Reverse Piercing and Choice-of-Law
What law should apply when a creditor attempts to pierce the corporate veil of a foreign company whose shareholder is the debtor?
In Net International Property Limited v. Rachel Sofer (Civ. App. 3585/16, October 3, 2018), the Israeli Supreme Court stated that the applicable law is the law of the state of incorporation of the company. This may seem obvious for an international practitioner. In fact, the Supreme Court stated this almost as if it was a universally accepted principle of private international law. However, that is not the case and an argument can be made that under certain circumstances the "internal affairs doctrine" should be set aside for a more flexible choice-of-law analysis.
As an initial matter, "piercing the corporate veil" is a legal term that refers to the disregarding the separation between a company and its shareholders. When a court "pierces the corporate veil" it is saying that the plaintiff can get relief not only from the company but also from a shareholder of the company. The classic "corporate piercing" usually occurs in cases where the company is a debtor or is liable for damages. In Israel, it is common for employees to attempt to pierce the corporate veil of their employer-company to try to hold the owners of the company liable. This type of "piercing" is referred to as "direct piercing". "Reverse piercing" refers to when the shareholder is a debtor or a tortfeasor. In this case, the creditor has a claim against the shareholder only and wishes to collect from company assets. "Reverse piercing" is less common and less available as direct piercing. [See Acceptance and Application of Reverse Veil-Piercing—Third-Party Claimant, 2 A.L.R.6th 195].
The law of the state of incorporation applies when determining whether to attribute the liability of the company to the shareholder. The law of the state of incorporation also applies when determining whether to attribute the liability of the shareholder to the company. That is the gist of the ruling of the Supreme Court in Net International Property Limited v. Rachel Sofer.
As is typical of Israeli courts, the Supreme Court didn't tell the readers of the opinion why the law of the state of incorporation applies. The Supreme Court made it sound like this was an obvious and well settled principle of law.
Interestingly, that is not the case. At least in the U.S., the courts are split in this exact issue. See, in general, King Fung Tsang, Applicable Law in Piercing the Corporate Veil in the United States: A Choice With no Choice, Journal of Private International Law, 10:2, 227-264 (2014); See also Gregory Scott Crespi, Choice of Law in Veil–Piercing Litigation: Why Courts Should Discard the Internal Affairs Rule and Embrace General Choice of Law Principles, 64 N.Y.U. Ann. Surv. Am. L. 85, 90–91 (2008–09).
Just as recent as March 2018, a U.S. District Court rejected an argument to apply the law of the state of incorporation to a "piercing the corporate veil" claim. Morasch Meats, Inc. v. Frevol HPP, LLC, 2018 WL 1434814 (D. Or. Mar. 22, 2018). Relying on past decisions, the court found that the internal affairs doctrine "governs the choice of law determinations involving matters peculiar to corporations, that is, those activities concerning the relationships inter se of the corporation, its directors, officers and shareholders." This doctrine, however, should not apply when the claim against the corporation (or the shareholder) is based on contract, tort. etc.
The matter is far from settled and I do not intend to go into all the nitty-gritty and esoteric details of this topic. The Israeli Supreme Court was given a rare opportunity to instruct Israeli judges and practitioners where it stands on the matter. Net International Property Limited v. Rachel Sofer not only involved an important issue of private international law, but it also dealt with it in the context of reverse corporate veil piercing. It would have been nice had the Supreme Court actually discussed the reason for its conclusion in a little more depth and not leave us groping in the dark and leaving room for lower courts to err in the future.