Analysing the ‘No-Reflective Loss’ Principle in the Context of an SSPA

Sometimes share subscription and purchase agreements will contain a clause to the effect that if the contracting company breaches certain representations and warranties, causing the acquirer of the shares to suffer loss, the acquirer will be entitled to recover damages for such breach including in respect of any losses suffered as a result of a diminution in the value of its shares. A question arises as to whether such a claim is, indeed, enforceable or may be countered in reliance on the principle of reflective loss.

The reflective loss principle – perhaps more fittingly described as the ‘no reflective loss’ Principle – states that a member of a company is precluded from recovering any loss which merely reflects, or is inseparable from, the Company’s loss. It follows that a member holding shares in a company cannot claim from a ‘wrongdoer’ any compensation for losses which merely reflect a loss which has been suffered by the company.

This principle was given judicial recognition in the case of Prudential Assurance Co. Ltd v. Newman Industries Ltd [1982] Ch 204 and others and has subsequently been pronounced upon in other judicial decisions. The decision of the court in Prudential Assurance was critically examined in the case of Johnson v Gore Wood and Co. [2002] 2 AC 1 at 19, where the UK House of Lords held that:

“A claim will not lie by a shareholder to make good a loss which would be made good if the company’s assets were replenished through action against the party responsible for the loss, even if the company, acting through its constitutional organs, has declined or failed to make good that loss.”

 The existence of the principle is justified by the need both to prevent double recovery and to provide protection for a company’s creditor, who might be prejudiced if shareholder claims of this nature were to be permitted.

There are, however, three established exceptions to the ‘No-Reflective Loss’ principle by which a shareholder of a company will be entitled to claim for losses occasioned by a wrong committed against the company, to wit: (x) where the shareholder suffers a separate and distinct loss from that suffered by the company; (y) where the company has no cause of action; and (z) where the wrongdoer has disabled the company from pursuing its claim.

Returning to the scenario described in the opening paragraph; a defence premised on the ‘no reflective loss’ principle would, it seems, have little chance of success. In those circumstances, no wrong would have been done to the company by a third party. Indeed, the acquirer’s claim would be against the company itself as the wrongdoer owing to the breach of its representations and warranties as contained in the SPA. The company itself would have no cause of action (and any loss suffered by it would be separate and distinct from losses suffered by the shareholder), clearly establishing the scenario within one (or more) of the exceptions to the ‘no-reflective loss’ principle.

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