This briefing considers the existence and scope of the so-called “no reflective loss” principle as determined by the recent majority decision of the UK Supreme Court in Sevilleja v Marex Financial Ltd  UKSC 31 (the Marex case) and its significance in the context of shareholders’ agreements.
The facts of the Marex case
The facts in the Marex case (which were assumed for the purposes of the appeal) were that:
- Mr Sevilleja (S) owned and controlled two BVI companies (the Companies) against whom judgment was made to pay a debt of some $5.5 million to a creditor, Marex Financial Ltd (M).
- After the judgment was handed down to the parties but before it was made public, S moved assets from the Companies, leaving insufficient funds to repay the debt to M.
- M sought damages in tort on two grounds, firstly, that S had induced the violation of M’s rights under the judgment and, secondly, that S had intentionally caused the Companies to suffer loss by unlawful means.
S had originally challenged the court’s jurisdiction to hear the case on the grounds that M’s claims were precluded by the no reflective loss principle. In other words, that it was the Companies and not M that should have been claiming against S.
M was successful at first instance but the Court of Appeal allowed S’s appeal. The Companies had been placed in liquidation and lacked the resources to pursue S. Even if the Companies had pursued their rights against S, M would have had to claim as a creditor against the other creditors of the Companies, all of whom were alleged to be connected to S.
The agreed issues on appeal to the Supreme Court
Two linked issues went to appeal:
- Firstly, whether the “no reflective loss principle” applies to claims by creditors where their claims are for losses suffered as unsecured creditors, not solely to claims by shareholders.
- Secondly, whether there is any scope and if so what, for the court to permit proceedings and claims for losses prima facie within the no reflective loss principle and where there would otherwise be injustice for a claimant through the inability to recover, or practical difficulty in recovering, genuine losses intentionally inflicted on the claimant by the defendant in breach of duty both to the claimant and to a company with which the claimant has a connection, and where the losses are felt by the claimant through the claimant's connection with the company. This was described as the Giles v Rhind exception.
The Supreme Court’s answer to the first question was no, in other words that the reflective loss principle applies only to claims by shareholders. This was a unanimous decision.
In relation to the second question, the Supreme Court found that there was no Giles v Rhind exception to this principle.
The seven members of the Supreme Court were divided on a 4:3 basis as to the meaning and effect of the reflective loss principle, i.e. on this issue.
Lord Reed gave the leading judgment for the majority and Lord Sales gave the judgment for the minority.
Lord Reed’s judgment for the majority
The majority’s view was that the no reflective loss rule is a principle of company law having its roots in the proper plaintiff principle expressed by Foss v Harbottle (1843) 2 Hare 461.
In reviewing the 1982 case of Prudential Assurance Co Ltd v Newman Industries Ltd (No. 2)  Ch 204, Lord Reed stated that the Prudential case established that, as a distinct principle of company law, a shareholder cannot bring a claim in respect of a diminution in the value of his shareholding, or a reduction in the distributions which he receives by virtue of his shareholding, which is merely the result of a loss suffered by the company in consequence of a wrong done to it by the defendant, even if the defendant’s conduct also involved the commission of a wrong against the shareholder, and even if no proceedings have been brought by the company.
Lord Reed concluded that a number of the cases which came after the Prudential case had been wrongly decided and had resulted in an unsustainable extension of the no reflective loss principle. These cases were Giles v Rhind, Perry v Day and Gardner v Parker all of which were overruled. He further concluded that the rule in Prudential is limited to claims by shareholders to the effect that, as a result of actionable loss suffered by their company, the value of their shares, or of the distributions they receive as shareholders, has been diminished.
In summarising the position, Lord Reed stated:
“…it is necessary to distinguish between (1) cases 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, and (2) cases where claims are brought, whether by a shareholder or by anyone else, in respect of loss which does not fall within that description, but where the company has a right of action in respect of substantially the same loss.
In cases of the first kind, the shareholder cannot bring proceedings in respect of the company’s loss, since he has no legal or equitable interest in the company’s assets… It is only the company which has a cause of action in respect of its loss: Foss v Harbottle. However, depending on the circumstances, it is possible that the company’s loss may result (or, at least, may be claimed to result) in a fall in the value of its shares. Its shareholders may therefore claim to have suffered a loss as a consequence of the company’s loss. Depending on the circumstances, the company’s recovery of its loss may have the effect of restoring the value of the shares. In such circumstances, the only remedy which the law requires to provide, in order to achieve its remedial objectives of compensating both the company and its shareholders, is an award of damages to the company…The critical point is that the shareholder has not suffered a loss which is regarded by the law as being separate and distinct from the company’s loss, and therefore has no claim to recover it.”
Lord Sales’ judgment for the minority
Whilst Lord Sales agreed with the conclusion that M’s claims as creditor should not be denied by reason of any principle of no reflective loss, he saw no need to frame the no reflective loss principle, if it exists, as a bright line test of company law. He considered that there were plenty of means available to the courts to avoid injustice whilst also respecting other key principles such as the avoidance of double recovery. He put it this way:
“It is true that adoption of the rule of law identified by Lord Reed…would eliminate the need for debate about the interaction of the company’s cause of action and the shareholder’s cause of action, and in that way would reduce complexity. Bright line rules have that effect. But the rule only achieves this by deeming that the shareholder has suffered no loss, when in fact he has, and deeming that the shareholder does not have a cause of action, when according to ordinary common law principles he should have. In my respectful opinion, the rule would therefore produce simplicity at the cost of working serious injustice in relation to a shareholder who (apart from the rule) has a good cause of action and has suffered loss which is real and is different from any loss suffered by the company. Common law courts are used to working through complex situations in nuanced and pragmatic ways, to achieve practical justice. In my opinion, the fact that the interaction between the company’s cause of action in respect of its loss and the shareholder’s cause of action in respect of his own loss gives rise to complexity is more a reason for not adopting a crude bright line rule which will inevitably produce injustice, and requiring instead that the position be fully explored case-by-case in the light of all the facts, with the benefit of expert evidence in relation to valuation of shares and with due sensitivity to the procedural options which are available.”
Unanswered questions remain
The Marex case leaves a number of questions unanswered and raises points where clarification would have been welcome. For example:
- When will the no reflective loss principle come into play? Where a shareholder seeks to recover a diminution in the value of its shares or the value of its distributions, does the loss arise in consequence of a loss due to the company which is reflective of such loss such that it is irrecoverable? Whilst the test sounds straightforward, it may not be easy to apply in all circumstances and the Supreme Court did not explicitly address the situation where shareholders may have entered into a contractual framework such as a shareholders’ agreement.
- Can the principle be excluded by contract? Whilst it may be possible for shareholders who are parties to shareholders’ agreements to agree contractually that they will not seek to avoid claims against them (whether founded in contract or tort) or to reduce the loss recoverable from them by asserting the no reflective loss principle, it is unclear whether a court would enforce such an undertaking. In any event, a purported exclusion of such rights could lead to unintended results.
- Are there jurisdiction/conflict of laws considerations? One question raised by the Marex case but not specifically answered by it, is the question of the English court’s jurisdiction in such cases and the applicable law for these issues. Assuming the no reflective loss principle is a principle of English company law (as is the case with the law relating to derivative claims), then it would seem that the jurisdiction of incorporation of the company will determine whether the English law no reflective loss principle is automatically applicable. A company incorporated outside of the UK which establishes a branch (or place of business) within the UK is subject to certain obligations under the Companies Act 2006. However, if the company is incorporated in a jurisdiction other than England and Wales (whether or not parties to a shareholders’ agreement have agreed that English law should apply to their relationship as such and that English courts should have jurisdiction), then local law advice will be required on whether the English law principle of no reflective loss applies or a similar concept is recognised.1
- Should the Marex case affect the drafting of shareholders’ agreements? It remains to be seen whether market practice will change in the light of the Marex case. For example, does the fact that the so-called Giles v Rhind exception has been removed by the Marex case suggest that non-compete provisions would be better expressed as being given only between shareholders and not also in favour of the company?2 This would be on the basis that as a matter of contract at least, the company would not then have a claim for breach of such agreement against a breaching shareholder which might preclude another, non-breaching shareholder, from pursuing its own claim because the reflective loss principle has been engaged. However, this may not be appropriate or acceptable to a majority shareholder and may, in any event, fail to address the need to protect the company’s goodwill. Similarly, where shareholder claims may be precluded by the reflective loss principle, should the affected shareholder have any rights to require the company to pursue its rights against another shareholder or a third party even though it does not hold a majority of the company’s shares or control its board of directors?
Judicial consideration of the no reflective loss principle following the Marex case
Since the decision in the Marex case was handed down in July 2020, the no reflective loss principle has been considered in a number of cases which give further insight into the practical application of the principle.
The first case was Broadcasting Investment Group Ltd v Smith  EWHC 2501 (Ch) (the Broadcasting Investment case) which was appealed to the Court of Appeal in 2021 (see Broadcasting Investment Group Ltd & Ors v Smith  EWCA Civ 912), followed by Naibu Global International Company plc v Daniel Stewart & Company plc  EWHC 2719 (Ch) (the Naibu case) and Primeo v Bank of Bermuda  UKPC 22 (the Primeo case).
Broadcasting Investment case
This case concerned the question of whether an oral agreement to transfer shares to a joint venture company (referred to in the case as SS PLC) was enforceable or barred on the grounds of the no reflective loss principle. The Judge determined that despite the relevant joint venture structure agreement being an oral agreement, SS PLC did have an independent right of action by virtue of the Contracts (Rights of Third Parties) Act 1999 to enforce that agreement.
The question then arose as to the status of the claims of other parties with regard to the failure to transfer the shares.
Two claimants, respectively referred to as BIG and Mr Burgess, claimed specific performance of the joint venture structure agreement as regards the transfer to SS PLC of the relevant shares, alternatively damages in lieu of specific performance.
When the case was initially heard in the High Court, deputy judge Andrew Simmonds QC decided that BIG, which was a direct shareholder of SS PLC, had no enforceable claim by virtue of the no reflective loss principle and further that such principle was not confined to a damages claim. As the deputy judge put it:
“There is no suggestion that any specific remedy, such as specific performance (or, indeed, relief based on proprietary estoppel or constructive trust), is exempt from the rule.”
With regard to the claims of Mr Burgess, who was the majority shareholder in VIIL, which in turn owned 51 percent of the issued share capital of BIG, the deputy judge refused to bar his claims holding that the no reflective loss principle had no application to indirect shareholders of a company. In summary, he stated:
“Quintessentially, it seems to me, the rule in Prudential is something which the shareholder contracts into when he acquires his shares in (what proves to be) the loss-suffering company. But, none of this reasoning can apply to a second degree or third degree shareholder who does not acquire shares in the relevant company and therefore never contracts into the rule so far as it affects recovery of losses by that company.”
An appeal against the deputy judge’s decision was upheld on the grounds that SS PLC had a claim which was concurrent with a shareholder’s claim by virtue of section 1 of the Contracts (Rights of Third Parties) Act 1999 and the effect of section 4 of that Act was that this right would prevail such that the reflective loss principle was not engaged. Since the appeal could be allowed on these grounds, disappointingly, the Court of Appeal did not opine definitively on the two further and important points arising from the first instance decision. Firstly, the question of whether the no reflective loss principle would extend to preclude other types of remedy such as specific performance. This point was simply described as “complex”. Secondly, the deputy judge’s finding that the principle has no application to indirect shareholders of a company. Although one of the Court of Appeal judges stated that, in his view, this was “well arguable” in “appropriate circumstances” no finding was made on this issue.
The Naibu case
This was a case in which the High Court applied the principles of the Marex case to strike out certain claims on the basis of the 'no reflective loss' principle, finding that there was no requirement for the amount of loss suffered by a company to be identical to that suffered by its shareholder for the principle to be engaged – the decisive question was the nature of the loss claimed by the shareholder and whether it was a loss that took the form of a diminution in the value of its shareholding or its distributions.
The Primeo case
On appeal from the Cayman Islands Court of Appeal, the Privy Council did not permit reliance on the no reflective loss principle to deny Primeo its rights of action against professional providers of investment services. In doing so, the Privy Council appeared to show a judicial inclination to keep the application of the no reflective loss principle in check.
This case dealt with two principles relevant to the no reflective loss principle. Firstly, the question of when the claim arises and secondly, the operation of the “common wrongdoer” rule.
Primeo in official liquidation, brought claims against R1 and R2, the professional administrator and custodian respectively of Primeo’s funds. Primeo had, over time, invested virtually all of its funds with Bernard L Madoff Investment Securities LLC (BMLIS). This was a Bernie Madoff vehicle which collapsed when his fraudulent Ponzi schemes came to light. Primeo also (and, over time, exclusively) invested indirectly in BMLIS through two feeder funds. Herald Fund SPC (Herald), a Cayman-domiciled fund, and Alpha Prime Fund Limited (Alpha), a Bermuda-domiciled fund.
Primeo claimed against R1 and R2 for negligence and failure to perform its duties properly in circumstances where, had Primeo been advised properly, it would not have invested further in BMLIS and would have withdrawn funds already invested. Herald also brought claims against R2 (whom it had also appointed as its custodian and administrator) and Alpha brought claims against R2, as its sub-custodian and sub-administrator.
On the question of when the claim arose, the Privy Council decided that the no reflective loss rule had no application to bar Primeo from claiming in respect of the losses it suffered each time it made a direct investment in BLMIS, nor from claiming in respect of indirect investments made through Herald. Those losses were not suffered by Primeo “in its capacity as shareholder” of Herald. So far as was relevant, at the time Primeo suffered such losses it was not a shareholder in Herald. In summary: "since the [no reflective loss] rule is substantive rather than procedural in character, the relevant time to assess whether it applies or not is when the loss which is said by the claimant to be recoverable in law is suffered by it. The timing of the bringing of a claim and the circumstances which may pertain at that point in time are adventitious happenstance and have nothing to do with the operation of the rule."
In relation to the common wrongdoer point, the Privy Council also accepted Primeo’s position, finding that it is an inherent part of the no reflective loss rule that it applies only to exclude a claim by a shareholder where what is in issue is a wrong committed by a person who is a wrongdoer both as against the shareholder and as against the company. Accordingly, the no reflective loss rule established in Prudential, as endorsed by the Marex decision, “had no application to losses suffered by a shareholder which were distinct from the company’s loss or to situations where the company had no cause of action”.
Whilst the Supreme Court’s judgment in the Marex case provides welcome clarification on claims by creditors, it, and the cases which have followed it, have a number of questions unanswered in relation to shareholder claims and it will be interesting to see whether there is any change in market practice where parties are settling the terms of joint venture or shareholders’ agreements.