Marex Financial Ltd v Sevilleja
[2020] UKSC 31
Trinity Term
[2020] UKSC 31
On appeal from: [2018] EWCA Civ 1468
Appellant Respondent George Bompas QC David Lewis QC Sophie Weber Richard Greenberg
| (Instructed by Memery | (Instructed by Mackrell |
Crystal LLP) Turner Garrett)
Intervener (All Party
Parliamentary Group on Fair Business Banking)
Peter Knox QC
Simon Reevell
Richard Samuel
Amit Karia
Chloe Shuffrey
(Instructed by Trowers & Hamlins LLP (London))
LORD REED: (with whom Lady Black and Lord Lloyd-Jones agree)
1. This appeal concerns the supposed principle that “reflective loss” cannot be recovered. Before describing the factual background, or entering into the details of the legal issues, it may be helpful to begin by considering some basic principles of our law.
Introduction
2. It is not uncommon for two persons, A and B, to suffer loss as a result of the conduct of a third person, C. If that conduct was in breach of an obligation owed by C to A, then A will in principle have a cause of action against C. If the conduct was also in breach of an obligation owed by C to B, then B will also have a cause of action against C. A and B are both at liberty to sue C whenever they please, subject to rules as to limitation and prescription, and C is normally liable to compensate them both for the loss which they have suffered. If A obtains and enforces a pecuniary award against C, and some time later B also seeks a similar award but C is unable to pay it, then in principle that is B’s misfortune. However, where C is insolvent at the time when the first claim is made against him, the law of insolvency protects the position of both A and B by imposing a regime for the distribution of C’s assets among his creditors which ensures that they are treated equally, after the claims of secured or preferred creditors have been met.
3. The position can become more complicated where A and B have concurrent claims in respect of losses which are inter-related in such a way that a payment by C to one of them will have the practical effect of remedying the loss suffered by the other. The general position in situations of that kind was described by Brandon J in The Halcyon Skies [1977] QB 14, 32:
“There is no reason, as a matter of law, why two different persons should not have concurrent rights of recovery, based on different causes of action, in respect of what is in substance the same debt. The court will not allow double recovery or, in a case of insolvency, double proof against the insolvent estate: The Liverpool (No 2) [1963] P 64. Subject to this, however, either of the two persons is entitled to enforce his right independently of the other.”
4. The principle that double recovery should be avoided does not prevent a claimant from bringing proceedings for the recovery of his loss. But the court will have to consider how to avoid double recovery in situations where the issue is properly before it. Procedurally, that may occur in a number of ways. For example, both claimants may bring proceedings concurrently, or the wrongdoer may raise the issue by way of defence to proceedings brought by one claimant, and join the other potential claimant as a defendant, or the court may itself direct the claimant to notify the other potential claimant so that he has an opportunity to intervene (as explained in In re Gerald Cooper Chemicals Ltd [1978] Ch 262, 268-269).
5. The principle that double recovery should be avoided does not deflect the law from compensating both claimants, but affects the remedial route by which the law achieves that objective. There are a number of ways in which the law can avoid double recovery, or double proof in insolvency, where concurrent rights of recovery might otherwise have that result. In some circumstances, priority is given to the cause of action held by one person, and the claim of the other person is excluded so far as may be necessary to avoid double recovery. The rationale in such cases is that, by directly achieving its remedial objective in respect of the person who is permitted to bring the prior claim, the law indirectly achieves that objective in respect of the person whose claim is excluded.
6. That was the approach adopted, for example, in the decision cited by Brandon J, The Liverpool (No 2) [1963] P 64. In that case, a port authority sought to prove against an insolvent fund, established to meet the liabilities of the owners of one vessel, the Liverpool, for the cost of clearing the wreck of another, the Ousel, which had been damaged in a collision for which the Liverpool was responsible. The authority also made a statutory claim for the same cost against the owners of the Ousel, and they in turn sought to prove for that amount against the fund. The Court of Appeal held that the claim of the authority against the fund should be given priority over that of the owners of the Ousel, since the authority was actually out of pocket, while the claim of the owners of the Ousel against the fund should be disallowed. It also observed that it would be consonant with justice and good sense that, in the event that the authority sought to recover also from the owners of the Ousel (for any balance remaining after it had received a dividend out of the fund), it would have to give credit for the amount that it had already recovered. In that way, the owners of the Ousel benefited from the authority’s recovery from the fund to the same extent as they would have done if their claim against the fund had been allowed. A similar approach, in the context of concurrent claims arising out of the breach of a construction contract, can be seen in Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 AC 518, 595.
7. There are also circumstances in which the law finds other means of avoiding double recovery, such as subrogation (as discussed, for example, in Gould v Vaggelas [1984] HCA 68; (1984) 157 CLR 215), or the imposition on one claimant of an obligation to account to the other out of the damages which the former has received (as, for example, in O’Sullivan v Williams [1992] 3 All ER 385). The most suitable approach to adopt in a particular case will depend upon its circumstances.
8. This appeal is concerned with a particular type of situation in which two persons, A and B, suffer loss as a result of the conduct of a third person, C. The situation in question is one in which A is a company, B is a creditor of that company, and B’s loss is consequential upon the loss suffered by A, because C’s conduct has rendered A insolvent and unable to pay its debt to B.
9. The fact that a claim lies at the instance of a company rather than a natural person, or some other kind of legal entity, does not in itself affect the claimant’s entitlement to be compensated for wrongs done to it. Nor does it usually affect the rights of other persons, legal or natural, with concurrent claims. There is, however, one highly specific exception to that general rule. It was decided in the case of Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 that a shareholder cannot bring a claim in respect of a diminution in the value of his shareholding, or a reduction in the distributions which he receives by virtue of his shareholding, which is merely the result of a loss suffered by the company in consequence of a wrong done to it by the defendant, even if the defendant’s conduct also involved the commission of a wrong against the shareholder, and even if no proceedings have been brought by the company. As appears from that summary, the decision in Prudential established a rule of company law, applying specifically to companies and their shareholders in the particular circumstances described, and having no wider ambit.
10. The rule in Prudential, as I shall refer to it, is distinct from the general principle of the law of damages that double recovery should be avoided. In particular, one consequence of the rule is that, where it applies, the shareholder’s claim against the wrongdoer is excluded even if the company does not pursue its own right of action, and there is accordingly no risk of double recovery. That aspect of the rule is understandable on the basis of the reasoning in Prudential, since its rationale is that, where it applies, the shareholder does not suffer a loss which is recognised in law as having an existence distinct from the company’s loss. On that basis, a claim by the shareholder is barred by the principle of company law known as the rule in Foss v Harbottle (1843) 2 Hare 461: a rule which (put shortly) states that the only person who can seek relief for an injury done to a company, where the company has a cause of action, is the company itself.
11. Putting matters broadly at this stage, in Johnson v Gore Wood & Co [2002] 2 AC 1 the House of Lords purported to follow Prudential, but the reasoning of some members of the Appellate Committee was not clearly confined to circumstances of the kind with which Prudential was concerned. In particular, the reasoning of Lord Millett, which proved particularly influential in subsequent cases, advanced a number of other justifications for the exclusion of the shareholder’s claim whenever the company had a concurrent claim available to it, of wider scope than the approach adopted in Prudential.
12. The decision in Johnson has been interpreted in later cases as establishing a principle, generally referred to as the “reflective loss” principle, whose legal basis and scope are controversial. This supposed principle has been applied to claims brought by a claimant in the capacity of a creditor of a company, where he also held shares in it, and the company had a concurrent claim. In the present case, the Court of Appeal held that the principle applied to a claim brought by an ordinary creditor of a company (who was not a shareholder), where the company had a concurrent claim.
13. In the present appeal, the court is invited to clarify, and if necessary depart from, the approach adopted in Johnson, and to overrule some later authorities. It is also necessary for the court to examine the rationale and effect of the decision in Prudential, in order to consider the reasoning in Johnson and the later cases.
The present appeal
14. The appeal is brought against an order of the Court of Appeal (Lewison, Lindblom and Flaux LJJ), allowing an appeal against an order made by Knowles J in the Commercial Court. In summary, an application was made to Knowles J to set aside an order giving permission for service of proceedings on the respondent, Mr Sevilleja, out of the jurisdiction. One of the arguments advanced by Mr Sevilleja in support of his application was that the appellant, Marex, did not have a good arguable case against him because the losses which Marex was seeking to recover were reflective of loss suffered by two companies which had concurrent claims against him, and were therefore not open to Marex to claim. The judge held that Marex had a good arguable case that its claim was not precluded by the “reflective loss” principle, and therefore dismissed Mr Sevilleja’s application: [2017] EWHC 918 (Comm); [2017] 4 WLR 105. On appeal, the Court of Appeal accepted that the “reflective loss” principle applied to about 90% of Marex’s claim: [2018] EWCA Civ 1468; [2019] QB 173. The effect of the Court of Appeal’s decision is that although Marex’s permission to serve out was not set aside, it can pursue its claim only as regards the 10% of its alleged losses which were conceded not to be “reflective”.
The facts
15. It is common ground that, for the purposes of the present proceedings, the facts must be taken to be as alleged by Marex in its particulars of claim and supporting documents. On that basis, the material facts - which, it should be made clear, are disputed by Mr Sevilleja - can be summarised as follows.
16. Mr Sevilleja was the owner and controller of two companies incorporated in the British Virgin Islands (“the BVI”), Creative Finance Ltd and Cosmorex Ltd (“the Companies”), which he used as vehicles for trading in foreign exchange. Marex brought proceedings against the Companies in the Commercial Court for amounts due to it under contracts which it had entered into with them. Following a trial before Field J in April 2013, Marex obtained judgment against the Companies for more than US$5.5m. It was also awarded costs which were later agreed at £1.65m.
17. Field J provided the parties with a confidential draft of his judgment on 19 July 2013, the judgment being handed down and orders for payment made on 25 July 2013. Over a few days starting on or shortly after 19 July 2013, Mr Sevilleja procured that more than US$9.5m was transferred offshore from the Companies’ London accounts and placed under his personal control. By the end of August 2013, the Companies disclosed assets of US$4,329.48. The object of the transfers was to ensure that Marex did not receive payment of the amounts owed by the Companies. In procuring the transfers, Mr Sevilleja acted in breach of duties owed to the Companies.
18. The Companies were placed into insolvent voluntary liquidation in the BVI by Mr Sevilleja in December 2013, with alleged debts exceeding US$30m owed to Mr Sevilleja and persons and entities associated with him or controlled by him. Marex was the only non-insider creditor.
19. According to Marex, the liquidator has been paid a retainer, and has been indemnified against his fees and expenses, by an entity controlled by Mr Sevilleja or associated with him. The liquidation process has effectively been on hold. The liquidator has not taken any steps to investigate the Companies’ missing funds or to investigate the claims submitted to him, including claims submitted by Marex. Nor has he issued any proceedings against Mr Sevilleja.
20. Marex refers in its pleadings to proceedings in the United States, where the court, after hearing evidence, refused to recognise the BVI liquidation as a main proceeding under Chapter 15 of the US Bankruptcy Code. It described the liquidation as “a device to thwart enforcement of a $5m judgment against the [Companies] that Marex won in the courts of England - and the most blatant effort to hinder, delay and defraud a creditor this Court has ever seen”: In re Creative Finance Ltd (In Liquidation) et al, (2016) 543 BR 498, p 502 (United States Bankruptcy Court for the Southern District of New York). It also found that “[f]rom beginning to end, Sevilleja’s tactics were a paradigmatic example of bad faith, and the Liquidator’s actions - and inaction - facilitated them” (p 503). Mr Sevilleja was found to be guilty of “attempting (unfortunately, successfully) to control a BVI liquidator, who was supposed to act as an independent fiduciary, by the purse strings … [and] depriving the Liquidator of the resources he needed to properly do his job” (p 513).
21. In the present claim against Mr Sevilleja, Marex seeks damages in tort for (1) inducing or procuring the violation of its rights under the judgment and order of Field J dated 25 July 2013, and (2) intentionally causing it to suffer loss by unlawful means. The amounts claimed are (1) the amount of the judgment debt, interest and costs awarded by Field J, less an amount recovered in US proceedings concerning the bankruptcy of a company which was indebted to the Companies, and (2) costs incurred by Marex in the US proceedings and in other attempts to obtain payment of the judgment debt. Mr Sevilleja concedes that those costs fall outside the scope of the “reflective loss” principle.
22. The issues in the appeal are agreed by the parties to be the following:
“1. Whether the No Reflective Loss Rule applies in the case of claims by company creditors, where their claims are in respect of loss suffered as unsecured creditors, and not solely to claims by shareholders.
2. Whether there is any and if so what scope for the court to permit proceedings claiming for losses which are prima facie within the No Reflective Loss Rule, where there would otherwise be injustice to the claimant through inability to recover, or practical difficulty in recovering, genuine losses intentionally inflicted on the claimant by the defendant in breach of duty both to the claimant and to a company with which the claimant has a connection, and where the losses are felt by the claimant through the claimant's connection with the company.”
Prudential Assurance v Newman Industries (No 2)
23. Although incorporated companies have long existed, it was only towards the end of the 19th century that the independent legal personality of the company was conclusively established by the decision of the House of Lords in Salomon v A Salomon & Co Ltd [1897] AC 22. During the 20th century, the implications of corporate personality for rights of property, and for the nature of a shareholder’s interest, were addressed by the courts in a series of cases, including Macaura v Northern Assurance Co Ltd [1925] AC 619 and Short v Treasury Comrs [1948] 1 KB 116, affirmed [1948] AC 534. In more recent times, the courts have had to consider the position where a shareholder seeks to recover damages in respect of a diminution in the value of his shareholding or in the distributions received from the company, resulting from a loss suffered by the company in respect of which the company has its own cause of action.
24. The issue appears to have arisen for the first time in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2). The case concerned a situation where the directors of a company were alleged to have made a fraudulent misrepresentation in a circular distributed to its shareholders, so as to induce them to approve the purchase of assets at an overvalue from another company in which the directors were interested. Prudential, which was a minority shareholder in the company, brought a personal and a derivative action against the directors, claiming that they had committed the tort of conspiracy against the company and its members. In relation to the personal claim, the Court of Appeal (Cumming-Bruce, Templeman and Brightman LJJ) concluded that, where a company and its shareholders had suffered wrongs which resulted in a loss to the company and a fall in the value of its shares, a shareholder could not bring a personal action against the wrongdoer.
25. The court devoted most of its judgment to the derivative action, and dealt with the personal action relatively briefly. It approached the issue on the basis that the directors had acted in breach of their obligations to the shareholders (p 222), and that the loss suffered by the company had brought about a fall in the value of its shares. It recorded at p 222 that no facts were relied upon in support of the personal claim which were not relied upon in support of the derivative claim. It also expressed the opinion, at pp 223-224, that the plaintiffs were never concerned to recover in the personal action, and were only interested in it as a means of circumventing the rule in Foss v Harbottle, which stood directly in the way of a derivative action. Nevertheless, it dealt with the personal action on the basis of general principles rather than on its particular facts; and the court’s decision was treated by the House of Lords in Johnson as establishing principles of general application, which Lord Bingham of Cornhill set out at pp 35-36 (see para 41 below).
26. The court disallowed Prudential’s claim on the ground that it had not suffered any personal loss. It stated at pp 222-223:
“But what he [the shareholder] cannot do is to 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.”
As that passage makes clear, the decision was concerned only with a diminution in the value of shares or in distributions, suffered by a shareholder merely because the company had itself suffered actionable damage. It was not concerned with other losses suffered by a shareholder, or with situations where the company had not suffered any actionable loss.
27. The court explained its reasoning as follows, at p 223:
“The shareholder does not suffer any personal loss. His only ‘loss’ is through the company, in the diminution in the value of the net assets of the company ... The plaintiff’s shares are merely a right of participation in the company on the terms of the articles of association. The shares themselves, his right of participation, are not directly affected by the wrongdoing. The plaintiff still holds all the shares as his own absolutely unencumbered property.”
28. That reasoning requires elaboration. It is unrealistic to assert as a matter of fact that the shareholder does not suffer any personal loss: ex hypothesi, there has been a fall in the value of his shares. It is not immediately obvious what it means to say that his only loss is through the company. It is, however, possible to explain the court’s decision, particularly in the light of later passages in the judgment. As I understand its reasoning, what the court meant, put shortly, was that 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.
29. The court provided at p 223 an illustration of its approach:
“Suppose that the sole asset of a company is a cash box containing £100,000. The company has an issued share capital of 100 shares, of which 99 are held by the plaintiff. The plaintiff holds the key of the cash box. The defendant by a fraudulent misrepresentation persuades the plaintiff to part with the key. The defendant then robs the company of all its money. The effect of the fraud and the subsequent robbery, assuming that the defendant successfully flees with his plunder, is (i) to denude the company of all its assets; and (ii) to reduce the sale value of the plaintiff’s shares from a figure approaching £100,000 to nil. There are two wrongs, the deceit practised on the plaintiff and the robbery of the company. But the deceit on the plaintiff causes the plaintiff no loss which is separate and distinct from the loss to the company … The plaintiff obviously cannot recover personally some £100,000 damages in addition to the £100,000 damages recoverable by the company.” (Emphasis added)
The court also made it clear that the company’s failure to recover its loss would not open the door to recovery by the shareholder, asking rhetorically how the failure of the company to pursue its claim could entitle the shareholder to recover the loss for himself.
30. The cash box example has been criticised for its artificiality. Certainly, by envisaging a company whose only asset was cash, the court greatly simplified a situation which, in real life, is likely to be more complex. But the point being made has a rationale in real life as well as in the simplified example.
31. The starting point is the nature of a share, and the attributes which render it valuable. A share is not a proportionate part of a company’s assets: Short v Treasury Comrs. Nor does it confer on the shareholder any legal or equitable interest in the company’s assets: Macaura v Northern Assurance Co Ltd. As the court stated in Prudential, a share is a right of participation in the company on the terms of the articles of association. The articles normally confer on a shareholder a number of rights, including a right to vote on resolutions at general meetings, a right to participate in the distributions which the company makes out of its profits, and a right to share in its surplus assets in the event of its winding up.
32. Where a company suffers a loss, that loss may affect its current distributions or the amount retained and invested in order to pay for future distributions (or, if the company is wound up, the surplus, if any, available for distribution among the shareholders). Since the value of a company’s shares is commonly calculated on the basis of anticipated future distributions, it is possible that a loss may result in a fall in the value of the shares. That is, however, far from being an inevitable consequence: companies vary greatly, and the value of their shares can fluctuate upwards or downwards in response to a wide variety of factors. In the case of a small private company, there is likely to be a close correlation between losses suffered by the company and the value of its shares. In the case of a large public company whose shares are traded on a stock market, on the other hand, a loss may have little or no impact on its share value. If there is an impact on share value, it will reflect what Lord Millett described in Johnson [2002] 2 AC 1, 62 as “market sentiment”, and will not necessarily be equivalent to the company’s loss. If the company’s loss does not affect the value of its shares, then there is no claim (or at least no sustainable claim) available to a shareholder, and in principle the problem addressed in Prudential does not arise. A problem only arises where, as in Prudential, a shareholder claims that the company’s loss has had a knock-on effect on the value of his shares.
33. Considering, then, the situation where a company suffers actionable loss as the result of wrongdoing, the company then acquires a right of action. If the company’s loss results (or is claimed to result) in a fall in the value of its shares, then, but for the rule in Prudential, the shareholder would simultaneously acquire a concurrent right of action. The purpose of an award of damages to the company is to restore it to the position in which it would have been if the wrongdoing had not occurred. In circumstances where an award which restores the company’s position to what it would have been if the wrongdoing had not occurred would also restore the value of the shares, the only remedy which the law would require to provide, in order to achieve its remedial objectives of compensating both the company and its shareholders, would be an award of damages to the company. For the shareholders to have a personal right of action, in addition to the company’s right of action, would in those circumstances exceed what was necessary for the law to achieve those objectives, and would give rise to a problem of double recovery. Most of the cases in which the rule in Prudential has been applied (but not Prudential itself) have concerned small private companies, where those circumstances are likely to have existed. As I have explained, however, there are also circumstances where there may not be a close correlation between the company’s loss and any fall in share value. The avoidance of double recovery cannot, therefore, be sufficient in itself to justify the rule in Prudential.
34. That conclusion is also supported by another point. What if the company fails to pursue a right of action which, in the opinion of a shareholder, ought to be pursued, or compromises its claim for an amount which, in the opinion of a shareholder, is less than its full value? If that opinion is shared by a majority of the shareholders, then the company’s articles will normally enable them to direct the company’s course of action by passing a suitable resolution at a general meeting. Even if the shareholder finds himself in a minority, he has a variety of remedies available to him, including the bringing of a derivative action on the company’s behalf, equitable relief from unfairly prejudicial conduct, or a winding up on the “just and equitable” ground, if (put shortly) those in control of the company are abusing their powers. But what if the company’s powers of management are not being abused, and a majority of shareholders approve of the company’s decision not to pursue the claim, or its decision to enter into a settlement? Should the minority shareholder not then be able to pursue a personal action?
35. In Prudential, the court answered that question in the negative, stating at p 224 that the rule in Foss v Harbottle would be subverted if the shareholder could pursue a personal action. The rule, as stated in Edwards v Halliwell [1950] 2 All ER 1064 and restated in Prudential at pp 210-211, has two aspects. The first is that “the proper plaintiff in an action in respect of a wrong alleged to be done to a corporation is, prima facie, the corporation”. As was explained in Prudential at p 210, one of the consequences of that aspect of the rule is that a shareholder cannot, as a general rule, bring an action against a wrongdoer to recover damages or secure other relief for an injury done to the company. The second aspect of the rule is that “[w]here the alleged wrong is a transaction which might be made binding on the corporation and on all its members by a simple majority of the members, no individual member of the corporation is allowed to maintain an action in respect of that matter because, if the majority confirms the transaction, cadit quaestio [the question falls]; or, if the majority challenges the transaction, there is no valid reason why the company should not sue.” This second aspect of the rule reflects the fact that the management of a company’s affairs is entrusted to the decision-making organs established by its articles of association, subject to the exceptional remedies mentioned in para 34 above. When a shareholder invests in a company, he therefore 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. As the court stated in Prudential at p 224:
“When the shareholder acquires a share he accepts the fact that the value of his investment follows the fortunes of the company and that he can only exercise his influence over the fortunes of the company by the exercise of his voting rights in general meeting.”
36. Accordingly, in a situation where a shareholder claims that his shares have fallen in value as a result of a loss suffered by the company, and the company has a right of action in respect of that loss, the shareholder can exercise such rights of control over its decision-making as have been granted to him by the articles of association. These normally provide for the ultimate control of the company’s affairs by a majority of the shareholders voting at a general meeting. A minority shareholder has other remedies available to him if the company’s management is acting improperly, including a derivative action and an application for relief against unfairly prejudicial conduct.
37. As the court observed in Prudential, to allow the shareholder in addition to pursue a personal action would subvert the rule in Foss v Harbottle. This is not merely a theoretical concern. Examples of the use of personal actions, post-Johnson, to circumvent the rule in Foss v Harbottle are discussed in paras 52-53 below. The existence of concurrent claims could also result in the shareholder’s preventing the company’s management from dealing with its claim in the way they considered appropriate in the best interests of the company, thereby undermining the rule in Foss v Harbottle. That could occur, for example, where the company’s management wanted to compromise the company’s claim but were prevented from doing so by the shareholder’s refusal to enter into a settlement with the wrongdoer. One can envisage other situations where the existence of concurrent claims could result in the shareholder’s acting contrary to the company’s interests, for example where the wrongdoer’s assets were inadequate to satisfy both claims. But the effect of the rule in Foss v Harbottle, as the court said in Prudential at p 224, is that “[the shareholder] accepts the fact that the value of his investment follows the fortunes of the company”. It is for that reason that the rule in Prudential has been said to recognise “the unity of economic interests which bind a shareholder and his company”: Townsing v Jenton Overseas Investment Pte Ltd [2007] SGCA 13; [2008] 1 LRC 231, para 77.
38. In addition to arguments based on Foss v Harbottle, there are also pragmatic advantages in a clear rule that only the company can pursue a right of action in circumstances falling within the ambit of the decision in Prudential. As Lord Hutton commented in Johnson at p 55, the rule in Prudential has the advantage of establishing a clear principle, rather than leaving the protection of creditors and other shareholders of the company to be given by a judge in the complexities of a trial. Those complexities should not be underestimated. Even without the complications arising from the existence of concurrent claims, it would not be straightforward to establish the extent, if any, to which a fall in the value of a company’s shares was attributable to a loss that it had suffered as a consequence of the defendant’s wrongdoing. But the existence of a concurrent claim by the company would add another dimension to the difficulties. It would be necessary, for example, to take account of the fact that the wrongdoing had resulted in the company’s acquiring an asset, namely its right of action against the defendant, which might have offset any detrimental effect of the wrongdoing on the value of his shares. It would also be necessary to consider the question of double recovery, and how it should be addressed both procedurally and substantively. Those issues might have to be addressed in the context of a proliferation of claims, possibly in different proceedings, at different times, and in different jurisdictions. They would also arise in a context where there might well be conflicts of interest between the shareholder and the company’s directors, its liquidator, other shareholders, and creditors.
39. In summary, therefore, Prudential decided that a diminution in the value of a shareholding or in distributions to shareholders, which is merely the result of a loss suffered by the company in consequence of a wrong done to it by the defendant, is not in the eyes of the law damage which is separate and distinct from the damage suffered by the company, and is therefore not recoverable. Where there is no recoverable loss, it follows that the shareholder cannot bring a claim, whether or not the company’s cause of action is pursued. The decision had no application to losses suffered by a shareholder which were distinct from the company’s loss or to situations where the company had no cause of action.
Johnson v Gore Wood & Co
40. The decision in Prudential was considered by the House of Lords in Johnson v Gore Wood & Co [2002] 2 AC 1. The case concerned alleged negligence on the part of solicitors acting for a private company, which caused it to suffer losses. The company brought proceedings against the solicitors, which were settled during the sixth week of the trial for a very substantial proportion of the sum claimed, as Lord Bingham explained at p 18. Mr Johnson, who owned virtually all the shares in the company and was its managing director, then brought proceedings against the solicitors in which he alleged that they had also acted in breach of a duty owed to him personally, and that he had suffered personal losses. The claim was struck out as an abuse of process. Mr Johnson appealed against the striking out of his claim, and the defendants cross-appealed to have certain heads of loss struck out on the ground that Mr Johnson was seeking to recover for damage which had been suffered by the company. It is only the latter aspect of the case which needs to be considered.
41. Lord Bingham stated at pp 35-36 that the authorities supported the following statement of principle:
“(1) Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder’s shareholding where that merely reflects the loss suffered by the company. A claim will not lie by a shareholder to make good a loss which would be made good if the company’s assets were replenished through action against the party responsible for the loss, even if the company, acting through its constitutional organs, has declined or failed to make good that loss. So much is clear from Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, particularly at pp 222-223, Heron International [Heron International Ltd v Lord Grade [1983] BCLC 244], particularly at pp 261-262, George Fischer [George Fischer (Great Britain) Ltd v Multi Construction Ltd [1995] 1 BCLC 260], particularly at pp 266 and 270-271, Gerber [Gerber Garment Technology Inc v Lectra Systems Ltd [1997] RPC 443] and Stein v Blake [[1998] 1 All ER 724], particularly at pp 726-729.
(2) Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding. This is supported by Lee v Sheard [1956] 1 QB 192, 195-196, George Fischer and Gerber.
(3) Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other. I take this to be the effect of Lee v Sheard, at pp 195-196, Heron International, particularly at p 262, R P Howard [RP Howard Ltd v Woodman Matthews & Co [1983] BCLC 117], particularly at p 123, Gerber and Stein v Blake, particularly at p 726. I do not think the observations of Leggatt LJ in Barings [Barings plc v Coopers & Lybrand [1997] 1 BCLC 427] at p 435B and of the Court of Appeal of New Zealand in Christensen v Scott [1996] 1 NZLR 273 at p 280, lines 25-35, can be reconciled with this statement of principle.”
42. In Lord Bingham’s proposition (1), the first sentence is a statement of the rule in Foss v Harbottle. The second sentence encapsulates the reasoning in Prudential, and explains why, in the circumstances described, a shareholder who is “suing in that capacity and no other” cannot bring a claim consistently with the rule in Foss v Harbottle. The third sentence should not be understood as limiting the rule in Prudential to cases where there is an exact correlation between the company’s loss and the fall in share value. As was explained at paras 32-38 above, it is possible to envisage cases where there is not a precise correlation, and where recovery by the company might not therefore fully replenish the value of its shares, but where the rule in Prudential would nevertheless apply.
43. Lord Bingham’s proposition (2), stating that a shareholder can sue for “reflective loss” where the company has no cause of action, on the authority of Lee v Sheard, George Fischer (Great Britain) Ltd v Multi Construction Ltd and Gerber Garment Technology Inc v Lectra Systems Ltd, merits closer consideration.
44. In Lee v Sheard the plaintiff was a company director and shareholder who earned his living by working for the company and being remunerated by distributions out of its profits. He suffered injuries in a road accident for which the defendant was responsible. He was unable to work while he recovered from his injuries, and as a result there was a fall in the company’s profits, which led to a reduction in the distributions paid to him. He recovered damages for his loss of earnings. The company had no cause of action against the negligent driver. This was not, therefore, a case concerned with concurrent claims. The plaintiff’s loss of earnings took the form of a reduction in distributions, but it was not “merely a reflection of the loss suffered by the company”, in the phrase used in Prudential (para 26 above). He, not the company, had been injured in the road accident. He, not the company, was entitled to recover damages for his loss.
45. In George Fischer (Great Britain) Ltd v Multi Construction Ltd, the defendant entered into a contract with the plaintiff company (“the shareholder”) to install equipment at the premises of one of its subsidiaries (“the company”). When the equipment proved defective, causing the company to suffer a loss of profits, the shareholder was held to be entitled to damages for breach of contract in respect of the loss which it had suffered as a result of the company’s reduced profits. That was another case where the wrong was committed against the shareholder, not the company. Since the company had no cause of action, there was no reason why the shareholder should not recover its loss by means of an award of damages, in accordance with ordinary principles.
46. Similar observations apply to Gerber Garment Technology Inc v Lectra Systems Ltd. The plaintiff company was the owner of a patent which was infringed, causing it to suffer a loss of income. As the commercial exploitation of the patent was carried on by its subsidiary, the plaintiff’s loss of income took the form of a reduction in the distributions it received from its subsidiary. But it was the plaintiff, not its subsidiary, whose patent was infringed, and which suffered a loss of income to which its ownership of the patent entitled it.
47. Lord Bingham’s proposition (3), stating (put shortly) that a shareholder can sue to recover a loss which is separate and distinct from that suffered by the company, reflects the fact that the shareholder’s loss, where it does not consist merely of a fall in the value of his shareholding, or in the distributions which he receives by virtue of his shareholding, does not fall within the ambit of the rule in Prudential. This proposition also makes it clear that the rule renders certain heads of loss irrecoverable, rather than barring a cause of action as such.
48. Lord Bingham went on to explain how courts should apply the relevant
principles:
“On the one hand the court must respect the principle of company autonomy, ensure that the company’s creditors are not prejudiced by the action of individual shareholders and ensure that a party does not recover compensation for a loss which another party has suffered. On the other, the court must be astute to ensure that the party who has in fact suffered loss is not arbitrarily denied fair compensation.” (p 36)
The aims identified in the first sentence - respecting the principle of company autonomy, ensuring that the company’s creditors are not prejudiced by the action of individual shareholders, and ensuring that a party does not recover compensation for a loss which another party has suffered - are all objectives or consequences of the rule in Foss v Harbottle, and are consistent with the decision in Prudential. The second sentence reflects the fact that deciding whether a loss falls within the scope of the rule may call for the exercise of judgement.
49. Before turning to Lord Bingham’s treatment of the losses claimed, it is necessary to consider Lord Millett’s speech, which lies at the origin of the expansion of the supposed “reflective loss” principle in the subsequent case law. Lord Millett began by discussing the relationship between the company’s assets and the value of its shares. A share, he said at p 62, “represents a proportionate part of the company’s net assets, and if these are depleted the diminution in its assets will be reflected in the diminution in the value of the shares”. But a share is not a proportionate part of the company’s net assets: see Macaura. The idea that a diminution in the value of a company’s net assets will be reflected in the value of the shares is therefore not an axiomatic truth, as was noted in para 32 above. The rule in Prudential is not premised on any necessary relationship between a company’s assets and the value of its shares (or its distributions).
50. Approaching the matter on the basis which he had described, Lord Millett observed at p 62 that the problem which arose, where the company suffered loss caused by the breach of a duty owed to it, and a shareholder claimed to have suffered a consequent diminution in the value of his shareholding or in distributions, caused by the breach of a duty owed to it by the same wrongdoer, was the risk of double recovery, on the one hand, or a risk to the company’s creditors through the depletion of its assets, on the other:
“If the shareholder is allowed to recover in respect of such loss, then either there will be double recovery at the expense of the defendant or the shareholder will recover at the expense of the company and its creditors and other shareholders. Neither course can be permitted … Justice to the defendant requires the exclusion of one claim or the other; protection of the interests of the company’s creditors requires that it is the company which is allowed to recover to the exclusion of the shareholder.”
51. As explained at para 33 above, the principle that double recovery should be avoided is not in itself a satisfactory explanation of the rule in Prudential. As was explained at paras 34-37 above, the unique position in which a shareholder stands in relation to his company, reflected in the rule in Foss v Harbottle, is a critical part of the explanation. In addition, as was explained at para 38 above, there are pragmatic advantages in adopting a clear rule. However, by treating the avoidance of double recovery - a principle of wider application - as sufficient to justify the decision in Prudential, Lord Millett paved the way for the expansion of the supposed “reflective loss” principle beyond the narrow ambit of the rule in Prudential.
52. One problem with reasoning based on the avoidance of double recovery is that the principle is one of the law of damages. It does not deny the existence of the shareholder’s loss, as the rule in Prudential does, where the loss falls within its ambit, but on the contrary is premised on the recognition of that loss. Applying an approach based on the avoidance of double recovery, it is therefore possible for a shareholder to bring a personal action based on a loss which would fall within the ambit of the decision in Prudential, and to obtain a remedy which that decision would have barred to him, provided the relief that he seeks is not an award of damages in his own favour. This device has been exploited in a number of cases subsequent to Johnson, in ways which circumvent the rule in Foss v Harbottle: a rule which is not confined to actions for damages but also applies to other remedies, as explained at para 35 above.
53. For example, in Peak Hotels and Resorts Ltd v Tarek Investments Ltd [2015] EWHC 3048 (Ch), the judge considered it arguable that the “reflective loss” principle, as explained by Lord Millett in Johnson, did not bar proceedings by a shareholder, who complained of a fall in the value of his shares resulting from loss suffered by the company in respect of which the company had its own cause of action, where the relief that he sought was not damages but a mandatory injunction requiring the defendant to restore property to the company. A similar view was taken in Latin American Investments Ltd v Maroil Trading Inc [2017] EWHC 1254 (Comm), where the shareholder complained of a fall in the value of its shares resulting from a breach of obligations owed to the company, which also involved a breach of contractual obligations owed to itself. It responded to the argument that its claim was for “reflective loss” by seeking an order for the payment of the contractual damages not to itself but to the company. A further example is Xie Zhikun v Xio GP Ltd, Cayman Islands Court of Appeal, unreported, 14 November 2018. Summarising complex facts, in that case the shareholder applied for a quia timet injunction to prevent the breach of fiduciary duties owed both to the company and to himself, which would cause the company to suffer loss, and would consequently affect the value of his interest in it. Sir Bernard Rix JA observed at para 66 that he did not see “how, other than perhaps in terms of pure formalism … the present case differs from … a derivative action”.
54. Those cases demonstrate how right the Court of Appeal was in Prudential in considering that the rule established in that case, based on the absence of separate and distinct loss, was necessary in order to avoid the circumvention of the rule in Foss v Harbottle. The exception to that rule is the derivative action. Whether a shareholder can bring such an action depends on whether the relevant conditions are satisfied.
55. The most obvious difficulty with the avoidance of double recovery, as an explanation of the judgment in Prudential, is perhaps its unrealistic assumption that there is a universal and necessary relationship between changes in a company’s net assets and changes in its share value. Another serious problem is its inability to explain why the shareholder cannot be permitted to pursue a claim against a wrongdoer where the company has declined to pursue its claim or has settled it at an undervalue, and the risk of double recovery is therefore eliminated in whole or in part.
56. In addressing this point, Lord Millett relied on a number of arguments, none of which, with respect, appears to me to be persuasive. The first was based on causation. Lord Millett stated at p 66 that, “if the company chooses not to exercise its remedy, the loss to the shareholder is caused by the company’s decision not to pursue its remedy and not by the defendant’s wrongdoing”. The same reasoning, he added, applies if the company settles for less than it might have done. The logic of the argument is that it is impossible for the shareholder to suffer a loss caused by the wrongdoer, since his actions result in the company’s loss being balanced by a right of action of equivalent value, so that its net assets are unaffected. It is only if the company fails to enforce its right of action that the shareholder can suffer a loss, and his loss will in that event be caused by the company. That reasoning might be contrasted with the logic of the argument based on the avoidance of double recovery, namely that the company’s loss results in the shareholders suffering an equivalent loss, because their shares “represent” the company’s net assets.
57. As Lord Hutton observed in Johnson at p 54, causation does not provide a satisfactory explanation. One difficulty is that the failure of the company to sue the wrongdoer, or its decision to settle with him for less than the full value of its claim, may be the result of its impecuniosity, caused by the defendant’s wrongdoing. In those circumstances, the company’s failure to recover its loss can hardly be regarded as interposing a novus actus interveniens between the defendant’s wrongdoing and the shareholder’s loss. Furthermore, in an economic tort case, where the shareholder’s claim is based on an allegation that the wrongdoer committed the wrongdoing with the intention of causing the shareholder to suffer loss, it is bizarre to say that the loss which the defendant intended to cause, and which ensued from his wrongdoing, was nevertheless not caused by what he did.
58. In addition to the causation argument, Lord Millett put forward at p 66 two other reasons, which he described as policy considerations, for excluding the shareholder’s claim where the company had settled its claim. The first was that the personal interests of the directors might otherwise conflict with their fiduciary duty to the company. Presumably Lord Millett was envisaging a situation where the directors were also shareholders, and might be tempted to settle the company’s claim at an undervalue, or fail to pursue it altogether, in order to recover the balance of the loss for their personal benefit. This reasoning does not, however, explain why shareholders are generally prevented from pursuing a claim for a fall in share value which is consequential on the company’s loss, when the company has its own cause of action: the principle is not confined to shareholders who are also directors. Nor is it apparent why, having prohibited directors from acting in breach of their fiduciary duties, the law should also impose a disability on shareholders (who normally owe the company no such duties) as an additional, indirect, and indiscriminate safeguard.
59. The second policy consideration was that it would be difficult for a liquidator to settle claims against wrongdoers for the benefit of the company’s creditors, if the wrongdoers remained exposed to further claims brought by the shareholders: the conduct of the company’s claims would effectively be taken out of the liquidator’s hands. This point is addressed by the rule in Prudential, consistently with the underlying rule in Foss v Harbottle, as was explained in para 37 above.
60. The most serious difficulty with the approach favoured by Lord Millett is that the possibility of double recovery can arise where concurrent claims exist at the instance of companies and of persons who have suffered loss otherwise than as shareholders. As will be explained, Lord Millett’s approach has been interpreted in subsequent cases as extending to such persons the same categorical exclusion of claims as he applied to shareholders. That is not the position on the approach adopted in Prudential: the loss suffered by a creditor, for example, when he cannot recover a debt owed to him by a company because of losses which it has incurred, stands in a different relationship to the company’s loss from the loss sustained by a shareholder whose shares have fallen in value, and raises different issues. This is discussed at paras 62-63 and 84-85 below.
61. Lord Millett went on to express the opinion that the concept of reflective loss
extended beyond the diminution of the value of shares and the loss of dividends,
stating at p 66 (omitting the citation):
“[I]t extends to … all other payments which the shareholder might have obtained from the company if it had not been deprived of its funds. All transactions or putative transactions between the company and its shareholders must be disregarded. Payment to the one diminishes the assets of the other. In economic terms, the shareholder has two pockets, and cannot hold the defendant liable for his inability to transfer money from one pocket to the other.” (Emphasis added)
It appears from the passage cited in para 62 below that those observations may have been intended to apply only to payments receivable by shareholders in that capacity, in which case they correctly recognise that distributions can take other forms besides the payment of dividends. However, the words that I have italicised repeat a point made earlier on p 66, when Lord Millett said:
“The test is not whether the company could have made a claim in respect of the loss in question; the question is whether, treating the company and the shareholder as one for this purpose, the shareholder’s loss is franked by that of the company.” (Emphasis added)
These passages appear to suggest that the separate legal personalities of the company and its shareholder are to be disregarded in this context. That would provide a simple explanation of why the company and its shareholders cannot have concurrent claims, but would also introduce an important exception to the fundamental principle in Salomon v A Salomon & Co Ltd, with potentially significant ramifications. That issue was not discussed.
62. In words which have had a particular influence on later developments, Lord Millett continued at p 67:
“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.”
This is not altogether easy to follow. Lord Millett’s reasoning in the preceding passage, cited (first) in para 61 above, is not transferable to persons whose claims are not brought as shareholders, but, for example, as employees or creditors of the company. As Lord Millett had indicated, a company may be regarded in economic terms as the alter ego of its shareholders. It cannot be regarded as the alter ego of its creditors or employees, or of shareholders whose claims are brought in the capacity of creditors or employees.
63. If Lord Millett meant that all claims against a wrongdoer in respect of amounts which the company would have paid to the claimant if it had had the necessary funds must be excluded where the company also has a cause of action, then I would respectfully regard the dictum as going further than was necessary for the decision of the appeal, and as being mistaken. For example, one might envisage a situation in which a creditor of a company has entered into a contract with the wrongdoer, the performance of which would have preserved the company’s solvency, and the wrongdoer then breaches the contract and also his duties to the company, rendering it insolvent and unable to pay the debt it owes to the creditor. If the creditor sues the wrongdoer for breach of contract, he is entitled to damages. The fact that the company also has a cause of action is no reason why the creditor should be deprived of the benefit of his contract. In the event that any issue of double recovery arises, it will need to be addressed; but that possibility is no reason for barring the creditor’s claim, regardless of whether any such issue arises in the particular case. Where the creditor’s claim against the wrongdoer is based on tort, it is equally important that he should not be deprived of the protection afforded by the law of tort, merely because the debt in question is owed to him by a company rather than a natural person.
64. Turning to the remaining speeches in Johnson, Lord Goff of Chieveley agreed with Lord Millett’s analysis. Lord Cooke of Thorndon accepted the correctness of the decision in Prudential, and agreed that the English authorities cited by Lord Bingham supported the three propositions which he had stated. He also concurred in the order proposed by Lord Bingham. On the other hand, some of his observations (at pp 45 and 47) suggest that he regarded the avoidance of double recovery and of prejudice to creditors as the critical considerations. Lord Hutton also emphasised those considerations (at p 54). He considered that the Prudential principle should be upheld, although he was critical of the reasoning in that case in so far as it denied that the shareholder had suffered a personal loss.
65. The decision on the facts of Johnson is also important. The House of Lords concluded that two of the heads of loss should be struck out. The first of these was a claim for the fall in the value of Mr Johnson’s shareholding in the company. Its being struck out followed from Lord Bingham’s proposition (1). The second was a claim for loss in respect of the value of a pension policy set up by the company for Mr Johnson’s benefit. Since the striking out of this head of loss has featured prominently in the subsequent case law, it is necessary to consider the matter in some detail. Mr Johnson claimed that he had suffered loss as a result of the company’s failure to make payments into the policy which it would have made out of its profits if it had not suffered the losses caused by the defendants. It was not suggested in any of the speeches, or in the judgment of the court below ([1999] BCC 474), that the company was under any obligation to Mr Johnson to pay the pension contributions. That aspect of his claim was not, therefore, brought as a creditor of the company. It appears, instead, that the pension contributions were a form of distribution of the company’s profits to its 99% shareholder: an alternative to the payment of dividends or bonuses.
66. Lord Bingham dealt with this aspect of the case extremely briefly: an
indication that he did not regard it as raising any issue which he had not already
addressed in his discussion of shareholders’ claims. He stated at p 36:
“[T]his claim relates to payments which the company would have made into a pension fund for Mr Johnson: I think it plain that this claim is merely a reflection of the company’s loss and I would strike it out.”
The other members of the House agreed. There is no indication in the speeches, other than possibly in the passage in Lord Millett’s speech cited at para 62 above, that the Appellate Committee intended, in its treatment of this element of Mr Johnson’s claim, to suggest that the principle which excluded a shareholder’s claim for a diminution in the value of his shares or in the distributions which he received should also apply to claims brought otherwise than in the capacity of a shareholder. Lord Bingham clearly intended that the principle which he had explained should be confined to claims brought in that capacity: see the second sentence of his proposition (1), cited in para 41 above. His conclusion that this head of loss should be struck out was consistent with the application of that proposition.
67. In summary, Johnson gives authoritative support to the decision in
Prudential that a shareholder is normally unable to sue for the recovery of a diminution in the value of his shareholding or in the distributions he receives as a shareholder, which flows from loss suffered by the company, for the recovery of which it has a cause of action, even if it has declined or failed to make good that loss. Lord Bingham’s speech is consistent with the reasoning in Prudential. On the other hand, the reasoning in the other speeches, especially that of Lord Millett, departs from the reasoning in Prudential and should not be followed.
Later cases
68. Johnson has been followed by a multitude of cases in which litigants, usually relying on the speech of Lord Millett, have sought either to establish exceptions to the general principles laid down by Lord Bingham, or to establish that the rule against the recovery of reflective loss extends more widely than Johnson had determined. One of the issues which remained controversial was whether, notwithstanding Lord Bingham’s analysis, there were circumstances in which a shareholder could recover for loss which flowed from the company’s loss where the company had a cause of action but failed to pursue it.
69. In Giles v Rhind [2003] Ch 618 the Court of Appeal decided that such circumstances existed. The claimant was a former company director who was also a shareholder in the company. He brought proceedings against a defendant who had conducted a business in competition with that of the company, in breach of contractual obligations owed to both the claimant and the company. The company’s action for damages had been discontinued due to its inability to find security for costs, as a result of impecuniosity caused by the defendant’s wrongdoing. The terms on which the action was discontinued precluded the company from bringing any further proceedings in relation to its claim. The claimant sought to recover for a variety of losses, including the loss of the value of his shares. The Court of Appeal allowed the claim to proceed to trial. It considered that it would be unjust to allow a wrongdoer to defeat a claim by shareholders on the basis that the claim was trumped by a right of action held by the company which his own wrongful conduct had prevented the company from pursuing. It concluded that the “reflective loss” principle, in so far as it was relevant, did not apply in those circumstances.
70. One can sympathise with the Court of Appeal’s sense of the unattractiveness of the defendant’s position, but the fact that a wrongdoer has unmeritoriously avoided his liability in damages to A is not a reason for requiring him to pay damages to B. The basis of the decisions in Prudential and Johnson is that a shareholder, whose shares have fallen in value as the consequence of loss suffered by the company for the recovery of which it has a cause of action, has not suffered a recoverable loss. That conclusion does not depend on whether the company is financially able to bring proceedings or not. If the shareholder has not suffered a recoverable loss, he has no claim for damages, regardless of whether, or why, the company may have failed to pursue its own cause of action.
71. The same criticism applies to the later decision in Perry v Day [2004] EWHC 3372 (Ch); [2005] 2 BCLC 405, where the court followed Giles v Rhind in a situation where the wrongdoer had abused his powers as a director of the company so as to prevent it from bringing a claim under which it could have recovered its loss. The solution which company law provides, in a situation of that kind, is the derivative action.
Gardner v Parker
72. A question left in doubt by Lord Millett’s speech in Johnson was how widely the bar on the recovery of reflective loss applied. That issue came before the Court of Appeal in Gardner v Parker [2004] EWCA Civ 781; [2004] 2 BCLC 554. The claim was brought by the assignee of rights of action held by a company (“the shareholder”) which was both a shareholder and a creditor of a second company (“the company”), against a defendant who was a director of both the shareholder and the company. He was alleged to have sold the company’s principal assets at an undervalue to another entity in which he had an interest, rendering the company insolvent, and preventing the shareholder from recovering the debt which the company owed it. In so acting, the defendant had acted in breach of fiduciary duties owed separately to the shareholder and to the company as a director of both of them. The shareholder then sought to recover in respect of the fall in the value of its shareholding, and also in respect of the loss arising from its inability to obtain repayment of the debt. Proceedings brought by another of the company’s creditors against the purchaser of the company’s assets had been resolved by a settlement, to which the company, acting by receivers appointed by that creditor over its property, and the defendant, were both party. Under the settlement, a payment was made to that creditor, and the defendant was released from all claims which the company might have against him (other than claims vested solely in its liquidators; but the company was not in liquidation).
73. The Court of Appeal considered three questions. The first was whether the “reflective loss” principle applied where the wrongdoing took the form of a breach of fiduciary duty rather than the breach of a duty arising under the common law. The court held that it did, following its earlier decision in Shaker v Al-Bedrawi [2003] Ch 350. That aspect of the decision is not challenged in the present appeal.
74. The second question was whether the exception established in Giles v Rhind ought to be extended to a situation in which the company had disabled itself, under a settlement with the wrongdoer, from bringing proceedings against him for the recovery of its loss. The court held that it should not. As I have explained, I would hold that no such exception exists.
75. The third question was whether the “reflective loss” principle applied to a claim arising from a creditor’s inability to recover a debt owed to it by a company in which the creditor was a shareholder. The court held that it did, relying on the treatment of the claim for loss of pension in Johnson’s case, and applying Lord Millett’s dictum, cited at para 62 above. Neuberger LJ stated at para 70:
“It is clear from those observations, and indeed from that aspect of the decision, in Johnson’s case that the rule against reflective loss is not limited to claims brought by a shareholder in his capacity as such; it would also apply to him in his capacity as an employee of the company with a right (or even an expectation) of receiving contributions to his pension fund. On that basis, there is 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.”
The claim brought as a creditor was therefore dismissed. Taking this reasoning to its logical conclusion, Neuberger LJ added (ibid) that the same reasoning should apply even where the employee or creditor was not also a shareholder.
76. As was explained in paras 65-66 above, on the facts of Johnson the claim in respect of lost pension contributions was a claim for a loss of distributions, brought by Mr Johnson in the capacity of a shareholder. It therefore fell within the scope of the reasoning in Prudential, and Lord Bingham’s proposition (1). The claim brought by the creditor-shareholder in Gardner v Parker did not fall within the scope of that reasoning, or Lord Bingham’s proposition. It should not have been barred as reflective loss. The court might have had to consider the avoidance of double recovery, applying the general principles discussed in paras 2-7 above, if that issue had been raised; but it was not.
77. The cases since Gardner v Parker have followed the approach adopted in that case. The supposed “reflective loss” principle has been treated as being based primarily on the avoidance of double recovery and the protection of a company’s unsecured creditors, and as being applicable in all situations where there are concurrent claims and one of the claimants is a company. So understood, the “reflective loss” principle, as Sir Bernard Rix JA observed in Xie Zhikun at para 95, “seems to be extending its scope wider and wider”. Sir Bernard added at para 96 that “a number of distinguished judges have commented on the uncertainties and difficulties of the reflective loss doctrine”. Professor Andrew Tettenborn has rightly warned that “[t]oday it promises to distort large areas of the ordinary law of obligations”: “Creditors and Reflective Loss: A Bar Too Far?” (2019) 135 Law Quarterly Review 182. The decision of the Court of Appeal in the present case, applying the approach laid down by Lord Millett in Johnson and by the Court of Appeal in Gardner v Parker, confirms that threat. It is the first case in this jurisdiction in which the “reflective loss” principle has been applied to a claimant which is purely a creditor of a company. The extension of the principle to such cases has the potential to have a significant impact on the law and on commercial life. The possibility of the further extension of the principle to creditors of natural persons, which the Court of Appeal considered, indicates the extent to which it has become difficult to confine. As the scope of the principle has expanded, so have the volume of litigation and the level of uncertainty.
Other jurisdictions
78. Almost 40 years have passed since Prudential was decided. The decisions in that case and in Johnson have been followed throughout much of the common law world, albeit sometimes on the basis of different reasoning. Without attempting an exhaustive survey, they have, for example, been followed in Australia (see, for example, Chen v Karandonis [2002] NSWCA 412 and Hodges v Waters (No 7) (2015) 232 FCR 97); in the Cayman Islands (see Xie Zhikun v Xio GP Ltd, Cayman Islands Court of Appeal, unreported, 14 November 2018, and Primeo Fund v Bank of Bermuda (Cayman) Ltd, Court of Appeal of the Cayman Islands, 13 June 2019); in Hong Kong (see, for example, Waddington Ltd v Thomas [2008] HKCU 1381; [2009] 2 BCLC 82, where Lord Millett’s approach in Johnson was followed, in a judgment delivered by Lord Millett NPJ, and Giles v Rhind was doubted and not followed); in Ireland (see, for example, Alico Life International Ltd v Thema International Fund plc [2016] IEHC 363, where the court followed the reasoning in Prudential, and of Lord Bingham in Johnson, and rejected the reasoning in Christensen v Scott [1996] 1 NZLR 273); in Jersey (Freeman v Ansbacher Trustees (Jersey) Ltd [2009] JRC 003; JLR 1, where the principle was treated, consistently with the reasoning in Prudential, as an aspect of the rule in Foss v Harbottle); and in Singapore (see, for example, Townsing v Jenton Overseas Investment Pte Ltd [2007] SGCA 13; [2008] 1 LRC 231, where the principle was explained as an aspect of the rule in Foss v Harbottle, and the reasoning in Christensen was rejected).
Summary
79. Summarising the discussion to this point, it is necessary to distinguish between (1) cases where claims are brought by a shareholder in respect of loss which he has suffered in that capacity, in the form of a diminution in share value or in distributions, which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer, and (2) cases where claims are brought, whether by a shareholder or by anyone else, in respect of loss which does not fall within that description, but where the company has a right of action in respect of substantially the same loss.
80. In cases of the first kind, the shareholder cannot bring proceedings in respect of the company’s loss, since he has no legal or equitable interest in the company’s assets: Macaura and Short v Treasury Comrs. It is only the company which has a cause of action in respect of its loss: Foss v Harbottle. However, depending on the circumstances, it is possible that the company’s loss may result (or, at least, may be claimed to result) in a fall in the value of its shares. Its shareholders may therefore claim to have suffered a loss as a consequence of the company’s loss. Depending on the circumstances, the company’s recovery of its loss may have the effect of restoring the value of the shares. In such circumstances, the only remedy which the law requires to provide, in order to achieve its remedial objectives of compensating both the company and its shareholders, is an award of damages to the company.
81. There may, however, be circumstances where the company’s right of action is not sufficient to ensure that the value of the shares is fully replenished. One example is where the market’s valuation of the shares is not a simple reflection of the company’s net assets, as discussed at para 32 above. Another is where the company fails to pursue a right of action which, in the opinion of a shareholder, ought to have been pursued, or compromises its claim for an amount which, in the opinion of a shareholder, is less than its full value. But the effect of the rule in Foss v Harbottle is that the shareholder has entrusted the management of the company’s right of action to its decision-making organs, including, ultimately, the majority of members voting in general meeting. If such a decision is taken otherwise than in the proper exercise of the relevant powers, then the law provides the shareholder with a number of remedies, including a derivative action, and equitable relief from unfairly prejudicial conduct.
82. As explained at paras 34-37 above, the company’s control over its own cause of action would be compromised, and the rule in Foss v Harbottle could be circumvented, if the shareholder could bring a personal action for a fall in share value consequent on the company’s loss, where the company had a concurrent right of action in respect of its loss. The same arguments apply to distributions which a shareholder might have received from the company if it had not sustained the loss (such as the pension contributions in Johnson).
83. The critical point is that the shareholder has not suffered a loss which is regarded by the law as being separate and distinct from the company’s loss, and therefore has no claim to recover it. As a shareholder (and unlike a creditor or an employee), he does, however, have a variety of other rights which may be relevant in a context of this kind, including the right to bring a derivative claim to enforce the company’s rights if the relevant conditions are met, and the right to seek relief in respect of unfairly prejudicial conduct of the company’s affairs.
84. The position is different in cases of the second kind. One can take as an example cases where claims are brought in respect of loss suffered in the capacity of a creditor of the company. The arguments which arise in the case of a shareholder have no application. There is no analogous relationship between a creditor and the company. There is no correlation between the value of the company’s assets or profits and the “value” of the creditor’s debt, analogous to the relationship on which a shareholder bases his claim for a fall in share value. The inverted commas around the word “value”, when applied to a debt, reflect the fact that it is a different kind of entity from a share.
85. Where a company suffers a loss, it is possible that its shareholders may also suffer a consequential loss in respect of the value of their shares, but its creditors will not suffer any loss so long as the company remains solvent. Even where a loss causes the company to become insolvent, or occurs while it is insolvent, its shareholders and its creditors are not affected in the same way, either temporally or causally. In an insolvency, the shareholders will recover only a pro rata share of the company’s surplus assets, if any. The value of their shares will reflect the value of that interest. The extent to which the company’s loss may affect a creditor’s recovery of his debt, on the other hand, will depend not only on the company’s assets but also on the value of any security possessed by the creditor, on the rules governing the priority of debts, and on the manner in which the liquidation is conducted (for example, whether proceedings are brought by the liquidator against persons from whom funds might be ingathered, and whether such proceedings are successful). Most importantly, even where the company’s loss results in the creditor also suffering a loss, he does not suffer the loss in the capacity of a shareholder, and his pursuit of a claim in respect of that loss cannot therefore give rise to any conflict with the rule in Foss v Harbottle.
86. The potential concern that arises in relation to claims brought by creditors is not, therefore, the rule in Foss v Harbottle. On the other hand, the principle that double recovery should be avoided may be relevant, although it is not necessarily engaged merely because the company and the creditor have concurrent claims against the same defendant. In International Leisure Ltd v First National Trustee Co UK Ltd [2013] Ch 346, for example, the principle was not engaged where the company and a secured creditor had concurrent claims against an administrative receiver whom the creditor had appointed, since the company could only claim in respect of any loss remaining after the secured creditor had been paid in full.
87. Where the risk of double recovery arises, how it should be avoided will depend on the circumstances. It should be borne in mind that the avoidance of double recovery does not entail that the company’s claim must be given priority. Nor, contrary to the view expressed in a number of authorities, including the decision of the Court of Appeal in the present case, does the pari passu principle entail that the company’s claim must be given priority. That principle requires that, in a winding- up, a company’s assets must be distributed rateably among its ordinary creditors. The proceeds of its recovery from a wrongdoer will form part of its assets available for distribution (subject to the claims of secured and preferred creditors). But the pari passu principle does not give the company, or its liquidator, a preferential claim on the assets of the wrongdoer, over the claim of any other person with rights against the wrongdoer, even if that claimant is also a creditor of the company. In other words, the pari passu principle may restrict a creditor of an insolvent company to the receipt of a dividend on the amount which the company owes him, but it does not prevent him from enforcing his own right to recover damages from a third party, or confer on the company’s right against the third party an automatic priority. In the event that the third party cannot satisfy all the claims made against him, the position will be regulated by the law of (his) insolvency.
187. In my view, the same flawed premise underlies the following two paragraphs in Lord Millett’s speech, which have particular relevance in the context of the present appeal concerning the application of the reflective loss principle to claims brought by a creditor of a company ([2002] 2 AC 1, 66G-67C):
“Reflective loss extends beyond the diminution of the value of the shares; it extends to the loss of dividends (specifically mentioned in [Prudential]) and all other payments which the shareholder might have obtained from the company if it had not been deprived of its funds. All transactions or putative transactions between the company and its shareholders must be disregarded. Payment to the one diminishes the assets of the other. In economic terms, the shareholder has two pockets, and cannot hold the defendant liable for his inability to transfer money from one pocket to the other. In principle, the company and the shareholder cannot together recover more than the shareholder would have recovered if he had carried on business in his own name instead of through the medium of a company. On the other hand, he is entitled (subject to the rules on remoteness of damage) to recover in respect of a loss which he has sustained by reason of his inability to have recourse to the company’s funds and which the company would not have sustained itself.
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. The plaintiff’s primary claim lies against the company, and the existence of the liability does not increase the total recoverable by the company, for this already includes the amount necessary to enable the company to meet it.”
188. The analogy with a shareholder with two pockets does not give appropriate recognition to the separate legal personality of a company, as emphasised in the Salomon case. The analogy assumes, incorrectly, that the loss suffered by the company is identical with the loss suffered by the shareholder. Starting from that assumption, Lord Millett would extend the reflective loss principle to prevent recovery from a wrongdoing defendant by a creditor of the company who suffers the loss of being unable to recover what he is owed by the company as a result of the wrong done at the same time by the defendant to him and the company. His speech therefore provides support for Mr Sevilleja’s case on this appeal. I will discuss the position of creditors after finishing this discussion of Johnson.
189. Lord Cooke stated that he had difficulty with the part of Lord Bingham’s speech dealing with the recoverability of damages by Mr Johnson on his personal claim against GW. Although he was at pains not to criticise the decision in Prudential ([2002] 2 AC 1, 43A and 45F), he observed that the cash box illustration was not helpful in the Johnson case “because it does not envisage any loss except of the company’s £100,000” ([2002] 2 AC 1, 42G-43B). In other words, the illustration proceeds on the basis that the company’s loss and the shareholder’s loss are identical, as was also true of the analysis in Stein v Blake. Lord Cooke agreed that the English authorities cited by Lord Bingham supported the three propositions stated by him. Nonetheless, Lord Cooke was not willing to dismiss the statement of the law by Thomas J in Christensen v Scott and pointed out that Leggatt LJ in Barings and Hobhouse LJ in Gerber (at [1997] RPC 443, 475) had regarded it as in line with English legal principles. Lord Cooke observed that the court in Christensen v Scott had been guarded in its approach and he stated that if a client is suing his own solicitor, “it would appear that only the problems of double recovery or prejudice to the company’s creditors would justify denying or limiting the right to recover personal damages which, on ordinary principles of foreseeability, would otherwise arise” ([2002] 2 AC 1, 45D-E; also 47E and 48B). Despite his reservations about Lord Bingham’s reasoning, however, Lord Cooke was prepared to agree the order proposed by him, as were the other members of the appellate committee ([2002] 2 AC 1, 48B-E).
190. Lord Hutton also agreed with the order proposed by Lord Bingham, but his analysis was different from the others. Lord Hutton noted that the basis on which Prudential had been distinguished by Hobhouse LJ in Gerber (on the footing that the shareholder claimants in Prudential did not have an individual cause of action) was invalid, since the Court of Appeal considered that they did have such a cause of action (however, see para 148 above); contrary to the view of Hobhouse LJ in Gerber, Lord Hutton stated (correctly, in my view) that the ruling against the shareholder claimants in Prudential could not be explained on the ground of causation; and he agreed (again correctly, in my view) with the court in Christensen v Scott that the shareholders could be regarded as suffering a personal loss caused by breach of duty of the defendant, different from the loss of the company, and considered that the reasoning in Prudential on this point was open to criticism ([2002] 2 AC 1, 54). However, he stated that there is a need to ensure that there is no double recovery and that creditors and the other shareholders of the company are protected: [2002] 2 AC 1, 54H-55D. On that basis, faced with the conflict between Prudential and Christensen v Scott, Lord Hutton preferred to endorse the approach in Prudential despite the flaws in its reasoning, since it provided a bright line rule to debar a shareholder from bringing a claim without the need for “the complexities of a trial” to examine the extent of overlap between the loss of the claimant shareholder and the loss of the company. A bright line rule of this character would ensure that there would be no double recovery and that the creditors and other shareholders would be protected; it would also avoid the possibility of conflicts of interest between directors and some shareholders or between liquidator and some shareholders: [2002] 2 AC 1, 55C-G.
191. I disagree with this last step in the reasoning of Lord Hutton. None of the other law lords endorsed this. The problem, as I see it, is that the factors mentioned by Lord Hutton do not justify depriving a claimant shareholder who has suffered a loss different from the loss suffered by the company of what Lord Hutton accepted would otherwise be a perfectly valid cause of action in his own right. I also agree with Mitchell’s criticism of Lord Hutton’s bright line approach, that it proves too much, in that it would prevent recovery by a shareholder even if there is no policy reason to support this, eg in a case where the company itself never had a cause of action against the defendant: (2004) 120 LQR 457, 460.
192. It is a very strong thing for a bright line rule to be introduced in the common law as a matter of policy to preclude what are otherwise, according to ordinary common law principles, valid causes of action; especially on the basis of the very summary explanation given by Lord Hutton. Whilst, as noted above, it would allow for simple and speedy resolution of disputes, the price to be paid for that is too high. The effect of Lord Hutton’s bright line rule would be disproportionate and arbitrary. So long as there is any degree of overlap between the company’s loss and the shareholder’s loss, however small the degree of overlap and however large the shareholder’s loss might be, it seems that the shareholder’s claim must fail in limine. And this is so even though, as explained above, the claimant shareholder’s loss would be calculated after due allowance for the effect of rights of action which the company would have against the wrongdoing defendant and even though the law has other techniques available to deal with issues of conflict of interest which might arise.
193. It is also a rule which, in my view, gives undue priority to the interests of other shareholders and creditors of the company in circumstances where the claimant shareholder is not subject to any obligation to subordinate his interest in vindicating his personal rights to their interests. Insolvency law is a regime which already makes appropriate provision to cater for the possibility that the defendant does not have sufficient assets to meet all claims against him, and there is no good policy basis for recognition of the reflective loss principle at common law to supplement that regime. Further, there will be cases where there is in fact no difficulty in the defendant being able to meet all claims.
194. In summary, in my respectful opinion the reasoning in Johnson, in so far as it endorses the reflective loss principle as a principle debarring shareholders from recovery of personal loss which is different from the loss suffered by the company, ought not to be followed. The reasoning of Lords Bingham, Goff and Millett purports to be based on the logic in the Prudential case, which on critical examination is not sustainable. The reasoning of Lord Hutton relies on a policy- based bright line exclusionary rule which is not justified. The reasoning of Lord Cooke is suspended uneasily between the majority and Lord Hutton. Lord Cooke endorsed the decision in Prudential (and in my opinion was right to do so as to the result: para 148 above), albeit he was unwilling to disclaim the judgment in Christensen v Scott (even though the reasoning in the two cases cannot be reconciled, a fact which he was not prepared to acknowledge); and to the extent that, like Lord Hutton, he emphasised that there should not be double recovery and that the company’s other shareholders and creditors should be protected, in my view he gave insufficient attention to the ways in which the law already allows for the risk of double recovery to be taken into account and did not explain why the interests of the company’s other shareholders and creditors should take priority over the interests of the claimant shareholder suing to vindicate a personal cause of action.
195. Lord Reed points out (para 78) that the decisions in Prudential and Johnson
have been followed in other common law jurisdictions. However, whilst there is some variation in the reasoning which is deployed, the courts in those jurisdictions have not given Prudential and Johnson the same interpretation as Lord Reed gives them. To a substantial degree they have regarded them as being concerned with the issues of double recovery and protection of the interests of creditors and other shareholders of the company, which I have addressed above: see eg the discussion at para 164 above of the judgment of the Court of Appeal of Singapore in Townsing v Jenton Overseas Investment Pte Ltd. This is not surprising, given that in Johnson Lords Millett, Goff, Cooke and Hutton all identified these as the important issues by reference to which the reflective loss principle fell to be justified, and Lord Bingham (as I read his speech) did not dispute this.
196. Flaux LJ in his judgment in the Court of Appeal in the present case at para 32 distilled a four-fold justification for the reflective loss principle, principally derived from the speech of Lord Millett in Johnson: (i) the need to avoid double recovery by the claimant shareholder and the company from the defendant; (ii) causation, in the sense that if the company chooses not to claim against the wrongdoer, the loss to the claimant is caused by the company’s decision not by the defendant’s wrongdoing ([2002] 2 AC 1, 66; also per Chadwick LJ in Giles v Rhind, para 78); (iii) the public policy of avoiding conflicts of interest, particularly that if the claimant had a separate right to claim it would discourage the company from making settlements; and (iv) the need to preserve company autonomy and avoid prejudice to minority shareholders and other creditors.
197. In my opinion, none of these considerations in fact provides a viable justification for the reflective loss principle. Points (i) and (ii) reflect Lord Millett’s incorrect view that the loss suffered by the company is the same as the loss suffered by the shareholder (to the extent of his shareholding), and ignore the ways in which the law takes account of the need to avoid double recovery by other means. Point (iii) also reflects Lord Millett’s view regarding the identity of the loss suffered by the company and the loss suffered by the shareholder, and ignores the availability of other mechanisms to deal with conflicts of interest on the part of directors and the interest that a defendant would have in settling with a company which makes a claim in parallel with a personal claim made by a shareholder. Point (iv) again reflects Lord Millett’s view regarding identity of loss; it ignores the fact that company autonomy (safeguarded by the rule in Foss v Harbottle) remains in place as regards any cause of action vested in the company; and it gives undue weight to protection of other shareholders and other creditors.
The reflective loss principle and claims by creditors of the company
198. The discussion above indicates that the reflective loss principle as stated in
Prudential is a flimsy foundation on which to build outwards into other areas of the law, and particularly when it is sought to be deployed in answer to Marex’s claim in the present case. Marex was not a shareholder in the Companies, but their creditor. In my view this means that there is even less reason for saying that its interest in obtaining recovery directly from Mr Sevilleja should be eliminated by virtue of the fact that the Companies also have claims against him. A creditor of a company has not chosen to be in a position where he is required to follow the fortunes of the company in the same way as a shareholder. Subject to the company having sufficient assets, whether the creditor gets paid or not does not depend on the decision of the directors, as payment of a dividend to a shareholder does: when armed with a court judgment the creditor can execute it against the assets of the company. Moreover, there is a clear mechanism available to meet the problem of possible double recovery against the defendant in respect of the loss suffered by Marex and the loss suffered by the Companies. To the extent that Marex sues Mr Sevilleja and obtains recovery from him for the judgment sum, Mr Sevilleja can be subrogated to Marex’s rights against the Companies or allowed a right of reimbursement in respect of them.
| 201. The question which arises, therefore, is whether the fact that Marex’s debtor a right of reimbursement against the Companies, as they are the primary obligee in respect of the debt obligations: Moule v Garrett (1872) LR 7 Ex 101; Duncan Fox & Co v North & South Wales Bank (1880) 6 App Cas 1, 10 per Lord Selborne LC; Goff & Jones, The Law of Unjust Enrichment, 9th ed (2016), paras 19-19 to 19-21. If Mr Sevilleja seeks to compromise Marex’s claim, he could make it a term of their agreement that he takes an assignment of Marex’s rights as creditor. Absent such agreement, a court ruling on Marex’s claim against him could impose as a condition for the grant of relief that Marex should assign its rights to him to an appropriate extent or that it should acknowledge his payment as discharging the debt to that extent, thereby bringing into effect a right of reimbursement in favour of Mr Sevilleja pursuant to Moule v Garrett. is a company rather than an individual should make any difference. In my view, | there is no good reason why it should. |
| 203. Even if these mechanisms were not pursued and payment by Mr Sevilleja did not discharge the debts of the Companies, in my view Mr Sevilleja would have a right to be subrogated to an appropriate extent to the rights of Marex as against the Companies. In my opinion, this would in fact be the simplest and most appropriate solution. Subrogation is a flexible equitable remedy which would be available in this case for basic reasons of equity and natural justice similar to those which underlie the rule in Moule v Garrett, in order to ensure that neither the Companies (if Marex did not sue them on the debts) nor Marex (if it did sue them on the debts) would receive a windfall enrichment by virtue of the payment by Mr Sevilleja of the judgment sum or part thereof: see Banque Financière de la Cité v Parc (Battersea) Ltd [1999] 1 AC 221 and Swynson Ltd v Lowick Rose LLP (formerly Hurst Morrison Thomson LLP) [2017] UKSC 32; [2018] AC 313, paras 18-19 per Lord Sumption; and C Mitchell and S Watterson, Subrogation Law and Practice (2007), paras 1.01 to 1.03, 1.07 and 1.08. | |
| 204. Again, the decision of the High Court in Gould v Vaggelas provides a helpful illustration. The case was concerned with a situation in which a company owed money to creditors (who happened to be shareholders, but who sued the defendants relying on their capacity as creditors of the company), which the company had been prevented from repaying by reason of losses suffered as a result of a deceit practised on it by the defendants. As Brennan J put it at p 253: “The [claimants’] loss is the loss suffered by a creditor of the company which, apart from its cause of action in deceit, is worthless”. The position was in my view analogous to that in the present case. The High Court held that the claimants were entitled to sue the defendants to vindicate their personal rights in respect of the loss suffered by them as a result of the failure of the company to repay the loans. The justices who directly considered the question of what would happen if the defendants paid the claimants the equivalent of the money owed to them by the company while claims against the defendants by the company remained on foot were clear that the justice of the case would require that the claimants could not take the benefit of sums which the company might later be able to repay: see p 246 per Wilson J and pp 258-259 per Brennan J. Gibbs CJ at p 229 referred to the possibility of there being a right of subrogation for the defendants should the company later be able to pay back the loans. | |
| 205. The most considered discussion was that by Brennan J, who observed that since satisfaction of the claimants’ judgment against the defendant would not discharge the company from liability for the company’s debt, a right of reimbursement under the principle in Moule v Garrett would not arise; but said that the defendant would be subrogated to the claimants’ rights against the company in respect of the loans (p 259). Save that, as indicated above, I think there would be ways in which the principle in Moule v Garrett might be brought into operation, I agree with Brennan J’s analysis. | |
| 206. Turning to address the four considerations identified by Flaux LJ at para 32 of his judgment, this time in the context of liability in respect of a claim by a creditor of a company, I do not consider that they justify excluding Marex’s claim against Mr Sevilleja, even if (contrary to my view above) they might have force in respect of a claimant shareholder’s claim. Point (i) (the need to avoid double recovery) is satisfied by recognising that Mr Sevilleja will have a right to be subrogated to Marex’s right of action against the Companies, to the extent that he makes a payment referable to the debts they owe Marex. Point (ii) (absence of causation, because the claimant’s rights depend on the company’s decision) has no force, because Marex’s right to seek payment from the Companies had already accrued and was not dependent on a choice to be made by the Companies. Mr Sevilleja’s wrongdoing clearly caused loss to Marex because it prevented Marex from being able to execute a judgment in respect of the judgment sum against the Companies’ assets. Point (iii) (avoidance of conflicts of interest and discouraging settlements by the company) similarly has no force. The Companies were obliged to pay Marex to satisfy its accrued rights against them, so it was out of the hands of their directors and not a matter of discretion whether they should do so or not. If the liquidator of the Companies seeks a compromise of their claims against Mr Sevilleja, it is open to Mr Sevilleja to bargain for protection against double liability if Marex is also successful in obtaining payment from him. Point (iv) (preservation of company autonomy and avoidance of prejudice to minority shareholders and other creditors) also cannot justify dismissing Marex’s claim. The Companies have no autonomy to exercise as regards the debt claim against them, and have no right or power of control in respect of Marex’s own property in the form of its rights of action against Mr Sevilleja. If the Companies had been insolvent at the time of Mr Sevilleja’s wrongdoing so that, but for his actions, Marex would only have received, say, 50% of the value of what was due to it, its claim for damages against Mr Sevilleja would be limited to that amount. It is not apparent that minority shareholders or other creditors of the Companies would suffer unacceptable detriment from allowing Marex to proceed directly against Mr Sevilleja. In any event, as explained above, there is no rule which governs the order in which people can seek to vindicate their rights against others; and even less than in the case of a shareholder can it be said that an ordinary creditor of a company has undertaken not to seek to enforce his rights against the wrongdoing defendant in order to safeguard the interests of the shareholders and other creditors of that company. | |
| 207. There is an additional consideration in respect of point (iv) which arises on the facts of this case which I should mention, albeit I prefer to state the reasons why Marex’s appeal should succeed in more general terms. It appears that Mr Sevilleja is very wealthy and both for that reason and because there is no indication that the liquidator proposes to pursue the Companies’ claims against him, it does not seem that there is any real risk that the creditors of the Companies will in fact find themselves less well off if Marex’s claim against him is allowed to proceed than they would otherwise have been. | |
| 208. There is support from Lord Millett’s speech in Johnson (at [2002] 2 AC 1, 66G-67C, quoted above) for Mr Sevilleja’s submission that the reflective loss principle precludes a claim against him by Marex, as a creditor of the Companies, in respect of loss suffered by Marex as a result of the non-payment by the Companies of the judgment sum. Lord Bingham also arguably provides implicit support for Mr Sevilleja’s submission, in that he struck out Mr Johnson’s claim under head (3) for payments which the company would have made into a pension fund for his benefit. It seems that these would have been discretionary, non-contractual payments for Mr Johnson’s benefit as part of his remuneration, not payments by way of dividend. Lord Bingham did not suggest that it would make a difference if these payments constituted remuneration to which Mr Johnson was contractually entitled. | |
| 209. There is also support for Mr Sevilleja’s submission in the judgment of Neuberger LJ in Gardner v Parker [2004] EWCA Civ 781; [2004] 2 BCLC 554, with which Mance LJ and Bodey J agreed. The case concerned the claim of a company (BDC), as assigned to the claimant in the proceedings, against its sole director, Mr Parker. BDC’s principal assets were a 9% shareholding in another company, S Ltd (of which Mr Parker was also the sole director and in which he held 91% of the shares), and a debt of £799,000 owed to BDC by S Ltd. The claimant alleged that, in breach of the fiduciary duties he owed to BDC and S Ltd, Mr Parker procured the sale by S Ltd of its principal asset at an undervalue to another company in which Mr Parker had an interest; that his purpose in doing so was to extract from S Ltd its most valuable asset to the detriment of BDC or to damage BDC; and that as a consequence of the sale S Ltd became insolvent. It was pleaded that, as a consequence, the value of BDC’s 9% shareholding in S Ltd was reduced to nil and the value of the loan due from S Ltd was also reduced to nil. Neuberger LJ held that the losses claimed by BDC in its capacity as creditor of S Ltd were caught by the reflective loss principle, as were BDC’s claims in its capacity as shareholder in S Ltd, with the result that it could not claim in respect of them: paras 35 and 67-75. Neuberger LJ relied on the speeches of Lord Bingham and, in particular, Lord Millett in Johnson. Proceeding on the basis of the reasoning in those speeches, Neuberger LJ observed that there was no logical reason why the reflective loss principle should not apply to a shareholder in his capacity as a creditor of the company and added that “it is hard to see why the [reflective loss principle] 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” (para 70). According to Neuberger LJ, the creditor would not be without remedies; he “can put the company into liquidation (if that has not already happened) and can either fund a claim by the liquidator against the defendant or, as Mr Gardner did in relation to BDC, he can take an assignment of the company’s claim” (para 74). Neuberger LJ observed that the arguments for the claimant were more consistent with the approach in Christensen v Scott, but that decision had been disapproved in Johnson. Accordingly, in his view, although the claimants’ arguments were “not without force, although not without difficulties either”, they could only be accepted at the highest level if it was thought appropriate to reconsider the reflective loss principle (para 75). | |
| 210. The Court of Appeal in the present case followed these authorities in respect of Marex’s claims, based as they are on its being a creditor of the Companies. In this court, it is open to us to re-examine them from the point of view of principle, rather than to treat them as binding authority. | |
| 211. In my judgment, the foundation in the reasoning of Lord Bingham and Lord Millett regarding the reflective loss principle in respect of shareholder claimants is not sustainable. I would not follow Johnson in so far as it endorsed the reflective loss principle identified in Prudential in relation to claims by shareholder claimants. But even if the principle is to be preserved in relation to such claimants, the questionable nature of the justification for it means that it is appropriate for this court to stand back and ask afresh whether it can be justified as a principle to exclude otherwise valid claims made by a person who is a creditor of the company. We are not trapped by Prudential and the speeches of Lord Bingham and Lord Millett in Johnson in the way in which the Court of Appeal in Gardner v Parker felt that it was bound by their reasoning. For the reasons given above, I would hold that the reflective loss principle, if it exists, does not apply in the present case. | |
| The exception in Giles v Rhind | |
| 212. In view of my conclusion that the reflective loss principle does not apply in this case, the question regarding the ambit of the exception to that principle which was identified in Giles v Rhind does not arise. However, it is worth pointing out that the exception was identified in an effort to achieve practical justice against the backdrop of an assumption that the reflective loss principle stated in Prudential was valid. If Prudential is held to lay down a bright line rule of law deeming reflective loss not to be a loss, whatever the true position on the facts, and that bright line rule is endorsed, cases such as Giles v Rhind, exemplifying the dissonance between the rule and practical justice on the facts, will continue to arise. This will put pressure on the acceptability of the rule itself. | |
| Conclusion | |
| 213. For the reasons set out above, I would allow Marex’s appeal and permit it to proceed with its OBG claim and Lumley v Gye claim directly against Mr Sevilleja. |
199. If Marex’s debtor had been an individual and Mr Sevilleja had stolen all his assets with a view to preventing him paying the debt due to Marex, it would be possible for Marex to bring an OBG claim against him, in line with the part of the judgment of Robin Knowles J which is not under appeal. Also, in line with that part of the judge’s judgment, Marex would arguably have been able to bring a Lumley v Gye claim against him. By his tortious actions, Mr Sevilleja would have made himself, in a practical sense, jointly and severally liable with the individual debtor in respect of the amount of the unpaid debt and Marex could sue either or both of them. Marex would not be required to sue the individual debtor to make him bankrupt and then seek to procure his trustee in bankruptcy to pursue Mr Sevilleja in the hope that a recovery would eventually lead to it receiving a dividend in the bankruptcy (after deduction of the trustee’s fees). Mr Sevilleja’s torts in respect of Marex would create a direct nexus between them of such force that Marex’s rights against him would not have to be postponed behind any proof in the individual debtor’s bankruptcy in this way.
200. To the extent that the individual debtor or Mr Sevilleja paid the money due, Marex would have to give credit in pursuing the other. To the extent that Mr Sevilleja paid Marex a sum representing money owed by the individual debtor (which he would have had to pay Marex had Mr Sevilleja not stolen all his assets), the justice of the case would require that the individual debtor should give credit for that when suing Mr Sevilleja in relation to the theft. In my view, this outcome could readily be achieved in a case involving an individual debtor.
| JUDGMENT |
Sevilleja (Respondent) v Marex Financial Ltd
(Appellant)
before
Lady Hale Lord Reed
Lord Hodge Lady Black
Lord Lloyd-Jones
Lord Kitchin
Lord Sales
JUDGMENT GIVEN ON
15 July 2020
Heard on 8 May 2019
13
5
0