News

The Court of Appeal clarifies the scope of the rule against reflective loss

On 26 June 2018, the Court of Appeal handed down in Carlos Sevilleja Garcia v Marex Financial Limited [2018] EWCA Civ 1468 an important decision on the rule against reflective loss.

The rule against reflective loss originated in Prudential Assurance v Newman Industries (No 2) [1982] 1 Ch 204 to prevent claims by shareholders seeking to pursue causes of action which are not theirs but the company’s. The rule was subsequently broadened, including by the House of Lords in Johnson v Gore Wood [2002] 2 AC 1, to bar any claims by a shareholder whether in his capacity as shareholder, employee or creditor. Accordingly, the rule against reflective loss prevents claims by shareholders where the loss claimed is in effect the same loss as suffered by the company as a consequence of the defendant’s wrongdoing.

The question for the Court of Appeal was whether the rule against reflective loss applies to unsecured creditors who are not shareholders of the relevant company, an issue which remained until recently undecided as a matter of English law.

The case also raised an issue as the proper scope of the exception to the rule against the recovery of reflective loss established by the Court of Appeal in Giles v Rhind [2003] Ch 618 – namely, that where the wrongdoing caused the company’s inability to pursue an action against the wrongdoer, the rule against reflective loss does not bar any action by a shareholder (whether qua shareholder or qua creditor) against the wrongdoer.

The Court of Appeal (Lord Justice Flaux giving the leading judgment with whom Lewison and Lindblom LJJ agreed) clarified the law in relation to the rule against reflective loss in two respects.

First, the Court of Appeal decided that the rule against reflective loss also applied to claims by unsecured creditors who are not shareholders of the relevant company. Flaux LJ held that the justification for the rule is not limited to the preservation of company autonomy in the sense of the unity of economic interest between a company and its shareholders as Prudential Assurance v Newman Industries might suggest and it was therefore “difficult to draw a principled distinction between a claim by a shareholder qua creditor … and a claim by any other creditor who is not a shareholder. As a matter of logic and principle it is difficult to see why a claim by a creditor who has one share in a company should be barred by the rule against reflective loss whereas a claim by a creditor who is not a shareholder is not”. Having noted that, as a matter of authority, the rule against reflective loss precludes a claim by a shareholder qua employee or creditor, Flaux LJ said that the rule should also apply to all creditors of the company to do away with the “illogical and unprincipled” and “artificial [and anomalous] distinction between shareholder creditors and non-shareholder creditors”.

Second, Flaux LJ said that the exception to the rule against reflective loss recognised in Giles v Rhind [2003] Ch 618 is somewhat controversial and limited in scope noting that it had only been successfully involved in one subsequent case (Perry v Day [2005] 2 BCLC 405). He held that “the exception can only apply in limited circumstances where the wrongdoing of the defendant has been directly causative of the impossibility the company faces in bringing the claim … The exception is a narrow one, only applicable where as a consequence of the actions of the wrongdoer, the company no longer has a cause of action and it is impossible for it to bring a claim or for a claim to be brought in its name by a third party …. I consider the impossibility or the disability must be a legal one and what might be described as factual impossibility [e.g. impecuniosity] is insufficient”. By this decision, it would appear that the Court of Appeal has effectively emasculated the exception leaving it with almost no practical application, not least because even in those cases where the wrongdoer has dissipated all of the company’s funds and assets, and procured the company to abandon its cause of action against the wrongdoer (e.g. by means of a settlement), it will always be possible for the wrongdoer to say that it is open to the company to seek external funding and set aside the settlement and pursue its claims against the wrongdoer.

Alain Choo-Choy QC and Sophie Weber (instructed by Memery Crystal LLP) acted for Marex.

The Judgment can be found here.