Climate-related disclosures for issuers: FCA publishes final rules

The Financial Conduct Authority (FCA) has published a Policy Statement (PS20/17) and final rules and guidance in relation to climate-related financial disclosures for UK premium listed companies.

Companies will be required to include a statement in their annual financial report which sets out whether their disclosures are consistent with the Task Force on Climate-related Financial Disclosures (TCFD) June 2017 recommendations, and to explain if they have not done so. The rule will apply for accounting periods beginning on or after 1 January 2021.

As well as some additional guidance, the FCA has made only one material change to the rules consulted upon in March 2020 (CP20/03) with the final LR 9.8.6(8)(b)(ii)(C) R requiring non-compliant companies to set out details of how and when they plan to be able to make TCFD-aligned disclosures in the future.

With regard to monitoring compliance with the new listing rule, the FCA confirmed in its Policy Statement that it will provide further information on its supervisory approach to the new rule in a Primary Market Bulletin later in 2021.

In light of this latest regulatory development, issuers may also want to consider what, if any, litigation risks may arise in connection with climate-related disclosures (and indeed other sustainability-related disclosures which are made in response to these regulatory developments). There may be an increased risk of litigation under s90 FSMA, s90A FSMA, or in common law or equity. This was considered in greater detail in our recent Journal of International Banking & Financial Law article (published in October 2020) in which we also examined the existing climate-related disclosure requirements, the impact of the FCA’s proposals on issuers and how issuers can mitigate against such litigation risks.

Our article can be found here: Climate-related disclosures: the new frontier?

For a more detailed analysis of the FCA’s Policy Statement, please see our Corporate Notes blog post.

Simon Clarke

Simon Clarke
Partner
+44 20 7466 2508

Nihar Lovell

Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000

Sousan Gorji

Sousan Gorji
Senior Associate
+44 20 7466 2750

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
+44 20 7466 2948

Climate-related disclosures for issuers: next steps from UK financial regulators outlined

This month, there have been some significant regulatory announcements in relation to climate-related disclosures. These announcements are a result of the increasing focus on climate change and sustainability risks across governments, regulators and industry and a continued move towards corporate compliance with the Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations.

While not launching new developments or heralding the unexpected, these announcements are noteworthy for issuers as they mark a change in tone from the UK regulators regarding climate-related disclosures. Previously, the Financial Conduct Authority (FCA) and Prudential Regulation Authority took a cooperative and directional view, in recognising that issuers’ capabilities were continuingly developing in some areas which might limit their ability to model and report scenarios in the manner recommended by the TCFD. With the latest announcements, it seems increasingly likely that there will now be a shift away from voluntary climate-related disclosures towards mandatory TCFD aligned disclosures across the UK economy.

Key announcements

Recent key announcements include:

  • HM Treasury publishing the Interim Report of the UK’s Joint Government-Regulator TCFD Taskforce (the Taskforce) on the implementation of the TCFD recommendations and a roadmap towards mandatory climate-related disclosures;
  • the Governor of the Bank of England’s (BoE) speech reaffirming what the BoE is doing to ensure that the UK financial system plays its part in tackling climate change;
  • the FCA’s speech on rising to the climate challenge; and
  • the Financial Reporting Council’s (FRC) publication of its Thematic Review on climate-related risk.

Summary of key announcements

These announcements highlight the UK’s financial regulators’ strategy for improving and developing climate-related disclosures. The key points from these announcements include:

Taskforce

  • The Taskforce’s Interim Report highlighted the UK government’s commitment to introduce mandatory climate-related financial reporting, with a “significant portion” in place by 2023, and mandatory requirements across the UK economy by 2025. The Interim Report considered regulatory steps around tackling climate change, and also identified proposed legislative changes from the Department for Business, Energy and Industrial Strategy (which is intending to consult in the first half of 2021 on changes to the Companies Act 2006 to insert requirements around the TCFD recommendations on compliant disclosures in the Strategic Report of companies’ Annual Reports and Accounts, including large private companies registered in the UK).
  • The Taskforce strongly supports the International Financial Reporting Standards Foundation’s proposal to create a new global Sustainability Standards Board on the basis that internationally agreed standards will help to achieve consistent and comparable reporting on environmental and, social and governance (ESG) matters.

BoE

  • The BoE reaffirmed its commitment to driving forward the business world’s response to tackling climate change and reiterated the importance of data and disclosure in firms’ attempts to manage climate risk.
  • The BoE announced that the delayed climate risk stress test (its biennial exploratory scenario dubbed “Climate BES”) for the financial services and insurance sectors would be carried out in June 2021.
  • While the Climate BES will not be used by the BoE to size firms’ capital buffers, the BoE has put down the marker that it expects firms to be assessing the impact of climate change on their capital position over the coming year and will be reviewing firms’ approaches in years to follow.
  • The BoE also directed financial firms and their clients to the TCFD recommendations to encourage focus and drive decision-making, pointing to the benefits that the BoE has itself felt from reporting this year in line with the TCFD recommendations.

FCA

  • The FCA confirmed that from 1 January 2021 new rules will be added to the Listing Rules requiring premium-listed commercial company issuers to report in line with the TCFD recommendations. As anticipated by last year’s Feedback Statement, the new rule will be introduced on a ‘comply or explain’ basis. The general expectation is that companies will comply, with expected allowances for modelling, analytical or data based challenges. It is expected that these allowances would be limited in scope. The Taskforce’s Interim Report notes that the FCA is considering providing guidance on the “limited circumstances” where firms could explain rather than comply. A full policy statement and confirmation of the final rules are expected before the end of 2020.
  • The FCA is also intending to consult on “TCFD-aligned disclosure” by asset managers and life insurers. These disclosures would be aimed at “clients” and “end-investors”, rather than shareholders in the firm itself. The consultation is intended for the first half of 2021 and is stated that “there will be interactions with related international initiatives, including those that derive from the EU’s Sustainable Finance Action Plan” (it should be noted that such standards cover much more than climate disclosures). Current indications are that these disclosure standards would come into force in 2022.
  • The FCA is co-chairing a workstream on disclosures under IOSCO’s Sustainable Finance Task Force, with the aim of developing more detailed climate and sustainability reporting standards and promoting consistency across industry.

FRC

  • The FRC emphasised that all entities (boards, companies, auditors, professional advisers, investors and regulators) needed to “do more” to integrate the impact of climate change into their decision making. One of the FRC’s ongoing workstreams is investigating developing investor expectations and better practice reporting under the TCFD recommendations.

Regulatory reporting requirements and litigation risks for issuers

The recent announcements are a reminder by the UK’s financial regulators that issuers must look beyond the current Covid-19 crisis to the oncoming climate emergency. It is clear that not engaging is not an option, even as the regulatory environment continues to change. Issuers and firms will therefore want to consider the impact of those disclosure requirements/suggestions across the board, from investor interactions to regulatory reporting to meeting supervisory expectations.

As the sands shift, issuers may also want to consider what, if any, litigation risk may arise in connection with climate-related disclosures (and indeed other sustainability related disclosures that are brought out from the shadows with these regulatory developments). There may be an increased risk of litigation under s90 FSMA, s90A FSMA, or in common law or equity. This was considered in greater detail in our recent Journal of International Banking & Financial Law article (published in October 2020) where we also examined the existing climate-related disclosure requirements, the impact of the FCA’s proposals on issuers and how issuers can mitigate against such litigation risks.

Our article can be found here: Climate-related disclosures: the new frontier?

Simon Clarke

Simon Clarke
Partner
+44 20 7466 2508

Nish Dissanayake

Nish Dissanayake
Partner
+44 20 7466 2365

Nihar Lovell

Nihar Lovell
Senior Associate
+44 20 7374 8000

Sousan Gorji

Sousan Gorji
Senior Associate
+44 20 7466 2750

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

Climate-related disclosures: the new frontier?

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law on the Financial Conduct Authority (FCA)’s proposals for regulating climate-related disclosures and the litigation risks which may arise for issuers from such proposals.

Climate change has been part of the political and regulatory discourse for years. However, it is an issue which is gaining increasing prominence on the global stage. Over a thousand companies now support the Task Force on Climate-related Financial Disclosures (TCFD)’s recommendations, while shareholder activism in the climate arena is stretching beyond Greenpeace’s proposed resolutions at energy companies’ AGMs. Against this backdrop, both the EU and the UK have advocated for adapting their financial systems to address climate risks. Whilst the European Central Bank and Bank of England are addressing the risks from climate change in their financial systems, attention has also turned to how companies themselves can be affected by climate change, both in terms of risk assessment and management, and in terms of investor and market-facing disclosures. The current legal framework regarding issuer disclosure already provides some requirements for issuers to disclose climate-related risks in certain circumstances. However, the existing disclosure requirements fall short when it comes to consistent and meaningful disclosures. There are therefore systemic and policy drivers to increase transparency, reporting and potential regulation in this space.

The FCA has noted that voluntary adoption of the TCFD’s recommendations has been increasing. However, based on the feedback that the FCA received in response to a 2018 Discussion Paper, the FCA considers that there is evidence to support the case for it to intervene to accelerate such progress.

In our article, we examine the existing disclosure requirements for issuers, the FCA’s new proposals for regulating climate-related disclosures, the FCA’s reasons behind the proposals, how issuers will be impacted by the proposed regulatory change, the litigation risks which may arise for issuers and how issuers can mitigate against such litigation risks.

This article can be found here: Climate-related disclosures: the new frontier? This article first appeared in the October 2020 edition of JIBFL.

Simon Clarke

Simon Clarke
Partner
+44 20 7466 2508

Nihar Lovell

Nihar Lovell
Senior Associate
+44 20 7374 8000

Sousan Gorji

Sousan Gorji
Senior Associate
+44 20 7466 2750

Securities class actions in England and Wales: the challenges for funders and a perspective from Australia

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law on the principal characteristics of third party litigation funding in the securities class action markets in Australia and England and Wales.

In Australia, the rise of securities class actions over the last decade has been driven in part by the presence of an active third party litigation funding market: every shareholder class action to date has been backed by litigation funders. In England and Wales, securities class actions are a more recent trend (but rapidly growing), in which third party litigation funders are increasingly taking an active role.

In our article, we compare and contrast how recent case law developments in Australia and England and Wales may impact the approach adopted by third party litigation funders to securities class actions, and therefore the risks faced by listed companies in each of these jurisdictions.

This article can be found here: Securities class actions in England and Wales: the challenges for funders and a perspective from Australia. This article first appeared in the September 2020 edition of JIBFL.

Harry Edwards

Harry Edwards
Partner
+61 3 9288 1821

Hannah Lau

Hannah Lau
Associate
+44 20 7466 2314

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

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.

Harry Edwards

Harry Edwards
Partner
+61 3 9288 1821

Ceri Morgan

Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

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