Kirkland partners Kate Stephenson and Harkiran Hothi and associate Alexander Rayner consider reflective loss following the Supreme Court’s decision in Marex, in this article for Corporate Rescue and Insolvency.
- The Supreme Court’s recent judgment in Sevilleja v Marex Financial Ltd  UKSC 31 (‘Marex’) provides important clarification on when a company’s shareholders or creditors can or cannot sue a third party alleged to have harmed the company, thereby causing the shareholder or creditor ‘reflective loss’.
- The Supreme Court narrowed the scope of the general restriction on such claims – the so-called ‘reflective loss principle’ – to claims by a shareholder where, due to an actionable loss suffered by the company, a shareholder suffers a diminution in the value of their shares or distributions received as a shareholder.
- The Supreme Court confirmed that creditors are not barred by the reflective loss principle from bringing an action against a third party alleged to have harmed the company, where the creditor has suffered loss.
- The majority also held that the reflective loss principle is a bright line rule of company law, to which there are no exceptions.
This article considers the Supreme Court’s judgment in Sevilleja v Marex Financial Ltd  UKSC 31 (‘Marex’) in detail, as well as the background to the reflective loss principle and the market impact of the Supreme Court’s judgment.
This decision is significant for creditors of a company, especially where, in cases of fraud, both the creditor and the company have concurrent claims against the same potential defendant. The Supreme Court has confirmed that creditors are not barred by the reflective loss principle from bringing an action against the wrongdoer in such a case.
The decision will be a blow for shareholders, however, who now no longer can rely on a previous exception which had permitted shareholders to pursue such a claim where the alleged wrongdoing means the company itself is unable to pursue the claim.
BACKGROUND TO THE REFLECTIVE LOSS PRINCIPLE
The reflective loss principle was first identified in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2)  Ch 204. It refers to the principle that a shareholder cannot bring an action for a diminution in value of their shares or the loss of dividends, where that merely reflects the loss suffered by the company (in consequence of a wrong done to it by the defendant), in respect of which the company has its own cause of action. The rule applies even if the defendant’s conduct also involved the commission of a wrong against the shareholder, and even if the company brings no proceedings against the defendant.
The rule in Prudential is distinct from the general principle against double recovery in the law of damages. In particular, one consequence of the rule is that, where it applies, the shareholder’s claim against the wrongdoer is excluded even if the company does not pursue its own right of action, and there is accordingly no risk of double recovery.
The rationale is that, where the rule applies, the shareholder does not suffer a loss which is recognised in law as having an existence distinct from the loss sustained by the company.
Later cases made various adjustments to the principle:
- a claim brought by a company’s shareholder is barred by the rule against reflective loss if the loss that he himself has suffered would have been made good by restoration of the company’s assets; a shareholder can sue for reflective loss where the company itself has no cause of action (even though the loss is a diminution in the value of the shareholding) ( Johnson v Gore Wood & Co  2 AC 1);
- the reflective loss principle applies to a claim arising from a creditor’s inability to recover a debt owed by a company in which the creditor happens to be a shareholder (Gardner v Parker  EWCA Civ 781);
- the reflective loss principle does not apply where alleged wrongdoing means the company is unable to pursue the wrongdoer (Giles v Rhind  Ch 618; followed in Perry v Day  EWHC 3372 (Ch)); and
- the reflective loss principle extends to a claim brought by an ordinary creditor of a company (who is not also a shareholder), where the company also has a concurrent claim against the wrongdoer. See the Court of Appeal’s judgment in Marex:  EWCA Civ 1468.
The Court of Appeal’s concluding comments had questioned the coherence of the existing law on this rule and invited the Supreme Court to ‘put it right’. The Supreme Court was invited to clarify or overrule these authorities on the reflective loss principle which has been likened to ‘some ghastly legal Japanese knotweed’. (Originally from Professor Tettenborn, Creditors and Reflective Loss: A Bar Too Far?’ (2019) 135 Law Quarterly Review 182, cited approvingly by the Supreme Court.) As Lord Reed noted, ‘as the scope of the principle has expanded, so have the volume of litigation and the level of uncertainty’.
BACKGROUND TO MAREX
The facts of this ‘asset-stripping’ case were extreme. Put briefly:
- a draft court judgment was circulated which would order two BVI companies owned by Mr Sevilleja to pay Marex c $5.5m (plus costs);
- allegedly, Sevilleja then transferred nearly $10m out of the companies’ accounts into his personal control and placed the companies into liquidation; the liquidator was allegedly under Sevilleja’s control and took no steps to investigate the missing funds;
- Marex attempted to bring certain tort claims against Sevilleja;
- Sevilleja argued that the reflective loss principle operated to bar Marex’s claim (because the losses which Marex was seeking to recover were reflective of loss suffered by the companies, which had concurrent claims against him); and
- the High Court found against Sevilleja, but the Court of Appeal accepted that the ‘reflective loss’ principle applied to bar the vast majority of Marex’s claim.
The Supreme Court unanimously held that the Court of Appeal’s decision – which had barred Marex’s claim – should be reversed. Unfortunately, there was no consensus as to the extent of the reflective loss principle, which leaves some uncertainty. In essence:
- a majority (4:3) of the Supreme Court considered that the reflective loss principle is justified in a shareholder case, but that the rationale for it does not extend to cover a creditor case;
- a majority (4:3) of the Supreme Court considered that the reflective loss principle is a rule of company law, that loss suffered by a shareholder is regarded as irrecoverable (and therefore it is not a matter of evidence whether the shareholder has or has not in fact suffered such a loss); accordingly, the reflective loss principle is not concerned with the issue of double recoverability against the third party defendant;
- the three-member minority of the Supreme Court considered that Prudential did not lay down such a rule of law, and that the issue of double recovery is of importance to both shareholder and creditor claims; and
- the three-member minority would not have preserved the reflective loss principle.
The Supreme Court held that the reflective loss principle only applies where a shareholder suffers a diminution in their share value or distributions, which is the consequence of loss sustained by the company, where the company has a cause of action against the same wrongdoer. In such cases, the shareholder has not suffered a loss which is separate and distinct from the company’s loss.
Where a claim is brought (whether by a shareholder or anyone else) for any other loss, and where the company has a right of action in respect of substantially the same loss, the reflective loss principle does not apply and does not bar an action against the wrongdoer by the party that suffers loss.
In distinguishing between shareholders and creditors of a company, the Supreme Court observed that, where a company suffers a loss, it is possible that its shareholders may also suffer a consequential loss in the value of their shares, but its creditors will not suffer any loss in such a scenario, so long as the company remains solvent.
Crucially, even where the company’s loss causes it to become insolvent, the company’s shareholders and creditors are not affected in the same way. Shareholders will only recover a pro rata share of the company’s surplus assets (if any); the extent to which the company’s loss will impact a creditor’s recovery of its debt will depend on the company’s assets and the value of any security possessed by the creditor, as determined by the relevant rules of
Fundamentally, a creditor does not suffer such loss in the capacity of a shareholder, and the creditor’s pursuit of a claim in respect of that loss cannot therefore give rise to any conflict with the so-called rule in Foss v Harbottle (1843) 2 Hare 461 (which states that the only person who can seek relief for an injury done to a company, where the company has a cause of action, is the
Accordingly, the Supreme Court found that the Court of Appeal’s judgment in Marex (expanding the application of the reflective loss principle to creditors), and certain cases providing exceptions to the reflective loss principle (namely, Johnson v Gore Wood & Co  2 AC 1 (other than the speech of Lord Bingham), Giles v Rhind  Ch 618, Perry v Day  EWHC 3372 (Ch) and Gardner v Parker  EWCA Civ 781), should be overruled.
Thus, there is no exception to the reflective loss principle where the company is unable to pursue the wrongdoer due to the alleged wrongdoing. The Supreme Court noted that shareholders have open to them other potential actions, such as a derivative action (where the requirements are met) or unfair prejudice claims, which may provide a remedy where the company fails to bring an action against the wrongdoer.
The Supreme Court lacked consensus on whether the principle was a legal rule or merely a means to avoid double-recovery. The minority considered it to be a means to avoid double-recovery and questioned the justification for the reflective loss principle. The majority considered that the reflective loss principle is a ‘bright line legal rule’ of company law, which applies to companies and their shareholders, with no exceptions.
The minority disagreed with the key foundation of the reflective loss principle that where a shareholder suffers a diminution in their share value or distributions, which is the consequence of loss sustained by the company, the shareholder has not suffered a loss which is separate and distinct from the company’s loss. Instead, the minority considered, there are some cases where the shareholder suffers a loss which is different to that suffered by the company, and it is not open to the court to rule out that cause of action as a matter of judicial fiat.
The minority preferred the question of whether a shareholder has a valid cause of action to be determined on a case-by-case basis and would not have preserved the reflective loss principle. However, if the principle was to be preserved, the minority considered it appropriate for the Supreme Court to ‘ask afresh whether it can be justified as a principle to exclude otherwise valid claims made by a person who is a creditor of the company’ (Marex at 211). On that issue, the minority came to the same conclusion as the majority – it cannot.