Shattering the Mirror: Privy Council Confirms Highly Specific and Limited Scope of Reflective Loss Principle

Kristy Zander and Madeleine Harland

The recent decision of the Judicial Committee of the Privy Council in Primeo Fund (In Official Liquidation) v Bank of Bermuda (Cayman) Ltd & Anor [2021] UKPC 22 (Primeo) has endorsed the approach of the UK Supreme Court in Marex Financial Ltd v Sevilleja [2020] UKSC 31 (Marex), cementing the principle that the reflective loss principle is both highly specific and limited in scope.

The reflective loss principle

The reflective loss rule excludes a shareholder’s claim made in its capacity as a shareholder where (a) a wrong is done to the company, and a shareholder suffers a ‘knock-on’ loss through a diminution in the value of shares or a reduction in distributions payable to the shareholder; and (b) the company has a cause of action against the same wrongdoer as the shareholder.  The rationale for the rule is that by becoming a member of the company the shareholder agrees to ‘follow the fortunes of the company’ in relation to losses suffered by it as a result of wrongs done to the company, and agrees that the company’s organs will have the right to decide whether claims should or should not be brought in respect of such wrongs.

The facts

The facts were reasonably complicated. We provide an overview here only to the extent necessary to explain the decision.

The claim was brought by Primeo (a Cayman Islands’ investment fund which was one of the many casualties of the high profile Ponzi scheme operated by Bernard Madoff) against its custodians and administrators, Bank of Bermuda (Cayman) (BoB) and HSBC Securities Services (Luxembourg) (HSBC).

Primeo had invested in Mr Madoff’s investment vehicle, Bernard L Madoff Investment Securities LLC (BLMIS). Until mid-2007, most of Primeo’s investments with BLMIS were made directly. In May 2007, Primeo restructured its investments by divesting all of its direct investments in BLMIS to Herald Fund SPC (a Cayman-domiciled fund – Herald) in return for newly issued shares in Herald (the Herald Transfer). From that date, all of Primeo’s investments in BLMIS were made indirectly via Herald and to a lesser extent Alpha Prime Fund (a Bermuda-domiciled fund – Alpha). The indirect investments were made by Primeo making share subscriptions in Herald and Alpha who, in turn, made direct investments in BLMIS. HSBC was also the custodian and administrator for Herald and Alpha, but neither Herald nor Alpha had any legal relationship with BoB.

In February 2013, Primeo commenced proceedings in the Cayman Islands against BoB and HSBC for losses it suffered by making investments with BLMIS prior to the Herald Transfer (the Primeo litigation).  The types of loss claimed included (a) the moneys which were invested with, and misappropriated by, BLMIS; and (b) the loss of the opportunity for Primeo to redeem its BLMIS investments and its shares in Herald and Alpha. Herald and Alpha separately commenced proceedings against HSBC in Luxembourg (the Herald litigation).

It was common ground that if Herald and Alpha were successful in the Herald litigation (and any relevant judgment was satisfied), Primeo would be repaid the full apparent value of its indirect investments in BLMIS at the time of its collapse, and hence would have suffered no loss from its investments in BLMIS. However, Primeo contended that it was far from certain that Herald and Alpha would recover the full measure of compensation they claimed from HSBC. Primeo also accepted that, to the extent that Herald and Alpha did make recovery from HSBC in the Herald litigation, and that recovery was passed on to Primeo, Primeo would have to give credit for that recovery in the Primeo litigation.

The decisions appealed from

It was held both at first instance and on appeal[1] that Primeo’s loss was “reflective” of Herald’s and Alpha’s loss, so that Primeo had no right of recovery against BoB or HSBC. Both decisions pre-dated the decision of the UK in Marex, which narrowed the scope of the reflective loss principle.[2]

The issues before the Privy Council

In summary, the issues substantively considered by the Privy Council were (at [45]):

  • What was the relevant time to determine whether the reflective loss rule applied? Was it the time when Primeo commenced the Primeo litigation (by which time Primeo was a shareholder in Herald) or was it the time when Primeo acquired its causes of action against BoB and HSBC (prior to it being a shareholder in Herald) (the timing issue)?
  • If the latter, did Primeo nonetheless lose its right to claim for the losses it suffered and become subject to the reflective loss rule by reason of the Herald Transfer (the Herald Transfer issue)?
  • Herald had no claim of its own against BoB, but if Herald was successful in its claim against HSBC, HSBC had an onward claim against BoB. Primeo had claims against both BoB and HSBC. Did this degree of economic overlap mean that BoB was to be regarded as a ‘common wrongdoer’ vis-à-vis Primeo and Herald for the purpose of the reflective loss rule (the common wrongdoer issue)?

The Privy Council’s decision

On appeal to the Judicial Committee of the Privy Council, the Board found, in favour of Primeo, that the reflective loss rule had no application to Primeo’s claims for losses it suffered by making direct and indirect investments with BLMIS.

Referring to and applying Marex, the Board observed that the appeal was concerned with identifying where the boundary lay between the following two types of cases (at [50]-[51]):

  • Cases where claims were brought by a shareholder in respect of loss which he or she had suffered in that capacity, in the form of diminution in share value or in distributions, which was the consequence of loss sustained by the company, in respect of which the company had a cause of action against the same wrongdoer.

The reflective loss rule applied to this type of case, and the shareholder was barred from seeking recovery for loss they might have suffered.

  • Cases where claims were brought, whether by a shareholder or by anyone else, in respect of loss which did not fall within the above description, but where the company had a right of action in respect of substantially the same loss.

The reflective loss rule did not apply to this type of case, and the claimant could sue for loss they had suffered, even though they happened also to be a shareholder in a company which had a cause of action against the same wrongdoer.

This was the second type of case.

The timing issue

In relation to the timing issue, the Board adopted the reasoning in Marex that the focus of the reflective loss inquiry was on the ‘nature’ or ‘characterisation’ of the loss assessed at the point in time when the claimant suffered loss (and not at the time when proceedings are brought). This involved a consideration of the capacity in which the claimant suffered the loss and the form of the loss claimed (at [55]-[59]).

In relation to Primeo’s direct investments in BLMIS prior to the Herald transfer in 2007, the Board found (at [60]) that:

“The relevant losses suffered by Primo are not ‘merely’ the result of a loss suffered by Herald in consequence of a wrong done to it by [HSBC] (cf. Marex, para 39); and they do not take the form of a diminution in share value which is the consequence of a loss sustained by Herald (cf. Marex, para 79).”

This conclusion was based on the reasoning that Primeo suffered an immediate loss when it paid over monies to BLMIS which were misappropriated, such loss being measured by the value of the money misappropriated less any money actually recovered. On each occasion that it made a payment to BLMIS, Primeo acquired a cause of action against BoB and HSBC in respect of the loss it suffered at that time. The cause of action acquired by Primeo was its property and formed part of its funds of assets. At the time that Primeo had acquired its cause of action, no relevant wrong had been committed by BoB or HSBC against Herald (at [54]-[56]). The misappropriation loss was a real and recoverable loss suffered by Primeo in its personal capacity, which had nothing to do with Herald; it was not merely the result of a loss suffered by Herald.

By parity of reasoning, the Board also found that Primeo’s claim for the loss of a chance to redeem its investments in BLMIS was also a genuine loss suffered by Primeo in its personal capacity at a time before it was a shareholder (in a relevant sense) in Herald (at [58]).

The Herald Transfer issue

The Board found that the Herald Transfer did not remove Primeo’s right to claim against BoB and HSBC in respect of its direct investments in BLMIS (at [68]). The reflective loss rule was prospective in effect, and to apply the rule to preclude a new shareholder from enforcing rights of action which had already accrued to it before it became a member of the company would be an unwarranted extension of the rule (at [64], [66]-[68]).

The fact that, by operation of the Herald Transfer, Herald had come to acquire a right of action against HSBC which could potentially restore to Primeo the value of the losses it has suffered was not found by the Board to be sufficient, in itself, to bring the reflective loss rule into operation (at [60]). The Board found that the losses which Herald claimed to have suffered were not the same as the losses suffered by Primeo, since “it was Primeo, not Herald, which paid the relevant sums to BLMIS in the first place and suffered loss thereby, and it was Primeo, not Herald, which lost the opportunity to redeem the BLMIS investments in the period up to the Herald Transfer” (at [60]). Moreover, by making the Herald Transfer, Primeo had not agreed to forego its right to vindicate its claims against HSBC (at [70]).

The common wrongdoer issue

The Board upheld Primeo’s submission that the Court of Appeal was wrong to apply the reflective loss rule in relation to Primeo’s claims against BoB, because neither Herald nor Alpha had any claim against BoB (at [74]-[83]). It was an inherent part of the reflective loss rule that it only applied to exclude a claim by a shareholder where what was in issue was a wrong committed by a person who was a wrongdoer, both as against the shareholder and as against the company.

This was notwithstanding that there was some economic overlap between BoB and HSBC since HSBC would have an ‘onward claim’ against BoB if it was found liable.

The Board noted that to apply the reflective loss rule in these circumstances would “amount to a significant extension of the rule beyond its current boundary” and would be contrary to Marex, which was “directed to keeping the operation of the rule within narrow parameters” (at [77]). The Board was concerned that extension of the reflective loss rule to cover this sort of case would “magnify the scope for the rule to work injustice” (at [78]).

Double recovery

As a practical matter, concerns as to possible double recovery were not sufficient to enliven the reflective loss principle (at [70]-[73]). The Board was aware of these issues, but concluded that they would have to be managed as a matter of case management. Primeo’s concession that they would have to give credit for any recoveries made by Primeo resulting from the Herald litigation was correct. Nevertheless the fact remained that “the losses which Herald claims to have suffered are not the same as the losses suffered by Primeo” (at [60]).

[1] Court of Appeal Takes a Hard Look in the Mirror: the Policy Behind Reflective Loss – LK – Court of Appeal Takes a Hard Look in the Mirror: the Policy Behind Reflective Loss

[2] UK Supreme Court Narrows Reflective Loss Principle – LK – UK Supreme Court Narrows Reflective Loss Principle

Kristy Zander and Madeleine Harland have extensive experience advising investment funds in a Master-Feeder structure, including as to reflective loss issues and other loss causation defences. Please click here to contact Kristy or click here to contact Madeleine.

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