Newsletter Update - October 2006

Welcome to the latest Anti-Fraud Network newsletter. In this edition we have shifted our focus from the US to Israel.  Micah Menes, partner in Michael Shachor, Menes & Co. in Tel Aviv, sets out a number of issues arising out of recent corporate failures in Israel featuring fraud.  The article provides an insight into the Israeli legal process that we hope is useful both in Israel and elsewhere.

In the next issue, a team from Australian law firm Allens Arthur Robinson will examine MIDAS. In 2003, the Board of the Australian Crime Commission authorised the Money Laundering and Tax Fraud Determination (MIDAS), triggering the commencement of a wide scale investigation into certain types of federally relevant criminal activity. One of the key ongoing investigations arising from MIDAS, code-named Operation Wickenby, is described as an investigation of national and international significance into allegations of tax fraud, money laundering and financial crimes.

The AAR team will outline some of the key legal issues which have arisen so far.  These include the recent court decisions relating to the coercive powers of the multi-agency investigative team (the Australian Crime Commission, the Australian Federal Police, the Australian Securities and Investments Commission, the Australian Taxation Office and the Commonwealth Director of Public Prosecutions) during the investigation and the implications for domestic and international institutions who may become involved.

Previous issues of the AFN newsletter are available on the Anti-Fraud Network’s website www.antifraudnetwork.com.  The newsletters include insights into fraud issues in different parts of the world.  They are a useful resource for anyone faced with fraud-related issues.

Nick Burkill

The Investigation of Fraud in
Failed Companies in Israel

Over the past few years, the Israeli economy has, like many others worldwide, seen the collapse of an array of companies. These range from small start-ups, through medium size, well-established businesses to large commercial conglomerates such as “Club Market”, one of the top three supermarket chains in Israel.

According to reports in the media, almost 15 per cent of all Israeli organizations have suffered from embezzlement but less than 10 per cent were insured against such losses. It also transpires that most Israeli companies do not perform regular checks on employees, and do not apply basic controls or precautions which could significantly reduce the number and scope of embezzlements.   Basic precautions include a hiring policy that excludes candidates with a criminal record, and testing for reliability through simple investigations.

These failed companies have served to catalyze investigations that often revealed a variety of forms of fraud that took place in these organizations prior to their downfall. As a result, fraud and financial investigation have become an almost standard procedure in liquidation cases in Israel.

The Liquidator

In Israel, investigations are usually initiated by the receiver or liquidator.  Once an application is filed by one or more creditors, a court hearing is scheduled, usually for within three months.  An interim liquidator may be appointed by the court but the choice of permanent liquidator is generally at the largest creditor’s discretion, usually after consultation between the other creditors.  In accordance with Israeli law, the liquidator himself is defined as an Officer of the Court, but has full discretion in protection of the company’s assets and securing the creditors’ rights. Similarly, a receiver nominated by the court in relation to a debenture is supervised by the court but has fewer authorities than a liquidator.

When ordinary collection proceedings fail, the application in itself can, and does sometimes, serve as a catalyst which compels a company to make payments it has avoided until then. However, ordinary civil debt, which has not been adjudicated, cannot serve as a basis for a liquidation application and such an application would probably be rejected by the courts.
The receiver or liquidator is equipped with essential investigative tools that make a basic examination possible. Usually the liquidator will immediately attempt to seize accounting documents and gather information about the activities of the company and its principal officers. The liquidator will then try to reach a clear understanding of the share or capital structures and the holdings of the principals in the organization.  This is not always a simple matter. Often there is evidence of potentially unethical repayment of shareholder’s loans immediately prior to the collapse.

The liquidator will also attempt to identify the company’s assets, as well as those of any related companies, entities, or officers. Another important task, common in Israel, is to trace suspicious movements of funds and transactions related to the company’s assets. Finally, the liquidator will try to understand the immediate reasons for the collapse of the company. This may lead to uncovering of evidence of fraudulent acts and offences committed shortly before the winding up.

The interim period prior to the permanent liquidation order is extremely important.  Correct and effective action taken in this time may be the only way to save at least a part of the company’s assets and secure partial repayment of its debts.

Fraudulent Dealings

There is a wide variety of deceitful and fraudulent activities, which take place either prior to the company being declared bankrupt or after. The following are the three major categories.

Illegal transfer of company’s assets immediately prior to receivership
These transfers will usually take place on the eve of the receivership order. Officers or controlling shareholders, who are aware of the company’s dire financial situation, transfer valuable assets to controlled or affiliated third parties. These transfers take place without other shareholders or the company’s creditors being notified and there tends to be no actual consideration. The transfer of assets may not be obvious.  The company might assign intellectual property or grant a free license to an interested party; or the company might assign certain monetary rights, such as debts, to an interested party or waive the right to receive payments from its shareholders.

Attributing third party expenses to the company
Another common activity is to simply shift the expenses or debts of another company, usually an entity affiliated to an officer or controlling shareholder, to the failing company.

Granting creditors unlawful preference
This is a very common activity in which the company gives preference to creditors who are affiliated to the company’s officers or controlling shareholders, or hold personal guarantees from such officers or shareholders. This could include the transfer of assets or payments to the preferred creditors.

The liquidator, even within the interim period prior to his permanent nomination, and any creditor, have full authority to request the court to invalidate unlawful preference of creditors and illegal transfer of assets. It is therefore not uncommon for a creditor who wishes to collect a debt to file an application for the nomination of an interim liquidator, stating that there is concern that the company may be illegally transferring certain assets. Occasionally, a situation occurs where a company has provided a genuine debenture and lien, but transferred its assets to third parties. This tends to be because a creditor has not examined the company’s situation and is not aware that consent is required from a prior creditor with a superior claim. 

Additional leverage is achieved for creditors by filing a personal claim against the company’s officers and directors, as well as against the company. This is permitted in certain circumstances under Israeli case law. This personal liability creates an incentive for fast debt settlement by the officers and directors when there is an “Israeli angle” in a cross border dispute. Investments by foreign investors in high-tech start-ups are common in Israel. Frequently these investments, which involve, amongst other things, loans and debentures, result in a competition between the company’s creditors.

Laws and Regulations That Apply

Since the new Companies Law (1999) does not deal with liquidation, it is the Israel Companies Ordinance (1983) which governs the receivership and liquidation of companies.

Under certain circumstances (usually after review of an initial report), the court handling the receivership may summon office holders of the company in order to give testimony.  The receiver or liquidator has authority to summon and interrogate parties who are suspected to be in possession of the company’s assets. This authority may not, however, be invoked in the case of parties against whom the receiver or liquidator intend to file claims.

 The court has a general discretion to pierce the corporate veil and impose personal liability for the company’s debts on any office holder, or controlling shareholder, who took part in fraudulent dealings.  If it becomes evident that an office holder was involved in unlawful activity with respect to the company’s assets, the court has the discretion to oblige the office holder to return the monies or assets to the company.  The court can also enforce this obligation, thus by-passing the filing of an ordinary claim.

Civil and Criminal Procedures in Israel

A very basic element in Israeli legal proceedings regarding fraudulent dealings is that the company, its shareholders, employees and or creditors are not automatically a party to any criminal proceedings.  These are initiated and handled solely by the law enforcement authorities. In general, if a situation appears to be simply a civil dispute, the authorities will probably refrain from investigating it.

Another relevant point is that, according to Israeli rules of evidence, in common with other countries, a civil court must recognize any relevant factual findings of the criminal court.  If a criminal procedure has been brought to court it will therefore have priority over any civil case.  If two cases are to run, the civil case is postponed until the criminal case has ended. However, due to the fact that criminal investigations sometimes take years to initiate, the civil procedure will often begin first.  If this occurs, as soon as a criminal procedure is commenced, the civil case is halted until the criminal case is concluded.

Michael Sachor, Adv., is a partner in Michael Shachor, Menes & Co. Michael heads the litigation department of the firm and specializes in private international law, with specific concentration in areas of a contractual nature including, agency, franchising, insolvency and receivership, commercial contracts, real estate and administrative disputes and fraud. Contact Details: Tel: + 972 3 608 1797 michaels@sachorlaw.com

Micah Menes, Adv., is a partner in Michael Shachor, Menes & Co. Micah serves as general counsel to many clients including companies publicly traded on the Tel Aviv and foreign stock exchanges. He advises on both contentious and non-contentious issues in relation to fraud, agency, joint ventures, securities, anti-trust, employment and real estate. Contact Details: Tel: + 972 3 608 1797 micahm@shachorlaw.com

The Anti-Fraud Network

The Anti-Fraud Network is a network of lawyers who specialise in the pursuit of claims arising out of the theft or other dishonest appropriation of assets, corruption, misuse of confidential information or similar breaches of duty. Recovering the proceeds of fraud and corruption is one of the truly global problems facing organisations today. Proceeds rarely stay in the country where they have been stolen. For organisations to recover stolen or corrupt assets they need access to lawyers specialising in their recovery across the world.

News and Events

London held a number of fraud conferences in September, including the 2006 Fraud World conference at which AFN member Nick Burkill chaired a discussion on ‘Anti-Money Laundering, Legal and Regulatory Issues.’   The discussion included consideration of the UK’s Fraud Bill, expected to come into law shortly.  Recipients of the AFN newsletter who wished to attend were eligible for a discount from conference organisers IIR if they applied through the AFN.

Future conferences in London on fraud issues include the IQPC conference on Regulatory and Internal Investigations due to take place on 27 and 28 November.  AFN member Nick Burkill will be speaking and taking part in a Q&A panel.  Email us at info@antifraudnetwork.com if you wish to receive details of the IQPC conference.

Click here for a list of upcoming events 

AFN member Jerry Carter recently appeared in Money Media, talking about his practice on the Isle of Man and the Anti-Fraud Network. Click here to read the article in full.

If you would like to draw attention to fraud related issues, developments in the field, or key events of interest to anti-fraud professionals, please let us know at info@antifraudnetwork.com. We welcome contributions and articles from all jurisdictions.

Associate Members

If you have responsibilities within your organisation for preventing or recovering the proceeds of fraud or corruption you could be eligible to join the Anti-Fraud Network as an associate member. There is no cost involved and you will have the opportunity to help shape the development of the Network, as well as have access to the expertise of colleagues across the world. For more information, contact us at info@antifraudnetwork.com.

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