COMPANY LAW – Reflective loss: UK Supreme Court majority reaffirms Prudential  Ch 204 (CA) and Johnson  2 AC 1 (HL) per Lord Bingham (only)
Sevilleja (Respondent) v Marex Financial Ltd (Appellant)
Reference:  UKSC 31
Court: Supreme Court of the United Kingdom
Before: Lady Hale, Lord Reed, Lord Hodge, Lady Black, Lord Lloyd-Jones, Lord Kitchin, Lord Sales
Date of Judgment: 15 July 2020
In a seminal Judgment handed down on 15 July 2020, the majority in reasoning (Lord Reed PSC, Lord Hodge DPSC, Lady Black and Lord Lloyd-Jones JJSC) of a seven-Justice UK Supreme Court reaffirms the fundamental limitation of the principle barring recovery of reflective loss, holding that the principle applies only where a claim is asserted:
(i) by a shareholder
(ii) in respect of loss which he has suffered
(iii) in that capacity, in the form of a diminution in share value or in distributions, which is the consequence of loss sustained by the company
(iv) in respect of which the company has a cause of action
(v) against the same wrongdoer.
In doing so, this majority reaffirms the orthodox principles of company law barring recovery of reflective loss laid down in: (a) the English Court of Appeal’s decision in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2)  Ch 204 to the effect that a shareholder cannot bring a claim in respect of a diminution in the value of his shareholding, or a reduction in the distributions which he receives by virtue of his shareholding, which is merely the result of a loss suffered by the company in consequence 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; and (b) Johnson v Gore Wood & Co  2 AC 1 (HL), per Lord Bingham of Cornhill at 35 – 36:
“(1) Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder’s shareholding where that merely reflects the loss suffered by the company. A claim will not lie by a shareholder to make good a loss which would be made good if the company’s assets were replenished through action against the party responsible for the loss, even if the company, acting through its constitutional organs, has declined or failed to make good that loss….
(2) Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding….
(3) Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other….”
In the majority’s leading judgment (Lord Hodge DPSC giving a separate concurring judgment), Lord Reed PSC helpfully summarises the legal exposition on the reflective loss principle thus (at §§79 – 89):
“79. Summarising the discussion to this point, it is necessary to distinguish between (1) cases where claims are brought by a shareholder in respect of loss which he has suffered in that capacity, in the form of a diminution in share value or in distributions, which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer, and (2) cases where claims are brought, whether by a shareholder or by anyone else, in respect of loss which does not fall within that description, but where the company has a right of action in respect of substantially the same loss.
80. In cases of the first kind, the shareholder cannot bring proceedings in respect of the company’s loss, since he has no legal or equitable interest in the company’s assets: Macaura [v Northern Assurance Co Ltd  AC 619] and Short v Treasury Comrs [ 1 KB 116, affirmed  AC 534]. It is only the company which has a cause of action in respect of its loss: Foss v Harbottle [(1843) 2 Hare 461, laying down essentially 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 company itself]. However, depending on the circumstances, it is possible that the company’s loss may result (or, at least, may be claimed to result) in a fall in the value of its shares. Its shareholders may therefore claim to have suffered a loss as a consequence of the company’s loss. Depending on the circumstances, the company’s recovery of its loss may have the effect of restoring the value of the shares. In such circumstances, the only remedy which the law requires to provide, in order to achieve its remedial objectives of compensating both the company and its shareholders, is an award of damages to the company.
81. There may, however, be circumstances where the company’s right of action is not sufficient to ensure that the value of the shares is fully replenished.One example is where the market’s valuation of the shares is not a simple reflection of the company’s net assets, as discussed at §32 above. Another is where the company fails to pursue a right of action which, in the opinion of a shareholder, ought to have been pursued, or compromises its claim for an amount which, in the opinion of a shareholder, is less than its full value. But the effect of the rule in Foss v Harbottle is that the shareholder has entrusted the management of the company’s right of action to its decision-making organs, including, ultimately, the majority of members voting in general meeting. If such a decision is taken otherwise than in the proper exercise of the relevant powers, then the law provides the shareholder with a number of remedies, including a derivative action, and equitable relief from unfairly prejudicial conduct.
82. As explained at §§34-37 above, the company’s control over its own cause of action would be compromised, and the rule in Foss v Harbottle could be circumvented, if the shareholder could bring a personal action for a fall in share value consequent on the company’s loss, where the company had a concurrent right of action in respect of its loss. The same arguments apply to distributions which a shareholder might have received from the company if it had not sustained the loss (such as the pension contributions in Johnson).
83. The critical point is that the shareholder has not suffered a loss which is regarded by the law as being separate and distinct from the company’s loss, and therefore has no claim to recover it. As a shareholder (and unlike a creditor or an employee), he does, however, have a variety of other rights which may be relevant in a context of this kind, including the right to bring a derivative claim to enforce the company’s rights if the relevant conditions are met, and the right to seek relief in respect of unfairly prejudicial conduct of the company’s affairs.
84. The position is different in cases of the second kind. One can take as an example cases where claims are brought in respect of loss suffered in the capacity of a creditor of the company. The arguments which arise in the case of a shareholder have no application. There is no analogous relationship between a creditor and the company. There is no correlation between the value of the company’s assets or profits and the “value” of the creditor’s debt, analogous to the relationship on which a shareholder bases his claim for a fall in share value. The inverted commas around the word “value”, when applied to a debt, reflect the fact that it is a different kind of entity from a share.
85. Where a company suffers a loss, it is possible that its shareholders may also suffer a consequential loss in respect of the value of their shares, but its creditors will not suffer any loss so long as the company remains solvent. Even where a loss causes the company to become insolvent, or occurs while it is insolvent, its shareholders and its creditors are not affected in the same way, either temporally or causally.In an insolvency, the shareholders will recover only a pro rata share of the company’s surplus assets, if any. The value of their shares will reflect the value of that interest. The extent to which the company’s loss may affect a creditor’s recovery of his debt, on the other hand, will depend not only on the company’s assets but also on the value of any security possessed by the creditor, on the rules governing the priority of debts, and on the manner in which the liquidation is conducted (for example, whether proceedings are brought by the liquidator against persons from whom funds might be ingathered, and whether such proceedings are successful). Most importantly, even where the company’s loss results in the creditor also suffering a loss, he does not suffer the loss in the capacity of a shareholder, and his pursuit of a claim in respect of that loss cannot therefore give rise to any conflict with the rule in Foss v Harbottle.
86. The potential concern that arises in relation to claims brought by creditors is not, therefore, the rule in Foss v Harbottle. On the other hand, the principle that double recovery should be avoided may be relevant, although it is not necessarily engaged merely because the company and the creditor have concurrent claims against the same defendant.In International Leisure Ltd v First National Trustee Co UK Ltd  Ch 346, for example, the principle was not engaged where the company and a secured creditor had concurrent claims against an administrative receiver whom the creditor had appointed, since the company could only claim in respect of any loss remaining after the secured creditor had been paid in full.
87. Where the risk of double recovery arises, how it should be avoided will depend on the circumstances. It should be borne in mind that the avoidance of double recovery does not entail that the company’s claim must be given priority. Nor, contrary to the view expressed in a number of authorities, including the decision of the Court of Appeal in the present case, does the pari passuprinciple entail that the company’s claim must be given priority. That principle requires that, in a winding-up, a company’s assets must be distributed rateably among its ordinary creditors. The proceeds of its recovery from a wrongdoer will form part of its assets available for distribution (subject to the claims of secured and preferred creditors). But the pari passu principle does not give the company, or its liquidator, a preferential claim on the assets of the wrongdoer, over the claim of any other person with rights against the wrongdoer, even if that claimant is also a creditor of the company. In other words, the pari passu principle may restrict a creditor of an insolvent company to the receipt of a dividend on the amount which the company owes him, but it does not prevent him from enforcing his own right to recover damages from a third party, or confer on the company’s right against the third party an automatic priority. In the event that the third party cannot satisfy all the claims made against him, the position will be regulated by the law of (his) insolvency.
88. It is also necessary to consider whether double recovery may properly be avoided by other means than the prioritising of one claim over the other, such as those mentioned in §§5-7 above. The judgments of Gibbs CJ and Brennan J in Gould v Vaggelas HCA 68; (1984) 157 CLR 215, at pp 229 and 258-259 respectively, raise the possibility that subrogation, in particular, may provide a solution to issues of double recovery arising in connection with creditors’ claims. That question has not, however, been discussed in the present proceedings, and I express no view upon it.
89. I would therefore reaffirm the approach adopted in Prudential and by Lord Bingham in Johnson, and depart from the reasoning in the other speeches in that case, and in later authorities, so far as it is inconsistent with the foregoing. It follows that Giles v Rhind[ Ch 618], Perry v Day [ EWHC 3372 (Ch);  2 BCLC 405] and Gardner v Parker [ EWCA Civ 781;  2 BCLC 554] were wrongly decided. The rule in Prudential is limited to claims by shareholders that, as a result of actionable loss suffered by their company, the value of their shares, or of the distributions they receive as shareholders, has been diminished. Other claims, whether by shareholders or anyone else, should be dealt with in the ordinary way.“
On the issue of double recovery, Lord Reed PSC also noted at §55 of the Judgment:
“The most obvious difficulty with the avoidance of double recovery, as an explanation of the judgment in Prudential , is perhaps its unrealistic assumption that there is a universal and necessary relationship between changes in a company’s net assets and changes in its share value. Another serious problem is its inability to explain why the shareholder cannot be permitted to pursue a claim against a wrongdoer where the company has declined to pursue its claim or has settled it at an undervalue, and the risk of double recovery is therefore eliminated in whole or in part.”
As to when a personal action would be allowed, one example is given at §45, where Lord Reed PSC considers George Fischer (Great Britain) Ltd v Multi Construction Ltd  1 BCLC 260:
“the defendant entered into a contract with the plaintiff company (‘the shareholder’) to install equipment at the premises of one of its subsidiaries (‘the company’). When the equipment proved defective, causing the company to suffer a loss of profits, the shareholder was held to be entitled to damages for breach of contract in respect of the loss which it had suffered as a result of the company’s reduced profits. That was another case where the wrong was committed against the shareholder, not the company. Since the company had no cause of action, there was no reason why the shareholder should not recover its loss by means of an award of damages, in accordance with ordinary principles.”
Despite the possibility of bringing a personal claim, the overall principle summarised by Lord Reed in §79(2) should be borne in mind.
In summary, to prevent double recovery (reflective loss), a shareholder cannot bring a claim against a defendant in respect of a diminution in the value of the shareholding or in distributions to shareholders, where that loss of value results purely from a loss sustained by the company through the defendant’s wrongdoing. Where, however, a claim is not in respect of loss which the claimant has suffered as a shareholder, in the form of a diminution in share value or in distributions, which is the consequence of loss sustained by the company, then such claim would not be barred by the reflective loss rule, even where the company has a right of action in respect of substantially the same loss.
This case commentary is authored by Thomas WK Wong.
Thomas WK Wong
Thomas WK Wong, FCIArb, FHKIArb, is a seasoned civil litigator who was called to the Bar in 2018. Prior to that, Thomas had practised for seven years as a civil litigation solicitor at three top-tier litigation firms (Hogan Lovells, Clifford Chance, and Wilkinson & Grist). His expertise spans a full range of civil cases, from commercial/contract, chancery and companies, to defamation, enforcement of arbitral awards, and judicial review. For more details, please visit his profile.