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30 October 2018
In a cautionary tale, a group company and its current liquidators have had their claim against the group company's former liquidators struck out under the 'no reflective loss' principle.(1) The strike-out was granted on the basis that the group company's subsidiaries had a closer nexus to the relevant loss than the group company. The group company's argument on appeal that it would be unjust to prevent it from making its own claim, in case its subsidiaries' claim failed, was rejected. As a mere shareholder of the wronged company, the group company was not entitled to bring proceedings in its own name against the alleged wrongdoer. The appeal judgment follows on from other recent case law(2) which demonstrates that the courts will not shy away from dismissing defective claims against professional advisers without trial (for further details please see "Flawed claim against solicitors struck out").
The group company, whose shares were publicly traded on the Stock Exchange of Hong Kong, had two subsidiaries. These subsidiaries acquired all of the shares in another company named Summit Mass Ltd in January 2000 for HK$45 million. Summit Mass's sole asset was a piece of land outside Jiangmen City on the mainland. Not long after the group company's subsidiaries purchased Summit Mass, a compulsory winding-up order was made against the group company. The group company's former liquidators were appointed in January 2001.
On 3 June 2006 the shares in Summit Mass owned by the group company's subsidiaries were allegedly misappropriated by an individual (who at one time had apparently worked for the former liquidators) and purportedly transferred to third parties, without the group company or its subsidiaries receiving any consideration. The employee was alleged to be under the former liquidators' supervision. Despite this, the former liquidators did not become aware of the misappropriation until November 2007.
Shortly after, in February 2008, the former liquidators brought proceedings in Hong Kong on behalf of one of the subsidiaries against the third parties alleged to have received the shares. A settlement agreement between all of the parties to those proceedings was executed on 5 August 2011. As part of the settlement agreement, the subsidiaries gave up their shares in Summit Mass for Rmb3.35 million. This constituted less than 10% of Summit Mass's original acquisition price.
The former liquidators were replaced by the current liquidators upon the application of one of the group company's creditors on 2 May 2012. The current liquidators commenced court proceedings in the name of the group company against the former liquidators on 30 April 2015. The writ alleged that the group company had suffered substantial loss and damage on account of the former liquidators' negligence.
Concurrently, the group company's two subsidiaries launched proceedings against the employee, the former liquidators and three other parties in respect of the same loss.
The former liquidators applied to strike out both the group company and the subsidiaries' claims and to reverse the decision of the current liquidators to bring a claim in the name of the group company.
Court of First Instance
The former liquidators were successful in striking out the entirety of the group company's claim and reversing the current liquidators' decision to bring a claim in its name. The court considered that there was a real risk that the 'cardinal principle'(3) that a shareholder could not recover for reflective loss was in danger of being contravened. Summit Mass was the indirect subsidiary of the group company through the group company's two subsidiaries and there was a high level of overlap between both sets of court proceedings, which were in essence claiming the same loss and damage as each other. The court concluded that:
The key here is that [the group company] does not have a personal claim against the Former Liquidators and [counsel for the plaintiffs] very fairly acknowledged that there is a risk of double recovery. In the circumstances, the right course is to strike out the pleadings in HCA 960/2015 and to dismiss the action.(4)
The claims brought by the group company's subsidiaries did not contravene the reflective loss principle and, therefore, were not struck out.
Court of Appeal
On appeal to the Court of Appeal, the decision of the Court of First Instance was upheld. The group company did not contest that it was attempting to recover for the same loss as the group company's subsidiaries. However, in short, the group company argued that it would be unjust to preclude it from recovering any loss from the former liquidators under a separate cause of action because:
there is a distinct possibility that only Wah Nam will succeed against the Former Liquidators, and [the two subsidiaries] will not; for example… [the two subsidiaries] may not succeed in establishing that the Former Liquidators owed… duties to them as de facto or shadow directors.(5)
The Court of Appeal disagreed. The no reflective loss principle, as the court explained, is based on the nature of the loss. In this case, the nature of the group company's loss arose solely from the fall in value of its interest in Summit Mass (which owned the piece of land). According to established case law referred to by the Court of Appeal,(6) even where a company has not sued an alleged wrongdoer, a shareholder in that company cannot claim directly against the alleged wrongdoer. As the Court of Appeal stated, "[t]he shareholder should look to the company and not directly to the wrongdoer, for his loss derives solely from his interest as a shareholder of the company".(7)
Therefore, the group company (as the shareholder) should have looked for recourse from its subsidiaries or from the wrongdoer on behalf of its subsidiaries, rather than suing the former liquidators directly.
This case confirms that the courts will be wary of attempts at double recovery. From the group company and its current liquidators' submissions in the appeal, it is possible that they saw their claim against the former liquidators as a type of insurance, in the event that the claim brought by the group company's subsidiaries failed.
The first-instance and appeal judgments also demonstrate how broadly the reflective loss principle can apply. It is usually applied with respect to individual shareholders who wish to take action against a party that has caused harm to the company in which they have an interest. In this instance, the group company was a corporate which wholly owned both subsidiary companies, which in turn wholly owned Summit Mass before its shares were allegedly misappropriated.
For further information on this topic please contact Jessica Wong or Lorcan Treacy at RPC by telephone (+852 2216 7000) or email (email@example.com or firstname.lastname@example.org). The RPC website can be accessed at www.rpc.co.uk
(6) Waddington Ltd v Chan Chun Hoo,  11 HKCFAR 370; Basab Inc and anor v Superb Glory Holdings Ltd, HCA 6/2014, unrep, 4 December 2014, CACV 256/2014, unrep, 2 December 2016 (2017) 20 HKCFAR 384.
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