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Sevilleja v Marex Financial Ltd [2020] UKSC 31

Zaid Fathoala, Associate, and Jonathan Pagan, Senior Associate, Freshfields Bruckhaus Deringer LLP, London, UK

Synopsis Marex to suffer loss by unlawful means. Marex sought damages corresponding to (i) the amount of the judg- The Supreme Court has recently considered the so- ment debt plus interest and costs (less amounts recov- called ‘reflective loss’ principle, which in certain cir- ered in related US proceedings), and (ii) costs incurred cumstances prevents shareholders from bringing by Marex in its attempts to obtain payment. Marex was claims against third parties, and has narrowed the given permission to serve the proceedings on Mr Se- scope of that principle considerably. Following this de- villeja out of the jurisdiction. cision, the principle will apply in only very limited in- stances, namely to bar actions that are: (i) brought by a shareholder against a third party, (ii) in respect of loss The High Court which the shareholder has suffered in that capacity in the form of a diminution in share value or distributions, Mr Sevilleja applied to the High Court (Knowles J) to (iii) where that loss is the consequence of loss sustained set aside the order granting Marex permission to serve by the company, and (iv) in respect of which the com- proceedings outside the jurisdiction, on the basis that pany has a cause of action against the wrongdoer. Marex did not have a good arguable case against him because the losses which Marex sought to recover were reflective of loss suffered by the companies, which had Facts concurrent claims against Mr Sevilleja, and so could not be claimed by Marex (the so-called ‘reflective loss’ Mr Sevilleja was the owner and controller of two com- principle). Knowles J rejected that argument, holding panies incorporated in the British Virgin Islands. Marex that Marex had a good arguable case that its claim was brought proceedings against those companies in the not precluded by the reflective loss principle: [2017] Commercial Court of England and Wales for amounts EWHC 918 (Comm). it alleged were owed to it under contracts it had entered into with the companies. At first instance, Marex ob- tained judgment against the companies for more than The Court of Appeal USD 5.5 million, and was also later awarded costs. Shortly after the parties received a confidential draft Mr Sevilleja subsequently appealed to the Court of Ap- of the first instance judgment but before the judgment peal (Lewison, Lindblom and Flaux LJJ): [2018] EWCA was formally handed down and the orders for payment Civ 1468. It fell to the Court of Appeal to determine were made, Mr Sevilleja procured the transfer of more the proper ambit of the rule against reflective loss and than USD 9.5 million from accounts held in the compa- whether that rule applied to claims by unsecured credi- nies’ names. Marex argued that the object of the trans- tors such as Marex. fers was to ensure that Marex did not receive payment Flaux LJ, giving the main judgment, allowed Mr Se- of the judgment debt. villeja’s appeal in part, on the basis that the reflective The two companies were subsequently placed into loss principle was not restricted solely to claims made insolvent voluntary liquidation with alleged debts by a party as shareholder but also precluded claims by exceeding USD 30 million owed to Mr Sevilleja and creditors for loss caused by the abstraction of money entities associated with him. Marex was the only non- from the company. In other words, the Court of Appeal insider creditor. Marex alleged that the liquidator ef- held that the distinction between shareholders and fectively acted under Mr Sevilleja’s control and thus non-shareholder creditors was artificial when consid- had taken no steps to investigate Marex’s claims or the ering the reflective loss principle, and the same principle companies’ missing funds. should apply to all creditors of the company. As such, As a result, Marex sued Mr Sevilleja in the English the reflective loss principle applied to Marex’s claims courts for damages in tort for (i) inducing or procuring (save its claim to recover the costs of enforcement of its the violation of Marex’s rights under the first instance judgment), with the consequence that Marex was un- judgment and orders, and (ii) intentionally causing able to pursue the majority of its claims.

404 Sevilleja v Marex Financial Ltd [2020] UKSC 31

According to the Court of Appeal, one possible ex- correlated to the company’s loss. Where a company ception to the reflective principle was the exception suffered loss and as a result acquired a right of action, established in the case of Giles v Rhind [2002] EWCA the company’s right to damages would restore it to the Civ 1428, which applied where the alleged wrongdo- position that would have obtained but for the wrongdo- ing had caused the company to be unable to pursue the ing. If doing so also restored the value of the shares, wrongdoer. The Court of Appeal found that this excep- then permitting shareholders to vindicate a personal tion did not apply in Marex’s case. right to claim in these circumstances would give rise to double recovery. Further, if the company chose not to claim for that loss, then the shareholder (even if in The Supreme Court a minority) could exercise such rights of control over the company’s decision-making, or pursue such other Marex sought and obtained permission to appeal to the remedies, as have been accorded to it under the articles Supreme Court. of association or the general law. The Supreme Court unanimously allowed Marex’s According to Lord Reed, the decision in Prudential appeal, and took the opportunity to restate the law on therefore respected the ‘proper plaintiff’ rule derived the reflective loss principle. However, while all seven from Foss v Harbottle (1843) 2 Hare 461 and the vari- Justices reached the same overall conclusion, the rea- ous principled and policy-driven underpinnings of that soning of the four Justices in the majority (Lord Reed, rule. Establishing a clear rule that only the company with whom Lady Black and Lord Lloyd Jones agreed, may pursue a right of action in circumstances falling and Lord Hodge, who delivered a concurring judgment) within the ambit of Prudential also had ‘pragmatic was markedly different to that of the minority (Lord advantages’ (at [38]), in not leaving the protection of Sales, with whom Lady Hale and Lord Kitchin agreed). creditors and other shareholders to be determined by a judge in the complexities of a trial. These included is- sues around the possible proliferation and multiplicity The decision in Prudential of claims, difficulties with establishing causation in the context of a fall in share value, and double recovery. Lord Reed considered the decision of the Court of Ap- peal in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, which had established the The decision in Johnson v Gore Wood and reflective loss principle (that a shareholder could not subsequent cases claim for a diminution in the value of its shareholding). Lord Reed explained that decision as follows: Lord Reed then went on to consider Johnson v Gore Wood & Co [2002] 2 AC 1, a House of Lords case which had ‘where a company suffers actionable loss, and that considered and applied Prudential and which was the loss results in a fall in the value of its shares (or in its leading authority on the reflective loss principle. distributions), the fall in share value (or in distribu- Lord Reed held that Johnson gave authoritative sup- tions) is not a loss which the law recognises as being port to the decision in Prudential that a shareholder was separate and distinct from the loss sustained by the normally unable to sue for the recovery of a diminution company. It is for that reason that it does not give rise in the value of its shareholding or in the distributions to an independent claim to damages on the part of it received as a shareholder which flowed from loss suf- the shareholders’ (at [28]). fered by the company, for the recovery of which the He explained that that case had been concerned only company had a cause of action, even if it declined or with a diminution in the value of the shares or in dis- failed to make good that loss (at [67]). tributions, suffered by a shareholder merely because However, Lord Reed held that the judgment of Lord the company had itself suffered actionable damage (at Millett and the other judges in the majority in Johnson [26]). (save Lord Bingham) departed from the reasoning in Lord Reed set out the rationale for the decision in Prudential and should not be followed. In particular, Prudential and the reflective loss principle (see [31]- Lord Millett’s description of a share as representing a [36]; see also the concurring judgment of Lord Hodge, proportionate part of the company’s net assets was in- in particular at [96]-[108]). He explained that a share correct, and the rule in Prudential was not premised on was not a proportionate part of a company’s assets, any necessary relationship between a company’s assets and did not confer any legal or equitable interest in and the value of its shares or distributions (at [49]). the company’s assets. Rather, it was simply a right of Further, Lord Millett’s approach to the rule in Pruden- participation in the company on the terms of, and with tial – as being premised on the principle that double the rights set out in, the articles of association. A fall recovery should be avoided – was incorrect and did in the value of its shares was not an inevitable conse- not satisfactorily explain the rule in Prudential (at [50]- quence of loss suffered by a company, and the size of [60]), including because (a) it assumed unrealistically that fall would not necessarily be equivalent or even that there was ‘a universal and necessary relationship

405 International Corporate Rescue, Volume 17, Issue 5 © 2020 Chase Cambria Publishing Zaid Fathoala and Jonathan Pagan between changes in a company’s net assets and chang- whether by a shareholder or anyone else, in respect of es in its share value’, (b) it could not explain why a loss not falling within that description, but where the shareholder could not be permitted to pursue a claim company had a right of action in respect of substan- where the company had declined to pursue its claim tially the same loss. or had settled at an undervalue, and (c) double recov- In the first category of cases, as a bright line rule, ery could arise where there were concurrent claims by only the company has an actionable claim against the companies and persons who had suffered loss in capac- wrongdoer. That is because the shareholder has not ities other than as shareholders, and such claims were suffered a loss which is regarded by the law as being not prohibited by the rule in Prudential. separate and distinct from the company’s loss. If the Lord Reed added that, to the extent that Lord Millett company chooses not to pursue the claim, then the intended to extend the reflective loss principle to cover shareholder may seek another available remedy (e.g. all personal claims against a wrongdoer where the a derivative action, or equitable relief from unfairly company also had a cause of action and in respect of prejudicial conduct). amounts which the company would have paid to the However, the second category of claims are not claimant if it had had the necessary funds, that was caught by the reflective loss principle, and are therefore also mistaken. available to the shareholder or creditor (subject to the Lord Reed pointed out that Johnson had been followed need to avoid double recovery). by many cases in which litigants had sought to estab- Accordingly, the majority found that the rule in Pru- lish exceptions to the general reflective loss principle, or dential had no application to the present case, since the to establish that the rule against recovery of reflective claim had not been brought by a shareholder but rather loss extended more widely than had been determined a creditor of the company. Accordingly, the court held in Johnson. that Marex should be permitted to pursue the entirety For example, in Giles v Rhind, the Court of Appeal of its claim. held that a shareholder could recover for loss flowing from the company’s loss where the company had a cause of action but failed to pursue it, in circumstances The minority judgment where the wrongdoer’s own conduct had prevented the company from pursuing that cause of action. Lord Although Lord Sales (giving the judgment of the mi- Reed held that this decision, and Perry v Day [2004] nority) reached the same conclusion as Lord Reed and EWHC 3372 (Ch) which followed it, were inconsistent the majority (i.e. that Marex’s appeal should be al- with the bright-line rule in Prudential (at [68]-[71]), lowed), his reasoning differed significantly in a number given that the rule did not take into account whether or of respects. not the company was financially able to bring proceed- In Lord Sales’ view, the Court of Appeal in Pruden- ings to recover its loss. In addition, in Gardner v Parker tial had not laid down (and did not purport to have laid [2004] EWCA Civ 781 and subsequent cases, the scope down) a strict rule of law, as Lord Reed considered it of the reflective loss principle had been expanded so had. Instead, the Court of Appeal had sought to explain that it had come to be treated as if it was applicable ‘in why the shareholder in such a case had not as a matter all situations where there are concurrent claims and of fact suffered any loss. Lord Sales considered that the one of the claimants is a company’ (at [77]), for exam- reasoning in Prudential could not be supported and that ple where the claimant is not a shareholder but a third there were ‘clearly … some cases where the shareholder party creditor. Lord Reed argued that ‘[t]he extension does suffer a loss which is different from the loss suf- of the principle to such cases has the potential to have fered by the company’ (at [118]). He argued in common a significant impact on the law and on commercial life’, with Lord Reed and the majority that ‘the loss suffered and warned of the resulting increase in the ‘volume of by the shareholder is not the same as the loss suffered litigation and the level of uncertainty’ (at [77]). by the company’, and that there ‘is no necessary, direct correlation between the two’ (at [132]). Accordingly, Lord Sales opined that, in light of the Conclusions deficiencies in the Court of Appeal’s reasoning in Pru- dential, the Supreme Court could not now re-charac- Having reviewed the reflective loss principle in detail, terise that decision in the way in which the majority Lord Reed held that it was necessary to distinguish had sought to do. Indeed, Lord Sales believed that the between two cases: (a) where claims were brought by majority, in deriving from the decision in Prudential a a shareholder in respect of loss which it had suffered clear rule of law, had adopted a ‘crude bright line rule in that capacity in the form of a diminution in share which will inevitably produce injustice’ (at [167]). In- value or distributions, where that loss was the conse- stead, he considered that the question as to whether a quence of loss sustained by the company and in respect shareholder had suffered an actionable loss was one of which the company had a cause of action against that ought to be considered on the facts of each indi- the wrongdoer, and (b) where claims were brought, vidual case, rather than by reference to the majority’s

International Corporate Rescue, Volume 17, Issue 5 406 © 2020 Chase Cambria Publishing Sevilleja v Marex Financial Ltd [2020] UKSC 31 bright-line rule, and that other means such as sensible where that loss is the consequence of loss sustained by case management and subrogation were available to the company and in respect of which the company has the court to address issues such as double recovery. a cause of action against the wrongdoer. In essence, therefore, the minority went even further The majority’s approach, in its adoption of that than the majority in limiting the scope of the reflective bright-line rule, will bring helpful clarity to an area of loss principle. Indeed, in holding that it did not apply in law that has vexed litigants and the courts for years, this case, Lord Sales went so far as to doubt whether the as third party wrongdoers sought to cast the net of the reflective loss principle existed at all (at [211]). reflective loss principle ever wider. In particular, the decision restores some doctrinal consistency to this area of law and limits the ability of those wrongdoers Comment to rely on the reflective loss principle to stifle otherwise legitimate claims by shareholders and creditors. It ap- As will be evident from the fact that a panel of seven pears likely that the majority’s approach will result in Justices was convened to hear it, this case is likely to be a marked increase in the volume of claims brought by of major significance for various stakeholders, includ- creditors (including shareholders) who will no longer ing companies, shareholders, creditors and insolvency be locked out by reason of a widely interpreted reflec- practitioners. More than simply what was decided, the tive loss principle. particular significance of the decision lies in how it was However, a note of caution: in having decided the decided – in particular, in the decision of the majority case by a bare majority of four to three, the Supreme to overturn two decades of established case law and Court may have left room for argument in future cases establish a bright-line rule which (according to the ma- as to which side of the line any given case falls on. This jority) reflects the proper (narrow) basis of the decision may mean that, for all the helpful clarity resulting from in Prudential, namely that the reflective loss principle the majority’s approach, litigants may well continue to captures only claims by shareholders for loss in the argue about the scope of the reflective loss principle for form of a diminution in share value or distributions, years to come.

407 International Corporate Rescue, Volume 17, Issue 5 © 2020 Chase Cambria Publishing International Corporate Rescue

International Corporate Rescue addresses the most relevant issues in the topical area of insolvency and corporate rescue law and practice. The journal encompasses within its scope banking and financial services, company and insolvency law from an international perspective. It is broad enough to cover industry perspectives, yet specialised enough to provide in-depth analysis to practitioners facing these issues on a day-to-day basis. The coverage and analysis published in the journal is truly international and reaches the key jurisdictions where there is corporate rescue activity within core regions of North and South America, UK, Europe Austral Asia and Asia. Alongside its regular features – Editorial, US Corner, Economists’ Outlook and Case Review Section – each issue of International Corporate Rescue brings superbly authoritative articles on the most pertinent international business issues written by the leading experts in the field. International Corporate Rescue has been relied on by practitioners and lawyers throughout the world and is designed to help: • Better understanding of the practical implications of insolvency and business failure – and the risk of operating in certain markets. • Keeping the reader up to date with relevant developments in international business and trade, legislation, regulation and litigation. • Identify and assess potential problems and avoid costly mistakes.

Editor-in-Chief: Mark Fennessy, Proskauer Rose LLP, London Emanuella Agostinelli, Curtis, Mallet-Prevost, Colt & Mosle LLP, Milan; Scott Atkins, Norton Rose Fulbright, Sydney; James Bennett, KPMG, London; Prof. Ashley Braganza, Brunel University London, Uxbridge; Dan Butters, Deloitte, London; Geoff Carton-Kelly, FRP Advisory, London; Gillian Carty, Shepherd and Wedderburn, Edinburgh; Charlotte Cooke, South Square, London; Katharina Crinson, Freshfields Bruckhaus Deringer, London; Hon. Robert D. Drain, United States Bankruptcy Court, Southern District of New York; Simon Edel, EY, London; Matthew Kersey, Russell McVeagh, Auckland; Prof. Ioannis Kokkoris, Queen Mary, University of London; Professor John Lowry, University College London, London; Neil Lupton, Walkers, Cayman Islands; Nigel Meeson QC, Conyers Dill Pearson, Hong Kong; Professor Riz Mokal, South Square, London; Mathew Newman, Ogier, Guernsey; John O’Driscoll, Walkers, London; Karen O’Flynn, Clayton Utz, Sydney; Professor Rodrigo Olivares-Caminal, Queen Mary, University of London; Christian Pilkington, White & Case LLP, London; Susan Prevezer QC, Brick Court Chambers, London; Professor Arad Reisberg, Brunel University, London; Jeremy Richmond QC, Quadrant Chambers, London; Daniel Schwarzmann, PricewaterhouseCoopers, London; The Hon. Mr Justice Richard Snowden, Royal Courts of Justice, London; Anker Sørensen, De Gaulle Fleurance & Associés, Paris; Kathleen Stephansen, New York; Dr Artur Swierczok, CMS Hasche Sigle, Frankfurt; Meiyen Tan, Oon & Bazul, Singapore; Stephen Taylor, Isonomy Limited, London; Richard Tett, Freshfields Bruckhaus Deringer, London; The Hon. Mr Justice William Trower QC, Royal Courts of Justice, London; Mahesh Uttamchandani, The World Bank, Washington, DC; Robert van Galen, NautaDutilh, Amsterdam; Miguel Virgós, Madrid; L. Viswanathan, Cyril Amarchand Mangaldas, New Delhi; Prof. em. Bob Wessels, University of Leiden, Leiden, the Netherlands; Angus Young, Hong Kong Baptist University, Hong Kong; Maja Zerjal Fink, Arnold & Porter, New York; Dr Haizheng Zhang, Beijing Foreign Studies University, Beijing. For more information about International Corporate Rescue, please visit www.chasecambria.com