The Commercial Court has ruled that a remedy of specific performance of shareholder’s rights can be sought under shareholder agreements, enabling shareholders to circumvent the difficulties created by the “reflective loss” principle.

What is “Reflective Loss”?

The principle of reflective loss states that that the company itself, as opposed to its shareholders, has the sole right to recover company losses. The principle is an important part of company law, as preventing individual shareholders from claiming for company losses can protect a company’s creditors from prejudice – allowing shareholders to claim for a company’s losses could frustrate a legitimate claim advanced by other creditors.

In Johnson v Gore Wood [2002] 2 AC 1, Lord Bingham summarised the scope of the principle in three points:

1. Where a company suffers a loss, the company is the only party entitled to claim for that loss. A company can bring an action to replenish their assets, and so they remain the only party entitled to bring forward an action. A shareholder cannot sue for the diminution in the value of their shares, as this is merely a “reflection” of the loss suffered by the company and therefore the loss cannot be considered the party’s own.
2. Where a company has no cause of action to recover a loss, a shareholder may sue even though the loss suffered by the shareholder is a diminution in the value of the shareholding.
3. When the losses of a shareholder and company are separate and distinct from one another, both may make individual, but separate claims to recover their losses.

Decision

Oceanic Trans Shipping Corp, Latin American Investments Limited and Maroil Trading Inc. were three shareholders in two companies. These companies owned two oil carriers. These three shareholders entered into two shareholder agreements. Pursuant to these shareholder agreements, the oil carriers were made available to another company, Sea Pioneer Shipping Corporation, who entered into a contract with an oil company.

The oil company was alleged to have failed to perform its obligations under the contract and disputes arose as a result. They were then settled by the two other shareholders without the consent of Oceanic for $30m.

Oceanic argued that the dispute ought not to have been settled for less than $89m. In addition, Oceanic claimed that it did not receive its share of a settlement, which is valued at $10m. Oceanic claimed that as a result of both the two companies, alongside Oceanic itself as a shareholder, suffered a loss.

In the claim, Oceanic sought an order that the loss is paid back into the two companies by the other two shareholders. It sought this by way of an order specific performance of the shareholder’s obligations under the shareholder’s agreements. The two other shareholders argued that this fell foul of the “reflective loss” principle, as Oceanic suffered a loss simply due to the diminution of the value of its shareholding in the two companies.

It was decided that the claim for specific performance was able to circumvent the “reflective loss” principle. Mr Justice Teare in the Commercial Court drew attention to the purpose of the “reflective loss” principle being to protect company Autonomy. While claiming directly for the diminution in value of shareholdings may undermine the principle of company autonomy (and thus fall foul of the principle), this claim aimed to pay funds back into the two companies. Seeking specific performance of the shareholder’s agreement, therefore, did not undermine the principle of company autonomy, nor would it prejudice the interests of a company’s creditors.

The case is being appealed.

Summary

With the principle of “reflective loss” forming a barrier to individual shareholders from claiming for the diminution in the value of their shareholdings, this judgment provides shareholders with a potential avenue for circumventing the “reflective loss” principle. While generally a claim cannot be made for the reduced value of a shareholding, the remedy of specific performance can be sought to have funds transferred into a company in order to make good on the loss. Shareholders, therefore, have an alternative avenue where the value of their shareholdings can be restored in a way which does not fall foul of the “reflective loss” principle alongside any derivative actions they might be able to bring.