In brief

Shareholders, holding companies and beneficiaries of trusts who suffer losses through a diminution in the value of their shareholding / trust interest are often prevented from pursuing actions to recover those losses by the “Reflective Loss Principle.”

The Principle is clearly part of the law of Hong Kong, and its application is complex. But a recent landmark ruling by the UK Supreme Court in Sevilleja v Marex Financial Limited [2020] UKSC 31 has rejected the broad application of the Reflective Loss Principle developed over the years, and questioned its justification and whether it should still be recognised. This calls into question whether it will remain an impediment to recovery by claimants in Hong Kong and elsewhere.

This has significant implications for the potential liability of directors and officers, professional trustees, auditors and other advisers, and may lead to a materially higher risk of liability.


Key takeaways

The Reflective Loss Principle, although complex and difficult to apply, presently is part of Hong Kong law.

However, the decision by the UK Supreme Court in Sevilleja v Marex Financial calls the continued existence or application of the Reflective Loss Principle into question in Hong Kong. When the next case “test” comes before the Court of Final Appeal on the issue, there is a significant chance that it will follow the approach of the UK Supreme Court, and substantially limit (or potentially go one step further and reject) the Principle going forward.

Now is the time to look at engagement terms, trust deeds and the like, to ensure they contain well drafted and appropriate exclusions, limitations and exoneration clauses. Doing so hopefully will help avoid the question, and therefore the risk of being the “test case” that next comes before the Court of Final Appeal to consider whether and if so how the Principle applies in Hong Kong.

In more detail

What is the Reflective Loss Principle?

The Principle is: where a company suffers loss caused by a breach of duty owed to it – only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity to make good a diminution in the value of their shareholding where that merely reflects the loss suffered by the company. It applies notwithstanding that the company may have declined or failed to sue: the Principle is not concerned with barring causes of action but with barring recovery of types of loss.

However, the Principle doesn’t limit the right of a shareholder to sue where (1) the company has no cause of action, even where the loss is a diminution in the value of the shareholding, or (2) a shareholder suffers a loss separate and distinct from that suffered by the company. Each may sue to recover the loss caused to it, but damages may be limited by the rules preventing a double recovery.

Application in Hong Kong

The Reflective Loss Principle forms part of the law of Hong Kong: see the Court of Final Appeal in Waddington v Chan [2008] HKCFA 63. The Hong Kong courts have applied the Principle to defeat claims.

For example, in Hotung v Hillhead [2008] 3 HKLRD 200, the Court applied the Reflective Loss Principle to strike out a claim by a beneficiary against a trustee where the trust assets were shares, which lost value as a result of the diversion of assets from the companies by the settlor.

Recently, in Topping Chance Developments Ltd v CCIF [2020] HKCA 478 (June 2020), the Hong Kong Court of Appeal, dealing with a claim brought by the holding company for the negligent audit of its subsidiaries, indicated that the complexities of the Principle are such that it is unlikely that a claim would be struck out at an interlocutory stage. So while Hotung may well be decided differently at the strike-out stage if determined today, the Reflective Loss Principle would remain a complete defence on the merits at trial.

The Marex Financial Decision

In Marex Financial, Marex Financial had obtained judgments against two BVI companies controlled by Mr Sevilleja. Mr Sevilleja then allegedly stripped assets from those companies, allegedly to evade enforcement of those judgments.

Marex Financial then sued Mr Sevilleja personally for his conduct. Mr Sevilleja sought to bar the claim on the basis of the Reflective Loss Principle; that is, Marex Financial’s loss was merely reflective of the loss incurred by the BVI companies, and therefore could not be pursued. The UK Court of Appeal agreed, holding that the Principle applied to claims by creditors of a company, and hence Marex Financial was barred from suing.

The UK Supreme Court unanimously rejected that ruling. It held that the cases developing the Reflective Loss Principle were wrongly decided. The majority held that the rule, properly understood, is a rule of company law (known as the Rule in Foss v Harbottle); not a general rule as to the recovery of loss. It applies in only limited situations to prevent a shareholder from claiming in respect of a diminution in the value of their shares, or a diminution in distributions they would otherwise receive from the company, where that diminution merely reflects the loss suffered by the company due to a wrong done to it and for which the company could bring its own claim. It did not prevent Marex Financial, as a creditor of the victim companies, from pursuing Mr Sevilleja directly.

The minority opinion went further, questioning whether the rule should still be recognised at all. In particular, the minority criticised the “bright line” maintained by the majority opinion as producing simplicity at the cost of potentially serious injustice to a shareholder who has suffered loss which is different from that suffered by the company.

Implications of the Marex Financial decision for boards, trustees and other service providers in Hong Kong

The Reflective Loss Principle is clearly a part of the law of Hong Kong, and serves to limit the potential liability of boards, professional trustees, auditors and others to claims by shareholders or beneficiaries for losses they may have suffered. But Marex Financial raises a real issue in Hong Kong and elsewhere: will it survive here and, if so, what is its scope? Will the potential for liability expand?

Decisions of the UK Supreme Court are not binding in Hong Kong, but are highly persuasive. Therefore, it is foreseeable that the Court of Final Appeal may, in the right case, reconsider the Reflective Loss Principle in light of Marex Financial.

The situation is therefore in a state of flux – with implications for boards, professional trustees, auditors and, of course, their insurers.

It is therefore important that trustees and others look to strategies to help mitigate this uncertainty. Where possible or appropriate, it may be time to revisit engagement terms, trust deeds or the like. For example, in another important recent case (Zhang Hong Li v DBS Bank and others, November 2019, a case about trustee liability) the Court of Final Appeal has made it clear that the duties of a trustee must be assessed in light of the express terms of the trust deed, and that well-drafted limitation, exclusion or exoneration clauses in the trust deed will be effective to protect the trustee from liability. That case arose from claims in relation to risky investment decisions made on behalf of an investment company owned by the trust.