What is reflective loss?
Firstly, the rule of reflective loss is derived from the principle of Foss v Harbottle, the company, being a separate legal entity, is the proper claimant to recover any loss resulting from an actionable wrong.
A shareholder’s loss in respect of a diminution in the value of his shareholding or a reductions in the distributions of dividend resulted from a loss suffered by the company in consequence of a wrong done to it by the defendant. In this circumstance, the shareholder’s loss is said to be merely a “reflection” of the loss suffered by the company, and the company or its liquidator is the proper claimant. The purpose to award a damages to the company is to restore its position it would have been if the wrongdoing had not occurred. For the shareholders to have a right of action would exceed what was necessary and would give rise to a problem of double recovery.
Sevilleja v Marex Financial Ltd  UKSC 31
In 2013, Marex Financial Ltd (Marex) brought claims against two British Virgin Islands (“the BVI”) companies, Creative Finance Limited and Cosmorex Limited, both of which were controlled by Mr Sevillja. Those claims were tried before Field J in the Commercial Court who released a draft judgement on 19 July 2013 showing that Marex had succeeded and consequently the BVI companies would be required to pay in excess of US$5m. At that stage, approximately US$9.5m was held by the BVI companies in England.
The more relevant proceedings, in terms of the rule against reflective loss, concerned the allegation that Mr Sevilleja then took the opportunity to dishonestly asset-strip the BVI companies such that they would be unable to pay the judgement debt to Marex. The judgement of Field J was handed down on 26 July 2013. Marex did not put in place a freezing injunction until 14 August 2013, by which point the disclosure showed the companies to have assets amounting to approximately US$4,000 and the BVI companies eventually went into liquidation in December 2013.
On 11 August 2016, Marex obtained permission to serve English proceedings on Mr Sevilleja out of the jurisdiction under the tort gateway. On 5 October 2016, Mr Sevilleja issued an application challenging the jurisdiction of the English courts.
At first instance, Knowles J dismissed Mr Sevilleja’s jurisdiction challenge. In particular, he rejected the submission on behalf of Mr Sevilleja that, even if Marex otherwise had a cause of action in tort, the reflective loss rule barred its ability to recover compensation.
The principle is set out in Prudential Assurance Co Ltd v Newman Industries (No 2)  1 All ER 354, and has been developed in cases including Johnson v Gore Wood  1 All ER 481, Giles v Rhind  EWCA Civ 1428, Perry v Day  EWHC 3372 (Ch), and Gardner v Parker.
The 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 and distinct from damage suffered by the company, and is therefore not recoverable by the shareholder. There was a suggestion in later cases, including Johnson v Gore Wood, that the principle also covered claims by creditors of a company against a wrongdoer (usually a director of the company) whose wrongs prevented the company from being able to pay the debt.
The case went to the Court of Appeal which allowed Mr Sevilleja’s appeal against the lower court’s findings. As such, Marex’s claim to recover the judgement debt, together with interest and costs, was found to be barred by the reflective loss rule which the court determined would apply to non-shareholder creditors in the same way as it had been applied to shareholder creditors.
Marex’s appeal of such finding was heard by a seven panel in the Supreme Court in May 2019 and a judgment was handed down on 15 July 2020.
The decision of the Supreme Court
Lord Reed delivered the lead judgement allowing Marex’s appeal and therefore held that its claims were not barred by the rule against reflective loss made clear that the principle applied only ‘… where claims are brought by a shareholder in respect of loss which he has suffered in that capacity, in the form of a diminution in share value or in distributions, which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer’ (at para ). In such circumstances, the rule against reflective loss was held to apply regardless of whether the company in fact recovers its loss in full.
In respect of any other claims (whether by a shareholder or by anyone else), for loss that do not fall within that description but for which the company has a right of action in respect of substantially the same loss, the rule against reflective loss does not apply, although it may be necessary to avoid double recovery.
Lord Reid has succinctly made the distinction clear in paragraph 84 of the judgement: “… there is no analogous relationship between a creditor and the company. There is no correlation between the value of the company’s assets or profits and the “value” of the creditor’s debt, analogous to the relationship on which a shareholder bases his claim for a fall in share value…” In other words, the amount for which the company is indebted to a creditor is not dependent upon the value of the company.
In short, the rule against reflective loss does not apply to creditors of a company. The Supreme Court has now significantly curtailed the principle of reflective loss. If a principle of reflective loss does exist, it is narrowly confined to shareholder claim.
Before becoming a shareholder, you may want to make sure a bespoke articles of association is adequately drafted (or the model articles of association is modified) to set out the business operation. In a small private limited company where directors are also often the shareholders, ensure that your shareholders agreement is well drafted to cover all foreseeable eventuality to protect your interests.
Always consider and evaluate the risk of immediate risk of asset dissipation and keep it at the forefront of your mind as the case progresses. You should discuss the merits of freezing or notification injunctions with your legal representatives.
If a claim is unavoidable, it is best to always consider if this could be a case where there is a separate legal duty owed / legitimate cause of action for the loss to be classified as a non-reflective loss. It is important to categorise this as a ‘separate and distinct’ loss than those suffered by the company.
In some circumstances, a shareholder may be permitted to bring or continue a claim on behalf of a company (“a derivative claim”). In such circumstances, the individual is given permission to pursue the company’s claim and therefore the rule against reflective loss is not relevant.
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