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27 July 2020

Supreme Court decides that reflective loss rule does not bar claims made by unsecured creditors

In what is being described as a landmark decision, on 15 July 2020, the Supreme Court handed down a decision which significantly narrowed the scope of the so-called rule against recovery of reflective loss.

The “reflective loss” Principle

The rule prevents claims by shareholders of a company to recover loss suffered as a result of a defendant’s wrongdoing against the company, and has existed since the 1981 Court of Appeal decision in Prudential Assurance v Newman Industries (No 2) [1982] 1 Ch 204. The decision, and the rule, was subsequently broadened by the House of Lords in Johnson v Gore Wood [2002] 2 AC 1, to bar any claims made by a shareholder in his other capacities as a shareholder, employee or, importantly, a creditor.

The Supreme Court decision in the recent case of Sevilleja (Respondent) v Marex Financial Ltd (Appellant) (on Appeal) [2020] UKSC 31 found that the reflective loss principle has no application in the case where the claimant is a creditor and not a shareholder.

Background

Marex Financial Ltd (Marex) obtained judgment against two companies incorporated in the British Virgin Islands (the Companies) of which Mr Sevilleja was the owner and controller. Following the circulation of the judgment in draft, Mr Sevilleja stripped the Companies of their assets, thereby rendering them insolvent.

Marex issued proceedings against Mr Sevilleja seeking damages for procuring a violation of its rights under the judgment, and for intentionally causing loss to Marex by unlawful means. Marex obtained permission to serve proceedings on Mr Sevilleja out of the jurisdiction. Mr Sevilleja appealed against the permission, on the grounds that Marex did not have a good arguable case against him because the loss suffered by Marex was irrecoverable due to the reflective loss principle i.e. the loss was suffered by the Companies, not Marex.  

In his application, Mr Sevilleja relied upon the principle established by the Court of Appeal in Prudential, 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 the company chose not to bring proceedings in respect of the same. Mr Sevilleja also relied on the decision of Lord Millet in Johnson v Gore Wood, which extended the principle in Prudential to cover a much wider range of potential claimants.

Supreme Court Judgment

The Supreme Court determined that the reflective loss rule has no application in the case of Marex’s claim where it is a creditor and not a shareholder.

The judgment, which expands to some 82 pages, involves a careful consideration of the previous law on the principle of reflective loss and as the Supreme Court has now significantly curtailed the principle, which is likely to have an immediate impact in practice.

Whilst the decision of the Supreme Court was unanimous, the judgments varied and there was no consensus on the question of how far the Court should go in refining the reflective loss principle. This led to a 4:3 split. The majority (led by Lord Reed) decided to retain the reflective loss principle as a bright line legal rule, albeit it should be confined to the narrow ambit established in Prudential. The minority (led by Lord Sales) would have been more radical and, in effect, abolished the rule entirely.

Lord Hodge in his judgment concurring with Lord Reed said the expansion of the reflective loss principle “has had unwelcome and unjustifiable effects on the law”, and if it had been applied in this case, “would result in great injustice.”

The removal of this injustice is likely to be welcomed by victims of fraud who seek to recover the loss of assets from a fraudster, although given the dissenting opinions of the Supreme Court Justices, it is likely that this is not he final say on the controversial rule, once described by one academic commentator (Professor Andrew Tettenborn), as being likened to “some ghastly legal Japanese knotweed”.

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