditor. (see the Israel Companies Act 350) Israeli insolvency law provides three scenarios for distressed businesses: 1) voluntary arrangement; 2) liquidation; and 3) receivership. Voluntary arrangement allows for negotiation; liquidation is considered hostile; receivership is friendly. Israeli insolvency generally has no equivalent of an automatic stay; courts may apply a stay when it favors creditors. There is no right to reject contracts or leases; a creditor that provides debtor financing subsequent to an insolvency proceeding has no priority over other creditors.

Israeli insolvency does provide for corporate rescue with a cramdown-like provision. When an arrangement is proposed between the debtor and its creditors, the court, in its discretion, can order that a meeting be held with such creditors to discuss and vote on that proposal. The proposal must be approved by a majority of participants and those approving must hold at least 75 per cent of the value represented. If adopted, the draft arrangement is submitted to the court for approval. Unlike the U.S. regime that utilize cramdowns as a right, Israeli insolvency law utilizes its form of cramdown at a court’s discretion.

From a policy standpoint, a creditor-friendly insolvency regime is advantageous in that it prevents strategic default and excessive risk taking. Because a debtor faces the likelihood of liquidation upon loan default, it has a strong incentive to avoid default and act prudent. Once distressed, however, a creditor-friendly regime actually promotes excessive risk taking because the debtor attains a “nothing to lose” attitude. A distressed company with a positive reputation may seek to capitalize on that reputation by reckless borrowing, further dragging other parties into its web of negligence. When balancing the positive and negatives of its insolvency regime, Israel seemingly determined that having a creditor-friendly regime is the better option.

Israel tapped into the world’s seemingly insatiable appetite for better technology. With companies like Apple consistently introducing technological products on top of its own products, technological advancement needs bold companies that take risks. Bright minds need the comfort that their employers will take risks in the technological world. If not, Israel risks falling behind in its recently-discovered technology cash cow.

If so, Israel’s insolvency regime is not in sync with its economic needs. Under Israel’s previous economic model, a creditor-friendly insolvency regime is arguably better because, as an agrarian socialist-Zionist economy, it promotes fiscal responsibility by marginalizing strategic default and excessive risk taking. However, the current economic model suggests that the insolvency regime is antiquated. Israeli technology companies seeking a place in the global market need the flexibility to imagine and create, which includes risk-taking. The world technological marketplace runs at a dizzying pace. Competing in that marketplace requires high-stakes innovation. Placing any sort of constraints on Israeli innovation hampers growth. For Israeli insolvency, it is time for a change.

About the Author
Ari Mushell works in the banking industry.