What is reflective loss in litigation claims? When and how are the claims of shareholders, company creditors, etc affected by reflective loss? Chris Hall looks at a recent case study in New York and explores the issue.
What is reflective loss?
To put in the most simple of terms, it is a loss suffered as a result of a reduction in the value of a party’s interest in a company. The rule against reflective loss prohibits a party that has suffered such a loss from claiming directly against the party that has caused that loss. The theory being that it is the company that should bring such a claim.
The case study
“(T)he most blatant effort to hinder, delay and defraud a creditor this Court has ever seen.”
This is how Mr Sevilleja’s actions were described by a judge in New York. However, out of his actions has come a highly significant judgment in which the Supreme Court has held that the rule against reflective loss does not apply to a company’s creditors.
Mr Sevilleja owned, and was in control of, two companies which he used to trade in foreign exchange that were registered in the British Virgin Islands. Marex Financial Ltd provided the trading service to those companies and, back in 2013, obtained judgment against them in the UK for money owed in excess of $5.5m plus costs in excess of £1.6m.
On 19th July 2013, the Judge in the case handed both parties a draft copy of his judgment, however that judgment was not handed down straight away. Mr Savilleja took the opportunity to transfer around $9.5m from the accounts of those companies to accounts under his own personal control. By the end of August 2013, the companies had little more than $4,000 between their accounts, certainly not enough to pay the judgment that Marex had obtained.
The companies were placed into liquidation in the BVI with alleged debts of over $30m, although Marex was the only creditor which was not associated with Mr Sevilleja. Marex Financial alleged that the liquidation was effectively on hold and that no steps had been taken to investigate the companies’ missing funds.
Marex brought a claim against Mr Sevilleja for inducing or procuring the violation of its rights under the judgment it had obtained, as well as for intentionally causing it to suffer a loss by unlawful means. Mr Sevilleja argued that the claim was barred by the reflective loss principle (although he conceded that this argument did not extend to the costs that had been incurred in trying to obtain payment further to the judgment).
The reflective loss principle is that a diminution in the valuation of a shareholding, or in distributions to shareholders, which is the result of loss caused to the company by a wrong done to it by a third party is not damage which is separate or distinct from damage suffered by the company. This would therefore not be recoverable by the shareholder. It had been suggested in previous case law that this principle extended to claims by creditors.
The outcome
The Supreme Court unanimously found in favour of Marex. Lord Reed gave the leading judgment, and expressed the majority view that the rule against reflective loss set out in Prudential Assurance Co Ltd v Newman Industries (No 2) [1982] 1 All ER 354 is a rule of company law.
It is based on the rule in Foss v Harbottle (1843) 67 ER 189 which essentially provides that the company, rather than its shareholders, is the proper claimant in respect of a wrong done to that company. Lord Reed said it was necessary to distinguish between two types of cases:
- cases where claims were brought by shareholders in respect of a loss they had suffered in the form of a diminution in the value of their shares or distributions, which was a loss sustained by the company in respect of which it had a claim against the wrongdoer; and
- cases where claims were brought by shareholders or anyone else in respect of a loss which did not fall within the first type of case, but where the company had a claim in respect of substantially the same loss.
In the first type of case, he said that only the company had a claim. But in the second type of case, it was possible for shareholders, creditors and others to also have a claim.
Lord Sales, in the minority judgment, said that the reasoning in the case of Johnson v Gore Wood [2001] 1 All ER 481, which suggested that the reflective loss principle also covered claims by creditors, ought not to be followed. This was because it was an endorsement of the reflective loss principle which debarred shareholders from recovering a personal loss which was different to the loss suffered by the company. He said that it was not helpful to speak in terms of the loss of the shareholders in their personal capacity as ‘reflecting’ the loss of the company because those losses were not in fact the same. There was not necessarily any direct correlation between them nor was did they necessarily correspond with one another.
Lord Sales said that if shareholders had a cause of action against a third party who had caused them loss in their capacity as shareholders, they should be able to pursue a claim. He acknowledged that it was a matter of basic justice that the third party should not be liable twice for the same loss, but he said that the risk of double-recovery could be addressed according to the circumstances of each case.
Implications
So, what do we take away from this judgment? Well, two things really:
- company creditors will not be adversely affected by the reflective loss principle when advancing parallel claims against company directors; and
- the position of shareholders that want to bring a claim against a director (or any other wrongdoer) is now less clear following Lord Sales’ minority view. Whereas previously such a claim would have been summarily dismissed, it may now be allowed to proceed to trial.
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