Strategy & Operations » Legal » Cause for further reflection on the rule against reflective loss?

Cause for further reflection on the rule against reflective loss?

Sinead Lester, partner at law firm BDB Pitmans, discusses potential changes to the law allowing shareholders and small business owners to take direct legal action against parties they blame for causing them losses when their companies fall into insolvency.

The Supreme Court recently granted the All-Party Parliamentary Group (APPG) on Fair Business Banking, permission to intervene in the Supreme Court hearing of Carlos Sevilleja Garcia v Marex Financial Ltd [2018] EWCA Civ 1468 (Marex) that took place on 8 May 2019, concerning the rule against reflective loss.

In allowing the intervention, the court heard the public policy arguments put forward by the APPG on the obstructive nature of the current rule against reflective loss for the personal claims of directors and shareholders of insolvent businesses.

The Rule Against Reflective Loss

Where a company suffers a loss as a result of an actionable wrong, the shareholder suffers indirectly as the value of their shares are diminished; the shareholder’s loss is reflective of the company’s. The rule against reflective loss, established in Prudential Assurance Co Ltd v Newman Industries Ltd (No.2) [1982] Ch. 204 (Prudential) means that in such circumstances the shareholder cannot bring a claim (as his or her claim is reflective of the company’s loss) and instead the company must sue. That remains the case even where the company chooses not to bring a claim.

Whilst the rule was initially formulated to apply in the context of shareholders who sought to recover the diminution in value of their shareholding or a diminution in dividends, it has since been expanded to prevent claims by shareholders, whether in his capacity as shareholder, employee or creditor, where the loss claimed is effectively a loss suffered by the company.


The latest judgment of the Court of Appeal in Marex greatly widens the scope by holding that the rule applies not only to shareholders but also to unsecured creditors. In Marex, Mr Sevilleja was accused of having dishonestly asset-stripped two companies (the BVI Companies) which he controlled in order to avoid payment of a judgment debt which Marex had secured against the BVI Companies in excess of US $5m. Marex therefore brought a claim against Mr Sevilleja as it was unable to recover from the BVI Companies.

At first instance, the Court was satisfied that the rule against reflective loss should not prevent Marex from bringing a claim against Mr Sevilleja. On appeal, the Court of Appeal, reversing the first instance decision, held that even though Marex was just a creditor of the BVI Companies, the rule against reflective loss prevented Marex’s claim; it could not find a reason to draw a distinction between a claim by a shareholder-creditor and a claim by a non-shareholder creditor.

The justifications for the rule against reflective loss were set out as:

(I) avoiding double recovery against the wrongdoer, meaning recovery by the company and then separately by any of its shareholders;

(ii) causation, if the company chose not to claim against a wrongdoer, any loss to its shareholders was because of the decision of the company and not the actions of the wrongdoer;

(iii) public policy grounds of avoiding conflicts of interest as if the creditor or shareholder has a separate cause of action, it would discourage the company from making settlements; and

(iv) preserving company autonomy and avoiding prejudice to minority shareholders and other creditors.

There is an exception to this rule that was developed in Giles v Rhind [2003] Ch 618 which provided that where the company was disabled from bringing a claim against the wrongdoer, as a result of the actions of the wrongdoer, the rule did not apply.

However, the Court of Appeal in Marex greatly narrowed this exception by finding that this exception only applied where the wrongdoer had directly caused it to be impossible in law for the company to bring a claim against the wrongdoer, or for a claim to be brought in its name by a third party. This exception did not apply in Marex.

What does this mean?

The Court of Appeal was seemingly disinterested in controlling Mr Sevillja’s dishonest conduct and in widening the rule’s scope, is thought by some to present a real obstacle in access to justice which was why the APPG intervened in the appeal to the Supreme Court.

As it presently stands, where a creditor’s misconduct causes the company’s insolvency (for example, through the mis-selling by a bank of an interest rate swap), the other shareholders and creditors are prevented from pursuing the bank directly as the claim lies exclusively with the insolvent company which must be pursued through the insolvency practitioner.

Even if, which may in practice be difficult, the shareholders and creditors can intervene in the insolvency and require the appointed insolvency practitioner to bring a claim against the creditor (in this example, the bank), the insolvency practitioner may seek to settle the claim at a low value. In such a scenario, the shareholders and creditors cannot bring a separate claim and are instead reliant on the outcome of the claim, if brought at all, by the insolvency practitioner (who may have been appointed by the wrongdoing creditor in the first place).

By its intervention to the Supreme Court, we understand that APPG argued that an exception should be made to the rule against reflective loss in order to enable  shareholders and creditors to seek redress in circumstances where the company’s insolvency has been caused by a third party’s wrongdoing because, as a matter of policy, it cannot be right that the wrongdoer can benefit from their own wrongdoing.

Whether or not the Supreme Court agrees with APPG’s arguments remains to be seen but it does feel unjust that a wrongdoing creditor can effectively shield itself from claims as a result of the company’s insolvency which seems to be the practical effect of the law as it currently stands.


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