On 15 July 2020, the Supreme Court handed down its much-anticipated judgment in the case of Sevilleja v Marex Financial Ltd  UKSC 31, significantly cutting back the scope of the “reflective loss” principle that had been steadily expanding for several decades.
The rule against reflective loss
The rule that “reflective loss” cannot be recovered has its origins in Prudential Insurance Co Limited v Newman Industries Limited (No 2)  1 Ch 204. In that case the Court held that a shareholder cannot bring a claim in respect of a diminution in the value of their shareholding (or a reduction in the distributions which they receive by virtue of their shareholding), which is merely the result of a loss suffered by the company as a result of a wrong done to it by the defendant, even if the defendant’s conduct also involved the commission of a wrong against the shareholder, and even if no proceedings have been brought by the company. The shareholder’s loss is not a personal, separate and distinct loss from that sustained by the company, so does not give rise to an independent claim to damages. This decision is consistent with the rule established in Foss v Harbottle (1843) 2 Hare 461, namely that the only person who can seek relief for an injury to a company, where the company has a cause of action, is the company itself.
Twenty years later, in Johnson v Gore Wood & Co  2 AC 1, the Court of Appeal purportedly (in the words of the Supreme Court yesterday) followed the Prudential decision, reiterating the Foss v Harbottle rule and holding that a shareholder cannot sue for the recovery of a diminution in the value of his shares or in distributions, where that loss flows from loss suffered by the company and that company has a cause of action to recover its loss (even if it has declined or failed to pursue that cause of action). However, as discussed further below, the Supreme Court has now observed that some of the reasoning in Johnson “was not clearly confined to circumstances of the kind with which Prudential was concerned” and paved the way for the expansion of the rule beyond the narrow ambit of the circumstances at issue in Prudential.
An exception to the reflective loss rule was established in Giles v Rhind  EWCA Civ 1428, in which the Court of Appeal held that the rule did not apply where the wrong caused to the company had made it impossible for the company to pursue a remedy against the wrongdoer. In such circumstances, the shareholder can bring a claim even if it is for reflective loss. The decision in this case was followed in subsequent cases, including Gardner v Parker  EWCA Civ 781. This exception was also examined by the Court of Appeal in Sevilleja v Marex.
Sevilleja v Marex Financial Ltd
The case involved Mr Sevilleja - the owner of two companies (the “Companies”) incorporated in the British Virgin Islands, which were involved in foreign exchange trading - and Marex Financial Ltd (“Marex”), a creditor of the Companies. Marex had initially brought proceedings against the Companies in the Commercial Court, and obtained a judgment debt and costs against them. Following the draft judgment being issued to Marex and Mr Sevilleja, Mr Sevilleja arranged for funds held by the Companies to be transferred into his personal control. This resulted in the Companies being unable to satisfy the judgment debt and costs awarded in favour of Marex. Mr Sevilleja later placed the Companies into insolvent voluntary liquidation.
Marex subsequently sought damages in tort from Mr Sevilleja for inducing or procuring the violation of Marex’s rights in relation to the judgment debt and related court orders, and intentionally causing it to suffer loss by unlawful means. Mr Sevilleja claimed that certain of the amounts claimed by Marex could not be recovered because they were merely reflective of the loss suffered by the two Companies, which had concurrent claims against him. The Court of Appeal held that the reflective loss principle barred Marex from recovering those amounts. It applied the decision in Gardner v Parker, in which the Court had in turn relied on the reasoning in Johnson (in particular Lord Millet’s speech, discussed below), and found that the reflective loss principle not only applied to claims by shareholders, but also to claims arising from a creditor’s inability to recover a debt owed to it by a company in which the creditor was a shareholder.
Marex appealed the Court of Appeal’s decision to the Supreme Court, which was invited by the Court of Appeal to review the principle of reflective loss generally, including its conceptual basis.
The (majority) Supreme Court’s decision
The Supreme Court (with majority judgments from Lord Reed and Lord Hodge) closely examined the authorities on the principle of reflective loss, in particular Prudential and Johnson. The Court held that the speech of Lord Bingham in Johnson was consistent with the decision in Prudential that a shareholder is usually unable to recover a diminution in the value of their shareholding or in dividends/distributions due to them, as a result of loss suffered by the company and where the company has a cause of action to recover such loss (regardless of whether it has declined or failed to take action to recover that loss).
However, the speech of Lord Millet in Johnson came under particular scrutiny by the Supreme Court, which observed that Lord Millet had relied on the rule against double recovery – a principle of wider application – as justifying the Prudential rule. The Court noted that this was problematic because the double recovery rule is premised on recognising that a shareholder’s loss exists (but just does not permit it to be recovered), whereas the Prudential rule denies that the shareholder’s loss exists at all. Where there is no recoverable loss, a shareholder cannot bring a claim, regardless of whether the company pursues its own cause of action.
The majority of the Court recalled the basic nature and attributes of company shares in its reasoning, noting that shares are “merely a right of participation in the company on the terms of the articles of association”. Whereas a loss to a company may well cause a fall in share value in certain circumstances (particularly in small, private companies), there is not necessarily always a correlation between the two, meaning that an award of damages restoring the company’s position will not always restore a shareholder’s share value. The avoidance of double recovery is therefore not sufficient to justify the Prudential rule.
As a result of the decision in Johnson erroneously rooting the Prudential rule in double recovery reasoning, shareholders in subsequent cases have been able to circumvent the reflective loss rule by, for example, seeking injunctions rather than damages as their remedy. In the meantime, in decisions such as Gardner v Parker, the courts have expanded the application of the rule beyond the narrow ambit of Prudential to shareholders acting in their capacity as creditors expecting repayment of a debt. The Supreme Court held that Gardner v Parker was wrongly decided.
The Court also found unpersuasive Lord Millet’s reliance on other arguments, including:
- Causation, i.e. that the true loss to a shareholder is caused by a company’s decision not to pursue its remedy, and not by the defendant’s wrongdoing. The Court noted, among other things, that the failure of a company to sue (or its decision to settle) may be the result of impecuniosity caused by the defendant’s wrongdoing, so the company’s decision does not constitute an intervening act in the chain of causation.
- Policy considerations, including the need to avoid potential conflicts of interest between the personal interests of directors and the company claimant, which the Court noted does not justify a general rule against preventing shareholders from pursuing claims that are consequential on a company’s loss - the principle is not confined to shareholders who are also directors.
The Supreme Court considered that the “critical point” is that a shareholder has not suffered a loss that is regarded by the law as being separate and distinct from the company’s loss, and therefore has no claim to recover it. Shareholders instead have access to other rights that may be relevant, such as the right to bring a derivative or unfair prejudice claim. These considerations do not apply in the context of a creditor/company relationship. If a creditor pursues a claim in respect of a loss resulting from a company’s loss, there is no conflict with the Foss v Harbottle rule.
The Court also examined Giles v Rhind, which had established an exception to the rule in circumstances where the wrong caused to the company had made it impossible for the company to pursue a remedy against the wrongdoer. The Court recalled the fundamental basis of the decisions in Prudential and Johnson, namely that a shareholder whose shares have fallen in value as a consequence of a company’s loss has not suffered a recoverable loss. This conclusion is not affected by whether the company is financially able to bring a claim or not. Therefore the Court concluded that the so-called exception does not exist.
Having examined the authorities in great detail, the Court’s application of the reasoning to the facts of the present case was straightforward; this case did not concern a shareholder, so the rule on reflective loss simply did not apply. Marex’s appeal was allowed.
The minority judgment
Lord Sales gave the judgment for the minority. Despite agreeing that the appeal should be allowed, the minority took issue with the view that Prudential had laid down a “bright line” rule of law that a shareholder with a parallel claim to that of a company “simply had to be deemed to suffer no different loss of his own”. There were, the minority found, “some cases where the shareholder does suffer a loss which is different from the loss suffered by the company”, and it should not be open to a court simply to rule such claims out. Where the wrongs and the losses suffered by the claimant shareholder and the company are different, they each have different, personal, causes of action, and a shareholder should not be “subjected to the collective decision-making procedures which apply when the company decides what to do in relation to any cause of action it may have”. The minority considered that the exclusion of the shareholder’s cause of action falls outside the Foss v Harbottle rule rather than being consistent with it; it would actually erode the principle of the separate legal personality of the company simply to deny that the shareholder has a separate cause of action.
Lord Sales stated in his judgment for the minority that the reflective loss principle was a “flimsy foundation” on which to “build outwards into other areas of the law” and that the reasoning of both Lord Bingham and Lord Millet in Johnson, so far as it endorsed the principle originating in Prudential in relation to claims by shareholder claimants, was not sustainable. He concluded by noting that, even if the reflective loss principle exists, it did not apply to the Marex case.
The Supreme Court’s decision is a significant development, the effect of which is to create a “bright line” reflective loss principle that is limited to shareholders who bring claims for the loss in value of their shares or distributions, where that loss is a consequence of the company having suffered loss, in relation to which the company has a cause of action. Any other claims, such as those of a creditor, will not be caught by the ambit of the rule. This decision will be welcomed by many potential claimants, who may otherwise have found that the expansion of the rule prevented them from being able to recover their losses where their claims were concurrent to those of companies.
In addition, the Court has confirmed that there is no Giles v Rhind exception to the rule in circumstances where the action of the defendant makes it impossible for the company to pursue a claim. This exception was likely to be of quite narrow application anyway, and may not have been of much assistance to claimants. However, the removal of this exception removes the likelihood of further litigation around issues such as the meaning of “impossibility” and the causal link between the defendant’s wrongdoing and that impossibility. Although the increased certainty is positive, the complete removal of this exception does mean that situations may arise where a wrongdoer’s conduct goes entirely unremedied, with both a company and its shareholder being unable to pursue their claims.
The judgment is welcome in that the existence of a “bright line” rule in this context creates simplicity and certainty and should therefore reduce the volume of litigation involving parties seeking to avail themselves of an ever-expanding principle or the possibility of exceptions. However, as noted in the minority judgment, will this simplicity come “at the cost of working serious injustice” for shareholders who may well have suffered loss that is real and different from that suffered by the company? The minority declined to apply such strict limitations to an area of law that could present “complex situations”, requiring the courts to work through them in “nuanced and pragmatic ways”. However, in the light of 40 years of case law development in this area, the majority ultimately decided in favour of creating a clearly defined scope of the rule, embedded in company law principles, which will provide much needed certainty for commercial parties.
The authors would like to thank Imtiyaz Chowdhury, trainee solicitor at CMS, for his assistance with the preparation of this article.