Introduction
In its recent judgment of Sevilleja v Marex Financial Ltd [2020] UKSC 31, the Supreme Court of the United Kingdom ("Supreme Court") restated the rule against reflective loss ("No Reflective Loss Rule"). It held that the No Reflective Loss Rule would only bar the claims made by shareholders against wrongdoers who committed wrongs against and caused loss to the company, which in turn caused the shareholders to suffer diminution in the value of their shares or the amount of their distribution. The Supreme Court effectively narrowed down the scope of application of the No Reflective Loss Rule.
Facts
Marex sued and obtained judgment for more than US$5.5 million against two companies owned and controlled by Mr Sevilleja ("Companies"). Mr Sevilleja allegedly transferred the Companies' assets to his personal account and placed the Companies into insolvent voluntary liquidation. Marex claimed against Mr Sevilleja and sought damages for (1) inducing or procuring the violation of Marex's rights under the judgment against the Companies, and (2) intentionally causing Marex to suffer loss by unlawful means.
Mr Sevilleja contended that Marex's claim against him should be barred by the No Reflective Loss Rule because Marex, as a creditor of the Companies, was claiming for reflective loss which was suffered by the Companies (whose assets were depleted by Mr Sevilleja) and ought to be recovered by the Companies only.
What is the No Reflective Loss Rule?
The No Reflective Loss Rule originated from the principle 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 (Foss v Harbottle (1843) 2 Hare 461).
In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, the Court of Appeal adopted the principle in Foss v Harbottle and held that where a company suffered loss from the wrongs committed by a wrongdoer, and that loss resulted in a fall in the value of the shares of the company, a shareholder could not claim against the wrongdoer for the diminution in the market value of the shares. The shareholder did not suffer any personal loss. His only loss was through the company, in the diminution in the value of the net assets of the company, and was merely a reflection of the loss suffered by the company, which can be made good once the company recovered its loss from the wrongdoer.
The No Reflective Loss Rule was based on the company law principles that:
(1) a share is a right of participation in the company on the terms of the articles of association, which normally confer on a shareholder a number of rights, including a right to vote on resolutions at general meetings, a right to participate in the distributions which the company makes out of its profits, and a right to share in its surplus assets in the event of its winding up;
(2) it is for the company to decide whether to sue upon wrongs committed against it;
(3) the shareholder has entrusted the management of the company's affairs (including its right of action) to the company's decision-making organs, including, ultimately, the majority of members voting in general meeting; and
(4) if such a decision is not taken 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.
Expansion of the No Reflective Loss Rule
Prudential was approved in the subsequent House of Lords decision Johnson v Gore Wood & Co (a firm) [2002] 2 AC 1, where Lord Millett (mistakenly) considered the rationale behind the No Reflective Loss Rule to be the avoidance of double recovery and paved the way for the expansion of the No Reflective Loss Rule beyond its narrow ambit in Prudential.
Lord Millet's expositions of the No Reflective Loss Rule were interpreted subsequently (including by the Court of Appeal in the present case) as expanding to prevent other stakeholders (in the present case, Marex was in the capacity of a creditor only, and not a shareholder) from recovering loss where the company had a claim for the same wrongdoing. The Court of Appeal in the present case held that Marex's claim was barred by the No Reflective Loss Rule even Marex sued as a creditor and not a shareholder.
The Supreme Court's decision
The seven Supreme Court judges unanimously allowed Marex's appeal on the basis that the No Reflective Loss Rule did not apply to Marex's claim.
All judges recognised the rigidity of the No Reflective Loss Rule but were divided into 4:3 as to its fate – the majority (led by Lord Reed) acknowledged the No Reflective Loss Rule should be restated and confined to the original ambit in Prudential whereas the minority (led by Lord Sales) opined the Rule should be abolished in its entirety.
Lord Reed, delivering the judgment on behalf of the majority, reconfigured the Rule by dividing claims into two kinds:
(1) the first kind being claims that are brought by shareholder in respect of loss which he has suffered in the capacity as shareholder, 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) the second kind being claims that are brought, whether by a shareholder or by anyone else, in respect of loss which does not fall within the description of the first kind of claims, but where the company has a right of action in respect of substantially the same loss.
In the first kind, Lord Reed held that the No Reflective Loss Rule should stand to uphold company autonomy. Shareholders should not be empowered to bring proceedings separately in respect of company's loss.
In the second kind, to which this appeal belonged, the concern for company autonomy that underpinned Foss v Harbottle does not arise. While the risk of double recovery must be curbed, it does not mean such risk must be curbed to the prejudice of a creditor. Such risk may be properly avoided by other means without giving priority to company's claim as a matter of law. However, Lord Reed did not decide on whether double recovery did exist (and if so, the court's response to it) if Marex were to pursue its claim.
Implications on civil claims and Insolvency law
As pointed out by Professor Andrew Tettenborn in his commentary (L.Q.R. 2019, 135(Apr), 182-186) after the Court of Appeal decision of the present case, "[the No Reflective Loss Rule's] tentacles have spread alarmingly, rather like some ghastly legal Japanese knotweed. Today it promises to distort large areas of the ordinary law of obligations unless drastic steps are taken to prune it."
The landmark decision of the Supreme Court has the effect of pruning the scope of the No Reflective Loss Rule delineated in Prudential. It confined the Rule 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, has been diminished. Other claims, whether by shareholders or anyone else, should be dealt with in the ordinary way. The analysis and cases (notably those following the Lord Millet's reasoning in Johnson) that sought to expand the application of the Rule were overruled.
The decision is to be welcome. Getting an empty judgment, as the claimant Marex did in this case, is an all too common frustration for claimants in civil cases. After this decision, claimants in a similar position as Marex could sue the controllers of the corporate defendants whose assets they stripped away. In the past, claimants in the position like Marex would need to wind up the corporate defendants, appoint liquidators over them, in the hope that the liquidators could recover the company's assets from its former controllers. This is a very tedious, expensive and uncertain process. The Supreme Court decision would enable justice to be done in a more expeditious and less costly manner.
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