The Board of the Privy Council has clarified aspects of the operation of the reflective loss rule: Primeo Fund v Bank of Bermuda (Cayman) Ltd [2021] UKPC 22.
As a reminder, the reflective loss rule applies where the defendant commits a wrong against both a company and its shareholder, and the shareholder suffers loss through a drop in the value of their shareholding or lower distributions in respect of their shares. The rule prevents the shareholder from recovering these losses on the basis that the shareholder’s loss merely “reflects” loss suffered by the company. The scope of the rule, previously controversial, was significantly narrowed and clarified by the UK Supreme Court’s recent decision in Sevilleja v Marex Financial Ltd [2020] UKSC 31.
The Board’s decision in Primeo clarifies two key issues relating to the reflective loss rule. The first is whether the rule precludes a plaintiff’s claim where the plaintiff suffers a loss and later becomes, or ceases to be, a shareholder of a company that suffers the same loss. The Board held that what matters is the nature of the loss and the plaintiff’s status at the time the loss is suffered. As such, later becoming a shareholder does not trigger the rule, while ceasing to be a shareholder does not disapply the rule (see below under “Timing issue”).
The second issue the Board clarified is that the rule only applies where the shareholder and company have a direct claim against a common wrongdoer. The rule does not apply where the shareholder and the company have claims against different defendants, even if one of the defendants is entitled to bring an onward claim against the other defendant for the same loss (see below under “Common Wrongdoer issue”).
There remain areas of uncertainty in the operation of the reflective loss rule. In particular, the Board left open how strong the company’s claim against the defendant needs to be for the rule to operate (see below under “Merits issue”).
It also remains to be seen whether the Hong Kong courts will follow these decisions of the Supreme Court and Privy Council.
Factual background
Primeo was an investment fund that invested funds in Bernard L Madoff Investment Securities LLC (“Madoff”).
Primeo’s investments in Madoff initially were a mix of direct and indirect investments. Primeo’s indirect investments were made through feeder funds, including Herald Fund SPC (“Herald”). By these indirect investments, Primeo provided funds to the feeder funds in exchange for the issue of shares, and the feeder funds would use those funds to invest in Madoff.
Later, Primeo transferred its direct investments to Herald in consideration for new shares in Herald (“Herald Transfer”) and from that time only held indirect investments in Madoff.
When Madoff was revealed to be a Ponzi scheme, Primeo suffered heavy losses. Primeo brought claims against its administrators (“First Respondent”) and custodians (“Second Respondent”) (collectively, the “Respondents”) for breaches of duty in respect of these losses.
The feeder funds also brought claims against the Second Respondent. It was common ground that if the feeder funds succeeded in their claims against the Second Respondent and if the judgments were satisfied, this would mean that Primeo would receive full value in respect of its indirect investments in Madoff at the time of its collapse and as a result would suffer no loss.
The Respondents contended that Primeo’s claims were precluded by the reflective loss rule and had been successful before both the Cayman Islands Grand Court and the Court of Appeal.
The Privy Council disagreed with the courts below, holding that the reflective loss rule did not preclude Primeo’s claims against Respondents.
Timing issue
The Respondents contended that the reflective loss rule precluded Primeo’s claim in respect its direct investments in Madoff. The Respondents argued that by the time Primeo made its claim against the Respondents, it was a shareholder in Herald by virtue of the Herald Transfer, and its claim for loss overlapped with loss that Herald also claimed.
The Board rejected this contention. The Board held that the time for assessing whether the reflective loss rule applied was as at the time Primeo suffered the loss, and not at the time the Primeo brought the proceedings. Primeo suffered the loss at or shortly after each occasion it made its direct investments in Madoff. This loss was suffered by Primeo in its personal capacity at a time before it was a shareholder in Herald in respect of these investments. Accordingly, the reflective loss rule did not apply even though Primeo was a shareholder in Herald in respect of these investments by the time it brought the proceedings (at [55]-[58]).
Consistently with this reasoning, the Board also indicated that a shareholder could not avoid the reflective loss rule simply by selling their shares in the company before commencing proceedings. In doing so, the Board disapproved a Court of Appeal decision to the contrary (Nectrus Ltd v UCP Plc [2021] EWCA Civ 57). The Board reiterated that the focus of the rule is on the nature of the shareholder’s loss as at the date it was suffered and whether that loss is separate and distinct from that of the company (at [61]).
Common wrongdoer issue
Herald had claimed against the Second Respondent, but not the First Respondent. The Court of Appeal held that the reflective loss rule still precluded Primeo’s claim against the First Respondent. This was because the Second Respondent had an onward claim against the First Respondent, and so the First Respondent was, as a matter of economic reality, responsible for meeting Herald’s claims.
The Board agreed with Primeo’s contention that the reflective loss rule only operates where the shareholder and company have a direct claim against a common wrongdoer. The Board considered that the Court of Appeal’s focus on the economic effects of the interlocking contracts between the parties would give rise to significant uncertainty (at [74]-[79]).
Merits issue
The Board’s decision on the issues discussed above meant that Primeo’s claims were not precluded by the reflective loss rule. As such, the Board did not express any view on how strong the company’s claim against the defendant needed to be for the rule to preclude the shareholder’s claim. The Board did state that the decisions of the lower courts, that a realistic prospect of success was sufficient, should not be regarded as authoritative since that those decisions were made without the benefit of the Supreme Court’s decision in Marex (at [84]).
Comment
Together with the Supreme Court’s decision in Marex, the Privy Council’s judgment in Primeo further clarifies the scope of the reflective loss rule.
It remains to be seen whether the Hong Kong courts will follow the approach laid down in Marex and Primeo. The Hong Kong Court of Appeal most recently examined the reflective loss rule in detail in its decision in Topping Chance Development Ltd v CCIF CPA Ltd [2020] HKCA 478, which was handed down before Marex and Primeo.