UK Supreme Court ruling narrows scope of reflective loss principle

Out-Law News | 21 Jul 2020 | 9:42 am | 3 min. read

A ruling from the UK Supreme Court could make it easier for creditors of insolvent companies to recover their losses.

Dispute resolution expert Michael Fletcher of Pinsent Masons, the law firm behind Out-Law, said the judgment reined in the scope of the ‘reflective loss’ principle, which prevents shareholders of a company from bringing a claim for personal losses arising from a breach of duty or contract owed to the company. The principle is intended to avoid the double recovery of losses.

The appeal to the Supreme Court was brought by Marex Financial, which was the creditor of two liquidated British Virgin Islands companies owned and controlled by Carlos Sevilleja. In 2013 Marex won a case in the English Commercial Court for over $5.5 million (£4.4 million) for sums due under contract.

However, Sevilleja then allegedly transferred over $9.5m from the companies’ accounts to his own, and then put the companies into liquidation with debts exceeding $30m. Marex did not receive the sum or the costs it was awarded.

Marex then claimed damages against Sevilleja, alleging that he had violated the company’s rights and intentionally caused it to suffer loss. It won its case in the High Court, but the Court of Appeal in 2018 said the reflective loss principle meant that the claim should be struck out.

The Supreme Court disagreed with the Court of Appeal (82 page / 299KB PDF). The panel of judges said they agreed that the reflective loss principle had been expanded too greatly, and would cause a 'great injustice' if it was applied to Marex’s situation.

Giving the leading judgment, Lord Reed said the rule set down in the leading case establishing the reflective loss principle did not apply to Marex as it was a creditor of Sevilleja’s companies rather than a shareholder. The outcome of Lord Reed's judgment means that where a shareholder or creditor has a loss which is separate and distinct from the company's loss, such losses should be dealt with in the ordinary way.

In a separate judgment also upholding the appeal, but for slightly different reasons, Lord Sales said the governing principle should be avoidance of double recovery, rather than the exclusion of a shareholder’s recovery of losses where the loss was different from that of the company.

Lord Sales also said a shareholder should not be prevented from pursuing a valid personal cause of action, and double recovery could be avoided by other means. He said the reflective loss principle should not be extended to cover a case involving loss suffered by a creditor.

Pinsent Mason’s Fletcher said: “The Supreme Court reined in the scope of the reflective loss principle and ruled that a number of previous cases had been wrongly decided. Lord Reed drew the distinction quite literally, stating that there is a ‘bright red line’ between claims brought by a shareholder in relation to loss which he or she has suffered in the capacity of shareholder, such as a diminution in share value or in distributions, and claims which a shareholder or anyone else may bring in any other capacity, for example as a creditor or employee of the company."

“This is because the first category of claims concern loss sustained by the company; even though that loss may be reflected in a fall in share value, the claim belongs to the company and not the shareholder. The rule against reflective loss will not bar the second category of claims even if the company has a right of action in respect of substantially the same loss,” Fletcher said.

“While the Supreme Court bench was split on this decision, the majority outcome provides a logical clarity in my view. A shareholding increases or falls in value due to events that impact the company, and so it is the company that has the right of action in respect of those events,” Fletcher said.

“Nonetheless, shareholders and creditors are not without rights. If a company has suffered loss due to an infringement of its rights, the directors need to consider whether a claim should be brought in the best interests of the company. If the directors do not give this adequate or proper consideration, they become exposed to risk themselves – for example the risk of a derivative claim being pursued against them by the company on behalf of its shareholders,” Fletcher said

“Particularly in the present economic climate, this heightens the importance for company directors actively to consider potential litigation in order that informed decisions can be taken in the company’s best interests,” Fletcher said.