Reflective Loss: Can Shareholders claim directly against Company Directors?
Director | Attorney
The current continued climate of economic uncertainty, exacerbated by COVID-19 lockdowns, is likely to give rise to an increase in shareholder activism and potential disputes. But, quite apart from economic uncertainty, any dramatic reduction in the value of company shares will always be of concern to shareholders, particularly if they perceive the cause to be the result of decisions of the company with which they do not agree. A highly publicised example of director failure was that of African Bank Limited, the wholly-owned subsidiary of JSE-listed African Bank Investments Limited (“ABIL”). Between April 2013 and August 2014 the share price of ABIL dropped from ZAR28.15 per share to ZAR0.31 per share, resulting in its shareholders incurring considerable losses.
Two of the bank’s shareholders then brought a claim against the directors of ABIL for recovery of these losses on the basis that the directors had failed to exercise their powers in good faith and in the best interests of ABIL and African Bank Limited, which they claimed, resulted in the business of ABIL and the Bank being carried out with gross negligence and in contravention of sections of the Companies Act.
Generally speaking, claims open to shareholders in this scenario are not straightforward. In particular, such claims are restricted due to the “no reflective loss” rule, which has traditionally prevented shareholders from bringing claims where their loss merely reflects the loss suffered by the company.
The Africa Bank case (Investment Holdings (RF) Ltd and Another v Kirkinis and Others) provided a timely reminder of the application of the rule. The Supreme Court of Appeal (“SCA”) was required to deal with the question of whether the “no reflective loss” rule could be extended to claims brought by a shareholder directly against a director.
It could be argued that shareholders have a right to claim directly against directors for contraventions of the Companies Act, 2008, based on a reading of section 218(2) of the Companies Act which provides that, “Any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention.”
Do the terms “any person”, “any other person” and “any loss or damages” extend the liability of losses incurred by a shareholder to the guilty director?
In clarifying its position, the SCA court referred to a 2018 English case, Sevilleja Garcia v Marex Financial Ltd  EWCA Civ 1468. While the question before that court was whether the “no reflective loss” rule extended to claims brought by a non-shareholder creditor, the decision was instructive because the court considered the development and rationale behind the rule in making its decision.
Here the English court concluded there were four considerations which justified the rule against reflective loss:
- The need to avoid double recovery by the claimant and the company from the defendant.
- Causation – if the company chooses not to claim against the wrongdoer, the loss to the claimant is caused by the company’s decision and not by the defendant’s wrongdoing.
- The public policy of avoiding conflict of interest; particularly that if the claimant has a separate right to claim it would discourage the company from making settlements.
- The need to preserve company autonomy and avoid prejudice to minority shareholders or other creditors.
Consequently, that court found that; “A shareholder cannot recover damages merely because the company in which they are interested in has suffered damage. They cannot recover a sum equal to the diminution in the market value of their shares, or equal to the likely diminution in dividend, because this “loss” is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. Their only “loss” is through the company, in the diminution in the value of the net assets of the company, in which they have shareholding.”
The Companies Act gives the right of action to the company instead of its shareholders because were it not to do so, the company and its creditors would be prejudiced. Likewise, if both company and shareholders were allowed to have a claim, the wrongdoer would suffer double jeopardy and the shareholder would be compensated twice – once when their claim is successful and once when the company’s claim is successful.
The SCA also held that when the Companies Act became operative, the rule against claims for reflective loss was part of South African law. Accordingly, the appellants’ claims, being quintessentially reflective loss claims, were misconceived, unless saved by section 218(2) of the Companies Act.
Significantly, the provisions in Companies Act that deal with director’s duties state that directors owe duties to the company (definition of in the Companies Act as a distinct juristic person) and not the shareholders. Therefore, loss is occasioned to the company, and the company is the entity with the right of action. Accordingly, the court disallowed the shareholders’ claims.
It is important for shareholders to appreciate, in relation to any wrongdoing by directors or third parties, what claims lie with the company and what claims the shareholder may bring in their own capacity. The SCA’s judgment demonstrates that where a diminution in shareholdings is attributable to loss caused to the company by a director, the company has the claim, not the shareholders.
That is not to say there is no recourse for shareholders who believe they or the company have been wronged, and as such, directors should be conscious of the actions shareholders can take and attempt resolve any shareholder discontent before it escalates.