The impact of the Supreme Court judgment in Sevilleja v Marex on D&O claims

Published 13 October 2020

The recent Supreme Court judgment in Sevilleja v Marex (July 2020) has narrowed the scope of the legal principle of reflective loss. It confirms that reflective loss does not prevent claims by non-shareholders, which may increase the likelihood of claims against directors and officers.

Reflective loss

The principle of reflective loss has its roots in the case of Foss v Harbottle (1843), which provided that the company is the proper claimant in an action in respect of a wrong alleged to be have done to the company.  The case of Prudential Assurance v Newman Industries Ltd (No 2) (1982) extended the scope of the reflective loss principle.  That case found that a diminution in the value of a shareholding or in distributions to shareholders, which resulted from loss suffered by the company due to a wrong done to it by a third party was not recoverable as it was not separate and distinct from damage suffered by the company.

Facts of Sevilleja v Marex case

Marex obtained judgment for breach of contract against two companies (the “Companies”) owned and controlled by Mr Sevilleja (“S”).  The parties received a draft judgment which prompted S to transfer a significant proportion of the Companies’ assets to accounts in his control. This led the Companies to become insolvent and meant that Marex could not recover the judgment debt and costs.

Marex sought damages from S in tort for intentionally causing it to suffer loss by unlawful means. S had successfully argued in the Court of Appeal that Marex’s claim was barred by the principle of reflective loss. While the principle traditionally provided that a shareholder (as opposed to a creditor) was barred from pursuing an action against a wrongdoer, where the shareholder’s loss is “reflective” of loss suffered by the company, in Marex the Court of Appeal had expanded the principle’s scope to include creditors of a company (Marex, in this case).

Judgment

The Supreme Court unanimously allowed Marex’s appeal holding that the reflective loss principle applies only to claims by shareholders. The leading judgment was given by Lord Reed (with which Lady Black and Lords Lloyd-Jones and Hodge agreed), who ruled that:  

• The rule against reflective loss is limited to the narrow situation where a claim is brought by a shareholder in respect of loss which is suffered in that capacity alone (that is, by diminution in value of shares or reduction in distributions), which is a consequence of a wrong done to the company and where the company has (or had) a cause of action against the wrongdoer.  In such a situation, any personal action by the shareholder against the wrongdoer is absolutely barred.
• The rule no longer applies to prevent claims by non-shareholders and claims by shareholders for other types of loss. The Court accepted that this will give rise to the need to avoid double recovery, but the courts will have to resolve such situations by reference to the law of damages.

In a separate judgment, Lord Sales (with which Lady Hale and Lord Kitchin agreed) adopted a different analysis which questioned the justification for the reflective loss principle.  In this minority view, although there is a relationship between a company’s loss and the reduction in share values that it causes, “the loss suffered by the shareholder is not the same as the loss suffered by the company”. Lord Sales considered that a shareholder ought not to be prevented from pursuing a valid personal cause of action and that double recovery could be prevented by other means.

Impact on claims against directors and officers

The Supreme Court decision limits the operation of the reflective loss principle to claims brought by shareholders in that capacity. It confirms that claims by non-shareholders, including creditors are not limited by the principle of reflective loss. As a consequence, non-shareholder claimants may be more inclined to pursue direct claims against directors and officers, even where the company has suffered loss as a result of their actions.

The Marex decision has already been applied by the High Court in the judgment of Broadcasting Investment Group v Smith ( 21 September 2020).  In that case, the High Court held that a shareholder's claims, both for damages and specific performance, were barred by the rule in Prudential because they were reflective of the company's losses. However, the rule in Prudential applied only to shareholders and did not bar the claim of an individual, who was connected to the loss-suffering company by a chain of shareholdings, but who was not, in fact or law, a shareholder.

The judgment will be welcomed by creditors. The Court of Appeal’s decision had meant that creditors had no recourse against a (potentially fraudulent) director/officer or third party wrongdoer simply because the company had its own cause of action against that wrongdoer. The narrowing of the reflective loss principle grants creditors of an insolvent company more avenues to pursue directors for their respective losses. In an insolvency context, creditors may direct claims against directors, rather than relying on liquidators to take action.

The reduction in the scope of the principle of reflective loss may prompt more claims against directors (and professionals). However, claims can still be defended on the law of damages principles, particularly regarding those which prevent double recovery.

Lord Sales’ view that the principle of reflective loss should be abolished did not form the majority view on this occasion. The Supreme Court has confirmed that the principle of reflective loss will continue to prevent shareholders from pursuing claims in respect of loss suffered as a consequence of wrong done to the company. Shareholders are not without a potential remedy – for example, minority shareholders may seek to bring a derivative claim on behalf of the company, but such claims require court permission and in practice are difficult to pursue.