High Court strikes out “paradigm” claim for reflective loss in the context of allegedly negligent advice on an IPO

The High Court has struck out the most recent claim to engage the so-called “reflective loss” principle, in proceedings brought by a parent company and its subsidiary against advisers that prepared the parent company for its IPO on the Alternative Investment Market (AIM): Naibu Global International Company plc & Anor v Daniel Stewart & Company plc & Anor [2020] EWHC 2719 (Ch).

To put the decision in context, a significant number of judgments involving consideration of the reflective loss principle were adjourned pending the Supreme Court’s judgment in Sevilleja v Marex Financial Ltd [2020] UKSC 31, with the parties making submissions on the implications of the Marex judgment after it was handed down (in July 2020). This is precisely what happened in the present case, which represents the most recent application by the court of the newly defined rule.

As a reminder, the Supreme Court in Marex confirmed (by a 4-3 majority) that the reflective loss principle is a bright line legal rule, which prevents only shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, where the company has a cause of action against the same wrongdoer (see our blog post: Untangling, but not killing off, the Japanese knotweed: Supreme Court confirms existence and scope of “reflective loss” rule).

In Naibu, the court held that the relevant claim was a “paradigm” example of a claim for reflective loss, where the loss and damage pleaded by the parent turned almost entirely upon the loss suffered by the subsidiary, since the alleged loss consisted of a fall in the value of the shares in the subsidiary (to nil). The most interesting aspect of the judgment, is the court’s rejection of the suggestion that it should look at the losses of the parent and subsidiary as they evolved over time, and that the parent should be entitled to recover any loss suffered at a particular stage if it was different in nature or quantum to the loss to the subsidiary. The court found that it would be wholly artificial to carve up the losses by time in an attempt to circumvent the application of the reflective loss rule.

While Marex emphasised the narrow scope of the reflective loss rule, Naibu demonstrates that the court is prepared to take a robust approach and strike out claims falling within its parameters. This result is likely to be welcomed by financial institutions, as the reflective loss rule is an important defence to shareholder claims, as illustrated by the context of the present case.

Background

Naibu (China) Co Ltd (Naibu China) is a Chinese sportswear company and the wholly owned subsidiary of the second claimant, Naibu (HK) International Investment Limited (Naibu HK), which is in turn the wholly owned subsidiary of the first claimant, Naibu Global International Company plc (Naibu Jersey).

In 2011, Naibu China and Naibu HK instructed the defendants in relation to a proposed floatation on the AIM. The first defendant was instructed to act as their Nominated Adviser (NOMAD) and the second defendant (Pinsent Masons) was retained as their legal adviser. Naibu Jersey was incorporated for the purposes of the AIM floatation, which took place on 30 March 2012 and went on to raise around £6m.

Subsequently, the assets of Naibu China were dissipated (allegedly by its founder) and its factory was closed. The shares in Naibu China held by Naibu HK, and in turn by Naibu Jersey were rendered valueless. Naibu Jersey was de-listed from the AIM on 9 January 2015.

Naibu Jersey and Naibu HK brought proceedings against the defendants alleging breaches of duty and/or negligence in conducting due diligence and preparing Naibu Jersey for its IPO on the AIM.

The present judgment arose in the context of Naibu Jersey’s claim against Pinsent Masons. Amongst other interlocutory activity, Pinsent Masons applied to strike out Naibu Jersey’s claim and sought reverse summary judgment on the following grounds:

1. No implied retainer or duty of care. There was no contractual retainer between Pinsent Masons and Naibu Jersey, no need to imply any retainer, and no tortious duty of care owed to Naibu Jersey, since Pinsent Masons was engaged to act for Naibu HK and Naibu China only, and the terms and conditions incorporated in the letters of engagement with Pinsent Masons expressly excluded any liability to third parties other than their clients.
2. Claim barred by the reflective loss rule. The loss claimed by Naibu Jersey was almost entirely reflective of the losses claimed by Naibu HK and therefore irrecoverable under the rule against recovery of reflective losses.
3. Stay for arbitration. If the strike out / summary judgment applications failed, Pinsent Masons said that Naibu Jersey’s claim should be stayed pursuant to s.9 of the Arbitration Act 1996.

Decision

The court struck out Naibu Jersey’s claim on the basis of the reflective loss principle, save to the extent the claims related to the costs of steps taken by Naibu Jersey to assert control over and investigate the losses suffered by Naibu HK and Naibu China (in relation to which permission was given to amend the particulars of claim). The application for a stay under s.9 of the Arbitration Act was dismissed.

Implied retainer and duty of care

The legal principles governing the implication of a retainer were not disputed. It was common ground that where there is no express retainer, a retainer may nevertheless be implied from the conduct of the parties (as per Dean v Allin & Watts [2001] EWCA Civ 758).

The court was not persuaded that the facts alleged were sufficiently decisive to show that Naibu Jersey had no realistic prospect of establishing an implied retainer. In particular, Pinsent Masons had repeatedly described itself or permitted itself to be described, in formal documents, as being the solicitors for, or instructed by Naibu Jersey.

Given the court’s finding on the implied retainer, Pinsent Masons accepted that it must follow that the case on the duty of care must likewise have a real prospect of success.

Reflective loss

The main issue on the application was therefore the application of the reflective loss principle, i.e. whether Naibu Jersey's claim against Pinsent Masons was barred because the loss claimed was reflective of the losses claimed by Naibu HK against Pinsent Masons, and therefore irrecoverable under the rule.

The court noted that the starting point in such cases is now the Supreme Court’s decision in Marex, which accepted the rule against reflective loss in Prudential Assurance v Newman Industries (No. 2) [1982] Ch 204, confirming it as a rule of law, but limiting it to claims by shareholders based on the diminution in the value of their shares or distributions that they receive as shareholders.

The court agreed with Pinsent Masons that the loss and damage pleaded by Naibu Jersey turned almost entirely upon the loss suffered by Naibu HK, since the alleged loss consisted of a fall in the value of the shares in Naibu HK (to nil) and a consequent diminution (to nil) of the value of Naibu Jersey's investment in Naibu HK.

In the court’s view, the claim was a paradigm claim of reflective loss, which was barred by the principle as confirmed and restated in Marex. In reaching this conclusion, the court rejected Naibu Jersey’s submission that it was necessary to look at the losses of Naibu Jersey and Naibu HK as they evolved over time, making the following findings/observations:

• The court rejected Naibu Jersey’s arguments that: (a) an investigation (through expert evidence) was required to assess the loss suffered by each of the companies at different stages; and (b) Naibu Jersey should be entitled to recover any loss suffered at a particular stage if it was different in nature or quantum to the loss to Naibu HK (Naibu Jersey suggested the losses of the two companies might diverge at different points in time because the shares were being traded in different markets).
• Where the reflective loss rule is engaged, the decisive question is the nature of the loss claimed by the shareholder, and there is no further requirement that the amount of the loss to the company should be identical to the loss to the shareholder. In this context, the court referred to Lord Reed’s acknowledgement in Marex that a company's loss and any fall in its share value may not be closely correlated, particularly in cases where the company's shares are traded on a stock market. That is one of the reasons why Lord Reed rejected the avoidance of double recovery as a justification, in itself, of the reflective loss principle.
• Given that the total losses of Naibu Jersey were ultimately the same as those of Naibu HK, it would have entirely undermined the purpose of the rule to allow Naibu Jersey to use the simple device of identifying different losses occurring at different times, with the submission that the losses of the two companies might not have been precisely contiguous.
• The court considered that it was wholly artificial to carve up the losses by time in an attempt to circumvent the application of the reflective loss rule.

The claim by Naibu Jersey was, therefore, struck out, save in so far as it related to alleged losses relating to steps taken by Naibu Jersey to assert control over and investigate losses suffered by Naibu HK and Naibu China. The application for a stay under s. 9 of the Arbitration Act of those remaining claims was dismissed.