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Commercial law: Untangling a legal knotweed

Commercial law: Untangling a legal knotweed

By Anton Trichardt


A recent UK decision and the compelling reasons of the minority call for Australian courts to revisit the rule against reflective loss. 

  • Reflective loss is loss suffered by a company, which is inseparable from the loss suffered by shareholders, but for which only the company can bring a claim.
  • The UKSC undertook some heavy pruning to the reflective loss rule and came close to uprooting it altogether.
  • The rule continues to apply to shareholders but, given the nuanced reasons of some of the judges, the rule is likely to be revisited and tested.

Recently, in Sevilleja v Marex Financial Ltd (Marex)1 the UK Supreme Court (UKSC) significantly cut back the scope of the rule that “reflective loss” cannot be recovered. In the UK, the rule against reflective loss, the so-called “no reflective loss” principle, has now been limited to claims by shareholders whose value of their shares or of the distributions they receive as shareholders, has been diminished by reason of actionable loss suffered by the company.

Marex deals with what has been described as one of the most important and difficult questions of law to come before the UKSC for some time. In Johnson v Gore Wood & Co (No 1) (Johnson)2 the rule was described as being a “will o’ the wisp” in need of clarification. Not long ago, a commentator likened the rule to “some ghastly legal Japanese knotweed”, the tentacles of which have spread alarmingly, which

threatens to distort large areas of the ordinary law of obligations.3 The UKSC has endeavoured to untangle this legal knotweed.

Marex is an important decision not only for lawyers in the UK, but for all commercial and trust litigators in other common law jurisdictions, including Australia, and needs to be understood. The implications for current and future damages claims in contract, tort, breach of trust or fiduciary duty are extensive.

The rule and its origin

Under common law, the rule has its roots in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) (Prudential)4 and, following Johnson, flourished throughout common law jurisdictions.5 The exact basis of the rule and the circumstances of its application have been controversial. However, the effect of the rule, as a matter of policy, has been clear – that is, to prevent plaintiffs from recovering a loss they had suffered in circumstances where it was considered to be merely the reflection of a loss suffered concurrently by another party. 

The rule originated from the principle in Foss v Harbottle6 which states that, where a company has suffered a loss as the result of an actionable wrong, it is prima facie the company (or its legally appointed representative) which must sue to recover that loss. Where an individual also suffers a loss simultaneously, the courts will consider whether that individual’s loss would be made good if the company’s assets were replenished through a claim instituted by the company.7 If so, then the individual has only suffered a reflective loss. As long as the company has its own cause of action to recover that loss, the proper plaintiff is the company and the “reflective” claim by the individual is not permitted, even if the company ultimately decides not to bring a proceeding to recover the loss.8

So, the rule was initially confined to shareholders’ claims when a diminution in value of their shares or dividends reflected a loss suffered by the company concerned. Such loss was regarded as merely a reflection of the “loss” suffered by the company.9 It did not take long for the rule to be marred by uncertainties and difficulties, for its scope to be extended “wider and wider”10 and to embrangle many other types of claims. For example, it was extended to cover:

  • not just the original scenario in respect of diminution in the value of shares or dividends, but all transactions or putative transactions between the company and its shareholders11
  • claims by individuals with an equitable (rather than legal) interest in shares12
  • claims by employees or unsecured creditors who were not shareholders.13

An exception to the application of the rule was formulated in Giles v Rhind (Giles) where it was held that reflective claims could be brought in situations where “the wrongdoer, by the breach of duty owed to the shareholder, has actually disabled the company from pursuing such a cause of action as the company had”.14 Courts in general were reluctant to recognise further exceptions to the rule, and some judges have been keen to keep the principle under tight control.15

The Marex facts

Marex obtained judgments against two British Virgin Island companies owned and controlled by Mr Sevilleja. Mr Sevilleja allegedly proceeded to strip the companies of their assets, causing their insolvency. Marex issued proceedings against Mr Savilleja for economic torts, including a claim for intentionally causing it to suffer harm by unlawful means, arising from Mr Sevilleja’s conduct following the handing down of an earlier decision pursuant to which the companies were ordered to pay Marex a significant sum due under contracts, plus interest. On an application for leave to serve out of the jurisdiction, it was held that the claims were arguable. The Court of Appeal reversed that decision, stating that the rule barred Marex’s claims as a creditor of the companies for loss which was reflective of the loss caused to the companies by Mr Sevilleja.16 The English Court of Appeal, however, questioned the coherence of the law on reflective loss and invited the UKSC to put it right.

The UKSC decision

The seven member UKSC allowed the appeal, albeit for different reasons. All were of the view that the rule against reflective loss had been expanded excessively and that the rule would cause injustice if applied to Marex’s situation.

The majority 

The majority, (Lord Reed with whom Lady Black and Lord Lloyd-Jones agreed)17 and Lord Hodge18 agreeing with Lord Reed separately, regarded the rule as laid down in Prudential as a rule of law deeming a shareholder’s loss by diminution in value of their shares or dividends to be irrecoverable where the company has a parallel claim. The majority held that Prudential laid down a “bright line” rule of company law (which is a modest extension of the principles set out in Salomon v A Salomon & Co Ltd [1897] AC 22 and Foss v Harbottle)19 and that its ambit should be confined to what was decided in that decision. That is, a diminution in the value of shareholding or in distributions to shareholders which is merely a result of a loss suffered by the company in consequence of a wrong done to the company is not, according to the law, damage which is separate and distinct from the damage suffered by the company and is therefore not recoverable.

So, after Marex, plaintiffs may institute claims against all parties who have caused them loss, unless that claim is for loss as a shareholder and the company has its own concurrent claim. Companies and their external administrators may still bring claims based on the same wrongful conduct, whether against former officers or otherwise, but they may have to do so in competition with others. The rule against reflective loss has no further application concerning employees or creditors of the company claiming for loss as such. It also has no application in claims relating to loss suffered by an individual as opposed to companies. Moreover, the rule does not apply to a claim by a discretionary beneficiary against a trustee for breach of trust. The impact on potential shareholder class actions is yet to be considered. However, the majority held that Giles had been incorrectly decided. Where the rule against reflective loss continues to apply there is no exception to it in cases where the defendant’s own wrongful conduct prevented the company from pursuing a claim. 

The minority

The minority (Lord Sales with whom Lady Hale and Lord Kitchin agreed)20 questioned the justification for the rule against reflective loss and whether it should still be recognised. Effectively, the minority held that there was no rule against reflective loss as a principle of the law of damages or a rule of company law. The minority rejected the “legal fiction” that a shareholder’s loss is equal to a company’s loss, because the shareholder’s loss may be different. A share is a piece of property,21 the market value of which depends on the estimation of the future business prospects of the company and not just its net asset position. A recovery by the company may not necessarily eliminate a shareholder’s loss. Instead of having a rule against reflective loss, the minority was of the view that claims should be approached on a case by case basis, using expert evidence on share valuation and using procedural devices to manage the risk of concurrent claims, and double recovery, by a shareholder and the company. This view of the minority is to be welcomed as it appears that when faced with a shareholder claim the rule has sometimes been applied as a Pavlovian reaction. A shareholder ought not to be prevented from pursuing a valid personal cause of action. Imposition of the Prudential “bright line” could produce simplicity at the cost of working serious injustice in relation to a shareholder who, apart from the rule against reflective loss, has a good cause of action and has suffered loss which is real and is different from any loss suffered by the company.

Lord Sales’ judgment is a strong riposte to the continued existence of the rule, even in its diminished form. The minority’s approach necessitates consideration of available procedural mechanisms, subrogation and restitution to avoid double recovery.


In the 40 years since the Prudential decision was handed down, the rule against reflective loss has been applied throughout much of the common law world to a greater or lesser extent, albeit sometimes on the basis of different reasoning.22 The rule has, for example, been applied in Singapore (Townsing v Jenton Overseas Investment Pte Ltd),23 Jersey (Freeman v Ansbacher Trustees (Jersey) Ltd),24 the Cayman Islands (Zhikun),25 Hong Kong (Waddington Ltd v Thomas),26 Ireland (Alico Life International Ltd v Thema International Fund plc),27 New Zealand (Christensen v Scott),28 and Australia (Chen v Karandonis29 and Hodges v Waters (No 7)).30 Although not referred to in Marex, the rule was considered in Ontario (Locking v McCowan)31 and also enjoyed the attention of courts in South Africa, a hybrid legal system, in Itzikowitz v Absa Bank32 and Hlumisa Investment Holdings (RF) Ltd v Kirkinis.33 In the USA, the rule against reflective loss is similar to the “plaintiff standing” rule applied by the courts when dealing with so-called “generalized claims”.34

Marex is not an easy judgment to unravel and, although it was unanimous in allowing the appeal, there are subtle differences of interpretation between the various judgments. Both the majority and the minority decisions make for interesting reading and will no doubt elicit further debate. What is clear after Marex, however, is that even though the rule against reflective loss exists in the UK, it is to be interpreted strictly.35 But, it is doubtful whether Marex has eradicated the legal Japanese knotweed that is the “no reflective loss” principle in the UK. As expected there has already been further litigation in this area in the UK. Recently, Marex has been applied in Naibu v Stewart36 and Broadcasting Investment Group v Smith.37 The issue in the latter case, in respect of which an appeal is pending, is that since Marex made it clear that the rule only applied to shareholders, it 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 in law, a shareholder.

It remains to be seen whether the pruned legal knotweed following Marex will find fecund ground in the other common law jurisdictions, or whether the rule’s eradication has already begun. The narrow split between the majority and the minority in Marex, and the compelling reasoning of the minority, call out for Australian courts to revisit the rule against reflective loss. The majority decision in Marex should not necessarily be followed in Australia. Indeed, the observations made some time ago by a prominent UK silk could be equally applicable in Australia: “The law took a seriously wrong turn when in Prudential the Court elevated what was a relatively simple everyday problem concerned with assessment of damages into a principle of causation . . . the application of the principle has been controversial, and has caused and is liable to cause serious injustice. As was said appropriately enough in Alice Through the Looking Glass ‘when she thought it over afterwards it occurred to her that she ought to have wondered at this, but at the time it all seemed quite natural’ . . . it is about time our highest judges should also now think it over and wonder why it was ever thought to be necessary or just to have this rule at all”.38

Anton Trichardt is a barrister at the Victorian Bar and an adjunct associate professor at the University of New South Wales.

  1. [2020] UKSC 31. The UKSC unanimously allowed the appeal.
  2. [2002] 2 AC 1.
  3. See Andrew Tettenborn, “Creditors and Reflective Loss – A Bar Too Far?” (2019) 135 Law Quarterly Review 182 at 183.
  4. [1982] Ch 204.
  5. The rule also appears in a similar form in civil law jurisdictions. Eg, in The Netherlands, the rule pertains to “afgeleide schade” and dates back to the decision of the Hooge Raad in Poot/ABP 1995 NJ 288. See also BF Assink, “Vraagtekens rond afgeleide schade” in PJ van der Korst, R Abma, and GTMJ Raaijmakers (eds), Handboek Onderneming en Aandeelhouder – Serie Onderneming en Recht deel 69 (Kluwer, 2012) 305; WJ Oostwouder, “Actualiteiten ‘afgeleide schade’” (2018) 26 Onderneming en Financiering 5. In Belgium, a similar principle was recognised in the Hof van Cassatie 23 February 2012 (2012 TRV 3190) and by the Hof van beroep te Gent 23 October 2013 (2014 TRV 292).
  6. (1843) 2 Hare 461.
  7. Note 2 above, at 35G.
  8. Note 7 above.
  9. Note 4 above, at 223A.
  10. Zhikun v Xio GP Ltd (unreported Cayman Islands Court of Appeal, 14 November 2018) (Zhikun) at [95] and [96]. See David Foxton, “Reflections on Reflective Loss” 2019 LMCLQ 170.
  11. Note 2 above, at 66H.
  12. See Shaker v Al-Bedrawi [2005] Ch 350.
  13. See Gardner v Parker [2004] EWCA Civ 781; International Leisure Ltd v First National Trustee Co UK Ltd [2012] EWHC 1971.
  14. [2002] EWCA Civ 1428 at [34].
  15. See, eg, UCP Plc v Nectrus [2019] EWHC 3274 (Comm).
  16. For the decision at first instance, see [2017] 4 WLR 105, and for the Court of Appeal decision, see [2018] EWCA Civ 1468.
  17. Note 1 above, at [1]-[94]. The ratio of Lord Reed’s judgment is at [79]-[89].
  18. Note 1 above, at [95]-[109].
  19. Which deal respectively with the separate legal identity of a company principle and the principle that the company is the only one that can sue on a claim vested in it.
  20. Note 1 above, at [110]-[213].
  21. The majority held that a share was not part of the company’s assets, as it only conferred a right of participation in the company in accordance with the company’s articles of association.
  22. Note 1 above, at [78].
  23. [2007] SGCA 13.
  24. [2009] JLR 1.
  25. Note 10 above, Zhikun.
  26. [2008] HKCU 1381.
  27. [2016] IEHC 363.
  28. [1996] 1 NZLR 273.
  29. [2002] NSWCA 412.
  30. (2015) 232 FCR 97.
  31. 2015 ONSC 4435.
  32. [2016] ZASCA 43.
  33. [2020] ZASCA 83. Followed in De Bruyn v Steinhoff International Holdings NV [2020] ZAGPJHC 145.
  34. See, eg, RS Investments Limited v RSM US LLP 125 NE 3d 1206 [2019]; In re Manley Toys Limited (case no 16-15372, US Bankruptcy Court, DNJ).
  35. See David Milman, “Revisiting shareholder litigation in private companies” (2020) 421 Companies News Letter 1 at 4.
  36. [2020] EWHC 2719 (Ch).
  37. [2020] EWHC 2501 (Ch).
  38. See Alan Steinfeld QC, “In the looking glass: holding companies and reflective loss” (2016) 22 Trusts & Trustees 277 at 285.

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