Court of Appeal examines the rule against reflective loss in Marex

Carlos Sevilleja Garcia v Marex Financial Limited [2018] EWCA Civ 1468 – Court of Appeal considers the rule against reflective loss and the scope of the Giles v Rhind exception.

The rule against reflective loss stipulates that claims by shareholders to recover loss where, in effect, the loss of the shareholder is merely reflective of the loss suffered by the company are generally precluded.  For example, if a company suffered loss as a result of a director’s breach of fiduciary duty, the individual shareholders would not be able to sue in their individual capacities for the resulting loss to the value of their shareholdings.  The cause of action lies with the company, and the rule serves to prevent instances of double recovery being sought for the same loss.

Pursuant to the decision in Johnson v Gore Wood [2002] 2 AC 1 the rule against reflective loss applies to shareholders whether or not they purport to act in their capacity of shareholder, employee or creditor of the company in question.

There is an exception to the rule against reflective loss, which was established by the Court of Appeal in Giles v Rhind [2002] EWCA Civ 1428.  The exception applies in narrow circumstances where, by reason of the wrong committed against the company, the company is unable to pursue its cause of action against the wrongdoer.  In Giles v Rhind the defendant’s wrongdoing caused the company in question to go into receivership.  The defendant brought an application for security for costs against the company, which stifled the company’s claim.  The company was forced to discontinue, so the shareholder took up proceedings in its place.  Whilst the loss was reflective, the claim was allowed to proceed given the circumstances.

In short, the Court of Appeal in Marex refused to apply the exception to non-shareholder creditors.  In delivering the leading judgment, Lord Justice Flaux refused to distinguish between shareholder creditors (who are precluded from bringing claims for reflective loss) and non-shareholder creditors.  He reasoned that it would be perverse if a shareholder creditor with one share in a company would be precluded from seeking to recover reflective loss, whereby a creditor with no shareholding could do so.

Lord Justice Flaux also clarified the scope of the Giles v Rhind exception.  He stated that the impossibility or disability of the company to pursue its own cause of action must be a legal one, rather than a factual one.  He stated that impecuniosity would be a factual impossibility rather than a legal impossibility (because the claim would still exist and would be capable of being pursued with the assistance of third party funding for example).

The practical effect of the judgment confirms that the exception to the rule against reflective loss is very narrow in scope.