Reflective loss and the impact on claims against directors and officers

Sevilleja v Marex Finance [15.07.20]

On 15 July 2020, the Supreme Court handed down its long awaited judgment on the principle of ‘reflective loss’. Whilst the Justices unanimously agreed that the principle does not extend to claims made by parties other than shareholders (including creditors), thus significantly narrowing the scope of the principle, the difference in judicial opinion reflects the complexity of the area that will develop and impact the future of claims against directors and officers and their insurers.

The principle of reflective loss

The principle of ‘reflective loss’ stems from the leading case of Foss v Harbottle (1843) where the Court held that a shareholder cannot sue for wrongdoing to a company by a third party. Only the company itself can seek relief for loss caused to it; its shareholders cannot claim reflective loss to their share interests where the company has a concurrent claim of its own. This would prevent any double recovery.

The court developed the principle further in Prudential Assurance v Newman Industries (No 2) [1982] and held that a shareholder cannot claim for either a diminution in value of their shareholding or a reduction in distributions even where the company was not bringing a claim. The rule was subsequently broadened in Johnson v Gore Wood & Co [2002], and thereafter interpreted as barring any claims by a shareholder re third party wrongdoing, whether in his capacity as shareholder, employee or creditor.

The recent case of Sevilleja was the first opportunity for the Supreme Court to revisit the principle of reflective loss since Johnson. The Supreme Court confirmed that the principle against reflective loss is “limited to claims by shareholders that, as a result of actionable loss suffered by their company, the value of their shares, or of the distributions they receive as shareholders, has been diminished. Other claims, whether by shareholders or anyone else, should be dealt with in the ordinary way”.


Mr Sevilleja (Sevilleja) owned and controlled two companies registered in the British Virgin Islands. Marex Finance Limited (Marex), a creditor of the companies, brought proceedings against the companies in England for significant sums due under a contract.

Marex obtained judgment to the value of USD5.5m, plus costs of £1.65million. However, following the draft judgment, Sevilleja arranged for funds held by the BVI companies to be transferred into his personal control with the result that the companies were unable to satisfy the judgment. Sevilleja later placed the companies into insolvent voluntary liquidation. The US Insolvency Court commented that such acts were the ‘most blatant effort to hinder, delay and defraud a creditor this court has ever seen’.

Marex sought damages in tort from Sevilleja. Sevilleja relied on the principle of reflective loss to defend the claim. Sevilleja argued that because Marex was seeking to recover losses which were identical to those suffered by the two companies, and which would be made good if the companies succeeded in any action against him, the loss was reflective of the companies’ loss and as a result barred.

The Court of Appeal found in favour of Sevilleja and found that not only did the principle of reflective loss apply to shareholders, but also to creditors, even if creditors were not a shareholder. This in itself was an expansion of the rule as set out in Johnson.

The Court of Appeal granted Marex permission to appeal to the Supreme Court.

The Supreme Court judgment

The Justices were unanimous that the rule against reflective loss should not apply in this case. Marex’s appeal was therefore allowed and it was able to recover from Sevilleja.

However, the Justices reached their decision by alternative routes and were split 4:3 in their reasoning.

The leading judgment

Lord Reed considered that the rule of reflective loss is and should be limited to narrow situations where the claim is brought by a shareholder in respect of loss which he or she suffers in that capacity alone (i.e. by diminution in value of shares or reduction in distributions), which is a consequence of wrong done to the company by a third party and where the company has or had a cause of action against the wrongdoer. In these circumstances only is personal action by shareholders barred. The shareholder does not incur a loss that is regarded by the law as “separate and distinct from the company’s loss”, and so the shareholder has no claim. In all other cases, where the claims are brought by non-shareholders, or claims are brought by shareholders for other types of loss, the rule ought not to apply. Lord Reed considered that if a situation arose in which there was a double recovery, the Courts should handle this is in the usual way using ordinary legal principles.

The minority judgment

Lord Sales explained that a governing principle of the rule of reflective loss was to prevent double recovery and as such questioned the need for the rule on reflective loss at all, given the availability of other means to prevent double recovery. Nonetheless, Lord Sales agreed that the rule should not be extended to creditors of companies.

Impact on D&O claims

The effect of the judgment in Sevilleja will undoubtedly be felt by companies, their directors and officers, and their insurers:

  • The judgment reinforces the principle that if a loss is suffered by a company, only the company can seek recovery and not the shareholders (even if the company is not actively pursuing the loss). This may prompt shareholders to explore other avenues of recovery for loss to their shareholding – for example pressing the company’s directors to take action against a third party; or bringing a derivative claim on behalf of the company against its directors for breach of their duty to the company; or potentially an unfair prejudice claim.
  • The effect of COVID-19 and the government’s shutdown measures means that many companies are already in financial difficulty and insolvencies are on the rise. Whilst creditors are not limited by the principle of reflective loss, it is inevitable that given the economic climate, creditors will ‘hedge their bets’ and still look to directors/officers for recovery as a result of alleged wrongdoing – particularly if company assets are limited.
  • The reflective loss principle has often been a way to limit circumstances where a third party seeks to recover personally for losses suffered by a company. Potential claimants will welcome the Sevilleja decision and claims which previously could not be pursued, will be. Whilst the general principle of double recovery remains, this judgment paves the way for non-shareholders to pursue further avenues of recovery.
  • The split judgment suggests that this area of law may continue to evolve, particularly given the (minority) suggestion that the principle of reflective loss should be abolished in its entirety. Shareholders may challenge the principle but on present authority will need to distinguish their loss as separate and distinct from that of the company.

What this tells us is that, more than ever, directors and officers should be ensuring that they are proactively complying with their fiduciary duties and be able to readily evidence such. Whilst the Supreme Court is clear that third parties are not limited by the principle of reflective loss, neither are they (or company shareholders) prevented from pursuing directors directly, and with increased creditor/third party claims, it is likely that directors and officers will be in the firing line.

Related item: Investment fund administrators: liability for “gross negligence”

Read other items in Professions and Financial Lines Brief - October 2020

Read others items in London Market Brief - November 2020