AuthorPearlie KOH LLB (National University of Singapore), LLM (University of Melbourne); Advocate and Solicitor (Singapore); Associate Professor of Law, Singapore Management University.
Date01 December 2011
Published date01 December 2011

Allowing Recovery for Reflective Losses

An absolute application of the no reflective loss principle can result in unfairness. As such, retaining judicial discretion in the area will do much to ensure that genuine causes are not denied remedy. However, even as our courts appear prepared to allow a shareholder to recover for reflective loss, it is important that corporate autonomy is accorded due respect, and not be obscured by an over-consideration of policy concerns. To ensure this, the courts should allow recovery only if the right asserted by the shareholder is one that is separate and independent of the company's right.

I. Introduction

1 The rule in Foss v Harbottle1 decrees that where a wrong is done to a company, only the company may sue for any damage caused to it. This does not mean that the shareholders of the company do not suffer any loss, for any negative impact the wrongdoing may have on the company is likely to also affect the value of its assets, and hence the value of the shares of the company. It is, however, clear that the shareholders do not, by reason of that loss alone, acquire any direct cause of action against the wrongdoer.2 As the cause of action belongs to the company, it is only right that the company alone is entitled to prosecute in respect of that wrong. This is a necessary corollary of the separate legal status of the company.

2 What then if the shareholder is able to establish a personal cause of action against the same wrongdoer? Is he entitled to recover all losses he suffered as a consequence of the wrong against him? The answer appears settled in England by the House of Lords in Johnson v Gore Wood & Co3 (“Johnson”),

which made it clear that where the loss suffered by the shareholder “merely reflected the diminution of the company's assets”,4 the shareholder is debarred from claiming such loss. This rule, in the words of Lord Millett, is “a matter of principle; there is no discretion involved”.5 If the loss is reflective, the shareholder cannot recover. Reflective losses cover not only loss manifested in the diminution of share value, but extends to all payments6 which the company would have made to the shareholder had it not been deprived of its funds by the alleged wrong. The rule applies even if the claim made by the shareholder is in some other capacity apart from his capacity as shareholder. The shareholder's claim, whether qua employee or qua creditor, is therefore similarly debarred.

3 The Court of Appeal in Singapore had the occasion to comment on the no reflective loss principle in Townsing v Jenton Overseas Investment Pte Ltd.7 Whilst the court overtly adopted8 the no reflective loss principle as established by the English decisions of, inter alia, Johnson and Gardner v Parker,9 it is apparent nonetheless that the Court of Appeal was prepared to accept a somewhat less rigid stance vis-à-vis the principle.10 Specifically, the court was prepared to allow a plaintiff to adduce evidence or to take steps to disapply the no reflective loss principle by showing that there was no possibility or risk of double recovery.

4 In this article, it is argued that the Singapore Court of Appeal is, with respect, correct to eschew the rigid approach. A rigid rule, as Peter Gibson LJ observed in Shaker v Al-Bedrawi,11 can “work hardship”. Although an absolute approach does engender predictability and hence efficiency,12 it can in some circumstances be at the expense of fairness and justice. As Chao Hick Tin JA opined in Chwee Kin Keong v Pte Ltd,13“[w]hile certainty is desirable, it is not an

object which should prevail in all circumstances, even against the dictates of justice”.

5 However, it would be too simplistic an approach for the court to exercise its discretion to disapply the rule whenever the policy reasons that sustain it are not in issue. Adopting such an approach risks compromising the integrity of the company's separate legal status by according insufficient respect to the distinction between corporate (and hence derivative) and direct personal rights. If the losses claimed by the shareholder are presumptively reflective, before considering the policy concerns, the court should first satisfy itself that the shareholder's claim against the defendant can be properly classified, and therefore should be classified, as a personal claim. Only then should the court proceed to consider whether the policy concerns that support the rule may be adequately dealt with in the particular case. It is this author's view that adopting this approach will be in keeping with Lord Bingham's exhortation in Johnson for the court “to be astute to ensure that the party who has in fact suffered loss is not arbitrarily denied compensation”14 [emphasis added].

6 We begin by considering the no reflective loss principle as developed by the English courts and the policy concerns that sustain it.

II. The non-recovery of “reflective” loss

7 The rule barring a shareholder's personal action to recover a reduction in the value of his shares applies only when there re overlapping claims by both the company and the shareholder against the same defendant. The genesis of this no reflective loss principle may be traced to the English Court of Appeal decision in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2)15 (“Prudential Assurance”). The plaintiff, an institutional investor which held approximately 3% of the shares in Newman, a public quoted company, claimed against two directors of Newman both derivatively and personally. The claims were in respect of Newman's purchase of certain assets at an overvalue which was allegedly procured by the directors fraudulently. The personal claim, brought in the plaintiff's capacity as shareholder, was premised on the misleading advice given to the shareholders by the directors in order to procure general meeting approval of the purchase as was required by stock exchange rules.

8 Overruling the lower court,16 the Court of Appeal held that the personal claim against the directors was misconceived. Whilst recognising that the directors owed the shareholders a duty, when advising them to approve the transaction, to give such advice in good faith and not fraudulently, and which duty may have been breached, the plaintiff nevertheless could not succeed in its personal claim as it had not suffered any personal loss. The court said:17

[The shareholder] cannot … recover damages merely because the company in which he is interested has suffered damage. He cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend, because such a ‘loss’ is merely a reflection of the loss suffered by the company.

9 This view of the nature of the shareholder's “loss” has been criticised as “indefensibly narrow”.18 Indeed, whilst it is a basic principle of company law that ownership of a share in a company gives the shareholder no interest as such in the assets of the company,19 conferring on the shareholder only certain participation rights in connection with those assets whilst the company is a going concern and a pro rata interest in the net assets of the company upon its liquidation,20 it is nevertheless incontrovertible that shares are items of property21 belonging to the shareholder and to which a real monetary value may be ascribed.22 Accordingly, although a shareholder can have no insurable interest in the assets of the company,23 he certainly does have an

insurable interest in the value of his shares in the company.24 Necessarily, therefore, when the value of the shares decline, this is a real loss suffered by the shareholder personally. This was recognised and accepted by the New Zealand Court of Appeal in Christensen v Scott,25 where Thomas J opined as follows:26

The fact that the loss may also be suffered by the company does not mean that it is not also a personal loss to the [shareholder]. Indeed, the diminution in the value of [the claimants'] shares in the company is by definition a personal loss and not a corporate loss.

10 Contrary to the view of the court in Prudential Assurance, Lord Millett accepted,27 in Johnson, as did Lord Hutton,28 that a diminution of share value is a personal loss for the shareholder. But this, as Lord Millet said, is not the point:29

The point is that [the loss] merely reflected the diminution of the company's assets. The test is not whether the company could have made a claim in respect of the loss in question; the question is whether, treating the company and the shareholder as one for this purpose, the shareholder's loss is franked by that of the company. If so, such reflected loss is recoverable by the company and not by the shareholders.

11 As pointed out earlier, the concept of reflective loss to which the bar applies extends beyond the diminution of share value. Lord Bingham in Johnson stated that where the loss claimed “would be made good if the company had enforced its full rights against the party responsible”,30 that loss would be merely a reflection of the loss suffered by the company. This would clearly include such other payments which the company would have made to the plaintiff, whether or not qua shareholder, if it had not been deprived of its funds by the defendant's wrongdoing.31 For example, in Johnson, the House of Lords struck out claims for lost salary and pension contributions, which the shareholder had sustained in his capacity as employee. And, in Gardner v Parker,32

a shareholder's claim as creditor for the loss of its ability to recover on a loan made to the company was similarly held barred by the principle.33

12 If “reflective losses” are by definition personal losses suffered by the shareholder, why then should the shareholder not be entitled to recover for that loss? The non-recovery is dictated on policy grounds. Lord Millett alluded to these when he stated as follows:34

If the shareholder is allowed...

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