The origins of the rule come from the decision in Prudential Assurance v Newman Industries (No. 2)  1 Ch 204, in which the court said: “what [the shareholder] cannot do is to recover damages merely because the company in which he is interested has suffered damage. He cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend, because such a “loss” is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. His only “loss” is through the company, in the diminution in the value of the net assets of the company, in which he has (say) a three per cent shareholding. The plaintiff’s shares are merely a right of participation in the company on the terms of the articles of association. The share themselves, his right of participation, are not directly affected by the wrongdoing. The plaintiff still holds all the shares as his own absolutely unencumbered property. The deceit practised upon the plaintiff does not affect the shares; it merely enables the defendant to rob the company.” The rationale was to avoid subverting the “proper plaintiff” rule in Foss v Harbottle (1843)2 Hare 461.
Subsequent authorities have confirmed that the rule extends beyond the diminution of the value of shares; it extends to the loss of dividends and all other payments which the shareholder might have obtained from the company had it not been deprived of its funds.
Following consideration of the authorities, the court in Sevilleja Garcia concluded there were four considerations which justified the rule against reflective loss
- The need to avoid double recovery by the claimant and the company from the defendant.
- 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 and avoid prejudice to minority shareholders or other creditors.
The court also considered whether the exception, recognised in Giles v Rhind  EWCA Civ 1428, applied so that the rule of reflective loss does not bar a shareholder/creditor from bringing an action against the wrongdoer where the company is unable to pursue an action itself. It was decided that the exception is a narrow one and only applies 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. The impossibility must be a legal one – a factual impossibility, such as lack of funds, would not be sufficient. If the impossibility is cured by an injection of funds by a shareholder or creditor or the company’s claim being assigned to a third party the exception will not apply.