Inquiry as to damages
Law on reflective loss
Arguments on reflective loss
In Malhotra v Malhotra(1) the claimant, Rakesh Malhotra, had given a cross-undertaking in damages in support of a without notice injunction, which was later discharged. Rajinder Kumar Malhotra (the first defendant) and Rajiv Malhotra (the second defendant) sought damages under the cross-undertaking and, at an interim hearing, applied for an order for an inquiry as to damages.
In deciding whether to make such an order, the court had to consider whether the defendants' damages claim would fall within the rules on reflective loss – that is, where a loss claimed by a shareholder is merely reflective of a loss suffered by the company, which is not recoverable.
The court applied the reasoning in Gardner v Parker(2) that the claimant must demonstrate that there was no reasonable doubt that the relevant loss would be irrecoverable under the reflective loss rule. At this interim stage the claimant was unable to overcome this high hurdle and the court granted the order sought by the defendants.
A dispute arose between the parties, who were family members, over the control of certain Indian companies. The companies concerned were Transauto & Mechaids Private Limited and a number of its subsidiaries.
Following a restructuring, the claimant gained control of the boards of Transauto and the subsidiaries.
On February 3 2012 the first defendant issued proceedings in India against Transauto and several of the subsidiaries together with their board members, alleging oppression and acts of mismanagement by the companies' directors acting under the influence of the claimant.
In an effort to regain control of Transauto, the first defendant served notices on its board of directors calling for an extraordinary general meeting for the purpose of removing the directors and appointing replacements. When the directors failed to respond, on March 20 2012 the first defendant and his wife, together holding the entire share capital of Transauto, wrote to the directors stating that they had convened the extraordinary general meeting themselves pursuant to their rights under Indian company law.
In response, the claimant issued proceedings in England and was granted an anti-suit injunction on March 26 2012. In addition to restraining the defendants from continuing the Indian proceedings, the order prevented the defendants from holding the extraordinary general meeting. This order was ultimately discharged on November 16 2012.
However, despite the discharge of the order, the first defendant was still unable to regain control of Transauto as a result of the actions of the Mumbai court. On November 7 2012, following a hearing, the court recorded that undertakings had been given so as to preserve the status quo pending the hearing of the Indian proceedings.
The defendants claimed that the injunction had curtailed their ability to regain control of the companies which they alleged had been mismanaged by the claimant and, as a result, the value of their shareholdings had been substantially reduced. They applied for an order for an inquiry as to damages.
The claimant opposed the application on the grounds that the defendants had failed to adduce credible evidence that they had suffered loss and damage as a result of the granting of the injunction. The claimant argued that:
- if there were any damage, it had not been caused by the injunction; and
- in any case, if there were any such damage, it would be recoverable only by the companies, not by the defendants, under the reflective loss principle.
The court has discretion as to whether to enforce an undertaking in damages (Yukong Line Ltd v Rendsburg Investments Corp(3)). If it appears that an injunction was wrongly granted, even without fault on the claimant's part, and loss might have been caused as a result, the court will ordinarily order an inquiry as to damages.
In order to succeed, the applicant must produce credible evidence that it has suffered loss as the result of the making of the order. If the applicant can show an arguable case that its loss was caused by the order, the evidential burden that the relevant loss would have been suffered irrespective of the order passes to the claimant and an inquiry will be ordered.
The principle as to the non-recoverability of reflective loss is summarised in Prudential Assurance v Newman Industries (No 2):(4)
"what [a 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." (emphasis added)
There are a number of exceptions to the general rule. These include:
- where the shareholder has suffered a loss distinct from the company's loss, in which case the shareholder can sue and recover in respect of that loss;(5)
- where the company itself has no cause of action;(6) and
- where the company itself, by reason of the wrong done to it, is unable to pursue its claim against the wrongdoer.(7)
The defendants argued that by preventing an extraordinary general meeting of Transauto, the injunction prevented them from regaining control of the subsidiaries, which they asserted would (once under their control) have achieved certain rental income and investment returns.
The claimant asserted that these alleged losses had nothing to do with the English injunction, because even if it had not been granted, the situation would have been no different due to the orders already made by the Indian courts.
The defendants argued that the exceptions to the general rule on reflective loss applied and, as such, their losses were recoverable. The defendants advanced four principal arguments:
- First exception – because a cross-undertaking in damages is treated as a contract between claimant and defendants,(8) the losses that the defendants were seeking to recover would not be available to Transauto or the subsidiaries (ie, they were a distinct type of loss). The claimant argued that it was irrelevant that it owed an independent duty to the shareholders as well as to Transauto.
- First exception – the defendants' losses were different from those of the subsidiaries, because the loss of dividends was caused by the fact that the defendants were unable to run the companies in the manner in which they would have wished. The claimant argued that the recovery of lost dividends and diminution of value of shareholding was clearly precluded under the reflective loss rule.
- Second exception – neither the subsidiaries nor Transauto would be able to recover the claimed losses from the claimant, because the claimant was not a director of any of those companies. The claimant argued that, contrary to the defendants' argument, the subsidiaries could recover directly from the claimant because they were third parties entitled to sue on the undertaking. Furthermore, they might also have additional claims against the claimant (eg, by arguing that he was a shadow director).
- Third exception – it might not be possible for the subsidiaries to bring claims against the claimant because of what, in the defendants' view, was the claimant's own continuing misconduct – that is, that because of the injunction and the current state of proceedings in India (the status quo undertakings), the subsidiaries were being prevented from bringing proceedings to enforce the cross-undertaking. The claimant argued that its "wrong" had ceased in November 2012 when the injunction was discharged and the status quo undertakings, which currently prevented the first defendant from regaining control of the companies, could not be characterised as "wrongful conduct".
On the causation point, the court considered that, although untested on the evidence, the account of the defendants was credible. Following the principles in Yukong Line Ltd v Rendsburg Investments Corp, all that the defendants needed to show in order to succeed in their application was that there was an arguable case on causation, which they had done.
The court then turned to the issue of reflective loss, which it considered was potentially the claimant's "knock-out blow". At issue was whether the defendants could invoke one or more of the exceptions to the general rule.
In respect of the defendants' arguments under the first exception, the court held in favour of the claimant that the fact that an independent duty may also be owed to the shareholder was not relevant, quoting from Gardner v Parker as follows:
"provided the loss claimed by the shareholder is merely reflective of the company's loss and provided the defendant wrongdoer owed duties both to the company and to the shareholder, it is irrelevant that the duties so owed may be different in content."
The defendants' second argument under the first exception was not addressed by the court.
In respect of the defendants' argument under the second exception, the court could "see the force of" the claimant's argument that there would be causes of action against the claimant available to the subsidiaries or Transauto. However, the claimant had provided no evidence to that effect and the court was unable to assume that this was the case.
In respect of the defendants' argument under the third exception, the court thought that there might be impediments to the defendants' assertion that the companies were unable to pursue their own claims under the cross-undertaking as a result of the grant of the injunction, but did not elaborate on what those impediments might be.
The court followed the comments made by Lord Justice Neuberger (as he was then) in Gardner v Parker which referred to the rule that reflective loss is not recoverable by the shareholder, adding that:
"where there is no reasonable doubt that [the relevant loss is not recoverable under the reflective loss rule] the court can properly act, in advance of trial, to strike out the offending heads of claim." (emphasis added)
The court concluded that, at this interim stage, the claimant had not met this "high hurdle". Although the court indicated that the claimant's arguments might be correct, it was not prepared to reach that conclusion summarily. It therefore ordered an inquiry as to damages.
The principle of reflective loss is a developing area of English law and the court's comments in this case do little to provide additional insight, although it is noteworthy that it considered the issue potentially to be the claimant's "knock-out blow".
The case serves to illustrate the high threshold that claimants need to overcome in order to resist an inquiry into damages following the discharge of a wrongly obtained injunction.
It is also clear that the claimant's failure to adduce sufficient credible evidence to back up its arguments prejudiced its position at the hearing, which should serve as a learning point for claimants that find themselves in the same position in future.
For further information on this topic please contact Geraldine Elliott or Chris Whitehouse at RPC by telephone (+44 20 3060 6000), fax (+44 20 3060 7000) or email ([email protected] or [email protected]). The RPC website can be accessed at www.rpc.co.uk.
(1)  EWHC 113 (Comm) (January 31 2014).
(2)  BCC 46.
(3)  2 Lloyd's Rep 113.
(4)  Ch 204 (CA) at 222H-223A.
(5) Johnson v Gore Wood & Co  2AC 1.
(6) Rehman v Jones Lang La Salle  EWHC Civ 1339 (QB).
(7) Giles v Rhind  EWCA Civ 1428.
(8) F Hoffman-La Roche & Co AG v Secretary of State  AC 295 at 361.