The Recovery of Reflective Loss: A Note on Sevilleja v Marex Financial Ltd

1.                  On 15th July 2020 the Supreme Court handed down judgment in Sevilleja v Marex Financial Ltd [2020] UKSC 31 in which the majority of the Court reasserted the orthodox view as to both the existence and extent of the principle that reflective loss cannot be recovered (“the reflective loss principle”). It is without doubt the most important decision on that principle since Johnson v Gore Wood [2002] 2 AC 1.

The Facts

2.                  In Marex, the defendant (“S”) was the owner and controller of two BVI registered companies (“the Companies”).   The claimant (“M”) was a judgment creditor of the Companies under a judgment of the Commercial Court (“the Judgment/Judgment Debt”).

3.                  M alleged (and the claim proceeded on the basis) that S, in breach of duty to the Companies, had misappropriated their assets with a view to ensuring that the Companies could not satisfy the Judgment Debt. The defendant had then placed the Companies into insolvent voluntary liquidation with alleged debts exceeding US$30m the vast majority of which were owed to S and connected entities. M was the only external creditor.  M alleged that the liquidator was being funded by one of M’s connected entities and had not taken any steps to investigate S. M also referred to US proceedings in which the liquidation had been found to be a device to thwart enforcement of the Judgment Debt.

4.                  M commenced proceedings in tort for (1) inducing or procuring the violation of its rights under the Judgment and (2) intentionally causing it to suffer loss by unlawful means. It sought damages equal to (a) the amount of the Judgment Debt (including interest and costs) less an amount recovered in US proceedings and (b) the costs incurred in the US proceedings and in other attempts to obtain payment of the Judgment Debt.

The Issues

5.                  Two issues arose in the Supreme Court:

5.1.        Whether the reflective loss principle applied in the case of claims by company creditors, where their claims were in respect of loss suffered as unsecured creditors, and not solely to claims by shareholders.

5.2.        Whether there was any and if so what scope there was for the court to permit proceedings for losses which were prima facie within the reflective loss principle where there would otherwise be injustice to the claimant through inability to recover or practical difficulty in recovering genuine losses intentionally inflicted on the claimant by the defendant in breach of duty both to the claimant and to a company with which the claimant had a connection and where the losses were felt by the claimant through the claimant’s connection with the company.

The Decision

6.                  The Supreme Court unanimously held that the reflective loss principle had no application to the claim by M in its capacity as creditor of the Companies.  However, the Court was split as to the route by which that outcome was achieved. 

7.                  The justices agreed on two matters:

7.1.        First, a shareholder might as a matter of fact suffer a personal loss in the form of a diminution in the value of the shareholding; and

7.2.        Second, there was no automatic correlation between the amount of a diminution in the asset value of the company and the diminution in the value of the shares in that company: shares were not typically valued as a proportionate part of the asset value of the company.

8.                  However, they did not agree on the significance of those two matters.

9.                  The majority[1] upheld the reflective loss principle as a rigid rule of law but confined its operation to claims by shareholders for damages to compensate them for a diminution in the value of their shareholdings (or lost distributions[2]) suffered by reason of a diminution in the net assets of the company where the loss was but for the reflective loss principle actionable at the suit of both the company and the shareholders. It did not extend to losses suffered by a creditor of the company.

10.              The minority regarded the reflective loss principle essentially as being concerned with the quantification of loss and the avoidance of double recovery: insofar, as a matter of fact, the loss suffered by the shareholder was not demonstrably distinct from that suffered by the company the shareholder could not establish an entitlement to damages. However, where the claimant shareholder had in fact suffered a distinct loss, there was no good reason as to why that claimant should not pursue a claim in respect of that separate loss. It followed that there was no basis for the reflective loss principle to extend to claims by creditors of the company since in such cases the loss was demonstrably distinct from that suffered by the company.

The Approach of the Majority

11.              It is likely that the judgment of Lord Reed, who gave the lead judgment on behalf of the majority,[3] will be relied upon to identify the proper limits of the reflective loss principle. In his judgment, several important observations were made. They can be summarised as follows.

11.1.    First, the reflective loss principle does not bar causes of action but renders certain heads of loss irrecoverable: specifically, diminution in value of shareholdings and loss of distributions.

11.2.    Second, the basis of the reflective loss principle is that the loss suffered by the shareholders is not a loss that the law recognises as being separate and distinct from the loss suffered by the company.  That is necessary to avoid the circumvention of the rule in Foss v Harbottle. 

11.3.    Third, the reflective loss principle cannot be explained on the basis of the avoidance of double recovery not least because that explanation depends upon an unrealistic assumption of a universal and necessary relationship between changes in a company’s nets assets and changes in its share value and cannot explain the application of the reflective loss principle where the company has declined to pursue the claim or has settled the claim at an undervalue. Moreover, the possibility of double recovery can arise where concurrent claims exist at the instance of companies and of persons who have suffered loss otherwise than as shareholders.

11.4.    Fourth, the reasoning in the speeches in Johnson v Gore Wood other than that of Lord Bingham, in particular that of Lord Millett, ought not to be followed.

11.5.    Fifth, the exception to the reflective loss principle established in Giles v Rhind [2003] Ch 618 - namely that where the company was unable to bring proceedings because of the defendant’s wrongdoing, the claimant shareholder would be entitled to damages to compensate him for the diminution in the value of his shareholding caused by that wrongdoing – is wrong. Likewise, the exception established in Perry v Day [2005] 2 BCLC 405, which applied where the defendant had abused his powers as a director of the company to prevent the company pursuing a claim against him. If the claimant has not suffered a recognisable loss, no action for damages lied at his suit irrespective of the conduct of the defendant and the consequent inability of the company to pursue its own claim.

11.6.    Sixth, the reflective loss principle loss does not preclude claims by a shareholder in respect of loss caused by wrongdoing to both the company and himself where that loss is suffered by him in some other capacity. Thus, a creditor of the company can recover against the defendant for losses suffered by reason of his being unable to recover a debt owed by the company due to the defendant’s conduct. The reasoning in Gardner v Parker [2004] 2 BCLC 554 to the contrary is wrong. However, the Court will have to be astute to avoid double recovery in such a case. 

11.7.    Seventh, the reflective loss principle applies even where the company’s right of action is not sufficient to ensure that the value of the shares is fully replenished: for example, because there is not a strict correlation between share value and company assets or because the company fails to bring proceedings or compromises proceedings at what is considered to be an undervalue. In the latter case, if the shareholder believes that the management of the company has failed to act in accordance with its duties the proper course is a derivative action or an unfair prejudice petition.

Conclusion

12.              The approach of the majority has the merit of clarity and simplicity.  However, it also carries with it the obvious risk of injustice, particularly in cases in which the conduct of the defendant has rendered the company incapable of pursuing a claim for the wrong done to it but there is no alternative redress.

13.              In the circumstances, there is much to be said for the more flexible approach inherent in the judgment of Lord Sales, who gave the sole judgment for the minority. Subject to the need to avoid double recovery, there ought to be no rigid rule precluding the recovery of losses suffered by a shareholder that are separate and distinct from the damage suffered by the company.

Andrew Grantham QC

29 July 2020

[1] Lords Reed, Lloyd – Jones and Hodge and Lady Black

[2] The contribution to Mr Johnson’s pension scheme in Johnson v Gore Wood which would but for the defendant’s wrongdoing have been paid was treated by Lord Reed as a form of distribution and it was for that reason that the principle applied to such loss

[3] Lord Hodge gave a concurring judgment in which he emphasised that the principle was a rule of company law arising from the nature of a shareholder’s investment and participation in a limited company