Lessons From Burnford: Investors, Creditors And Recovering Reflective Losses

• Published date: 07 March 2023
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Shareholders
• Law Firm: Katten Muchin Rosenman LLP
• Author: Oliver Williams and Alex Potten
• topic: Business of Law,Bankruptcy and Insolvency,Contracts,Corporate / Commercial,Civil Procedure,Securities Law

It is an old rule of English law that the only person who can sue for a wrong done to a company is the company itself. Related to that rule is the principle that an individual shareholder cannot bring a personal claim for a loss suffered by the company, even where that shareholder has personally suffered loss as a result of the company's loss. This is known as the "no reflective loss" principle. The rule is complex and can operate against shareholders who seek to recover damages from other shareholders, so it must be considered carefully when relations between shareholders in a company break down. A recent case provides helpful guidance on its operation in the context of joint ventures.

The decision in Burnford

Certain shareholders (Individual Shareholders) in Motoriety Limited (the Company) entered into an investment agreement with an institutional investor (Institutional Investor) pursuant to which, amongst other things, the Institutional Investor acquired 50 percent of the equity in the Company and took a seat on the Company's board.

The investment agreement contained a call option in favour of the Institutional Investor, pursuant to which the Individual Shareholders would be paid an initial option payment and an earnout for their shares. Following the investment, the Company performed poorly and was ultimately purchased by another entity in the Institutional Investor's group for a value far less than the Institutional Investor's original investment.

The Individual Shareholders claimed that the Institutional Investor had (i) by various misrepresentations made to them and the Company, induced them to enter into the investment agreement and (ii) by a course of conduct following entry into the investment agreement, deliberately obstructed the Company's business and thereby avoided exercising the call option and subsequently paying the initial and earnout consideration to the Individual Shareholders. The Institutional Investor applied to strike out the claim on the basis that the losses claimed by the Individual Shareholders were barred by the no reflective loss principle.

The judge at first instance granted the application to strike out the claim on the basis that the claimants' losses were entirely derived from the losses of the Company (the "no reflective loss principle"). The Individual Shareholders appealed on the basis, amongst other things, that the no reflective loss principle was uncertain and developing. The Court of Appeal upheld the first...