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27th July 2020

The Supreme Court constrains shareholder claims: A brief reflection on ‘reflective loss’

The UK Supreme Court’s ‘back to basics’ analysis of the interests of a shareholder in a company reverses an expanding line of judicial thinking. The significant judgment on appeal in Marex Financial Limited v Sevilleja [2020] UKSC 31 both affirms a long-held principle of company law but also marks a retreat from its development over a quarter of a century.
It is not uncommon for a shareholder in an owner-managed private limited company to equate his or her shareholding in the company to a proportional interest in the company’s assets. That perception is supported by the way many companies are valued for sale. It is not however, how the law regards the interests of a shareholder.

A share is not a proportionate part of a company’s assets, and it does not confer on the shareholder a legal or equitable interest in the company’s assets. It is simply a right to participation in the company on the terms of its constitution (the articles of association). As Lord Reed observed in Marex. “The articles normally confer on a shareholder a number of rights, including a right to vote on resolutions at general meetings, a right to participate in the distributions which the company makes out of its profits, and a right to share in its surplus assets in the event of its winding up.”

The inevitable implication of the legal nature of a shareholding is that where a company suffers an actionable loss, and that loss results in a fall in the value of its shares or in its distributions in respect of those shares, the fall in share value or distributions is not a loss which the law recognises as being separate and distinct from the loss sustained by the company. The loss of value in the shares or distributions is simply said to ‘reflect’ the company’s loss: to be‘reflective loss’. Because it is only a reflection of the company’s loss, it does not give rise to an independent, concurrent claim to damages which the shareholders or one of them is entitled to pursue.

This was the principle established in the 1982 case of Prudential Assurance Co. Limited v Newman Industries Limited (No 2) [1982] Ch 204: that a claim cannot be made by a shareholder of a company for the loss in value of his or her shares where that loss is simply a reflection of the loss suffered by the company from a wrong done to it eg by one of its directors, even if the wrong is also done to the shareholder and the company has decided not to bring a claim. It has been said that the principle recognises “the unity of economic interests which bind a shareholder and his company”.

Whilst the principle arises from the legal nature of a shareholding, it also ensures that the principle of ‘majority rule’ in companies is not circumvented; by a shareholder bypassing the company’s constitutional mechanisms (which govern his participation in the company) to pursue recovery of a loss that may well be substantial but is simply a reflection of the company’s loss. Unless the shareholder can establish he has the right to pursue one of the narrow routes that protect a minority from the fraudulent conduct of the majority (eg by bringing a ‘derivative claim’ – to stand in the shoes of the company), the shareholder is without a remedy for the loss of value to his shareholding.

Through a number of cases since the ‘reflective loss’ principle was first laid down in Prudential v Newman the Courts have expanded its application in various directions, however, in Marex, the Supreme Court was clear that a number of these decisions, previously considered authoritative (albeit controversial), were wrongly decided. Influentially, their Lordships were clear that the ‘reflective loss’ principle was not based on the legal precept that the Courts should not permit a double recovery. The assumption that there is, in some way, a universal and necessary relationship between changes in a company’s net assets and changes in its share value might cause one to look in that direction but their Lordships considered this both unrealistic and based on a misunderstanding of the foundation of the ‘reflective loss’ principle (the legal nature of a shareholding).

The ‘back to basics’ look at a shareholder’s relationship with the company equipped the Court in one stroke to affirm the principle, and at the same time, limit it. Where a wave of successive decisions had extended the reach of the principle to bar claims by creditors or even employees of a company who happen to hold shares from pursuing losses referable to the company’s loss, the Supreme Court has pushed back the tide and said these were wrongly decided.

In affirming the basic principle however, their Lordships have made clear that whether it will bar a shareholder’s claim does not depend on whether the company is financially able to bring proceedings or not. If the shareholder has not suffered the loss in the value of his shareholding or distributions in relation to the shareholding by reason of a wrong done to him personally and his loss derives from a wrong done to the company, he has no entitlement to claim, regardless of whether, or why, the company may have failed to pursue its own cause of action.

Dominic Hopkins is Head of Disputes and Litigation at Hewitsons and advises boards, investors and other stakeholders in relation to company claims. For more information please contact him on 01604 233233 or click here to email him.
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