Supreme Court confirms existence and scope of “reflective loss” rule

The Supreme Court’s judgment in Sevilleja v Marex Financial Ltd [2020] UKSC 31 has been eagerly anticipated by financial institutions and brings much needed clarity in respect of the so-called “reflective loss” principle, first established in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204.

By a majority of 4-3, the Supreme Court confirmed that the “reflective loss” rule in Prudential is a bright line legal rule of company law, which applies to companies and their shareholders. The rule prevents 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. However, the Supreme Court unanimously held that the principle should be applied no wider than to shareholders bringing such claims, and specifically does not extend to prevent claims brought by creditors. In doing so, the entire panel rejected the approach in cases since Prudential where the principle has been extended to situations outside shareholder claims, in a way that has been likened to a legal version of Japanese knotweed.

The majority of the Supreme Court (led by Lord Reed) emphasised that the rule is underpinned by the principle of company law in Foss v Harbottle (1843) 2 Hare 461: a rule which (put shortly) states that the only person who can seek relief for an injury done to a company, where the company has a cause of action, is the company itself. On this basis, a shareholder does not suffer a loss that is recognised in law as having an existence distinct from the company’s loss, and is accordingly barred.

The division of the Supreme Court focused on whether or not to reaffirm the “reflective loss” principle as a legal rule which prohibits a shareholder’s claim, which was the view of the majority, or whether it is simply a device to avoid double-recovery (and therefore a question that arises when it comes to the assessment of damages), which was the view of the minority.

Putting the decision in context, the reflective loss rule was one basis (amongst several others) on which the recent shareholder class action against Lloyds and five of its former directors (the Lloyds/HBOS Litigation) was dismissed by Mr Justice Norris (see our blog post on the decision here). The court held that – if the elements of the shareholders’ claim had been proven – any alleged loss suffered by shareholders as a result of a fall in the price of Lloyds shares was reflective of what the company’s loss would have been. Of course, in the securities litigation context, sections 90 and 90A of the Financial Services and Markets Act 2000 (the usual basis of a shareholder class action) provide a statutory exemption to the reflective loss rule.

For more information see this post on our Banking Litigation Notes blog.