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Damages restriction applies to non-shareholder creditors too, says UK court

Out-Law Legal Update | 26 Jul 2018 | 4:17 pm | 3 min. read

LEGAL UPDATE: Unsecured creditors who are not shareholders are subject to a rule preventing the recovery of some damages, the Court of Appeal in the UK has ruled . The ruling clears up a previously undecided issue and avoids unequal treatment of creditors. The ruling confirms that the rule against reflective loss extends to claims by non-shareholder unsecured creditors, resolving previous uncertainty in this area.

The reflective loss rule says that a shareholder cannot 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."  The Court of Appeal was asked to determine the "yet undecided question whether the rule against reflective loss applies to claims by unsecured creditors who are not shareholders of the relevant company".  The Court of Appeal said that it did.

In July 2013, Marex Financial Limited obtained a UK judgment for more than $5 million against Creative Finance Limited and Cosmorex Limited, which were incorporated in the British Virgin Islands. In August 2013 the court granted a freezing order against Creative Finance and Cosmorex. Their disclosure, as required by the order, stated that together they held assets of only $4,392.48. The companies subsequently entered into liquidation in the BVI.

Marex alleged that the beneficial owner and controller of the companies, Carlos Sevilleja Garcia, stripped the assets from both companies following the release of the draft judgment but prior to the freezing order being made. The alleged asset stripping included a transfer of $9.5m to Sevilleja. Marex unsuccessfully attempted to recover the judgment debt in a number of ways before issuing fresh proceedings against Sevilleja personally in 2016 in the commercial court.

Marex claimed that Sevilleja was liable in tort as he knowingly induced and procured the companies to act in wrongful violation of the judgment, and intentionally caused loss to Marex by unlawful means. Sevilleja contended that Marex did not have grounds to bring the alleged claims against him in tort and that even if it did, the reflective loss rule would prevent Marex from bringing any such action. In a previous ruling the High Court disagreed and found in favour of Marex.  

Sevilleja sought to appeal all of the findings in the commercial court, but was only granted permission in relation to the finding on the reflective loss rule. The Court of Appeal said that the reflective loss rule could apply to claims by non-shareholder unsecured creditors of a company and did apply to Marex's claim.

The judge said "it is difficult to see why a claim by a creditor who has one share in a company should be barred by the rule against reflective loss whereas a claim by a creditor who is not a shareholder is not. That point is well illustrated by the example of a creditor who owns shares in the company, whose claim is initially barred by the rule, but, on this hypothesis, if he sells the shares, the rule no longer bars his claim. That makes no logical or legal sense at all."

The Court of Appeal then considered whether the exception in the Giles v Rhind case applied. The court said that this exception applies in limited circumstances "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 such as Marex in the present case".

The Court ruled that the exception did not apply in this instance as there was no evidence that Sevilleja's wrongdoing had prevented a claim being brought against him by the liquidator of the companies, or alternatively preventing Marex from taking an assignment of the companies' claim. The Court, therefore, found that Marex was not able to succeed with its claim against Sevilleja and granted Sevilleja's appeal.

As part of making its decision the court said that if Marex was able to pursue a claim against Sevilleja for the asset stripping of the companies it would be entitled to recover its debt to the detriment of the companies' other creditors. If a liquidator were to bring a claim against Sevilleja, any proceeds received would be for the benefit of the unsecured creditors as a whole. It said that enabling Marex to succeed with its claim would undermine the 'pari passu' principle that equal claims should be treated equally.

Tom Storer is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com