No reflective loss principle: shareholders will explore other avenues to recover their loss

Published 7 February 2023

In Burnford v Automobile Association Developments Ltd [2022] EWCA Civ 1943, the Court of Appeal upheld the High Court’s decision to strike out a claim by shareholders on the basis that the “no reflective loss” principle applied. The  shareholders’ claim for diminution in value of their shares was not “separate and distinct” from the loss suffered by the company; their loss was the consequence of the loss sustained by the company and only the company had a cause of action.  

While this confirmation that the rule against reflective loss applies is no surprise to us, in our experience, Burnford reflects the lengths shareholders will go to in order to recover their loss and they will (no doubt) explore other avenues which may be available to compensate them.  Professional advisors, such as accountants or auditors, will be in their cross hairs when financial statements relied on by investors present a flawed picture regarding the audited entity’s financial position.

What happened in Burnford?

The Claimants were former shareholders in Motoriety (UK) Ltd, a company providing software-based products to the motor industry, such as electronic records of a vehicle’s service history and prompts for services and MOTs.

In 2015, Motoriety, the Claimants and the Defendant company, AAD, entered into an investment agreement to help expand Motoriety’s subscriber base.  The venture failed and Motoriety went into administration in 2017.

The Claimants issued proceedings to recover their losses. The Claimants alleged that AAD made a number of misrepresentations, including that Motoriety would have access to AAD’s large customer base, and that AAD had breached the implied terms of a contract between the parties to act in good faith to promote the success of the venture. They argued that, but for the alleged misrepresentations, they would have entered into a different venture with a third party and their share values would have increased.

AAD applied for the claim to be struck out on the basis that the principle of reflective loss barred the Claimants from being able to bring a claim.

The Court of Appeal’s decision

The Court of Appeal upheld the High Court’s decision to strike out the claim. It determined:

1. The issue of reflective loss was suitable for summary determination as it had been considered in depth by the Supreme Court in Sevilleja v Marex [2020], and whilst elements of the principle had been the subject of debate in other cases, this did not give rise to any legal uncertainty in this case.

2. The principle of reflective loss applied to these facts. The Claimants’ loss derived entirely from Motoriety’s loss and only Motoriety (not its shareholders) had the cause of action.

3. Motoriety’s dissolution before the commencement of proceedings (i.e. at a time when the Claimants were no longer shareholders) made no difference because the reflective loss rule is assessed at the time the shareholders/company suffer loss and not the time when proceedings are commenced.

What are the implications of Burnford for professionals, like accountants and auditors?

Burnford underlines the immutable fact that, under English law, the reflective loss principle represents a bar to shareholders bringing a claim based on a diminution in the value of their shares, or a fall in distributions, where this results from loss sustained by the company and the company itself has a cause of action against another in respect of this loss.   The opportunities for shareholders to circumvent this principle are very limited. 

In our experience, the greatest exposure for auditors is where it might be alleged against them that they made direct representations to shareholders and/or investors regarding the accuracy of the audited entity’s financial statements, or some facet of them.  That is because of the now well tested “assumption of responsibility” line of cases which establish that the auditor may be held to owe a duty of care, and be liable, when they make such representations knowing that a future investment decision depends upon what is in the audited accounts. 

The success of such arguments will be fact specific and they face various hurdles.  Claimants who have retained independent due diligence advisors will struggle to argue their investment decision relied upon something the auditor said about the company’s financial statements.  Claimants would need to establish that the accountants or auditors assumed a duty of care to them and they relied on the representations made in brochures or the audited accounts as opposed to relying on their own enquiries or independent financial advice. 

Which underlines the importance of the Bannerman clause.  The Bannerman clause included with audited accounts states that the auditors do not accept or assume a responsibility to anyone other than the addressees of the audit report (namely the directors of the company being audited or the shareholders as a body).  The court held in Barclays Bank plc v Grant Thornton UK LLP [2015] that this type of clause is effective against third party investors and in line with this, these clauses are encouraged by the ICAEW. For more about this decision, please see our article here.

Burnford is a helpful reminder to accountants and auditors to check that the language of their disclaimers is sufficiently clear and wide to disclaim liability to third parties, and ensure they are included in all content which may be shown to potential investors and other third parties.