On 15 July 2020 the Supreme Court did the necessary pruning. Mr Sevilleja had two companies which were used for foreign exchange trading. They were clients of Marex. Marex succeeded in a claim against the companies for $5million. However, when a freezing injunction was served on the companies it only caught $4,000 because, in the interim, Mr Sevilleja had stripped the companies of their assets including $9million held in bank accounts, which he had transferred into his own name. The action taken against him by Marex was for the torts of inducing the companies to violate Marex's rights and intentionally causing Marex loss by unlawful means. Mr Sevilleja defended the actions on liability but also plead in his favour the rule against reflective loss. In other words, Marex was barred from claiming because its loss, as a creditor, simply reflected the loss suffered by the two companies which had concurrent claims against him (but which were, nonetheless, not pursuing these claims as they were now under the control of liquidators paid for by Mr Sevilleja). If Marex were allowed to pursue its claim there may be a double-recovery which infringed the reflective loss principle.
The rule against reflective loss finds it modern origin in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204. The Supreme Court, in a decision given by Lord Reed, outlines the limited ratio of that case. All that the Prudential case does is establish a rule of company law which provides that where a company suffers actionable loss, and that loss results in a fall in the value of its shares (or distributions), the fall in share value (or in distributions) is not a loss which the law recognises as being separate and distinct from the loss sustained by the company. For that reason it does not give rise to an independent claim to damages on the part of the shareholders. The rationale for the rule is that it is necessary to preserve the integrity of the principles outlined in Foss v Harbottle (1843) 2 Hare 461 to the effect 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.
It is distinct from the general principle of the law of damages that double-recovery should be avoided. The law of damages acknowledges that concurrent claims are possible and, as the Supreme Court explains, has its own way of dealing with such claims. In some circumstances, priority is given to the cause of action held by one person and a claim of the other person is excluded so far as may be necessary to avoid double recovery. In others the law deals with double recovery by way of subrogation or the imposition on one claimant of an obligation to account to the other out of the damages which the former has received. The approach taken by the court will depend on the circumstances of the particular case. However, the courts have previously sought to explain the reflective loss principle by reference to the rule against double recovery alone. In particular, in Johnson v Gore Wood & Co [2002] 2 AC 1, Lord Millett (whose speech was widely followed by other courts) outlined that "If a shareholder is allowed to recover in respect of such loss, then either there will be double recovery at the expense of the defendant or the shareholder will recover at the expense of the company and its creditors and other shareholders. Neither course can be permitted…Justice to the defendant requires the exclusion of one claim or the other; protection of the interests of the company's creditors requires that it is the company which is allowed to recover to the exclusion of the shareholder".
The problem, according to the Supreme Court, with addressing the problem as one of double-recovery of damages is that Lord Millett paved the way for an expansion of the reflective loss rule in a way never intended by the court in Prudential. It also proceeds on a misunderstanding of that judgment because reasoning based on double-recovery necessitates a recognition that the shareholder has suffered a loss whereas the rule in Prudential is based on a denial that the shareholder does, in fact, suffer a loss which is separate and distinct to that suffered by the company. One effect of the Johnson judgment was that series of actions were brought seeking a remedy which would have been barred by Prudential on the basis that what was sought was a remedy other than an award of damages. These cases are all ill-founded and circumvent the rule in Foss v Harbottle which is not confined to damages but also applies to other remedies which vest in the company and not its shareholders.
While four out of the five judges in Johnson took an approach along the lines of Lord Millett and, therefore, departed from the ratio of the judgment in Prudential the Supreme Court accepted that the fifth judge, Lord Bingham, had adopted an approach which was consistent with Prudential when he outlined three general propositions which (paraphrasing) are: (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; (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; and (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 a breach of duty owed independently to the shareholder, each may sue to recover the loss caused to it by the breach of each respective duty. Accordingly, while Lord Bingham's reasoning was correct, the Supreme Court held that Lord Millett's reasoning and that of the rest of the court was wrong and ought not to be followed.
The Supreme Court then turned its attention to the cases which followed Johnson. These cases either sought to extend the rule or establish exceptions to it. In Giles v Rhind the Court of Appeal sought to establish an exception where the defendant's own wrongdoing prevented the company from enforcing its claim. In Giles the defendant was a director of one company who left that company, set up a rival business and stole his former company's business using trade secrets. The former company was left without funds to pursue a claim and was put into administration whereupon the guilty director made an application for security for costs which the administrators could not put up. So the company had to discontinue proceedings. The claimant (who was a fellow director and shareholder of the company now in administration) raised his own proceedings against his former colleague for a breach of the shareholders agreement. The Court Appeal distinguished Johnson holding that there was an exception to the reflective loss rule whereby the defendant's own conduct had disabled the company from pursuing a claim.
The Supreme Court is sympathetic to the Court of Appeal's decision but holds that "the fact that a wrongdoer has unmeritoriously avoided his liability in damages to A is not a reason for requiring him to pay damages to B". It goes on to say that the rule in Prudential is not dependent on whether the company is financially able to bring proceedings or not. The shareholder has no recoverable loss if the only loss he has suffered is a fall in the value of the shares as a consequence of the loss suffered by the company. In that situation the shareholder can raise derivative proceedings but he cannot raise action himself. Accordingly, Giles was wrongly decided and the supposed exception to the reflective loss rule established by it, does not exist. The same criticism applies to the well-known case of Perry v Day [2004] EWHC 337 (Ch) which followed Giles.
The Supreme Court then looked at a decision which sought to extend the scope of the reflective loss rule, Gardner v Parker [2004] EWCA Civ 781, to the situation where the loss in question arose from a creditor's inability to recover a debt owed to it by a company in which the creditor was also a shareholder. Lord Neuberger held that there was no reason why it shouldn't apply to a shareholder in his capacity as creditor and commented obiter that there was also no reason why the rule shouldn't apply even where the employee or creditor was not a shareholder. However, for the reasons given above, the Supreme Court holds that the claim in Gardner does not fall within the scope of the reasoning in Prudential or Lord Bingham's reasoning in Johnson. The Court of Appeal falls into the trap of looking at it simply from the point of view of double-recovery of damages and, by doing so, falls into error. Accordingly, the Supreme Court also concludes that Gardner was wrongly decided. The rule against reflective loss is simply 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 fall outwith the scope of the rule and should be dealt with in the usual way.
So the increasing expansion of the rule against reflective loss is brought to an end. Four of the Supreme Court judges (Lord Reed, Lord Hodge, Lady Black and Lord Lloyd-Jones) reached the above view. Three others (Lord Sales, Lady Hale and Lord Kitchin) agreed with the disposal but would have gone even further holding that there was no justification for the reflective loss principle in company law at all. They held that the true principle outlined in the Prudential case was the need to avoid double recovery and that justice could be done between the parties by other means such as subrogation of claims. As Lord Hodge explains in his concurring majority decision, however, "It may well be…that the law can achieve some protection of those interests by other means such as case management and equitable subrogation. But the creation of a bright line legal rule, as the Court of Appeal did in the Prudential case, is principled…We should not depart from it now".
