Author: Syedur Rahman
4 August 2020
3 min read
Syedur Rahman of Rahman Ravelli outlines a Supreme Court case that clarifies the limitations of the reflective loss principle.
On 15 July 2020, the Supreme Court allowed the appeal in the case of Sevilleja v Marex Financial Ltd. Rarely do English judges liken a question of law to a “ghastly legal Japanese knotweed”, but Lord Reed PSC did just that when handing down the judgment in this case. The knotweed in question was the reflective loss principle and this was a case which, according to Lord Reed, “raises one of the most important and difficult questions of law to come before the Supreme Court for some time”.
In reaching the decision, the Supreme Court thoroughly re-examined the principle of reflective loss. Its judgment fundamentally restates the doctrine of reflective loss in company law so that a claim by a company’s creditor against a third party will not be barred where it reflects loss suffered by the company, even if the creditor is a shareholder. There is no longer an exception to the doctrine where the wrongdoer has brought about the company’s impecuniosity (its lack of finances).
The facts in this case were that Mr Sevilleja owned and controlled two British Virgin Islands companies. Marex obtained judgments against the companies. Sevilleja allegedly then stripped the companies of their assets, making them insolvent. Marex issued proceedings against him for economic torts, including intentionally causing it to suffer harm by unlawful means.
On an application for permission to serve out of the jurisdiction, the judge held that the claim was arguable. But the Court of Appeal reversed him, saying that the doctrine of reflective loss barred Marex’s claim as a creditor of the companies for loss which was reflective of the loss caused to the companies by Sevilleja.
The Supreme Court has now unanimously held that the claim is not barred by reflective loss. But it reaches this conclusion by two different routes. The majority view (Lord Reed) narrows the doctrine of reflective loss while the minority (Lord Sales) would abolish it.
The English law rule against reflective loss states that shareholders cannot bring a claim for damages merely because the company in which they hold shares has suffered damage. In particular, they cannot claim for a diminution in the market value of their shares or a diminution in distributions they receive from the company because such diminutions are merely a “reflection” of the loss suffered by the company. Instead, the company is the proper claimant for that loss.
The principle, while superficially straightforward, has caused significant difficulties for shareholders trying to recover damages from wrongdoers where the company in which they hold shares has a claim relating to the same loss; even where the company has not itself brought any claims against the wrongdoer.
The rule against reflective loss finds its modern origin in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2)  Ch 204. In this case, the Court of Appeal applied the reflective loss principle and extended it. A shareholder sued two directors who had defrauded the company. The shareholder sought to bring a derivative claim but the Court of Appeal rejected this. The shareholder also sought to sue for loss caused to the value of its shares by the directors’ breaches of duty to the company. In recent years, the principle has also been expanded to broad categories of claims, including claims by creditors who are also shareholders and, most controversially, by creditors who are not shareholders in the company at all.
But in Sevilleja (Respondent) v Marex Financial Ltd  UKSC 31, the UK Supreme Court has unanimously rejected and overruled this expansion. It has confirmed that the reflective loss principle has no application at all to claims brought by creditors of a company, irrespective of whether they are also shareholders in that company.
The Judgment has now significantly curtailed the principle of reflective loss. There can be no doubt that this will have an important impact in practice. The judgment makes clear that if a principle of reflective loss does exist, it should be limited.
There is, however, no consensus as to how this might be achieved. The majority judgment, led by Lord Reed, held that the principle retains a place in the law. But it confined it to cases where the value of shareholders’ shares or of distributions they might receive as shareholders is reduced because of actionable loss suffered by their companies. The minority, however, led by Lord Sales, went further and concluded that the rule is unprincipled and ought to be rejected entirely.
Although the majority’s decision prevails, the strength of the minority judgment may indicate that this decision will not be the last word on this important topic. On either view, the Justices of the Supreme Court were united in the decision that the scope of the reflective loss principle does not extend to claims made by parties other than shareholders, including creditors.
This article was also featured on Lexology.com.
Syedur Rahman is known for his in-depth experience of serious fraud, white-collar crime and serious crime cases, as well as his expertise in worldwide asset tracing and recovery, international arbitration, civil recovery, cryptocurrency and high-stakes commercial disputes.