EU Advocate General considers interpretation of Prospectus Directive in relation to an issuer’s liability for a prospectus marketed to both retail and qualified investors

The Advocate General (AG) of the Court of Justice of the European Union (CJEU) has handed down an unsurprising opinion on the interpretation of Directive 2003/71/EC (the Prospectus Directive), considering the liability of issuers to qualified investors in respect of inaccuracies in a prospectus: Bankia SA v UMAS (Case C-910/19) EU:C:2021:119 (11 February 2021), (Advocate General Richard de la Tour).

The referral was made by the Spanish Supreme Court on the interpretation of Article 3(2)(a) and Article 6 of the Prospective Directive, which (before its repeal – as discussed further below) provided the framework for a “single passport” for prospectuses throughout the EU. As an EU Directive, it required further implementation measures by EU Member States to be effective. In the UK, the relevant provisions considered by the AG are found at s.90 of the Financial Services and Markets Act 2000 (FSMA).

The context for the referral was the relatively commonplace scenario in a securities issuance, where an issuer publishes a prospectus to the public at large, and as a consequence it is received by qualified investors as well as retail investors (e.g. where there is a combined offer). The question for the AG was whether the issuer could be liable (under Article 6 of the Prospectus Directive) to qualified investors (as well as retail investors) for any inaccuracies in the prospectus in circumstances where, if the offer had been directed solely at qualified investors, the issuer would have been exempt from publishing the prospectus under Article 3(2)(a) of the Prospectus Directive. If the qualified investor is entitled to bring a claim in these circumstances, the AG was asked if the qualified investor’s awareness of the true situation of the issuer could be taken into consideration.

In response to these questions, the AG’s opinion (which is non-binding but influential on the CJEU) concluded as follows:

  1. Article 6 of the Prospectus Directive, in light of Article 3(2)(a), must be interpreted as meaning that where an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued, an action for damages arising from the prospectus may be brought by qualified investors; although it is not necessary to publish such a document where the offer concerns exclusively such investors.
  2. Article 6(2) of the Prospectus Directive must be interpreted as not precluding, in the event of an action in damages being brought by a qualified investor on grounds of an inaccurate prospectus, that investor’s awareness of the true situation of the issuer being taken into consideration besides the inaccurate or incomplete terms of the prospectus, since such awareness may also be taken into account in similar actions for damages and taking it into account does not in practice have the effect of making it impossible or excessively difficult to bring that action, which is a matter for the referring court to determine.

From a UK perspective (and as prefaced above), this is an unsurprising outcome in the context of s.90 FSMA. In particular, because the second point (awareness of the true position of the issuer) is expressly included in the Schedule 10 defences to a s.90 claim.

Securities lawyers will immediately question the impact of the AG’s opinion in the light of the Prospectus Regulation (EU) 2017/1129 and Brexit.  Although the Prospectus Regulation repealed and replaced the Prospectus Directive (see our banking litigation blog post), the substance of the Articles considered by the AG have been carried forward into the equivalent Prospectus Regulation provisions.

As to Brexit, although the UK is no longer a member of the EU (following the end of the Brexit transition period on 31 December 2020), the AG’s opinion may still be of relevance to the interpretation of s.90 FSMA claims. S.90 FSMA represents “retained EU law” post-Brexit because it is derived from an EU Directive. In interpreting retained EU law, CJEU decisions post-dating the end of the transition period are not binding on UK courts, although the courts may have regard to them so far as relevant (see our litigation blog post on the practical implications of Brexit for disputes). As noted above, AG opinions are not binding in any event, but this will be the status of the CJEU decision when finally handed down.

The AG’s opinion is considered in more detail below.

Background

In 2011, the appellant Spanish bank (Bank) issued an offer of shares to the public, for the purpose of becoming listed on the Spanish stock exchange. The offer consisted of two tranches: one for retail investors and the other for qualified investors. A book-building period, in which potential qualified investors could submit subscription bids, took place between June and July 2011. As part of the subscription offer, the Bank contacted the respondent (UMAS), a mutual insurance entity and therefore a qualified investor. UMAS agreed to purchase 160,000 shares at a cost of EUR 600,000. The Bank’s annual financial statements were subsequently revised. This led to the shares losing almost all their value on the secondary market and being suspended from trading.

UMAS issued proceedings in the Spanish court against the Bank seeking to annul the share purchase order, on the grounds that the consent was vitiated by error; or alternatively for a declaration that the Bank was liable on the grounds that the prospectus was misleading. Having lost at first instance, the Bank appealed to the Spanish Provincial Court, which dismissed the action for annulment but upheld the alternative action for damages brought against the Bank on the grounds that the prospectus was inaccurate.

On the Bank’s appeal to the Spanish Supreme Court, the court held that neither the Prospectus Directive nor Spanish law expressly provided that it is possible for qualified investors to hold the issuer liable for an inaccurate prospectus where the offer made to the public to subscribe for securities is addressed to both retail and qualified investors.

The Spanish Supreme Court decided to stay the proceedings and referred two key questions to the ECJ for a preliminary ruling:

  • When an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued for the retail investors, is an action for damages arising from the prospectus available to both kinds of investor or only to retail investors?
  • In the event that an action for damages arising from the prospectus is also available to qualified investors, is it possible to assess the extent to which they were aware of the economic situation of the issuer of the offer of shares to the public for subscription otherwise than through the prospectus, on the basis of their legal and commercial relations with that issuer (e.g. being shareholders of the issuer or members of its management bodies etc)?

Decision

We consider below each of the issues addressed by the AG in his opinion.

Issue 1: Inaccurate prospectus as the basis for a qualified investor’s action for damages

The AG concluded that Article 6 of the Prospectus Directive, in the light of Article 3(2)(a), must be interpreted as meaning that, where an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued, an action for damages arising from the prospectus may be brought by qualified investors, although it is not necessary to publish such a document where the offer concerns exclusively such investors.

In the AG’s view, this interpretation was supported by both a literal/systematic interpretation of the Prospectus Directive, and a teleological interpretation (paying attention to the aim and purpose of EU law).

Before considering each approach to interpretation below, and by way of reminder, Article 3(2)(a) of the Prospectus Directive contains an exemption from the obligation to publish a prospectus where the offer is limited to qualified investors. However, the publication of a prospectus is mandatory where there is a combined offer to the public (i.e. both non-qualified and qualified investors) (Article 3(1)); or in the event of an issue of shares for trading on a regulated market (Article 3(3)).

Literal/systematic interpretation

Considering first the linguistic interpretation of the words used, the AG noted that Article 6 establishes a principle of liability in respect of inaccurate/incomplete prospectuses, but does not provide for an exception to that principle based on the nature of the combined offer, whether it is offered solely to the public or is intended for trading on a regulated market.

The AG contrasted the approach in other provisions of the Prospectus Directive, which do provide for exemptions from the obligation to publish a prospectus, based either on the person to whom the offer is addressed (Article 3(2)(a)), the number of shares or total offer issues (Article 3(2)), or on the nature of the shares issued (Article 4). However, those exemptions from the publication obligation do not prohibit voluntary publication of a prospectus by an issuer who will then benefit from the “single passport” if the shares are issued on a regulated market.

From a systematic perspective, the AG pointed out that the effect of the exemptions was to create circumstances in which qualified investors will receive a prospectus, even if they would not have received one if the offer had been directed solely at qualified investors. For example, where there is a combined offer (as in the present case) or where the prospectus is published voluntarily to benefit from the “single passport”.

The AG commented that the referring court appeared to start from the premise that, since the prospectus was intended solely to protect and inform retail investors, qualified investors could not rely on the inaccuracy of the prospectus in order to bring an action for damages. In the AG’s view, a literal and systematic interpretation of the Prospectus Directive cast doubt on the idea that a prospectus is produced merely in order to protect non-qualified investors.

Teleological interpretation (looking at the aim and purpose of EU law)

The AG said the interpretation of Article 6 of the Prospectus Directive must have regard to and balance two objectives: (i) the completion of a single securities market through the development of access to financial markets; and (ii) the protection of investors whilst taking account of the different requirements for the protection of the various categories of investors and their level of expertise.

Again, in the AG’s view, the presence of exemptions in Articles 3 and 4 versus the lack of any exemptions in Article 6, must lead to an interpretation that where a prospectus exists it must be possible to bring an action for damages on the basis of the inaccuracy of that prospectus irrespective of the type of investor.

The AG also commented that if it were accepted that each Member State could determine itself whether or not qualified investors may bring an action for damages in the event of an inaccurate prospectus, that would lead to possible distortions occurring among Member States that would undermine, disproportionately, the objective of completing the single securities market. A uniform interpretation of Article 6 is required, therefore, concerning persons who may bring proceedings against the issuer in connection with an offer.

Issue 2: Qualified investor’s awareness of the true situation of the issuer

The AG concluded that a Member State has the discretion to provide in its legislation or regulations that awareness by a qualified investor of the true situation of the issuer should be taken into account, in the event of an action for damages being brought by a qualified investor on the grounds of an inaccurate prospectus (i.e. that Article 6(2) does not preclude this principle). However, this is subject to the condition that the principles of effectiveness and equivalence are observed.

The AG said that the extent of liability for inaccuracies in a prospectus is a matter for Member States (in terms of whether to take account of the contributory fault of the investor and questions of causation). Accepting that Member States may factor in the awareness of a qualified investor in their legislation, the AG drew an analogy with the reasoning of the CJEU’s decision in Hirmann C‑174/12, EU:C:2013:856. In Hirmann, the court accepted that a Member State may limit the civil liability of the issuer by limiting the amount of compensation by reference to the date on which the share price is determined for the compensation (although again, the Member State must observe the principles of equivalence and effectiveness).

In terms of observing those principles of equivalence and effectiveness, the AG emphasised the need to take the investor’s awareness into consideration specifically in a given situation, which will require the courts of Member States to assess the evidence of such awareness and of the extent to which that awareness has been taken into consideration.

Harry Edwards
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Ceri Morgan
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High Court strikes out s.90A FSMA claims for failure to comply with pre-service joinder rules following expiration of arguable limitation period

The High Court has struck out certain of the claims brought against G4S under section 90A Financial Services and Markets Act 2000 (FSMA), in a judgment which emphasises the risks inherent in issuing complex group litigation shortly before the expiry of an arguable limitation period: Various Claimants v G4S plc [2021] EWHC 524 (Ch). The decision brings into sharp relief the need for claimants to balance the tension between the crucial practice of book-building and awaiting regulatory investigations on the one hand and limitation periods on the other. Ultimately, in this case, the court had little sympathy for claimants who had failed to get theirducks in a pen, let alone in a row” prior to the expiry of the limitation period.

The successful application will have a significant impact on the proceedings, with approximately 90% of the quantum of the claims being struck out.

The claims were primarily struck out on the basis that new claimants cannot be added to an existing claim form using CPR 17.1, which allows a party to amend its statement of case before it has been served. The Court also held that, in order for new claimants to be properly added to an existing claim form, a separate document recording their written consent must be filed with the court pursuant to CPR 19.4(4). The filing of an amended claim form, signed by the claimants’ solicitor, does not constitute such consent.

The Court further considered whether to grant the claimants permission to amend the claimants’ names where certain claimants were incorrectly identified on the claim form. The judgment provides a helpful reiteration of the legal principles which apply when the Court is considering whether to exercise its discretion to amend party names following the expiry of a limitation period.

Herbert Smith Freehills acts for the defendant, G4S, in this matter.

Background

The applications arose in the claims brought by shareholders in G4S under section 90A and schedule 10A FSMA in relation to allegedly false and misleading statements or omissions made by G4S regarding its billing practices between 2011 and 2013.

The claim form was issued on 10 July 2019 and was subsequently amended 6 times to add or remove claimants before it was served on 30 April 2020. The claimants added on or after 11 July 2019 (the Additional Claimants) were purportedly added pursuant to CPR 17.1, which provides that “A party may amend his statement of case at any time before it has been served on any other party”.

93 claimants were listed on the claim form which was served on 30 April 2020, of which 64 were Additional Claimants. In addition, a number of the claimants (including some original claimants) listed on the claim form did not appear to be legal persons capable of bringing a claim (the Unidentified Claimants).

G4S applied for the claims of the Additional Claimants to be struck out on the basis that:

  1. CPR 17.1 does not permit the addition of claimants before service either generally or where there is said to be an arguable limitation defence; and/or
  2. Under CPR 19.4(4) a party cannot be added as a claimant unless it consents in writing and the consent is filed with the court. The requirements of CPR 19.4(4) had not been met and therefore the claimants had not been validly added.

G4S also applied for the claims of the Unidentified Claimants to be struck out on the basis that they were not properly identified on the claim form and / or were not legal entities with appropriate capacity to sue.

The claimants applied for permission to amend the names of the Unidentified Claimants. The amendments sought ranged from the correction of typos to the substitution of claimants for other entities.

G4S also sought to have claims relating to publications by G4S from 2006 to 2011 struck out of the Particulars of Claim on the basis that the claim form limited the relevant time period to publications made from 2011 onwards.

The decision

The High Court (Mann J) struck out the claims of the Additional Claimants, which accounted for approximately 90% of the quantum of the claims, and refused the Claimants’ amendment application (save for a correction to the name of one claimant).

Addition of claimants pursuant to CPR 17.1

Mann J considered whether the Additional Claimants could be joined to the claim form prior to service without the Court’s permission under CPR 17.1, and whether G4S was right to bring a challenge to the addition of those claimants under CPR 3.4.

G4S argued that CPR 17.1, on its true construction, applies only to an existing party amending their own statement of case, and therefore an amendment which seeks to introduce a new claimant does not fall within this rule.

Mann J agreed, noting that the natural meaning of “his statement of case” does not include an amendment to plead another claimant’s entirely separate case. Instead, this is bringing in a new party with a distinct claim. In such circumstances, rather than seeking to amend the original claim form, the Additional Claimants should commence their own separate proceedings and later apply for the claims to be consolidated. The claims of the Additional Claimants therefore fell outside the scope of CPR 17.1 and had not been validly added to the claim form.

Given the above, Mann J considered G4S’s decision to challenge the amendments via a strike out application under CPR 3.4 to be the correct approach. However, he also dealt with the case in the alternative, assuming he was wrong in respect of the use of CPR 17.1. In doing so he held that, if the amendments to the claim form in order to add the Additional Claimants had been validly made under CPR 17.1, any challenge to the addition of the Additional Claimants would need to be made under CPR 17.2 within 14 days of service of the claim form. In this case, G4S’s strike out application could stand as an application under CPR 17.2, but the fact that it was issued outside the 14 day period meant relief from sanctions would be required.

In applying the three stage test from Denton v White and other appeals [2014] EWCA Civ 906 in respect of the relief from sanctions application, Mann J found the 8 week delay between service of the claim form and issuing G4S’s application to be significant. However, Mann J did not consider that G4S’s failure to invoke CPR 17.2 was deliberate.

The most significant factor in this case was proportionality; if relief were refused, and the amendments allowed, the Additional Claimants would be deemed to have brought their claims on the date of issue of the original claim form. G4S argued this was the last day of the limitation period, and it would therefore be deprived of the benefits of the Limitation Act 1980. This was considered to outweigh any prejudice that may be caused to the claimants if relief were granted. Mann J noted that the matters in issue had come about due to “an apparent failure to get all the claimant’s ducks in a pen, let alone in a row”. Accordingly, relief from sanctions was granted.

Mann J then went on to find that, in reliance upon Chandra v Brooke North [2013] EWCA Civ 1559, in circumstances where there is an arguable limitation point in relation to the Additional Claimants, the challenge under CPR 17.2 would succeed. This is because of the finding in Chandra that, if on an amendment application it appeared that there was an arguable limitation point, then the appropriate course was not to decide it but to refuse permission and leave it to the claimant to issue fresh proceedings in which the limitation point could be tried.

Additional Claimants – consent under CPR 19.4(4)

CPR 19.4(4) provides that:

“Nobody may be added or substituted as a claimant unless –

(a)        he has given his consent in writing; and

(b)        that consent has been filed with the court.”

The Claimants’ submitted that (i) CPR 19.4(4) did not apply to the joinder of the Additional Claimants pre-service, and (ii) in any event, filing an amended claim form signed by a solicitor as agent for the claimants constituted such consent. Mann J considered it impossible to think of a reason why this rule should apply post-service and not pre-service, and found therefore that it plainly did apply to addition of the Additional Claimants. Further, applying Court of Appeal authority Kay v Dowzall [1993] WL 13726011, Mann J held that consent impliedly expressed by a solicitor signing a claim form on behalf of the claimants cannot count as a consent under CPR 19.4(4). The rule requires a separate document from the sort of pleading the claimant (or someone on their behalf) would have to sign anyway, and this separate document would need to be filed before the addition of a party which takes effect via an amended claim form. The claims of the Additional Claimants were therefore not properly added to the claim form.

“Unidentified” Claimants

Parties can apply to amend a claim form to correct the name of a claimant or defendant under 17.4(3) if there has been a genuine mistake as to the name of that party which would not cause reasonable doubt as to the identity of the proper party. Alternatively, if a limitation period has expired, a party can be added or substituted under CPR 19.5 if the limitation period was current when the proceedings started and the amendment is necessary. An amendment will be “necessary” under CPR 19.5 if (a) the original party was named in the claim form by mistake, or (b) the claim cannot be carried on without the new party.

In considering these provisions, Mann J applied the following principles:

  1. Under both CPR 17.4 and CPR 19.5, the mistake must be as to name and not identity.
  2. CPR 19.5 refers in terms to a substitution. However, in reality CPR 17.4(3) has also been interpreted so as to allow what is, in fact (and law) a substitution.
  3. That is because the concept of a “mistake as to name” is interpreted generously.
  4. Generosity is achieved by looking to the description of the claimant or defendant (as the case may be) in the claim form (and perhaps Particulars of Claim if served with it). If the correct claimant or defendant matches the description in the claim form, the mistake may constitute a mistake as to name, rather than identity.
  5. If a description is to be relied on as saving a misdescribed party it must be sufficiently specific to allow identification in the circumstances. A successful amendment will very often be a case where there is an intention to sue in a certain capacity (for example, landlord, tenant, shipowner).
  6. The true identity must be apparent to the litigation counterparty under 17.4(3), where it is a requirement that the mistake would not have caused reasonable doubt as to the identity of the party intending to sue. While there is no “reasonable doubt” requirement under CPR 19.5, it may be a significant factor to the Court when exercising its discretion.

The “reasonable doubt” test is an objective one, and such doubt could not be removed by the possibility that the identity of the proper claimant might be apparent from G4S’s share register or other transactional information shared by the claimants’ solicitors after the date of the mistake – the “resolving of any doubt…should not depend on the defendant having to put together a jigsaw out of material provided for a different purpose”.

Even if the above requirements were met, the claimants still needed to satisfy the court that it should exercise its discretion in their favour to allow the amendments. Mann J noted that the claim was hastily put together in the knowledge that a limitation period was approaching. Had the litigation been put in train earlier, there would have been fewer mistakes or more time to correct them. The court’s discretion is not intended to encourage or assist “such disorderly litigation”, and Mann J refused to exercise it in the claimants’ favour (save for in respect of one claimant which had been identified by its former name in the original claim form).

Claim for losses prior to 2011

The claim form was limited to claims from 2011 onwards, but the claimants’ Particulars of Claim included claims going back to 2006. It was accepted that an amendment to the claim form was needed and, in circumstances where a limitation defence arguably applies, any amendment application would have to satisfy the requirements of CPR 17.4(2) (which states that the court may allow an amendment whose effect will be to add a new claim, but only if the new claim arises out of the same facts or substantially the same facts as a claim in respect of which the party applying for permission has already claimed a remedy in the proceedings).

Mann J considered it impossible to maintain that claims from 2006 onwards arose out of the same or substantially same facts as the claims limited to 2011 onwards. While the facts giving rise to the original claim may have to be investigated in the earlier period, any claim in relation to that earlier period would require additional investigations into any statements made by G4S in that period, the alleged falsity of those statements, the effect on the market of those statements, and the way in which the claimants reacted to such statements. These may be the same type of facts as the original claim, but were in reality different facts. As such, G4S’s application to strike out claims based on publications prior to 2011 succeeded.

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High Court strikes out “paradigm” claim for reflective loss in the context of allegedly negligent advice on an IPO

The High Court has struck out the most recent claim to engage the so-called “reflective loss” principle, in proceedings brought by a parent company and its subsidiary against advisers that prepared the parent company for its IPO on the Alternative Investment Market (AIM): Naibu Global International Company plc & Anor v Daniel Stewart & Company plc & Anor [2020] EWHC 2719 (Ch).

To put the decision in context, a significant number of judgments involving consideration of the reflective loss principle were adjourned pending the Supreme Court’s judgment in Sevilleja v Marex Financial Ltd [2020] UKSC 31, with the parties making submissions on the implications of the Marex judgment after it was handed down (in July 2020). This is precisely what happened in the present case, which represents the most recent application by the court of the newly defined rule.

As a reminder, the Supreme Court in Marex confirmed (by a 4-3 majority) that the reflective loss principle is a bright line legal rule, which prevents only shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, where the company has a cause of action against the same wrongdoer (see our blog post: Untangling, but not killing off, the Japanese knotweed: Supreme Court confirms existence and scope of “reflective loss” rule).

In Naibu, the court held that the relevant claim was a “paradigm” example of a claim for reflective loss, where the loss and damage pleaded by the parent turned almost entirely upon the loss suffered by the subsidiary, since the alleged loss consisted of a fall in the value of the shares in the subsidiary (to nil). The most interesting aspect of the judgment, is the court’s rejection of the suggestion that it should look at the losses of the parent and subsidiary as they evolved over time, and that the parent should be entitled to recover any loss suffered at a particular stage if it was different in nature or quantum to the loss to the subsidiary. The court found that it would be wholly artificial to carve up the losses by time in an attempt to circumvent the application of the reflective loss rule.

While Marex emphasised the narrow scope of the reflective loss rule, Naibu demonstrates that the court is prepared to take a robust approach and strike out claims falling within its parameters. This result is likely to be welcomed by financial institutions, as the reflective loss rule is an important defence to shareholder claims, as illustrated by the context of the present case.

Background

Naibu (China) Co Ltd (Naibu China) is a Chinese sportswear company and the wholly owned subsidiary of the second claimant, Naibu (HK) International Investment Limited (Naibu HK), which is in turn the wholly owned subsidiary of the first claimant, Naibu Global International Company plc (Naibu Jersey).

In 2011, Naibu China and Naibu HK instructed the defendants in relation to a proposed floatation on the AIM. The first defendant was instructed to act as their Nominated Adviser (NOMAD) and the second defendant (Pinsent Masons) was retained as their legal adviser. Naibu Jersey was incorporated for the purposes of the AIM floatation, which took place on 30 March 2012 and went on to raise around £6m.

Subsequently, the assets of Naibu China were dissipated (allegedly by its founder) and its factory was closed. The shares in Naibu China held by Naibu HK, and in turn by Naibu Jersey were rendered valueless. Naibu Jersey was de-listed from the AIM on 9 January 2015.

Naibu Jersey and Naibu HK brought proceedings against the defendants alleging breaches of duty and/or negligence in conducting due diligence and preparing Naibu Jersey for its IPO on the AIM.

The present judgment arose in the context of Naibu Jersey’s claim against Pinsent Masons. Amongst other interlocutory activity, Pinsent Masons applied to strike out Naibu Jersey’s claim and sought reverse summary judgment on the following grounds:

  1. No implied retainer or duty of care. There was no contractual retainer between Pinsent Masons and Naibu Jersey, no need to imply any retainer, and no tortious duty of care owed to Naibu Jersey, since Pinsent Masons was engaged to act for Naibu HK and Naibu China only, and the terms and conditions incorporated in the letters of engagement with Pinsent Masons expressly excluded any liability to third parties other than their clients.
  2. Claim barred by the reflective loss rule. The loss claimed by Naibu Jersey was almost entirely reflective of the losses claimed by Naibu HK and therefore irrecoverable under the rule against recovery of reflective losses.
  3. Stay for arbitration. If the strike out / summary judgment applications failed, Pinsent Masons said that Naibu Jersey’s claim should be stayed pursuant to s.9 of the Arbitration Act 1996.

Decision

The court struck out Naibu Jersey’s claim on the basis of the reflective loss principle, save to the extent the claims related to the costs of steps taken by Naibu Jersey to assert control over and investigate the losses suffered by Naibu HK and Naibu China (in relation to which permission was given to amend the particulars of claim). The application for a stay under s.9 of the Arbitration Act was dismissed.

Implied retainer and duty of care

The legal principles governing the implication of a retainer were not disputed. It was common ground that where there is no express retainer, a retainer may nevertheless be implied from the conduct of the parties (as per Dean v Allin & Watts [2001] EWCA Civ 758).

The court was not persuaded that the facts alleged were sufficiently decisive to show that Naibu Jersey had no realistic prospect of establishing an implied retainer. In particular, Pinsent Masons had repeatedly described itself or permitted itself to be described, in formal documents, as being the solicitors for, or instructed by Naibu Jersey.

Given the court’s finding on the implied retainer, Pinsent Masons accepted that it must follow that the case on the duty of care must likewise have a real prospect of success.

Reflective loss

The main issue on the application was therefore the application of the reflective loss principle, i.e. whether Naibu Jersey’s claim against Pinsent Masons was barred because the loss claimed was reflective of the losses claimed by Naibu HK against Pinsent Masons, and therefore irrecoverable under the rule.

The court noted that the starting point in such cases is now the Supreme Court’s decision in Marex, which accepted the rule against reflective loss in Prudential Assurance v Newman Industries (No. 2) [1982] Ch 204, confirming it as a rule of law, but limiting it to claims by shareholders based on the diminution in the value of their shares or distributions that they receive as shareholders.

The court agreed with Pinsent Masons that the loss and damage pleaded by Naibu Jersey turned almost entirely upon the loss suffered by Naibu HK, since the alleged loss consisted of a fall in the value of the shares in Naibu HK (to nil) and a consequent diminution (to nil) of the value of Naibu Jersey’s investment in Naibu HK.

In the court’s view, the claim was a paradigm claim of reflective loss, which was barred by the principle as confirmed and restated in Marex. In reaching this conclusion, the court rejected Naibu Jersey’s submission that it was necessary to look at the losses of Naibu Jersey and Naibu HK as they evolved over time, making the following findings/observations:

  • The court rejected Naibu Jersey’s arguments that: (a) an investigation (through expert evidence) was required to assess the loss suffered by each of the companies at different stages; and (b) Naibu Jersey should be entitled to recover any loss suffered at a particular stage if it was different in nature or quantum to the loss to Naibu HK (Naibu Jersey suggested the losses of the two companies might diverge at different points in time because the shares were being traded in different markets).
  • Where the reflective loss rule is engaged, the decisive question is the nature of the loss claimed by the shareholder, and there is no further requirement that the amount of the loss to the company should be identical to the loss to the shareholder. In this context, the court referred to Lord Reed’s acknowledgement in Marex that a company’s loss and any fall in its share value may not be closely correlated, particularly in cases where the company’s shares are traded on a stock market. That is one of the reasons why Lord Reed rejected the avoidance of double recovery as a justification, in itself, of the reflective loss principle.
  • Given that the total losses of Naibu Jersey were ultimately the same as those of Naibu HK, it would have entirely undermined the purpose of the rule to allow Naibu Jersey to use the simple device of identifying different losses occurring at different times, with the submission that the losses of the two companies might not have been precisely contiguous.
  • The court considered that it was wholly artificial to carve up the losses by time in an attempt to circumvent the application of the reflective loss rule.

The claim by Naibu Jersey was, therefore, struck out, save in so far as it related to alleged losses relating to steps taken by Naibu Jersey to assert control over and investigate losses suffered by Naibu HK and Naibu China. The application for a stay under s. 9 of the Arbitration Act of those remaining claims was dismissed.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Capital Raisings and Opportunistic M&A in a Covid-19 Environment—Lessons Learned from the Global Financial Crisis

The Journal of International Banking Law and Regulation (JIBLR) has published an article written by members of our securities class action practice: Capital Raisings and Opportunistic M&A in a Covid-19 Environment—Lessons Learned from the Global Financial Crisis.

Covid-19 will make it inevitable that some companies will need to bolster their capital positions, which will lead to rights issues and other forms of capital raising later this year and into 2021. On the other hand, there will be other companies who emerge from the immediate crisis and identify opportunities to gain market share or pursue other strategic goals through mergers and acquisitions. The article considers class action specific issues which companies may face during these types of transaction. There are certain parallels which may be drawn between the current environment and the financial crisis, and the article identifies learning points from the two class actions commenced in the English courts following major transactions in the run-up to and at the height of the financial crisis—the Royal Bank of Scotland rights issue and Lloyds’ acquisition of HBOS.

In particular, the article considers:

  • The legal tests governing what information is required to be disclosed;
  • Relevant considerations when information is excluded from public disclosures;
  • Forward-looking guidance;
  • Specificity of risk factors;
  • The impact of timetable pressure;
  • Working capital statements;
  • Recommendations to shareholders; and
  • Regulator capriciousness.

Please contact Ceri Morgan if you would like to request a copy of the full article.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Sarah Penfold
Sarah Penfold
Senior Associate
+44 20 7466 2619

High Court tests newly narrowed scope of the “reflective loss” rule in first decision since the Supreme Court’s judgment in Marex

In the first decision to consider the so-called “reflective loss” principle since the Supreme Court’s judgment in Sevilleja v Marex Financial Ltd [2020] UKSC 31 earlier this year, the High Court has emphasised the newly narrowed scope of the rule: Broadcasting Investment Group Ltd & Ors v Smith & Ors [2020] EWHC 2501 (Ch).

As a reminder, the Supreme Court in Marex confirmed (by a 4-3 majority) that the reflective loss principle is a bright line legal rule, which prevents shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, where the company has a cause of action against the same wrongdoer. Marex confirmed the narrow ambit of the rule, which should be applied no wider than to shareholders bringing such claims, and specifically does not extend to prevent claims brought by creditors. For a more detailed analysis of the decision in Marex, see our blog post: Untangling, but not killing off, the Japanese knotweed: Supreme Court confirms existence and scope of “reflective loss” rule.

The issue arose in the present case on an application for strike out / reverse summary judgment by the defendant to a claim for alleged breach of a joint venture agreement. The court found that the claim brought by the first claimant – a direct shareholder in the company that suffered the relevant loss – was a paradigm example of a claim within the scope of the reflective loss principle. The court was prepared to determine this question finally and strike out the claim, on the basis that the reflective loss principle is a rule of law and it was not suggested that further relevant evidence might emerge at trial.

However, the more interesting aspect of the decision considered whether the reflective loss principle should bar the claim of the third claimant, who was a “shareholder in a shareholder” in the first claimant (conveniently described in the judgment as a “third degree” shareholder).

The nub of the argument was that the third claimant should be treated as a “quasi-shareholder” in the relevant company, by reason of the chain of shareholdings connecting him to that company. The defendant argued that the third claimant should not be put in a better position, for the purposes of the rule, than if he had actually been a shareholder in that company (i.e. than the first claimant).

However, the court rejected this argument, and held that the reflective loss rule did not operate to bar the claim of a “quasi-shareholder” in this way. The court was particularly impressed by the emphasis in Marex that the reflective loss rule bars only shareholders in the loss-suffering company and is a “highly specific exception of no wider ambit”. This sentiment was antipathetic to any incremental extensions of the rule beyond that described in Marex. The court therefore refused to strike out the claim of the “third degree shareholder”, which will proceed to trial.

Considering the implications of this decision in a financial services context, the robust confirmation and clarification of the reflective loss principle in Marex has generally been well-received by the market. Although the rule has certainly been pruned, there was a clear risk in Marex that the principle, as a binding rule of law, could be lost altogether. In its surviving form, the reflective loss rule will continue to play an important part in the defence of shareholder claims against banks (aside from claims brought under section 90 and 90A of the Financial Services an Markets Act 2000, which provide a statutory exemption).

The present decision could (at first glance) raise concerns of opening the door to novel claims against the bank. For example, where it is alleged that a corporate customer has suffered loss for which the bank is responsible, a claim could theoretically be brought by both that company and by a “quasi-shareholder”, where there is a chain of shareholder ownership in the relevant company. However, the “quasi-shareholder” must have an independent cause of action against the bank, and in most cases there should be good arguments to say that there is no contractual relationship and no duty of care is owed to a second or third degree shareholder.

Background

The underlying facts of the dispute are complex, but relate to the development of a start-up company in the technology sector. In broad summary, in October 2012 an alleged oral joint venture agreement (JV Agreement) was entered into by the claimants, the first defendant (Mr Smith), the second defendant (Mr Finch) and certain other parties. Under the terms of the JV Agreement, it was intended (among other things) that a joint venture vehicle would be set up, called Simplestream Group plc (SS plc), and that Mr Smith’s shares in two existing software companies would be transferred to SS plc.

SS plc was subsequently formed and its shareholders were Mr Smith, Mr Finch and the first claimant, Broadcasting Investment Group Limited (BIG). In alleged breach of the JV Agreement, the relevant shares were not transferred to SS plc, and SS plc subsequently entered creditors’ voluntary liquidation.

BIG brought a claim against Mr Smith and Mr Finch (and others) for breach of the JV Agreement, claiming specific performance as regards the transfer of shares to SS plc, or damages in lieu of specific performance. Alternatively, BIG claimed that it suffered loss by reason of the consequent diminution in the value of its shareholding in SS plc and loss of dividend income from SS plc.

The second claimant (VIIL) was the majority shareholder of BIG and the third claimant (Mr Burgess) was, in turn, the majority shareholder of VIIL. Mr Burgess brought parallel claims to those brought by BIG, on the basis that both BIG and Mr Burgess personally were alleged to be parties to, and therefore prima facie entitled to enforce, the JV Agreement.

Mr Smith applied for strike out / reverse summary judgment on the basis that the claims of BIG and Mr Burgess were barred by the rule against reflective loss, as recently affirmed by the Supreme Court in Marex.

At the date of the hearing to which the present judgment relates, the liquidator of SS plc had not indicated any intention to pursue any claims which SS plc might have in relation to the JV Agreement.

Decision

The court held that, while BIG’s claim to enforce the JV Agreement was barred by the rule against reflective loss first established in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, and should be struck out, Mr Burgess’ claim was not barred by the same principle and could proceed to trial.

The court considered a number of other issues, but this blog post focuses on the court’s analysis of the reflective loss principle, being the first case to consider and apply the Supreme Court’s decision in Marex earlier this year.

Application of the Supreme Court’s decision in Marex

The application for strike out / summary judgment had been adjourned pending the determination of the appeal to the Supreme Court in Marex, which the court noted had clarified the law governing the reflective loss principle and made the task of considering the application at hand considerably more straightforward.

The court acknowledged that – strictly speaking – the application of the reflective loss principle to claims by shareholders was not a matter for decision in Marex, because the question before the Supreme Court considered the specific position of a creditor who was not a shareholder. Nevertheless, all members of the Supreme Court in Marex made it clear that it was necessary for them to review the scope of the principle in its entirety in order to decide whether it should be extended to creditors. It followed that the reasoning of the majority in Marex represents the law which must now be applied to all attempts to rely on the principle of reflective loss, whether the claims are by shareholders or others.

A detailed analysis of the Supreme Court’s decision in Marex can be found on our banking litigation blog. In summary, the Supreme Court (by a majority of 4-3) confirmed that the “reflective loss” rule in Prudential is a bright line legal rule of company law, which applies to companies and their shareholders. The rule prevents shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, where the company has a cause of action against the same wrongdoer. However, the Supreme Court unanimously held that the principle should be applied no wider than to shareholders bringing such claims, and specifically does not extend to prevent claims brought by creditors. The majority of the Supreme Court (led by Lord Reed) emphasised that the rule is underpinned by the principle of company law in Foss v Harbottle (1843) 2 Hare 461: a rule which (put shortly) states that the only person who can seek relief for an injury done to a company, where the company has a cause of action, is the company itself. On this basis, a shareholder does not suffer a loss that is recognised in law as having an existence distinct from the company’s loss, and is accordingly barred.

Requirement for concurrent claim

The court’s starting position was to determine whether SS plc (theoretically) had a cause of action arising out of the JV Agreement. It said this was the logical first question, since the rule in Prudential is concerned only with concurrent claims, one of which must be vested in the company which has suffered the relevant loss. The court stated that, if SS plc did not have such a claim, then the application should fail.

In response to this preliminary question, the court found that SS plc had a contractual claim to enforce the JV Agreement by virtue of the s.1(1)(b) of the Contracts (Rights of Third Parties) Act 1999 (1999 Act), which provides that a person who is not a party to a contract may in his/her own right enforce a term of the contract if “the term purports to confer a benefit” on that person.

One of the terms of the JV Agreement pleaded by the claimants (and therefore of course taken as factually correct for the purpose of the application), provided that the shares to be transferred to SS plc would be held by the company beneficially, which in the court’s view, appeared ostensibly to bestow an advantage on SS plc for the purpose of s1(1)(b). This analysis was unaffected by the fact that the agreement in question was oral rather than written, and the court found on the facts nothing to suggest that the parties did not intend the term in question to be enforceable by SS plc, so as to engage s.1(2) of the 1999 Act and disapply s.1(1)(b).

Scope of the rule in Prudential / the reflective loss principle

Having concluded that SS plc had a concurrent claim to enforce the JV Agreement, the court turned to consider whether the rule in Prudential, as explained by Marex, barred : (1) the claim brought by BIG, a shareholder in SS plc; and/or (2) the claim brought by Mr Burgess, who was not a direct shareholder in SS plc.

(1) BIG’s claim

In the court’s judgment, BIG’s claim was a paradigm example of a claim that was within the scope of, and was therefore barred by, the rule in Prudential.

The court accepted that BIG’s claim was in respect of a loss suffered by SS plc, because:

  • BIG’s claim was to enforce the JV Agreement, and in particular, Mr Smith’s alleged obligation to transfer shares to SS plc.
  • BIG was a shareholder in SS plc and its loss was merely reflective of that suffered by SS plc, as was apparent from the claimants’ pleaded case.
  • Since SS plc and BIG had concurrent claims against Mr Smith, BIG’s claim was barred by the rule in Prudential.

The court confirmed that the rule in Prudential extended to both the claim for damages and to the claims for specific performance of the JV Agreement. In particular, the court noted Lord Reed’s explanation in Marex that one of the consequences of the rule in Prudential is that a shareholder cannot (as a general rule) bring an action against a wrongdoer to recover damages “or secure other relief” for an injury done to the company. There was no suggestion in Marex that any specific remedy, such as specific performance, is exempt from the rule; to allow otherwise would permit the avoidance of the rule in Foss v Harbottle.

(2) Mr Burgess’ claim

The court then turned to consider whether Mr Burgess’ claim was within the scope of the rule in Prudential.

The court said the real question here was whether, following Marex, the rule in Prudential can apply to bar the claim of someone who is not a shareholder in the company which suffers the relevant loss (i.e. SS plc). As explained above, Mr Burgess was not a shareholder in SS plc directly. He was the majority shareholder in VIIL, which was the majority shareholder in BIG, which was a shareholder in SS plc.

The court noted that, given the conclusion reached by Lord Reed, the answer to this question might appear obvious (emphasis added):

“The rule in Prudential 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.”

While Lord Reed limited the application of the rule, in terms, to claims by shareholders in the relevant loss-suffering company, it was argued that a number of the justifications underlying the rule applied with equal force to Mr Burgess’ claim. This was because Mr Burgess was in the position of “a shareholder in a shareholder” or of “a shareholder in a shareholder in a shareholder” (conveniently described in the judgment as “second degree” or “third degree” shareholders).

The court commented that the nub of the argument seemed to be that Mr Burgess should be treated as a “quasi-shareholder” in SS plc who, by reason of the chain of shareholdings connecting him to SS plc, could not be in a better position, for the purposes of the rule, than if he had actually been a shareholder in that company.

The court was not persuaded, and held that the rule in Prudential did not operate to bar Mr Burgess’ claim, for the following key reasons:

  1. The judgments of the majority of the Supreme Court in Marex make it clear that the rule only bars claims by shareholders in the loss-suffering company.
  2. The descriptions of the rule in the judgments of Lord Reed and Lord Hodge are antipathetic to any incremental extension of the rule to non-shareholders, whatever policy justifications may be advanced for such an extension.
  3. A “second degree” or “third degree” shareholder is not, in fact or in law, a shareholder in the relevant company. To blur that distinction would be to ignore the separate legal personality of the companies which form the intervening links in the chain between the claimant and the loss-suffering company. In the present case, none of the limited circumstances applied for the court to “pierce the corporate veil”.
  4. The rule in Prudential derives from the legal relationship between a shareholder and his/her company; and the rule is something which the shareholder contracts into when he/she acquires his/her shares. This reasoning cannot apply to a second degree or third degree shareholder who does not acquire shares in the relevant company and therefore never contracts into the rule so far as it affects recovery of losses by that company.

Interestingly, there does not appear to have been any discussion of the lack of connection between the claim brought by Mr Burgess (where the cause of action was a personal claim for breach of the JV Agreement to which he was a party), and the loss alleged to have been suffered, which arose separately through his indirect shareholding in SS plc. As a result of the failed application, Mr Burgess’ claim will proceed to trial, which may offer the opportunity to consider this issue.

Suitability for summary judgment

The court rejected the claimants’ suggestion that the application of the rule in Prudential is inherently unsuitable for summary determination because there is a discretion in the operation of the rule.

The court commented that both the application of the Prudential rule itself and the question of whether SS plc had an independent cause of action under the 1999 Act raised questions of law, which were suitable for determination on a strike-out / reverse summary judgment application (following the court’s observations in Easyair Ltd v Opal Telecom Ltd [2009] EWHC 339 (Ch)).

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

The Tesco Litigation: lessons learned from split trial orders in the context of securities class actions

The long-running Tesco Litigation (a securities class action brought by shareholders under section 90A Financial Services and Markets Act 2000 (FSMA)) has reached the Pre-Trial Review stage and there are a couple of snippets arising from the PTR judgment which will be of interest to those who follow the development of the class action landscape in the UK: Manning & Napier Fund, Inc & Anor v Tesco plc [2020] EWHC 2106 (Ch).

First, it is apparent from the judgment that one of the claimant groups (the group of shareholders represented by Stewarts Law) have settled their claims (on confidential terms) with Tesco, leaving the Manning & Napier Fund and Exeter Trust Company claimants (represented by Morgan Lewis, the MLB Claimants) to continue alone. One potential reason for the difference in approach to settlement (at least for now) may be the difficulties which one of the MLB Claimants appears to have in establishing its reliance on the alleged disclosure defects, highlighting the critical importance of that battleground in these types of claim.

Second, the court’s decision brought into focus a key case management decision for securities class actions; whether the trial will be split and, if so, what the precise split of issues to be determined should be.

In this blog post, we consider the relevance of the different elements of the typical causes of action pursued in shareholder claims to parties’ preference for a split trial, and the approach the court has adopted to date in the key securities class actions which have progressed through the courts of England and Wales.

Key elements of shareholder claims

A securities class action brought under section 90A FSMA (as in the Tesco Litigation) or under common law (such as a negligent misstatement, as was the case in the Lloyds/HBOS Litigation) requires claimants to establish that:

  • There was a defect in the disclosures made with the requisite degree of fault on the part of relevant officers of the company;
  • The claimants relied on the alleged defect in their investment decision;
  • The claimants suffered loss; and
  • This loss was caused by the defect (i.e. but for the alleged breach by a defendant, the claimants would not have suffered that loss).

The enquiry into the existence of a defect and establishing the requisite knowledge and fault on the part of the company will inevitably focus principally on the position and conduct of the company, placing a heavy burden in the production of documentary and witness evidence squarely on the defendant(s) in a securities class action.

By contrast, the need for the claimants to prove reliance involves an enquiry into their investment decision-making and, as we have commented previously, courts have been clear that claimants will not be able to side-step the need to undertake an appropriate search for documents and produce witness evidence in support of their case on this issue (see our previous blog posts: The Lloyds/HBOS litigation: The first shareholder class action judgment in England & Wales and High Court orders claimants to provide disclosure to prove investment decisions were made in reliance on defective publications in the Tesco section 90A FSMA group litigation).

Claimants will also need to incur substantial time and expense in preparing the evidence which is required to establish causation and loss, a large part of which will be expert in nature but may also include (as is the case in the Tesco Litigation – see below) evidence about the alternative investments which the claimants may allege they would likely have made but for the defects.

Accordingly, it is natural for the question of a split trial to be a key case management battleground for parties seeking a strategic, as well as practical, advantage: claimants will often seek to defer the expenditure of the costs involved in establishing reliance, causation and loss to a later trial and have the focus of trial one solely on the defendants’ conduct.

Approaches to split trials in securities class actions to date

It is interesting, therefore, to compare the different approaches taken by the courts in the cases which have been pursued to date on this critical case management question:

  • In the RBS Rights Issue Litigation, only questions of breach were going to be determined at the first trial. This was in large part because the defendants accepted that section 90 FSMA (which governs claims for prospectus liability) did not require the claimants to establish that they relied on any defects in the disclosures. Accordingly, the court was persuaded that, for reasons of efficiency, the difficult questions of causation and loss could be held over until a second trial (if that was necessary based on the finding in trial one). Given the breadth of the issues in the case and hence the number of permutations of potential findings on questions of breach, it was simply unworkable for issues of causation and loss to be prepared for a unitary trial (for example, involving expert reports) on the basis of assumptions as to what findings the court might make at trial on questions of breach. However, this had a clear strategic benefit for the claimants who were able to focus all of their resources on seeking to establish that there had been disclosure breaches. Indeed, in contrast to the enormous volume of documents which the defendants had to search for and ultimately disclose, the claimants were required to produce no disclosure whatsoever for the purposes of trial one.
  • By way of contrast, in the Lloyds/HBOS Litigation, the defendants successfully resisted attempts by the claimants to seek a split trial. The question of whether the claimants relied on the alleged defects was an essential part of the liability question. Moreover, the evidence on causation and loss was bound up in the important question about the materiality of the information which was said to have been omitted (an essential element of establishing breach) since proving loss largely depended on the market reaction when the information was subsequently disclosed.
  • In the Tesco Litigation, the claimants initially proposed a split trial along similar lines to the RBS Rights Issue Litigation so that the first trial focused only on the allegations of breach and all other issues (including reliance, causation and loss) would be dealt with at a second trial. However, at the first CMC the court ordered a single trial, reserving only the question of whether “quantum calculation issues” should be decided separately. Accordingly, issues of reliance and causation fell within the scope of the first trial (reflecting the centrality of those questions to any claim under section 90A FSMA). At the second CMC, the court ordered that “issues of quantum calculation shall be dealt with at a subsequent hearing, if necessary”. As a result (and borne out in the disclosure issues which have led to various case management judgments during the lead up to trial), the claimants have not been able to defer production of evidence on these issues and, at the upcoming trial, reliance and causation issues will no doubt feature heavily in the course of evidence and argument. Indeed one of the issues at the PTR was a specific disclosure application by Tesco for documents relating to whether the relationship between one of the MLB Claimants and its investment adviser was one of agency such that any reliance which the adviser placed on the defects when making investment decisions would meet the reliance requirement of section 90A. The judge made the order, noting that the issue was “an important one capable of being determinative”.

Cautionary note: the importance of precision in your case theory

One of the issues which arose at the PTR in the Tesco Litigation highlights the importance of precisely analysing the elements of a claim which parties need to establish at a trial. This need is particularly acute when a trial is split:

  • The MLB Claimants’ primary loss claim is calculated by reference to the difference between the purchase price of the Tesco shares and the value of those shares on 23 October 2014 (when Tesco disclosed the “expected impact” of the £263 million overstatement in its previous profits guidance statements). In addition to this primary loss claim, the MLB Claimants are claiming for loss of profits they allege they would or might have made had their money not been invested in Tesco.
  • Although the loss of profits claim requires a loss calculation, which will be determined (if necessary) in the second trial, it also gives rise to questions of reliance and causation, which are issues which were ordered to be dealt with at the first trial.
  • It appears from the judgment that the MLB Claimants mistakenly assumed that all aspects of the loss of profits claim would be dealt with at the second trial and their witness evidence had not, therefore, addressed what alternative investments the MLB Claimants would have been made. Accordingly, in the absence of such evidence, the loss of profits claim would have to fail at trial.
  • At the PTR, the MLB Claimants sought permission to rely on evidence in relation to the loss of profits claim, which had been adduced out of time. The court viewed the application as a question of relief from sanctions, rather than an application for permission out of time, and was critical of the MLB Claimants failing to appreciate that such an application was necessary much sooner.
  • The court has given the MLB Claimants a short timeframe (until 14 August 2020) to provide relevant disclosure evidence in support of its loss of profits claim, but the application will be refused if the resulting extra work for Tesco in processing the disclosure is not fairly and proportionately manageable.
  • The court was reluctant to make an order, given that it will likely deprive the MLB Claimants of the chance to obtain full recovery of its losses, but gave significant weight to Tesco’s objections that any substantial exercise would distract them from trial preparation.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Harry Edwards
Harry Edwards
Partner
+61 448 072 588
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Sarah Penfold
Sarah Penfold
Senior Associate
+44 20 7466 2619

High Court orders expedition to determine issues relating to a financial restructuring given insolvency alternative

The High Court has expedited a trial at which it would be determined whether luxury car manufacturer McLaren Group could obtain the release of certain security for the benefit of its senior noteholders, failing which a financial restructuring which was contingent on that release could not be implemented: McLaren Holdings Ltd v US Bank Trustees Ltd [2020] EWHC 1892 (Ch). The court concluded that, absent determination of the proceedings within one month, McLaren Group would have no choice but to enter an insolvency process and that this justified expedition in this case.

The court also held that a senior noteholder should be joined to the proceedings to represent the interests of the senior noteholders.

The decision provides a useful illustration of the willingness of the courts to support efforts to financially restructure a company and save it from insolvency, even where the company does not seek assistance of the court via a more commonly used restructuring jurisdiction of the court (such as its ability to sanction a scheme of arrangement). That is particularly the case where all parties to the dispute have an interest in the company’s survival and ability to meet its debts as they fall due, as demonstrated by the senior noteholders’ decision in this case not to oppose expedition. For companies and their creditors dealing with urgent liquidity crises, the court’s practical approach in this case will be welcomed.

Background

As a result of the COVID-19 pandemic, McLaren fell into severe financial difficulty, to the point that it was forecast to run out of money by 17 July 2020. If McLaren ran out of money, the court concluded “that will be that for the company”.

In order to raise new money, McLaren proposed a restructuring of its senior notes including the release of certain security which was granted for the benefit of senior noteholders so that the secured assets could instead be used to secure new debt. McLaren’s proposals were opposed in correspondence by its existing senior noteholders, who argued that it would be unlawful for the existing security over the cars and properties to be released. The senior noteholders also wished to make proposals to refinance the company based on their existing security package, but McLaren did not wish to pursue that form of refinancing.

As a result, on 16 June 2020, McLaren filed a Part 8 claim against US Bank Trustees Limited (USBT) seeking a declaration that the security interests could be released. USBT was the sole defendant and, as a mere security agent and trustee for the senior noteholders, USBT raised concerns that, without the participation of a senior noteholder in the proceedings, there was a risk that senior noteholders could challenge the situation even after the declaratory relief had been granted.

That risk was exacerbated where the senior noteholders had already noted their objection to the release of the security in correspondence. If a senior noteholder was to be joined to the proceedings, there was an issue as to whether that senior noteholder should be joined in a representative capacity effectively on behalf of all senior noteholders. One senior noteholder had requested to be joined to the proceedings so the questions for the court were whether it should be joined and, if so, whether it should be taken to represent the interests of (and therefore effectively bind to any judgment) the other senior noteholders.

Having issued proceedings, McLaren applied for expedition. Its proposed timetable was described by the court as “incredibly compressed” and “ambitious”, requiring not only a trial but also the handing down of a final judgment by 10 July 2020. McLaren’s evidence was that, if the judgment was in its favour, this would leave five working days between 10 and 17 July 2020 for the relevant security to be released and the financial restructuring completed.

Decision

The court dealt with expedition first. It concluded that expedition would not involve an unfair or improper allocation of court resources to the parties to this dispute relative to the parties to other disputes before the court. That was particularly so where McLaren’s survival depended on the financial restructuring, which could only be completed if the court determined that the existing security in favour of the senior noteholders should be released. The court also pointed to the need for this sort of case to be given priority given the objectives of the Financial List and the significance in value and consequences for McLaren of this dispute.

The court’s principal concern was whether the expedition of a final judgment within one month from the issue of proceedings could practically be achieved and, if so, whether that would compromise the need for there to be a just trial. No party suggested that it would not be possible for there to be a fair trial within three weeks and the court concluded that all parties seemed able to cope with the expedited timetable proposed, notwithstanding that it was “one of the most aggressive trial timetables [the court had] ever seen”.

However, the order for expedition was made subject to two conditions. First, McLaren had to explain what steps it was proposing to take in relation to the security and the financial restructuring more broadly. That is because McLaren’s evidence in support of the application had stated only what form the financial restructuring might take, not the form it actually would take.

Second, and more importantly, the senior noteholder who wished to be joined to the proceedings would need to submit a position paper identifying the points that it wished to take when arguing that release of the security would be unlawful. Pending sight of that position paper, the court was not able to conclude that a judge would have sufficient time to prepare for trial because the issues in dispute had not been fully canvassed in statements of case, given that the application for expedition had been made before a defence had been filed. The court directed that, upon service of a position paper, the question of expedition would be revisited.

The parties having agreed that a senior noteholder would be joined to the proceedings, and a willing senior noteholder having been identified, the court ordered joinder. While USBT did not object to joinder, it did ask the court to clarify CPR 19.7A, which provides that where a claim is brought against a trustee in that capacity, it is not necessary also to join the beneficiaries and that the beneficiaries will nevertheless be bound unless the court orders otherwise. USBT was concerned to ensure that all creditors of McLaren for whom USBT acted as trustee were bound by any judgment in the proceedings.

The court indicated that, at first blush, it was inclined to agree with USBT that CPR 19.7A did mean that all beneficiaries of trusts of which USBT was the trustee would be bound by any judgment in the proceedings, but it refused to make a determination to that effect at this early stage in the proceedings, particularly given that it was not yet clear what arguments would be advanced by the willing senior noteholder and that there were certain contractual documents which may be in issue in the proceedings which bound other classes of interested parties (including other categories of creditors), who it may be appropriate to join to the proceedings at a later stage. Accordingly, CPR 19.7A could not be used at this stage to bind all creditors of the company.

Turning to the other method of binding parties who were not joined to the proceedings, the senior noteholder who was willing to be joined to the proceedings was content to represent other noteholders of his class, but not creditors more generally or anybody else. USBT conceded that the willing senior noteholder could not represent creditors generally given the potential conflict between the position of different classes of creditor. The court added a further reservation, that the willing senior noteholder could not be made to represent any class of persons he did not wish to represent. As a result, the court order that the willing senior noteholder should represent only other senior noteholders.

Natasha Johnson
Natasha Johnson
Partner
+44 20 7466 2981
Andrew Cooke
Andrew Cooke
Senior Associate
+44 20 7466 7566

High Court refuses to grant summary judgment based on contractual interpretation of Argentinian government bonds

The High Court’s recent judgment in Palladian Partners LP & Ors v The Republic of Argentina & Anor [2020] EWHC 1946 (Comm) is an interesting and high profile addition to the body of case law on the interpretation of complex financial instruments, here the terms and conditions applicable to euro-denominated government bonds issued by the Republic of Argentina in 2005 and 2010, as part of a restructuring which gave creditors of the Republic 25-35% of what they were originally owed.

The underlying dispute centres on a claim brought by three investment funds against the Republic on the basis that the Argentinian government allegedly improperly changed the baseline of the securities (referenced to the Republic’s GDP) used to calculate the amount due to the holders of the securities and declared that the relevant performance condition for payment was not met.

Applying established principles of contractual construction, the court refused to grant the Republic reverse summary judgment on the effect of two payment provisions in the terms and conditions applicable to the securities. The Republic contended that these clauses meant that the holders of the securities were bound by all calculations performed by the Argentinian Ministry of Economy in determining payment, and the claimants were therefore bound by its determination that the relevant performance condition for payment was not met.

The court did not accept that the Republic had the better of the arguments on the merits of the simple construction exercise, and stated that – in any event – this was not a case where the court could grasp the nettle and grant judgment in the Republic’s favour. It is a reminder that, while the court is willing to consider questions of contractual interpretation without the need for a full trial in an appropriate case; certain factors will make cases less likely to be suitable for summary determination, such as where the construction argument is hinged on commercial purpose for success.

Background

The claimants are holders of the Republic’s euro-denominated securities. As per the terms and conditions applicable to the securities, the Republic is required to pay to the holders annually an amount linked to the Republic’s GDP, subject to certain conditions being satisfied. The claimants brought a claim against the Republic alleging that in 2013 the Republic had incorrectly decided that no payment was due to the holders because one of the conditions for payment under the terms and conditions, that the actual GDP growth in that year is higher than the base case GDP growth (the “Performance Condition”), had not been satisfied.

The claimants allege that when the Republic rebased the securities in 2013 and changed the baseline of the securities from 1993 to 2004, it failed to adjust the base case GDP (calculated based on 1993 prices and a factor in determining if the Performance Condition is met) by the fraction set out in the terms and conditions (the “Adjustment Provision”). The claimants’ case is that if the Republic had applied the Adjustment Provision to the base case GDP, then the Performance Condition would have been satisfied, which consequently would have required the Republic to calculate the amount due to the holders of the securities (the “Payment Amount”). The claimants allege that this would have resulted in a payment of €525-€645 million to them.

In connection with the above litigation, the Republic made the following two applications –

  1. For summary judgment – the Republic’s contention was that on the proper construction of the terms and conditions, the Ministry of Economy’s determination that no payment was due to the holders of the securities in 2013 is binding on the claimants, unless they have properly pleaded and can prove bad faith, wilful misconduct or manifest error on the part of the Ministry of Economy. Therefore, if the court agreed with the Republic that under the terms and conditions the claimants were bound by the determination made by the Ministry of Economy that the Performance Condition was not met, then the claimants’ underlying claim (including in relation to the application of the Adjustment Provision to the base case GDP) falls away.
  2. To strike out the claim – the Republic’s argument was that the claimants’ secondary allegation of bad faith, wilful misconduct and / or manifest error is not properly pleaded and is therefore defective.

Decision

The High Court (Cockerill J) dismissed both applications.

(1) Application for summary judgment

The Republic’s application for summary judgment turned on the proper construction of two instances of what were termed as the “Binding Effect Provisions” in the terms and conditions. The first instance is in the definition of Payment Amount (emphasis added):

All calculations made by the Ministry of Economy hereunder shall be binding on … all Holders absent bad faith, wilful misconduct or manifest error on the part of the Ministry of Economy”.

The other instance is in the definition of Excess GDP (a form of GDP used in the calculation of the Payment Amount) which provides that:

All calculations necessary to determine Excess GDP … will be performed by the Ministry of Economy … and such calculations shall be binding on … all Holders of this Security, absent bad faith, wilful misconduct or manifest error on the part of the Ministry of Economy”.

The Republic argued that the Binding Effect Provisions applied to all the calculations made by the Ministry of Economy in determining the Payment Amount (including the base case GDP and the Performance Condition) and not just the calculations found in the definitions of Payment Amount and Excess GDP.

The court did not accept that the Republic had the better of the arguments on the merits of the construction exercise, and stated that – in any event – this was not a case where the court could grasp the nettle and grant judgment in the Republic’s favour. In refusing summary judgment, the key observations made by the court on the question of contractual construction of the terms and conditions of the securities were as follows:

  • The court held that on a simple reading of the Binding Effect Provisions, they are intended to cover only the calculations described in the Payment Amount and Excess GDP provisions as they are not free-standing provisions but tail-end the respective definitions. The court noted that if sophisticated legally-advised parties intended the Binding Effect Provisions to have general effect, they would have included them as a separate provision. This was further bolstered by the fact that the terms and conditions included provisions that were meant to have general effect as stand-alone provisions, for instance, general limitation of liability provisions.
  • In terms of the wider context, the court considered there to be a real distinction between the wording in relation to the satisfaction of the conditions and the calculation of the Payment Amount, which further weakened the Republic’s argument. The Payment Amount is expressly stated to be subject to the conditions. The conditions are then presented separately and are expressed in terms of entitlement and conditionality, not calculation.
  • Further, though not considered in detail given the conclusions reached in the previous paragraphs, the court preferred the claimants’ argument that the Binding Effect Provisions used classical words of exception, and would therefore need to be subject to a strict approach to construction.
  • The court also considered that the Republic’s commercial purpose argument, that a comprehensive Binding Effect Provision was required to promote certainty against a background where many of the holders had bought the securities long after they were issued and where the determination of the Payment Amount requires a number of calculations, was not one which was suitable for a summary determination.

Accordingly, the court found that the claimants had the better of the arguments in relation to the interpretation of the Binding Effect Provisions and dismissed the Republic’s summary judgment application.

(2) Application to strike out the claim

The Republic’s strike out application fell away as it was contingent on the court’s ruling on the summary judgment application. However, the court still considered the application briefly. In summary, the court did not accept the Republic’s contention that at the pleading stage, reference to a specific person who made an error or acted in bad faith or engaged in wilful misconduct is necessary. In the context of fraud, the court relied on the authorities to state that at the pleading stage what is required is not a pleaded set of facts which lacks any other possible explanation than fraud, but rather the pleading of facts which, if proved at trial, tilt the balance towards justifying a plea of fraud.

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Untangling, but not killing off, the Japanese knotweed: Supreme Court confirms existence and scope of “reflective loss” rule

The Supreme Court’s judgment in Sevilleja v Marex Financial Ltd [2020] UKSC 31 has been eagerly anticipated by financial institutions and brings much needed clarity in respect of the so-called “reflective loss” principle, first established in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204.

By a majority of 4-3, the Supreme Court confirmed that the “reflective loss” rule in Prudential is a bright line legal rule of company law, which applies to companies and their shareholders. The rule prevents shareholders from bringing a claim based on any fall in the value of their shares or distributions, which is the consequence of loss sustained by the company, where the company has a cause of action against the same wrongdoer. However, the Supreme Court unanimously held that the principle should be applied no wider than to shareholders bringing such claims, and specifically does not extend to prevent claims brought by creditors. In doing so, the entire panel rejected the approach in cases since Prudential where the principle has been extended to situations outside shareholder claims, in a way that has been likened to a legal version of Japanese knotweed.

The majority of the Supreme Court (led by Lord Reed) emphasised that the rule is underpinned by the principle of company law in Foss v Harbottle (1843) 2 Hare 461: a rule which (put shortly) states that the only person who can seek relief for an injury done to a company, where the company has a cause of action, is the company itself. On this basis, a shareholder does not suffer a loss that is recognised in law as having an existence distinct from the company’s loss, and is accordingly barred.

The division of the Supreme Court focused on whether or not to reaffirm the “reflective loss” principle as a legal rule which prohibits a shareholder’s claim, which was the view of the majority, or whether it is simply a device to avoid double-recovery (and therefore a question that arises when it comes to the assessment of damages), which was the view of the minority.

Putting the decision in context, the reflective loss rule was one basis (amongst several others) on which the recent shareholder class action against Lloyds and five of its former directors (the Lloyds/HBOS Litigation) was dismissed by Mr Justice Norris (see our blog post on the decision here). The court held that – if the elements of the shareholders’ claim had been proven – any alleged loss suffered by shareholders as a result of a fall in the price of Lloyds shares was reflective of what the company’s loss would have been. Of course, in the securities litigation context, sections 90 and 90A of the Financial Services and Markets Act 2000 (the usual basis of a shareholder class action) provide a statutory exemption to the reflective loss rule.

Background

Mr Sevilleja was the owner and controller of two companies incorporated in the British Virgin Islands, Creative Finance Ltd and Cosmorex Ltd (the Companies), which he used as vehicles for trading in foreign exchange. Marex Financial Ltd (Marex) brought proceedings against the Companies in the Commercial Court for amounts due to it under contracts which it had entered into with them. In July 2013, Marex obtained judgment against the Companies in excess of US$5 million.

Marex alleged that Mr Sevilleja had stripped the Companies of assets, in breach of duties owed to the Companies, to prevent the judgment debt from being satisfied.

The Companies were placed into insolvent voluntary liquidation in the BVI by Mr Sevilleja in December 2013, with alleged debts exceeding US$30 million owed to Mr Sevilleja and others (allegedly persons and entities associated with Mr Sevilleja or controlled by him). Marex claimed to be the only non-insider creditor.

A liquidator was appointed in the BVI, but on Marex’s case, he was effectively in the pocket of Mr Sevilleja and had not taken any steps to investigate the Companies’ missing funds or to investigate the claims submitted to him, including claims submitted by Marex. Nor had he issued any proceedings against Mr Sevilleja.

Marex brought a claim against Mr Sevilleja directly, seeking damages in tort for: (1) inducing or procuring the violation of its rights under the July 2013 judgment; and (2) intentionally causing Marex to suffer loss by unlawful means. Marex sought and obtained an order giving permission for service of proceedings on Mr Sevilleja out of the jurisdiction.

The present appeal arose from Mr Sevilleja’s application to set aside the order to serve out. Mr Sevilleja argued that Marex did not have a good arguable case against him because the losses that Marex was seeking to recover were reflective of loss suffered by the Companies, which had concurrent claims against Mr Sevilleja, and were therefore not open to Marex to claim.

High Court decision

At first instance, the Commercial Court ruled in favour of Marex and held that the so-called rule against “reflective loss” did not bar Marex’s ability to show a completed cause of action in tort. Permission to appeal was granted only in relation to the ruling on reflective loss.

Court of Appeal decision

The Court of Appeal (Lewison, Lindblom and Flaux LJJ) allowed Mr Sevilleja’s appeal (please see our litigation blog post for a summary of the decision).

The question for the Court of Appeal was whether the rule against reflective loss applies to claims by unsecured creditors who are not shareholders of the relevant company. In a unanimous decision, it held that the distinction between shareholder creditors and non-shareholder creditors was artificial and therefore the rule should apply equally to all creditors.

The Court of Appeal also considered the scope of the exception to the rule which applies where the company is unable to pursue a cause of action against the wrongdoer. It confirmed that this exception can only be invoked in limited circumstances, where the defendant’s wrongdoing has been directly causative of the impossibility the company faces in bringing the claim.

Marex appealed to the Supreme Court.

Supreme Court decision

The Supreme Court convened as an enlarged panel with the object of examining the rationale for the so-called “reflective loss” principle and providing greater coherence of the law in this area. In view of the significance of the case, the Supreme Court granted permission to the All Party Parliamentary Group on Fair Business Banking to intervene by oral and written submissions in support of Marex’s appeal.

The Supreme Court unanimously concluded that Marex’s appeal should be allowed. There was no disagreement within the court that the expansion of the so-called “reflective loss” principle was an unwelcome development of the law, and in the context of the present case would result in a great injustice. However, there was a clear division on the nature and effect of the “reflective loss” principle, with Lord Reed giving the majority judgment (with whom Lady Black, Lord Lloyd-Jones and Lord Hodge agreed) and a minority judgment given by Lord Sales (with whom Lady Hale and Lord Kitchin agreed).

Majority decision

The majority reaffirmed the rule in Prudential (often referred to as the “reflective loss” principle), as a rule of company law which, when it applies, prohibits a claim being brought by shareholders for the loss of value in their shareholding.

Lord Reed referred back to the origins of the reflective loss principle, in the case of Prudential, where the directors of a company were alleged to have made a fraudulent misrepresentation in a circular distributed to its shareholders, so as to induce them to approve the purchase of assets at an overvalue from another company in which the directors were interested. Prudential, which was a minority shareholder in the company, brought a personal and a derivative action against the directors. Prudential’s personal claim was disallowed on the ground that it had not suffered any loss distinct from its loss of value in its shareholding, with the following reasoning from the High Court:

“…what [the shareholder] cannot do is to 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.”

Lord Reed noted that this has been treated in subsequent cases as establishing the principle of “reflective loss” (most notably in Johnson v Gore Wood & Co [2002] 2 AC 1).

In an important clarification of the scope of this principle, Lord Reed confirmed as follows:

“…what the court meant, put shortly, was that where a company suffers actionable loss, and that loss results in a fall in the value of its shares (or in its distributions), the fall in share value (or in distributions) is not a loss which the law recognises as being separate and distinct from the loss sustained by the company. It is for that reason that it does not give rise to an independent claim to damages on the part of the shareholders.”

Lord Reed said that it is necessary to distinguish between:

  1. Cases where claims are brought by a shareholder in respect of loss which he/she has suffered in that capacity, in the form of a diminution in share value or in distributions, which is the consequence of loss sustained by the company, in respect of which the company has a cause of action against the same wrongdoer; and
  2. Cases where claims are brought, whether by a shareholder or by anyone else, in respect of loss which does not fall within that description, but where the company has a right of action in respect of substantially the same loss.

In cases of the first kind, Lord Reed said that the shareholder cannot bring proceedings in respect of the company’s loss, since he or she has no legal or equitable interest in the company’s assets. It is only the company that has a cause of action in respect of its loss under the rule in Foss v Harbottle. He said that the position is different in cases of the second kind, which would include claims (like Marex’s claim) brought by creditors of the company. This is because there is no correlation between the value of the company’s assets/profits and the loss which that party has suffered.

The majority therefore confirmed that the rule established in Prudential applies to cases of the first kind, but not the second. In doing so, Lord Reed and Lord Hodge emphasised the following key aspects of the rule:

  1. Rule of company law

Lord Reed said that the decision in Prudential established a rule of company law, which applies specifically to companies and their shareholders in particular circumstances. It has no wider ambit.

He noted that this rule is necessary in order to avoid the circumvention of the company law rule in Foss v Harbottle, which provides that the only person who can seek relief for an injury done to a company, where the company has a cause of action, is the company itself.

The judgment of Lord Hodge echoed Lord Reed’s statement that the rule in Prudential was a principled development of company law which should be maintained. In particular, he explained that the rule upholds the default position of equality among shareholders in their participation in the company’s enterprise: each shareholder’s investment “follows the fortunes of the company”; it maintains the rights of the majority of the shareholders; and it preserves the interests of the company’s creditors by maintaining the priority of their claims over those of the shareholders in the event of a winding up.

However, in the opinion of Lord Hodge, the principle should not be applied in other contexts, given the particular characteristics of a shareholding (and the rights and protections provided to shareholders), which justify the law’s refusal to recognise a diminution of value claim. The problems and uncertainties that have emerged in the law have arisen because the principle of reflective loss has broken from its moorings in company law.

  1. Distinct from double recovery principles

Lord Reed stated, categorically, that the avoidance of double recovery is not in itself a satisfactory explanation of the rule in Prudential.

Lord Reed noted the general position that, while two different persons can have concurrent rights of recovery based on different causes of action in respect of the same debt, the court will not allow double recovery (The Halcyon Skies [1977] QB 14, 32). This principle has its roots in the law of damages, and so it does not prevent the claims in themselves, but rather leaves the court to determine how to avoid double recovery in situations where the issue properly arises. For example, by giving priority to the cause of action held by one person with the claim of the other excluded so far as necessary (The Liverpool (No 2) [1963] P 64); or by subrogation (Gould v Vaggelas [1984] HCA 68); or the imposition on one claimant of an obligation to account to the other out of the damages it has received (O’Sullivan v Williams [1992] 3 All ER 385).

He said that Lord Millett in Johnson had incorrectly treated the avoidance of double recovery as sufficient to justify the decision in Prudential, which paved the way for the expansion of the reflective loss principle beyond the narrow ambit of the rule in Prudential. Lord Millett’s approach has in fact led in some cases, subsequent to Johnson, to a circumvention of the rule in Foss v Harbottle. For example, in Peak Hotels and Resorts Ltd v Tarek Investments Ltd [2015] EWHC 3048 (Ch), the court considered it arguable that the “reflective loss” principle – as explained by Lord Millett in Johnson – did not bar a claim for injunctive relief, even though the proceedings were brought by a shareholder who complained of a fall in the value of his shares resulting from loss suffered by the company in respect of which the company had its own cause of action. This was because the relief sought was not in damages and so there could be no danger of double recovery.

  1. Pragmatic advantages of a bright line legal rule

Lord Reed also emphasised the pragmatic advantages of a clear rule of law that only the company can pursue a right of action in circumstances falling within the precise ambit of the decision in Prudential. He referred to Lord Hutton’s speech in Johnson, saying that the rule in Prudential has the advantage of establishing a clear principle, rather than leaving the protection of shareholders of the company to be given by a judge in the complexities of a trial.

  1. Scope of personal claims by shareholders prohibited

The majority articulated the type of claim that will be prohibited by the rule against “reflective loss”. To fall within the rule, a claim must:

    • be brought by a shareholder;
    • relate only to the diminution in value of shares or in distributions which the shareholder suffers in his or her capacity as a shareholder;
    • result from the company having itself suffered actionable damage; and
    • be brought by the shareholder and the company against the same wrongdoer.

The majority confirmed that, where a shareholder pursues a personal claim against a wrongdoer in another capacity, such as guarantor or creditor of the company, the “reflective loss” rule has no application.

  1. Where the company does not bring a claim

Lord Reed stated that the rule in Prudential will apply even if the company fails to pursue a claim that a shareholder says ought to have been pursued, or compromises its claim for an amount which, in the opinion of a shareholder, is less than its full value.

He said the critical point is that the shareholder has not suffered a loss which is regarded by the law as being separate and distinct from the company’s loss, and therefore has no claim to recover it. It follows that the shareholder cannot bring a claim, whether or not the company’s cause of action is pursued.

Lord Reed justified this approach on the basis that shareholders entrust the management of the company’s right of action to its decision-making organs; and the company’s control over its own cause of action would be compromised, and the rule in Foss v Harbottle could be circumvented, if the shareholder could bring a personal action for a fall in share value (or distribution) consequent on the company’s loss, where the company had a concurrent right of action in respect of its loss.

The same will apply even where the wrongdoer has abused his or her powers as a director of the company so as to prevent the company from bringing a claim under which it could have recovered its loss. Lord Reed noted that shareholders (unlike a creditor or an employee) have a variety of other rights in this scenario, including the right to bring a derivative claim to enforce the company’s rights if the relevant conditions are met, and the right to seek relief in respect of unfairly prejudicial conduct of the company’s affairs.

A derivative action is an exception to the rule in Foss v Harbottle, and whether or not a shareholder can bring such an action depends on whether the relevant conditions are satisfied.

  1. The position of creditors

As will be clear from the above, the majority confirmed that the reflective loss rule does not apply to creditors. This is essentially because the potential concern arising from the rule in Foss v Harbottle is not engaged by claims brought by creditors, as distinct from shareholders.

However, Lord Reed noted that the principle that double recovery should be avoided may well be relevant to creditor claims (although this will not always necessarily be the case: in International Leisure Ltd v First National Trustee Co UK Ltd [2013] Ch 346 the company and a secured creditor had concurrent claims, but the double recovery principle was not engaged).

Lord Reed explained that how the court will address the risk of double recovery in creditor claims will depend on the circumstances, and did not mean that the company’s claim must automatically be given priority to that of the creditor. He also warned that the pari passu principle does not give the company (or its liquidator) a preferential claim on the assets of a wrongdoer, over the claim of any other person with rights against the wrongdoer, even if that claimant is also a creditor of the company. This means that a creditor can enforce his or her own right to recover damages from the wrongdoer concurrently with any action brought by the company. Lord Reed contrasted the situation where an insolvent company has made a recovery from the wrongdoer. In this situation, the proceeds will form part of the insolvent company’s assets available for distribution, where the pari passu principle may restrict the creditor’s receipt of a dividend.

Lord Reed also noted that double recovery arising in connection with creditors’ claims may be avoided by other means, such as subrogation.

In the light of the above, the majority held that the rule in Prudential had no application to the present case, since Marex was not a shareholder. Marex’s appeal was therefore allowed.

Minority decision

Lord Sales delivered the minority judgment. By contrast to the majority, in his opinion, the Court of Appeal in Prudential did not lay down a rule of law and (in any event) such a rule was not correct as a matter of principle. Whilst the rule would produce simplicity, this would be at the cost of serious injustice to a shareholder who (apart from the rule) has a good cause of action and has suffered loss which is real and is different from any loss suffered by the company.

In his view, the court in Prudential simply set out reasoning why it thought the shareholder in such a case in fact suffered no loss. However, he believed that that reasoning could not be supported, because in most cases shareholders suffer a loss which is different from the loss suffered by the company. In Lord Sales’ view, the whole premise of the “reflective loss” principle is flawed because it assumes correspondence between the losses suffered by company and shareholder. By contrast, in the real world, even if the company is successful (some time later) in recovering its loss, the shareholder whose shares were reduced in value by the wrong will not be restored to the position it would have been in but for the defendant’s wrongdoing. Whilst, as a matter of basic justice, the defendants should not be liable twice for the same loss, the correct approach to that issue would be to carefully assess whether the loss is indeed the same and if (and only if) it is the same, to be reflected in the calculation of each claimants’ loss.

In Lord Sales’ view, even if the “reflective loss” principle was appropriate in respect of shareholder claims, it could not be justified as a principle to exclude otherwise valid claims made by a person who is a creditor of the company. Accordingly, the minority also allowed Marex’s appeal.

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Lloyds/HBOS Litigation: Consequentials Judgment

Mr Justice Norris has now handed down judgment following the consequentials hearing in the landmark Lloyds/HBOS Litigation: Sharp & Ors v Blank & Ors [2020] EWHC 1870 (Ch). Norris J resoundingly refused permission to appeal the judgment on liability and made a number of interesting findings on the adverse costs position of the claimants, and the litigation funders who backed the claim, following their failure.

The findings are split into two main parts:

  1. Costs
  2. Permission to Appeal

Costs

Should the costs award be determined by reference to overall success?

The court considered whether, in light of the outcome of the case, there was any reason for departing from the general rule that costs are to be determined by reference to overall success.

The claimants argued that they should only be required to pay 60% of the defendants’ costs on the basis that they “succeeded” on two issues; namely that the defendant Directors were in breach of a duty of care in respect of two issues which the judge had held ought to have been disclosed. The claimants submitted that the defendants should have conceded the case on the disclosure duty and that, had they done so, costs would have been saved.

The court firmly rejected these arguments however. Norris J said that “there is no reason in principle why a party who succeeds in establishing one element of his cause of action but fails to establish the others should be regarded as partially successful”. Given the breadth of the attack made by the claimants against Lloyds and its Directors (which included both allegations of a number of disclosure defects and also an allegation that the recommendation given to shareholders to vote in favour of the acquisition was made negligently), their degree of success was in fact small. Moreover, the claimants failed to establish that the breaches were causative of any loss, or indeed that any loss was suffered. Even the points on which they were successful were finely balanced.

In singling out an issue for separate treatment by way of costs the court held that it must look for “some objective ground (other than failure itself) which alongside failure distinguishes it from other issues and causes the general rule to be disapplied”. Such a distinctive ground may include:

  1. the comparative weakness of an argument (even if not unreasonably maintained);
  2. the necessity for particular evidence relevant only to that issue; or
  3. extensive and intensive legal argument directed to that issue which gives it an especial significance in the costs context.

The court held that such a factor is missing in this case. As such, the general rule was found to apply, and costs will follow the event.

The liability of litigation funders to cover costs

Therium, the claimants’ litigation funder, accepted in principle that it was liable to pay costs awarded against the claimants. However, it submitted that it should be liable only

  1. to the extent that the Claimants did not satisfy the adverse order; and
  2. to the extent of the funding that Therium actually provided (i.e. subject to “the Arkin cap”: see Arkin v Borchard Lines Ltd [2005] 1 WLR 3055).

In an order which reflects the realities of the litigation funder’s role in group litigation such as this, the court found that Therium’s liability ought to be joint and several with the claimants’ own.

The court considered the recent Court of Appeal decision in Davey v Money [2020] 1 WLR 1751 on the application of the Arkin cap, noting that it “is not a binding rule, but simply guidance given to individual judges, who retain a complete discretion in relation to third party costs orders”, but ultimately withheld from making a decision regarding the application of the Arkin cap to this case at this stage given that the interim payment which he ordered was below what would have been the Arkin cap in this case.

“Risk-free” shareholder litigation

The judgment acknowledges that this may have been a case in which many of the claimant shareholders thought that they were “litigating risk-free”. However the judgment makes clear that this was “most unfortunately” not the case:

  1. the ATE insurance cover which was meant to protect the claimants from cost risk fell short of the defendants’ costs;
  2. the level of ATE insurance cover which had been put in place was affected by the insolvency of some of the insurers;
  3. the claimants had failed to cover the risk that interest would be awarded on the defendants’ costs (see further below); and
  4. pursuant to the Group Litigation Order, the court held the claimants severally liable for any costs awarded to the defendants.

Interim costs

The court awarded interim costs comprising of (a) 50% of the incurred costs identified in the cost budget; 90% of the budgeted costs; and (c) VAT thereon. In making this finding the court followed MacInnes v Gross [2017] 4 WLR 49 which held that:

  1. the approved costs budget almost always provided the starting point for assessing a payment on account, because the costs management process had established it to be a reasonable and proportionate sum; and
  2. a discount of 10% was the maximum deduction appropriate in a case where there is was an approved costs budget.

Interest on costs

The court considered whether it should award interest on pre-judgment costs. The claimants argued that it should not because the Defendants did not signal an intention to claim pre-judgment interest on costs at any time when costs budgets were under consideration, and a possible claim for interest was not factored in to the level of ATE cover obtained.

However, the court found in favour of the defendants noting that “it was ultimately for the Claimants to decide against what risks to insure and what risks to bear themselves. A claim for pre-judgment interest on costs is commonplace, and it was for the Claimants to decide whether any protective measures were required, not for the Defendants to call for them”.

Permission to Appeal

The court resoundingly rejected the claimants’ application for permission to appeal the judgment. In doing so, the court clarified findings made in the judgment handed down on 15 November 2019. Given that the court had found there to be two breaches of disclosure duties, but that those breaches were not causative of any loss, in order to successfully appeal the judgment, the claimants would need to overturn the court’s findings on both causation and loss, findings which the defendants alleged were factual, as opposed to legal.

In its November 2019 judgment the court held that the existence of both the repo facility entered into between Lloyds and HBOS (the Repo), and the Emergency Liquidity Assistance (ELA) facility being drawn upon by HBOS ought to have been disclosed. The judge also formulated hypothetical disclosures which in his view would have met the disclosure requirements. Those hypothetical disclosures did not contain details of the features of the Repo and ELA. The claimants contended that the court’s conclusions in that respect were wrong as a matter of law, and that the details ought to have been disclosed. The claimants then argued that the court’s findings in relation to causation were dependent upon its conclusions regarding the limited nature of the disclosures, and were therefore flawed.

The court accepted that the actual disclosures which could have been made in relation to the Repo and ELA may have been different to the hypothetical disclosures it had formulated in its judgment in November 2019, but did not accept that the conclusions it had reached were “plainly wrong” (which is the test that the defendants submitted to be the correct threshold for re-assessments by the Court of Appeal of intensely complex mixtures of fact and law).

However, more importantly, the court made clear that the findings it had reached regarding the causative effects of disclosure of each of the repo facility and ELA were not dependent upon the precise nature of the disclosure which was made: “The evidence assembled by the Claimants and the case put to the Defendants related to “detailed disclosure”: and my conclusion rests on an analysis of that evidence”.

The claimants also argued that the judgment did not consider whether the Repo or ELA constituted material contracts pursuant to the Listing Rules. The court clarified that it did not consider that a breach of the Listing Rules can found any claim for damages by an individual against a listed company or the directors of a listed company.

The claimants also sought permission to appeal on the basis that the court erred in law in holding that they had failed to make out a case on loss. However, the court explained in this judgment that the claimants’ loss case was built around their “recommendation case”, which was a part of the case in which the claimants had failed to establish there had been a breach (a conclusion which the claimants were not seeking to appeal). The court did not consider that the claimants had provided it with evidence establishing losses arising solely from disclosure breaches.

Finally, the court addressed the claimants’ argument that there was a “compelling reason” to grant permission to appeal because the decision sets a standard for disclosure which is too low. However, the court reiterated in its judgment that the test it had set in the November 2019 judgment was “that directors, when considering the materiality of items for disclosure, must not focus only on material supportive of the recommended outcome but ought, when laying out the proposal and in enumerating the risks attendant upon it, to set out in a balanced way material which shareholders might see as indicating disadvantages”, which, it contended, could not be controversial. The court refuted any suggestion that the application of that standard to the extraordinary facts of this case could be seen as setting any standard of wider significance.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Sarah Penfold
Sarah Penfold
Senior Associate
+44 20 7466 2619