The High Court has held that two director-shareholders of a company who were unsuccessfully prosecuted for fraud could not claim back the drop in the value of their shares when the company’s business failed.
Breeze and another v Chief Constable of Norfolk concerned two individuals who ran a company that provided mental health services to the National Health Service (NHS). Those individuals were also the company’s main shareholders.
Following a “tip-off” by a disgruntled former employee, local police arrested the two individuals on suspicion of over-charging. The individuals were tried two and a half years later but were emphatically exonerated by the judge, who said they could “leave court with [their] heads held high”.
However, during the period between arrest and trial, the individuals were unable to run the company. The company’s position deteriorated so badly it was ultimately placed into receivership and dissolved. The individuals consequently lost the value of their shareholdings in the company, which they estimated at a combined total of just over £30 million.
They subsequently claimed against the Chief Constable to recover the loss in value of their shares. They alleged malicious prosecution and misfeasance and said the Constable should have known that the prolonged investigation would cause the company’s business to fail.
The Constable argued the individuals could not claim damages due to the “reflective loss” principle.
The “reflective loss” principle states that, if a company suffers loss caused by someone else, it is the company that has the right to claim. Shareholders may suffer loss if the value of their shares goes down, but they cannot recover that loss unless they have their own, separate right of claim. If the loss in share value is merely “reflective” of the company’s own loss, it will not by itself give rise to a claim.
The principle can sound complex. However, in reality, it merely affirms the fact that a company is a person separate from its shareholders, with its own rights. This concept has been familiar to English law for over 150 years since the 19th century case of Foss v Harbottle.
What did the court say?
The court agreed with the Chief Constable. It said that the loss in the individuals’ shareholdings merely reflected a loss suffered by the company and so, at first glance, was irrecoverable.
However, the case raised two interesting points:
- The individuals argued, based on historic case law that the “reflective loss” principle applies only where a company has the right to claim for breach of a duty owed to it. That was not the case here, and so they should be allowed to claim.The court rejected this, saying that the principle applied to any claim a company may have which results in a loss reflected in the value of its shares.
- The individuals also argued that they should be allowed to claim despite the “reflective loss” principle, because the Constable’s actions had deprived the company of its management and so rendered it unable to claim itself. They said it would be unfair to allow the Constable to escape liability when it was his actions that caused the company to be unable to claim. This is a recognised exception to the “reflective loss” principle (known as the exception in Giles v Rhind).The court was not able to give a final view on this, as it did not have sufficient evidence before it. However, the master saw some merit in this argument and allowed the individuals to apply to amend their claim to provide more details.
The interesting element of the judgment in this case was the master’s willingness to “expand” the “reflective loss” principle to claims beyond breaches of duty owed to a company. Depending on how one approaches the principle, this is either a significant extension of the principle or (as the master suggested) not an extension at all.
The judgment was given in the context of an application to strike the individuals’ claim out. It does not therefore set any binding precedent for courts to follow, but the master’s decision was well-reasoned and future courts will probably follow a similar approach.
It will be interesting to see whether the individuals in question pursue their argument that the exception to the principle applies in this case.
The key point to remember is that a shareholder will usually have no right to claim for a loss in the value of its shares merely because the company itself suffers loss. If the shareholder wants to recover its loss value, it will need to examine whether it can launch an action some other way. These might include the following:
- Bringing a derivative claim on behalf of the company (if the company’s claim is against its directors for breach of duty).
- Using its voting rights in the company to replace the company’s board with directors who will be prepared to bring the claim.
- Identifying and establishing some other duty owed directly to the shareholder and claiming on that basis. However, even then, a shareholder is unlikely to be able to recover any damages that merely reflect an underlying loss to the company itself.