UK: Rule Against Reflective Loss Neither A Procedural Rule Nor An Overriding Mandatory Provision Of English Law, So Does Not Apply To Foreign Law Claims In English Court

The High Court has held that the rule against reflective loss is not a rule of procedure, so as to fall outside the Rome II Regulation, and nor is it an overriding mandatory provision of English law for the purposes of article 16 of Rome II. The rule therefore does not bar a Dutch law claim brought in the English court, even if that would be its effect in respect of the equivalent claim governed by English law: KMG International NV v Chen [2019] EWHC 2389 (Comm).

In determining applicable law, the English court (in common with all EU courts) applies the Rome I or Rome II regulation, depending on whether it is dealing with a question of the law to govern contractual or non-contractual obligations. That will remain the case even after Brexit, as the UK government has legislated to incorporate Rome I and Rome II into English law on exit day.

Rules of procedure are excluded from both Rome I and Rome II and, in the English courts, are dealt with under English law. Both Rome I and Rome II also provide for the application of “overriding mandatory provisions” of the law of the forum, even where the substantive claim is governed by a foreign law. The present decision is of interest in confirming that the English law rule against reflective loss will not be applied by the English court where, applying Rome I or Rome II, the applicable law is a foreign law.

The decision is of particular interest as a rare example of the English court considering what amounts to an overriding mandatory provision of English law. The test is, in summary, whether respect for the provision is regarded as crucial for safeguarding a country’s public interests, such as its political, social or economic organisation, irrespective of the law that otherwise applies. The court’s finding that the rule against reflective loss does not meet that test may not be seen as surprising. However, the decision is helpful in confirming that an overriding mandatory provision goes beyond a provision that cannot be derogated from by agreement, or is mandatory in the sense of not discretionary, or is informed by considerations of policy.

Background

The claimant obtained an arbitration award for US$200 million against a company called DPH Holding SA (“DPH”). It brought tort claims against the defendants in the English court, in its capacity as a creditor of DPH, for breach of duties allegedly owed by the defendants under Dutch or alternatively English law. It asserted that the defendants had caused a sub-sub-subsidiary of DPH to part with a valuable asset in order to disable DPH from satisfying the arbitration award.

The defendants applied to strike out the claims, or alternatively for summary judgment, on the basis that the claims were barred by the English law rule against reflective loss (the “RL rule”). In essence, the RL rule prevents a shareholder or creditor from bringing claims where their loss merely reflects the loss suffered by the company. The defendants’ position was that the RL rule applied even if the substantive claims were governed by Dutch law, applying Rome II, because:

1. The RL rule was a rule of procedure and not substance and was accordingly governed by the law of the forum (English law).
2. The RL rule was a mandatory overriding rule of English law within the meaning of article 16 of Rome II.
3. Any derogation from the RL rule would be manifestly incompatible with English public policy within the meaning of article 26 of Rome II.

The claimant in turn sought summary judgment on those three issues if the defendants’ application failed.

The court adjourned consideration of the English law claims, as the RL rule is the subject matter of a pending appeal to the Supreme Court. (That is the appeal against the Court of Appeal’s decision in Sevilleja v Marex Financial Ltd [2018] EWCA Civ 1468, considered here. The appeal was heard by a panel of seven Supreme Court justices on 8 May 2019 and judgment is awaited.) However, it determined the issues listed above, as to whether the RL rule would apply if the claims were governed by Dutch law.

Decision

The court (Christopher Hancock QC sitting as a Judge of the High Court) gave summary judgment in favour of the claimant on all three issues, as addressed below.

Substance or procedure?

Rome II does not apply to evidence and procedure, by virtue of article 1(3). Article 15 sets out particular matters the applicable law is to govern, including:

The judge reached “the very clear conclusion” that the RL rule falls within article 15 not article 1(3); it affects substantive rights and remedies and is not a procedural rule.

The judge noted that Rome II was designed to promote legal certainty in cross border disputes and, to that end, article 15 should be construed widely and any derogations from it should be construed narrowly. That is emphasised by the breadth of the list of matters falling within article 15, which the judge said “cover the entire gamut of matters which would generally arise in the course of non-contractual claims”, including a number of matters which would previously have been considered to fall outside the scope of the applicable law (eg limitation, assessment and remedies). It is further emphasised by the fact that even the broad list in article 15 is probably not meant to be exhaustive (in light of the words “in particular” in that article).

The judge referred to the test suggested by the leading textbooks as to whether a rule falls within the article 1(3) exception for matters of procedure, namely whether it is an indispensable feature of the forum’s legal framework for resolving disputes (see Dickinson on The Rome II Regulation, paragraphs 14.60 and 14.61, and Dicey, Morris and Collins on The Conflict of Laws, at paragraph 34-36). The judge accepted the claimant’s submission that the RL rule does not meet this test.

In the judge’s view, the RL rule falls most clearly within article 15(f), ie persons entitled to compensation, but also within articles 15(a) to 15(c) as it relates to the extent of liability and imposes a limit on the amount recoverable in respect of a particular head of loss.

Although it was not necessary to consider the point, given his conclusion that the RL rule falls within Rome II, the judge concluded that it is in any event a substantive rule of the common law, as it has to do with the kinds of damage recoverable, not assessment of the amount of compensation payable.

Overriding mandatory provision?

Article 16 of Rome II (Overriding mandatory provisions) states as follows:

Applying the test of whether it is a “provision the respect for which is regarded as crucial by a country for safeguarding its public interests, such as its political, social or economic organisation, to the extent that they are applicable to any situation falling within their scope, irrespective of the law otherwise applicable to the contract under this Regulation”, the judge concluded that the RL rule is clearly not an overriding mandatory provision within article 16.

The judge commented that, as he had been shown no authority that was of any assistance, the question was one of first principle and impression. The fact that the provision cannot be derogated from by agreement was not decisive of the issue; recital (37) to Rome I draws a distinction between provisions which cannot be derogated from by agreement and overriding mandatory provisions. Nor was the fact that the application of the RL rule is not discretionary (and is, in that sense, mandatory) or that it is informed by considerations of policy. The judge also noted the provisions of recital (32) to Rome II, which make it clear that article 16 is only to be applied in “exceptional circumstances”.

Public policy

Article 26 of Rome II (Public policy of the forum) states as follows:

The judge noted that, whereas under article 16 the focus is on the mandatory nature of the English rule, under article 26 it is on the effect of applying the rule of foreign law and whether that would be contrary to English public policy.

He concluded that the RL rule is not a rule English public policy within the meaning of article 26. Although the RL rule is a recognised rule of English substantive law, it is not “such a fundamental principle that it is to be equated with a fundamental right, such as a right guaranteed by the ECHR”.

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