Creditor's right to recover losses not barred by the "reflective loss" principle in the UK
Creditor’s right to recover losses not barred by the “reflective loss” principle in the UK
Sometimes a wrongful act will not only damage a company, but also its creditors, employees, and shareholders. A doctrine known as the "reflective loss principle" limited the circumstances in which claims could be pursued by such parties for losses "reflecting" those suffered by the company (which could presumably pursue such a claim in its own right).
However, a landmark UK Supreme Court judgment has recently limited the application of the reflective loss principle to (1) shareholders and (2) losses arising from a decrease in share value or in dividends to be distributed, potentially opening the door to claims by other parties in certain circumstances.
The decision narrows the scope of the principle in the UK and confirms that creditors and employees of a company are not necessarily barred from recovering losses under the reflective loss principle. However, it will still be necessary for such parties to have a basis to bring such a claim, such as a breach of a contractual or other duty owed to them individually, in addition to any duty owed to the company.
The reflective loss principle stops a shareholder from recovering losses relating to a fall in the share value or a reduction in dividends arising from a wrong committed against both the company and the shareholder. For example, a professional advisor may owe simultaneous duties to both a company and its major shareholders. If the advisor breaches its duties, but the loss suffered by the shareholder is a drop in the value of the company (and thus of the shareholder's interest in the company), or a reduction in dividends, the shareholder cannot recover those losses from the advisor. Such losses are considered "reflective" of the company's losses and it is for the company to recover those losses. If it does so, then the theory is that the shareholder will indirectly have been "made whole".
This principle was developed by the English Court of Appeal in 1982 and has been approved twice by the Irish Supreme Court.1 As the principle developed in the UK, so too did its scope, with it being suggested that a company's creditor or employee may also be barred from bringing a claim if their loss is merely "reflective" of loss suffered by the company.2 However, the extension of the principle was also controversial, with one academic, Professor Tettenborn, comparing the principle to "some ghastly legal Japanese knotweed' whose tentacles have spread alarmingly and which threatens to distort large areas of the ordinary law of obligations". This was the key issue in the recent UK Supreme Court decision, Savilleja v Marex.3
Marex had obtained a $5.5 million award against two companies owned and controlled by Mr Savilleja. Before the judgment could be enforced, Mr Savilleja allegedly stripped both companies of their assets, leaving them unable to satisfy the judgment. Marex sued Mr Savilleja for (1) inducing or procuring the violation of its rights to the $5.5 million, and (2) intentionally causing it to suffer loss by unlawful means. Mr Savilleja sought to block these claims by arguing that Marex was a creditor of the two companies and its losses were merely reflective of their losses (in being stripped of their assets).
The Court of Appeal accepted Mr Savilleja's argument but the UK Supreme Court unanimously rejected the proposition that creditors fell within the scope of the reflective loss principle, allowing the action to continue. Although united as to the outcome, the Court expressed different views as to why the principle of reflective loss did not apply to creditors.
The four judge majority decided that the reflective loss principle was a special rule of company law which only applied to shareholders, and which was required to avoid the issues that would arise from both a company and its shareholders bringing concurrent claims against a wrongdoer. However, the minority judgment, reflecting the views of three judges argued that the reflective loss principle should be abolished altogether. In their view, a decrease in share value was a loss personal to the shareholder which was different to the loss suffered by the company (and "reflective" of the company's loss only in a loose sense). If that loss arose from a breach of duty to the shareholder, there was no reason in principle why it should not be recoverable. To the extent that such litigation could create anomalies, they suggested the Court could manage such issues. They warned that the reflective loss principle could produce "simplicity at the cost of working serious injustice" to a shareholder.
A key feature of the decision is that the wrongdoer controlled the companies which had arguably suffered the loss. Therefore, the application of the principle could have made it harder for the injured parties to recover compensation for a clear attempt to deprive them of compensation which they had already been awarded.
The decision is a significant clarification of the scope of the reflective loss principle and will be carefully considered if a similar issue comes before the Irish courts. The clarification will be particularly welcome by creditors, as will the strengthening of a creditor's ability to bring economic tort claims. However, areas of uncertainty remain, such as the circumstances in which creditors and employees can bring claims in their own right, and the issues raised by the minority judgment.
It is clear that the strength of the minority judgment has raised questions as to whether the reflective loss principle will survive at all. This may turn on whether the Courts view the prospect of a multiplicity of shareholder actions as likely or as manageable, the extent to which allowing such claims is seen as interfering with the company’s ability to manage its claim (e.g. where concurrent shareholder claims thwart a settlement that was in the best interests of the company), and the potential for such claims to lead to "double recovery" against the wrongdoer. These issues have been of concern for the Irish Courts which have previously considered the reflective loss principle.4 It should also be noted that if the injured company itself does pursue a claim and recovers adequate compensation then this might in practice reduce or eliminate the basis for a claim by other parties – depending on the circumstances, if the compensation was adequate then such other parties may no longer be able to show that they have suffered loss. However, that was not the scenario before the UK Supreme Court.