On 15 July 2020 the Supreme Court handed down its judgment in the case of Sevilleja v Marex Financial Ltd [2020] UKSC 31 and in doing so clarified and reduced the scope of the rule against reflective loss for the benefit of creditors.
The rule against reflective loss was first set out in the case of Prudential Assurance Co Ltd v Newman Industries Ltd [1982] Ch. 204. It was held that where a shareholder suffered loss by reason of a diminution of the value of his shareholding as a result of a wrong committed against the company, the shareholder had no right of action against the perpetrator of the wrong in circumstances where the company also had its own right of action because the shareholder’s loss was simply reflective of the loss suffered by the company. The decision relied upon a fundamental principle of company law as expressed in the case of Foss v Harbottle (1843) 2 Hare 461, that where a wrong has been done to a company, it is the company itself which has the right to bring a claim. If the company were to recover damages from the Defendant in these circumstances the loss to the shareholder would be removed and therefore the rule prevented the risk of double recovery.
In Giles v Rhind [2002] EWCA Civ 1428 the Court of Appeal found that there was an exception to the rule in a case where proceedings had been brought by an administrative receiver against a director of the company. The director succeeded in obtaining an order for security for costs which the receiver could not comply with and therefore the claim was stifled. A shareholder subsequently brought a claim against the director which the court allowed to proceed despite accepting that it was a claim for reflective loss. The court decided that the shareholder’s claim against the director could proceed because it was a result of the director’s conduct that the company was not able to pursue the claim itself. As such this created an exception to the rule against reflective loss.
In Gardner v Parker [2004] EWCA Civ 781, the Court of Appeal further expanded the scope of the rule against reflective loss and held that the rule also applied to claims brought by a shareholder in his capacity as an employee and in his capacity as a creditor of the company. Furthermore, the rule also extended to claims by creditors who were not also shareholders.
The facts in Marex
Marex (M) brought claims against two companies registered in the British Virgin Islands of which Mr Sevilleja (S) was shareholder and director. The claims were for payment of sums due under a contract. The claims were successful and M obtained judgment for sums exceeding US$5.5m. S subsequently stripped the companies of their assets and transferred substantial cash sums to bank accounts in his personal name leaving the companies unable to satisfy the judgment debt. The companies were placed into voluntary liquidation but the liquidator declined to investigate S’s conduct or bring proceedings against him.
In light of this M issued proceedings in tort against S claiming that S induced or procured removal of its ability to enforce the judgment and (2) intentionally caused it to suffer loss by unlawful means. S applied to strike out the claim on the basis that it infringed the rule against reflective loss but this application was unsuccessful. S successfully appealed this decision. The Court of Appeal held that the rule against reflective loss was not limited to claims brought by shareholders and extended to claims brought by creditors for losses arising from the abstraction of money from the company. It held that the distinction between shareholder and other creditors was artificial and anomalous such that the rule should apply to all creditors of the company.
The Court of Appeal upheld the exception in Giles v Rhind but found that its scope was narrow and only applied where there was a legal reason why the company could not bring a claim. In this case the fact that the liquidator had chosen not to bring a claim fell outside the scope of the exception because there was nothing to prevent M from taking an assignment of the company’s claim from the liquidator.
M appealed to the Supreme Court which found in M’s favour in a split decision.
The decision in Marex
In his leading judgment Lord Reed took the opportunity to rein in and clarify the scope of the rule against reflective loss. He held that the Prudential case established a principle of company law that only applied in the narrow circumstances described in that case, namely where a shareholder had suffered a reduction in the value of his shareholding as a direct result of loss sustained by a company because of a wrong committed against the company. In these circumstances any right of action on the part of the shareholder is barred absolutely including in cases where the company is prevented from bringing a claim itself. The decision in Giles v Rhind was therefore overruled and the exception carved out by the decision is no longer applicable. This was because where the shareholder has suffered no recoverable loss (because his loss is merely reflective of the loss suffered by the company) he has no claim for damages regardless of whether or not the company has or has not pursed the claim. As such there is no need for the exception to the rule.
The rule only applies where the shareholder and company have concurrent claims and has no application where a shareholder has sustained losses which are separate and distinct from the losses sustained by the company. Furthermore, the rule has no application at all to cases where the claimant is not a shareholder.
It was accepted that this decision could lead to a risk of double recovery if proceedings were commenced by the company and another party, but the court found that this risk could be managed in other ways including joinder and case management.
Broadcasting Investment Group Ltd v Adam Smith
On 21 September 2020 the court handed down its first decision in a reflective loss case post Marex in the case of Broadcasting Investment Group Ltd v Adam Smith [2020] EWCH 2501 (Ch). The circumstances of that case were complex. The parties to a joint venture agreement had agreed that Adam Smith would transfer his shares in two broadcasting companies to a special purpose vehicle called SS Plc. SS was not a party to the joint venture agreement. In breach of the agreement Adam Smith failed to transfer his shares to SS.
Proceedings against Adam Smith were brought by Broadcasting Investment Group Ltd (BIG) which was a shareholder in SS, BIG’s parent company and a majority shareholder in that parent company, all of whom were parties to the joint venture agreement. The claimants sought specific performance of the joint venture agreement or alternatively damages for loss of value of BIG’s shareholding in SS and loss of dividends. SS was placed into creditors voluntary liquidation and the liquidator declined to pursue any claim that the company may have had in relation to the joint venture agreement.
Adam Smith applied to strike out the claim on the basis that to the extent that any claim existed it vested in SS and any losses sustained by the Claimants were merely reflective of the losses sustained by SS.
The decision in BIG v Smith
The court found that although SS was not a party to the joint venture agreement (and in fact had not even been incorporated as at the date of the joint venture agreement), the agreement conferred a benefit on SS and that the parties had intended that SS should have a right to enforce it for the purposes of the Contracts (Rights of Third Parties) Act 1999. Consequently, because SS had a concurrent claim, the claimants’ claim fell foul of the rule against reflective loss.
The court also found that the rule against reflective loss, as clarified in Marex, only applies to claims by the immediate shareholders in the company. As such the rule did not apply to the claims by i) the parent company of BIG and ii) the shareholder in the parent.
Finally, the court held that the rule against reflective loss also applies to claims for specific performance because in his leading judgement in Marex, Lord Reed said that “a shareholder cannot, as a general rule, bring an action against a wrongdoer to recover damages or secure other relief for an injury done to the company”. The words “or secure other relief” would therefore include claims for specific performance.
Comment
The Supreme Court’s decision in Marex has been widely welcomed as it restores the rights of creditors to bring direct action against those who have committed fraud against or simply asset stripped a company and thereby denied creditors of the company recourse against those assets. The Court of Appeal judgment had removed the ability of creditors to use a range of economic torts including inducing or procuring a breach of contract and lawful and unlawful means conspiracy. The decision of the Supreme Court has therefore returned these remedies into the creditors’ toolkit and should not be overlooked where the company is insolvent and dividend prospects are minimal.
