In the most recent case, the Broadcasting Investments Group Ltd v Smith, application of principle of ‘reflective loss’ in the Supreme Court decision in Marex Financial Ltd v Sevilleja was considered by court, shareholder of a shareholder of a shareholder of the claimant company seeking an order of specific performance, has been allowed to proceed to trial.
The principle of ‘reflective loss’
If a third party did something wrong to a company, can shareholder of that company bring a claim for its own loss against the third party?
Under the UK law, a shareholder can only bring a derivative action for losses of the company, and may not claim a loss in its personal capacity for its personal loss. This is the principle of ‘reflective loss’, or ‘no reflective loss’ rule, which is intended to avoid the double recovery of losses.
In the leading case Prudential Assurance v Newman Industries Ltd, the court ruled that shareholder of a company ‘cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend’.
Subsequent authorities extends the scope of “no reflective loss” rule beyond the diminution of value of shares and the loss of dividends to non-shareholder creditors and employees.
The Marex Financial Ltd v Sevilleja
The judgment in another leading case, Marex Financial Ltd v Sevilleja, however, cut back the scope of the ‘reflective loss’ principle. In this case, Lord Reed of The Supreme Court drew the distinction between claims brought by a shareholder in relation to loss which he or she has suffered in the capacity of shareholder, and claims which a shareholder or anyone else may bring in any other capacity, for example as a creditor or employee of the company.
As concluded by the court in Marex Financial Ltd v Sevilleja, the considerations to justify the ‘no reflective loss’ rule are:-
- The need to avoid double recovery from the defendant by the claimant and the company.
- Causation – if the company chooses not to claim against the wrongdoer, the loss to the claimant is caused by the company’s decision and not by the defendant’s wrongdoing.
- The public policy of avoiding conflict of interest; particularly that if the claimant has a separate right to claim it would discourage the company from making settlements.
- The need to preserve company autonomy.
- The need to avoid prejudice to minority shareholders or other creditors.
- Whether the company is able to pursue an action itself – the rule will not apply 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.
Broadcasting Investments Group Ltd v Smith
The Marex Financial Ltd v Sevilleja applied to a claim brought by a shareholder of a shareholder, in a decision handed down by court in Broadcasting Investments Group Ltd v Smith, on 21 September 2020.
Mr Burgess, Mr Smith and others entered into an oral agreement for a joint venture and agreed that a public company, Streaming Investments plc, would be incorporated as the vehicle for the joint venture. Broadcasting Investments Group Ltd (‘BIG’), owned as to 51% by VIIL, which is controlled by Mr Burgess, would have a 39% shareholding in Streaming Investments plc.
Following the incorporation of Streaming Investments plc, and the fulfilment of certain financing obligations, Mr Smith was to procure the transfer to the company of all the shares in two companies, SS Ltd and TVP, which were developing certain technology.
Mr Smith, however, failed to procure the transfer to Streaming Investments plc of the shares in SS Ltd and TVP, after Streaming Investments plc was incorporated and the financing obligations were fulfilled.
SS Ltd became insolvent and a liquidator was appointed.
Mr Burgess and BIG brought proceedings against Mr Smith and others alleging breach of contract. BIG claimed damages for breach of contract and an order that Mr Smith specifically perform the contract by procuring the transfer to Streaming Investments plc of all the shares in SS Ltd and TVP.
Mr Smith applied to strike out the claims of BIG and Mr Burgess. The grounds are that the claims were barred by the reflective loss principle, the loss suffered by Mr Burgess was the diminution in the value of his shareholding in BIG consequent on the diminution in the value of BIG’s shareholding in Streaming Investments plc.
The court’s decision
The court believed that while Prudential Assurance v Newman Industries Ltd was correctly decided, the reflective loss principle was an incident of company law and was limited to the very specific circumstances where:
- a shareholder in a company and the company suffered an injury which was actionable by both of them, and
- the loss claimed by the shareholder was limited to the diminution in the value of their shares in the company or in the dividends or other distributions which the company might make to them consequent on the loss suffered by the company.
The principle extended beyond claims for damages to any relief claimed by a shareholder in respect of such loss.
The court decided that:
- BIG was a shareholder in Streaming Investments plc and the loss that it claimed was the diminution in the value of its shareholding in Streaming Investments plc or in the dividends and distributions that it might receive from that company.
- Streaming Investments plc, while not a party to the contract, was entitled to enforce the contract pursuant to section 1 of the Contracts (Rights of Third Parties) Act 1999 and thus was able to bring its own claim for the loss that it had suffered. Accordingly, BIG’s claims were barred by the rule in Prudential v Newman and were struck out.
- Mr Burgess sought only an order of specific performance by Mr Smith of his contractual obligation to procure the transfer to Streaming Investments plc of the shares in SS Ltd and TVP. Mr Burgess was not a shareholder in Streaming Investments plc and the rule in Prudential v Newman did not therefore bar his claim, which would be allowed to proceed to trial.
In relation to any wrongdoing by third parties, it is important for shareholders to appreciate what claims properly lie with the company and what claims the shareholder may bring in their own right. Where a diminution in shareholdings is attributable to loss caused to the company by a third party, it is the company which will generally have the claim, not the shareholders themselves.
However, as the court’s decision in the two latest cases, Marex Financial Ltd v Sevilleja and Broadcasting Investments Group Ltd v Smith demonstrate, reflective loss principle was an incident of company law and was limited to the very specific circumstances.
Further, there are other recourses for shareholders who believe they or the company have been wronged, for example the recourses of unfair prejudice claim (section 994, Companies Act 2006 (CA 2006)), derivative claim (Part 11, CA 2006), or petition for winding up on just and equitable grounds (section 122, Insolvency Act 1986).
In summary, there are remedies for shareholders but generally speaking, remedies for shareholders are not straightforward and shareholders’ claims are restricted due to the “no reflective loss” rule.
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