Supreme Court unanimously decides 7-0 that the reflective loss rule does not bar claims made by unsecured creditors

Sevilleja v Marex Financial Limited [2020] UKSC 31

In a landmark decision handed down on 15 July 2020, the Supreme Court significantly narrowed the scope of the so-called rule against the recovery of reflective loss. 

The rule, which has existed since the 1981 decision in Prudential Assurance v Newman Industries (No 2) [1982] 1 Ch 204, prevents claims by shareholders of a company for loss suffered as a consequence of a defendant’s wrongdoing against the company. It 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.

In the present case, Marex Financial Limited (“Marex”) accuses Mr Sevilleja of asset-stripping two companies ultimately owned and controlled by him so that they were unable to pay their judgment debt to Marex. The companies are now in liquidation in the BVI. Marex sued Mr Sevilleja on the basis of unlawful means conspiracy and for knowingly inducing and procuring the Companies to act in wrongful violation of Marex’s legal rights. Mr Sevilleja challenged jurisdiction contending, amongst other things, that the rule against the recovery of reflective loss barred Marex from showing a completed cause of action in tort.

Mr Justice Knowles dismissed Mr Sevilleja’s challenge to the jurisdiction of the English Court (judgment available here). The Court of Appeal allowed Mr Sevilleja’s appeal holding that (1) the rule against the recovery of reflective loss applied to claims by unsecured creditors who are not shareholders of the relevant company (an issue which until then remained undecided as a matter of English law) and (2) the exception to the rule against reflective loss recognised in Giles v Rhind [2003] Ch 618 was a narrow one and did not assist Marex (judgment available here). Nevertheless, the Court of Appeal recognised the significance of the issues and gave Marex permission to appeal to the Supreme Court.

The Supreme Court was asked to consider (1) whether the rule against reflective loss applied to unsecured creditors who are not shareholders of the relevant company, and (2) whether there was any flexibility or discretion for a court to allow proceedings claiming for losses which are prima facie within the rule where there would otherwise be injustice to the claimant as a result of his inability to sue.

Seven Justices of the Supreme Court heard the appeal confirming the importance of the issues involved.

The Supreme Court unanimously allowed Marex’s appeal and held that Prudential did not establish a principle of the law of damages against the recovery of reflective loss and that Lord Millett’s judgment in Johnson v Gore Wood should not be followed. All 7 justices agreed that Marex’s claims as an unsecured creditor are not barred by the so-called rule against the recovery of reflective loss. However, the members of the Court disagreed as to the reasons for that conclusion and expressed different views as to whether a shareholder can recover damages for the diminution in value of its shareholder in a company or for the loss of distributions which the company would have paid to it in circumstances where a wrong has been done both to the company and to the shareholder.

Lord Reed (with whom Lady Black and Lord Lloyd-Jones agreed and with whom Lord Hodge also agreed though he gave a separate judgment) said that Prudential established a bright line rule of company law that a shareholder cannot sue in relation to a diminution in the value of a shareholding or in distributions to shareholders, which is merely the result of a loss suffered by the company in consequence of a wrong done to it by the defendant because such loss “is not in the eyes of the law damage which is separate and distinct from the damage suffered by the company, and is therefore not recoverable”. This rule is based on the rule in Foss v Harbottle (1843) 2 Hare 461, which would be subverted if the shareholder could pursue a personal action in those circumstances.

Given the views expressed about the nature and scope of the rule in respect of shareholders, the majority concluded that such rule had no application outside of company law and did not apply to unsecured creditors of a company. As Lord Reed explained, “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."

The minority (Lord Sales giving the judgment with whom Lady Hale and Lord Kitchen agreed) took a more radical approach holding that there was no reflective loss principle of the law of damages and no company law rule either. Lord Sales noted that the Court of Appeal’s reasoning in Prudential as to why a shareholder in fact suffered no loss could not be supported because there are clearly cases where a shareholder does suffer a loss which is, factually, different from the loss suffered by the company. According to Lord Sales, the governing principle is avoidance of double recovery, as was the view of the Law Lords in Johnson. However, none of the policy considerations previously advanced in support of the reflective loss rule, such as the need to avoid double recovery, causation, public policy of avoiding conflicts of interest amongst others, in fact justified the rule.

Noting that the bright line rule of company law supported by the majority would “produce simplicity at the cost of working serious injustice in relation to a shareholder who (apart from the rule) has a good cause of action and has suffered loss which is real and is different from any loss suffered by the company”, Lord Sales advocated that “the position be fully explored case by case in the light of all the facts, with the benefit of expert evidence in relation to valuation of shares and with due sensitivity to the procedural options which are available".

Given the division of opinion as to how far the rule should be limited or indeed abolished entirely as regards shareholders, and the eloquent reasoning of Lord Sales, this decision is unlikely to be the last word on the matter. 

Sophie Weber (led by George Bompas QC and instructed by Memery Crystal LLP) acted for the successful appellant, Marex Financial Limited. The Judgment can be found here.