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01 Feb 2021

Marex: Where next for the rule against reflective loss?

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The Supreme Court’s decision in Sevilleja v Marex Financial Ltd [2020] UKSC 31 of 15 July 2020 provided much needed clarity on the scope of the rule against “reflective loss”. Whilst the narrow scope of the rule was recently confirmed in the cases of Broadcasting Investment Group Ltd & Ors v Smith and Ors [2020] EWHC 2501 (Ch), Naibu Global International Company PLC and Ors v Daniel Stewart & Company PLC and Ors [2020] EWHC 2719 (Ch), and Nectrus Ltd v UCP Plc [2021] EWCA Civ 57, the judgments illustrate the issues that arise when determining where the “bright line” rule established in Marex should be drawn on the facts.

The rule, which has now been part of English law for almost 40 years, has its origins in the 19th century case of Foss v Harbottle1. In that case two shareholders of a company brought proceedings to recover losses incurred by the company as a result of an alleged fraud. The Court held that the shareholders did not have any standing to sue on the company’s behalf; the only person who can bring an action in respect of a wrong done to a company is the company itself. This became known as the rule in Foss v Harbottle.

The rule against reflective loss itself emerged in the decision of the Court of Appeal in 1981 in Prudential Assurance Co. Ltd v Newman Industries Ltd & others2. The facts of this case are somewhat complicated. In essence, Prudential brought claims against two directors of Newman, a listed company in which Prudential held shares, alleging that they had fraudulently concealed certain matters from Newman’s board and had caused it to enter into a transaction on less favourable terms than would have been agreed had those matters been disclosed. Prudential brought both a derivative action and a personal claim (in the tort of conspiracy and for breach of duty).

Prudential conceded that it was only really interested in pursuing the derivative action and that the personal claim was brought as a fallback in case the derivative claim was defeated by the rule in Foss v Harbottle. Its argument was that the fraud reduced Newman’s net profits and the quoted price of its shares. Prudential must, therefore, have suffered some damage in its capacity as shareholder. No facts were relied on in support of the personal claim which were not also advanced in the derivative action and no attempt was made to establish that Prudential had suffered any loss distinct from Newman’s losses.

The Court of Appeal held that the personal claim was misconceived and that a shareholder could not “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 rule in Prudential was established. Where a duty owed to both a company and a shareholder is breached and that breach causes loss to the company and “loss” to the shareholder in the form of a diminution in share value or reduction in distributions from the company (e.g. in the form of dividends), then the shareholder does not suffer any loss which is separate and distinct from that of the company. It is “reflective” loss and the shareholder cannot bring an action to recover it.

Johnson v Gore Wood and the expansion of the rule in Prudential

The next key development, which paved the way for further expansion of the principle, came some 20 years later when a Mr Johnson brought a professional negligence claim against his solicitors, Gore Wood & Co.in relation to the conduct of a dispute involving his company.3 One of the issues for the House of Lords was whether some of the losses were barred by the rule against reflective loss. Lord Millett said in this connection (emphasis added):

“Reflective loss extends beyond the diminution of the value of the shares; it extends to the loss of dividends […] and all other payments which the shareholder might have obtained from the company if it had not been deprived of its funds. […] The same applies to other payments which the company would have made if it had had the necessary funds even if the plaintiff would have received them qua employee and not qua shareholder and even if he would have had a legal claim to be paid. His loss is still an indirect and reflective loss which is included in the company's claim.”

Although these comments were strictly obiter, they paved the way for the expansion of the principle that had been established in Prudential. Notably, in Gardner v Parker4 Lord Justice Neuberger (as he then was) held, in reliance on Lord Millett’s comments from Johnson, that if the rule against reflective loss applied to claims brought by a shareholder in his capacity as an employee of the company then there was “no logical reason why it should not apply to a shareholder in his capacity as a creditor of the company expecting repayment of his debt” and that it was “hard to see why the rule should not apply to a claim brought by a creditor (or indeed, an employee) of the company concerned, even if he is not a shareholder.”

The result was that the principle established in Prudential was applied to bar an ever wider range of claims where it could be said that a claim was concurrent with that of the company.

Sevilleja v Marex: The new bright line

Mr Sevilleja had allegedly asset stripped two BVI companies that he ultimately owned and controlled so that those companies were unable to pay a judgment debt owed to Marex. Marex brought proceedings against Mr Sevilleja in the High Court. In response to Marex’s application to serve proceedings out of the jurisdiction, Sevilleja argued that Marex had no good arguable case on the basis that Marex’s loss was reflective of loss suffered by the companies. Marex did not, however, own any shares in the relevant companies.

The Supreme Court in Marex affirmed that reflective loss is a “bright line” rule of company law. The judgment however clarified that the scope of the principle is limited to that set out in Prudential. Accordingly, the Supreme Court unanimously agreed that the rule against reflective loss did not apply to claims by a non-shareholder creditor. There was, however, a clear division on the basis for the decision (and indeed whether the existence of the rule against reflective loss was justified at all).

The majority judgment

Lord Reed, who delivered the principal judgment for the majority, said that the rule applies:

 “… where a company suffers actionable loss, and that loss results in a fall in the value of its shares (or in its distributions), the fall in share value (or in distributions) is not a loss which the law recognises as being separate and distinct from the loss sustained by the company. It is for that reason that it does not give rise to an independent claim to damages on the part of the shareholders.”

It does not apply to other types of losses suffered by a shareholder, or to losses suffered by any other class of claimant, e.g. a creditor.

A shareholder is not precluded from bringing a claim where the company has no concurrent cause of action, but the rule does apply where the company has a cause of that it elects not to pursue. Shareholders entrust the management of the company’s right of action to its decision making organs, and the company’s control over its own cause of action would be compromised (and the rule in Foss v Harbottle circumvented) if the shareholder could bring a personal action for a fall in share value.

The minority judgment

The minority, by contrast, would have gone further than the majority and would have abolished the rule altogether.

Lord Sales, for the minority, considered that the use of the word “reflective” was deceptive. In his view it suggested that a shareholder’s loss in the form of a diminution in the value of shares was the same as the loss suffered by the company, which he did not consider to be an accurate reflection of reality. There was no necessary, direct correlation between the two. It did not, necessarily follow that “if these are depleted the diminution in assets will be reflected in the diminution in the value of the shares”, particularly in the case of large public companies.

The minority did not accept the need for any “bright line” rule. In the minority’s view, there was no reason why a shareholder’s claim should be barred where the shareholder has a valid cause of action in his or her own right. Any complexities that might result from the existence of concurrent claims are not by themselves a reason to bar such claims and, it said, there are tools available to manage those complexities.

Decisions following Marex

Although the majority judgment expressly sets out a “bright line” test for the rule, a couple of recent subsequent cases demonstrate that questions arise as to where the “bright line” could be said to fall.

Broadcasting Investment Group (BIG) v Smith

BIG and its majority beneficial owner, Mr Burgess, brought concurrent claims against Mr Smith for damages and specific performance of an alleged oral joint venture agreement, pursuant to which Mr Smith was required to transfer shares to a joint venture company, SS PLC. The issue the court had to address was whether the loss suffered was merely reflective of the loss of SS PLC (now in liquidation), in which Mr Smith and BIG held shares.

BIG’s claim

The court held that BIG’s claim was a “paradigm example” of a claim within the scope of the rule against reflective loss, and was therefore barred.

In particular, the court did not differentiate between BIG’s claims for damages and specific performance. The court referred to a passage in Marex that confirmed that one of the consequences of the Prudential judgment is the general rule that a shareholder cannot bring an action to recover damages or “secure other relief” for harm suffered by the company. On this basis, the principle extends to all forms of relief.

Mr Burgess’s claim

By contrast to BIG’s claim, Mr Burgess was not precluded from bringing a claim to enforce the joint venture agreement on the basis of the reflective loss principles.

The deputy judge said that the relevant question was whether, following Marex, the reflective loss principles could apply to bar the claim of someone who is not a direct shareholder in the loss suffering company (i.e. SS PLC). Mr Burgess was a “third degree shareholder” (a shareholder in a shareholder of BIG and not, therefore, a shareholder in the company in fact or in law). The deputy judge said that although t the decision in Marex only extended to a claim by a creditor is was clear that the Supreme Court was deciding the scope of the rule for all purposes and the rule only bars claims by direct shareholders in the loss-suffering company. It does not extend to bar claims by what the judge called “quasi-shareholders”. A second orthird degree shareholder has not acquired shares in the relevant company and therefore not contracted into the rules on reflective loss that affect that company.

Naibu Global International Company PLC and Ors v Daniel Stewart & Company PLC and Ors

In Naibu Global International Company PLC and Ors v Daniel Stewart & Company PLC and Ors, Mrs Justice Bacon applied the principles in Marex to strike out certain claims on the basis of reflective loss.

Pinsent Masons (“PM”) was retained by Naibu China and its parent company, Naibu HK, in relation to the listing on AIM of Naibu Jersey (which, once incorporated, was to be Naibu HK’s parent). Some time after the listing, Naibu China divested of all of its assets, which made Naibu Jersey’s shareholding in Naibu HK valueless. Naibu Jersey was delisted from AIM as a result.

Naibu HK and Naibu Jersey brought claims against PM alleging negligence in conducting due diligence and the conduct of the listing. It was accepted by the time of the hearing that the claim by Naibu HK should be stayed pursuant to an arbitration clause in the retainer letter with PM.

The judge held that a claim by Naibu Jersey on the basis of an implied retainer was arguable. PM, however, argued that Naibu Jersey’s claims for the loss in the value of its shareholding should be struck out on the basis that it reflected the loss suffered by Naibu HK.

Mrs Justice Bacon dismissed the Claimants’ suggestion that it was necessary to consider (with expert evidence) the losses suffered by Naibu HK and Naibu Jersey at various different stages in time in order to identify whether loss suffered by Naibu Jersey was different in amount to the loss suffered by Naibu HK to establish whether both companies’ losses correspond. The court held that following Marex there was no requirement for the amount of the loss to be identical between the shareholder and the company for the rule to be engaged; the decisive question is the nature of the loss claimed by the shareholder and whether that loss takes the form of a diminution in the value of the shareholding or distributions. The judge noted that one of the reasons the majority in Marex rejected the avoidance of double recovery as a justification for the rule against reflective loss was because share value may not be closely correlated with the company’s loss (especially where shares are listed).

Consequently, Naibu Jersey’s claims were struck out, save for losses that were different in nature to that of a fall in the value of the shareholding or distributions. On the facts, these losses included the costs of Naibu Jersey asserting control over and investigating losses suffered by Naibu HK and Naibu China. The court accepted (and indeed it had not been disputed) that these costs did not constitute reflective loss.

Nectrus Ltd v UCP Plc

In Nectrus (which was a decision about permission to appeal rather than a decision on the merits), Lord Justice Flaux held that the rule against reflective loss did not apply to a claim brought by a former shareholder. UCP had suffered loss as a result of a breach by Nectrus of duties owing both to UCP itself and its wholly-owned subsidiary, Candor. UCP sold its shareholding in Candor, and received less as a result of the breach. The Court held that UCP’s claim was not barred by the rule against reflective loss; the relevant date is the date the loss crystallises, not the date of the breach, and UCP’s loss crystallised when it sold its shares and no longer became subject to the rule against reflective loss. This decision confirms the narrow scope of the rule following Marex, and that it is a “highly specific exception” to the general position.

Where does the bright line fall?

The decision of the majority of the Supreme Court may have set out a “bright line” test but these cases show that issues will arise as to where it should fall. The approach in the Broadcasting Group case, in effect, applied a linguistic definition test: since the Supreme Court has said that only claims by shareholders are barred it follows that the claims by indirect shareholders are not barred. Once you identify that the claimant is not a shareholder then the claim for losses by a shareholder higher up the ownership chain is not barred. A similar approach was adopted in Nectrus: a former shareholder is not a shareholder and therefore the rule against reflective loss does not apply.

However, if the rule is looked at as set by the nature of the loss, as was the case in Naibu, there should have been a different outcome in the Broadcasting Group case. In Naibu, it did not matter that the losses of the shareholder were different in amount or incurred at a different time to the losses incurred by the company; it appears that the losses claimed to have been suffered by Naibu Jersey, as the indirect holding company, took the form of a diminution in the value of the shareholding or distributions received and were therefore within the scope of the rule against reflective loss, and those aspects of the claim were struck out.

Lord Reed, who delivered the leading judgment in Marex, justified the rule as follows: “When a shareholder invests in a company, he […] entrusts the company – ultimately, a majority of the members voting in a general meeting – with the right to decide how his investment is to be protected.”

Once it is appreciated that the core of the relationship is the shareholders’ status as an equity investor and the rule relates to losses in that capacity as a member of the company, it is difficult to see why it should make any difference whether the claimant is a direct shareholder or has an interest through an intermediate company. Indeed, it is commonplace for shareholdings to be held through intermediate companies. The relevant factor is whether shareholder loss reflects that of the underlying company that suffered the wrong.

Indeed it is to be noted that the ultimate losses in the Naibu case were, it seems, at the level of the operating company i.e. Naibu China. On the basis of the Broadcasting Group case the claim for losses by Naibu Jersey, as the indirect holding company, would not have been barred by the rule against reflective loss. That argument was not however made, it would seem rightly.

It is understood that the Broadcasting Group case is going to the Court of Appeal. It will be interesting to see what it makes of this point.


1(1843) 2 Hare 461

2 [1982] Ch 204

3 Johnson v Gore Wood & Co [2000] UKHL 65

4 [2004] EWCA Civ 781

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