In the recent case of Suen Kwai Kam v Zhong Hua International Holdings Ltd and others [2013] HKEC 457 the Hong Kong Court of First Instance (CFI) held that a shareholder was unable to claim for an unpaid debt owed to its company regardless of the fact that a third party had personally guaranteed payment of the debt to the shareholder.  To date there has been uncertainty whether the “no reflective loss” principle applies where the company and the shareholder have claims against different parties.  In this matter the CFI has decided the issue in favour of a broad application of the principle.

The “no reflective loss” principle – what does it mean?

The “no reflective loss” principle is a well-established common law principle based on English case law.  According to this principle a shareholder may not claim for a loss that is merely reflective of a loss suffered by the company, ie, which is a loss that would be made good if the company had enforced its rights in full against its debtor.

What is this case about?

In essence the Sun Kwai matter related to the sale of a business by the seller company to the buyer company for a price of HKD 35,000,000.  As the shareholder of the seller company had concerns about the sales structure suggested by the ultimate shareholder company and directors of the buyer company, one of the directors and the ultimate shareholder company provided oral guarantees to the shareholder of the seller company guaranteeing payment of the purchase price.  A significant portion of the purchase price was not paid and the shareholder brought, amongst other claims, a claim against the guarantors for payment.

What did the CFI decide?

The judge pointed out that the “no reflective loss” principle had two objectives:

  1. to avoid double-recovery at the expense of the defendant debtor – here there were different debtors (the buyer company on the one hand and the guarantors on the other hand) which meant that this concern did not apply;
  2. to avoid the shareholder recovering at the expense of the company and its creditors and other shareholders – the judge found that this concern applied as the seller company would lose its claim under the share purchase agreement if the guarantors paid out under the guarantee.

Based upon the above considerations the judge came to the conclusion that the shareholder’s claim under the guarantees was merely reflective of the loss suffered by the company and was therefore not recoverable, and the shareholder’s claim was struck out.

Take-away points

  • If this judgment is not appealed and is followed by other courts, it will mean that there is no point in shareholders obtaining personal guarantees relating to the payment of a company’s debts; they will be unenforceable under the “no reflective loss” principle.
  • If it is considered that a guarantee from the shareholder or director of a debtor is required to “secure” the debtor’s debt, the guarantee should be obtained by the creditor company and any claims will need to be pursued by the company rather than by the shareholder