28 Jul 2020

The UK's Supreme Court ("UKSC") has handed down its judgment following the hearing of the appeal in the case of Sevilleja v Marex Financial Limited [2020] UKSC 31 ("Marex"). The appeal was against the decision of the Court of Appeal to find that the rule of reflective loss applied to 90% of Marex's claim, which was brought in its capacity as a creditor.

The appeal was unanimously allowed by UKSC and it confirmed the rule did not extend to creditors.

The principle of reflective loss was established in the case of Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 ("Prudential"). It decided that a shareholder may not bring a claim for the diminution in value of its shareholding which results from a loss suffered by the company as a consequence of a wrong done by the defendant. That prohibition operated even if the defendant’s conduct also involved the commission of a wrong against the shareholder, and even if no proceedings had been brought by the company.

The key question for the Supreme Court was whether the rule against reflective loss applied to creditors of a company. The Court was unanimous in its answer to the question - “no”. In coming to that clear decision, UKSC has overturned nearly 20 years of decisions which had expanded and restated the rule against the recovery of reflective loss.

What is the impact for banks?

Prior to this decision the rule against the recovery of reflective loss was perceived to being used to prevent the former owners of insolvent businesses, who have allegedly suffered loss at the hands of their creditors, from pursuing claims against those creditors.

The All Party Parliamentary Group on Fair Business Banking intervened in Marex. It clearly had the banks in mind when it spoke of creditors. To reinforce this, its press release provided examples “even when the misconduct of the creditor—such as the mis-sale of an IRHP or the treatment of businesses such as those in RBS GRG—has caused the insolvency, the bank receives the benefit of the insolvency and the shareholders, directors and other creditors lose everything through no fault of their own.

The banks should have in mind:

  • This decision leaves creditors with a clearer path to pursuing the banks following a company's insolvency
  • However, it's important to emphasise there would still need to be wrongdoing by a bank such that the claim could be founded. In the Marex decision itself, the case was about a director asset stripping two companies following judgment having been granted against them. He intentionally caused the companies to suffer loss by unlawful means. 

The facts

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. Marex obtained judgment for more than US$5.5m and costs were agreed at £1.65m.

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 just US$4,329.48. The object of the transfers was to ensure 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.

The Companies were placed into insolvent voluntary liquidation in the BVI by Mr Sevilleja in December 2013. Marex seeks damages from Mr Sevilleja in tort and an order was made giving Marex permission to serve proceedings out of the jurisdiction. Mr Sevilleja failed at first instance to set aside the order but on appeal the Court of Appeal accepted the "reflective loss" principle applied to about 90% of Marex's claim, the remaining 10% falling out of scope of the principle.

Reflective loss

In Prudential it was held 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. 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.

In Johnson v Gore Wood & Co [2002] 2 AC 1 ("Johnson") the House of Lords purported to follow Prudential. However, 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 in Prudential.

Johnson has been followed by a multitude of cases where litigants have sought either to establish exceptions to the principles set out by Lord Bingham in Johnson or to establish the rule against the recovery of reflective loss extends even more widely – notably in the cases of Giles v Rhind [2003] Ch 618, Perry v Day [2004] EWHC 3372 Ch; [2005] 2 BCLC 405 and Gardner v Parker [2004] EWCA Civ 781.

The decision in Marex

Lord Reed, with whom Lady Black and Lord Lloyd-Jones agreed, stated the rule in Prudential has no application in the Marex case because it does not concern a shareholder. He reaffirmed the approach adopted in Prudential and by Lord Bingham in Johnson. Giles v Rhind, Perry v Day and Gardner v Parker were wrongly decided. The rule in Prudential is limited to claims by shareholders that, as a result of actionable loss suffered by their company, the value of their shares, or of the distributions they receive as shareholders, has been diminished. Other claims, whether by shareholders or anyone else, should be dealt with in the ordinary way.

Lord Hodge agreed with Lord Reed. He added that the problems and uncertainties which have emerged in the law have arisen because the principle of reflective loss has broken from its moorings in company law. Prudential was a principled development of company law which should be maintained.

Lord Sales, with whom Lady Hale and Lord Kitchen agreed, came to the same conclusion as Lord Reed but with different reasoning. Prudential did not lay down a rule of law and cannot be regarded as authority for the special rule of law described by Lord Reed and Lord Hodge. The reasoning in Johnson is predicated on the loss suffered by the company and the loss suffered by the shareholder being identical which, in Lord Sales' opinion, is a false premise.