Another Reminder for Principles of “Reflective Loss” and Abuse of Process

Introduction

The current litigation trend exhibited a rise in cases where shareholders sought to recover the reduction of their shares’ value which was reflective of the company’s loss. Various attempts to circumvent the principle to recover their own loss were labelled by the Court as an abuse of process. Before the conclusion of 2019, in another judgment handed down by the Honourable Mr. Justice Coleman, Power Securities Company Limited v Sin Kwok Lam and others [2019] HKCFI 2920, the Court reminded us again of the proper application of the principle of “reflective loss” and issues relating to abuse of process.

Material Facts

In 2016, Power Securities Company Limited (“Power Securities”) and Best Year Enterprise Limited (“Best Year”) entered into a Margin Agreement pursuant to which Best Year deposited shares in First Credit Finance Group Limited, a Hong Kong listed company (“First Credit”), with Power Securities. Mr. Sin Kwok Lam (“Sin”) was the sole shareholder and director of Best Year and was also the then Executive Director and the Chairman of First Credit. In 2017, a margin shortfall occurred and Best Year failed to meet the margin calls. Power Securities sought recovery of the debit balance against Best Year (“2017 Action”) and applied for summary judgment. The Court ruled in favour of Power Securities against which Best Year sought to appeal.

In 2018, instead of responding to Power Securities’ claims in the 2017 Action, Best Year commenced separate proceedings against Power Securities and others (“1st 2018 Action”), alleging that they conspired with the intention to cause loss to Best Year (“Alleged Conspiracy”), but the claim was then discontinued. Concurrently, Power Securities commenced a separate proceeding against Best Year, Sin and others to set aside various transactions relating to the First Credit shares (“2nd 2018 Action”). In response to that claim, Best Year and Sin recycled the Alleged Conspiracy as their defence and counterclaim. However, Sin did not claim any loss suffered by himself at that stage. 

In 2019, Best Year and Sin commenced another action (“2019 Action”) against Power Securities and others, seeking to reinstate the account balance on the Margin Account which was said to be artificially distorted as a result of the Alleged Conspiracy, and to set aside the summary judgment under the 2017 Action. 

As Best Year failed to pay the judgment debt under the 2017 Action, it was ordered to be wound up in June 2019. As a result, the appeal for the 2017 Action and the 2nd 2018 Action were stayed. To keep the action alive, Sin applied to be added as the 2nd Plaintiff to the Counterclaim in the 2nd 2018 Action, reinstating the Alleged Conspiracy arguments. It was only until 1.5 years after the commencement of the 2017 Action that Sin alleged for the first time he had suffered loss in his personal capacity by reason of the sale of his interest in Best Year at a depressed price. 

In the circumstances, Power Securities and others sought to strike out Sin’s claim relying on the principle of “reflective loss” and abuse of process in both senses of Res Judicata and Henderson v Henderson.

Applicable Legal Principles

Barring Recovery of Reflective Loss

The House of Lords’ decision in Johnson v Gore Wood & Co (a firm) [2002] 2 AC 1 provided three general propositions:

  • Category (1): Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. 
  • Category (2): Where a company suffers loss but has no cause of action to use to recover that loss, the shareholder in the company may sue in respect of it, even though the loss is a diminution in the value of shareholding. 
  • Category (3): Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of duty independently owed to the shareholder, each may sue to recover the lost cause to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of duty owed to that other. 

According to Coleman J, the focus is upon the type of loss suffered. It requires the Court to embark upon an assessment, the critical question being whether the claimant’s loss can be made good if the company enforces its rights against the defendant. If it can, the loss is a reflective loss and the claim should be struck out. 

In the present case, the loss claimed to be caused by the Alleged Conspiracy, being the diminution in the share value of First Credit, was only suffered by Best Year. Any loss caused to Sin in diminution of the value of his shares in Best Year simply reflects the loss caused to Best Year from its holding of shares in First Credit. Had Best Year been successful in enforcing its rights against Power Securities, Sin’s loss would be made good when Best Year’s assets were replenished through judgment. 

This case belongs to Category (1), where Best Year’s claim “trumps” Sin’s right of recovery as a shareholder. Unless there is a breach of an independent duty to the shareholder which causes a loss that is “separate and distinct” from the losses suffered by the company (ie Category (3)), the shareholder’s claim would be not be recoverable. Yet, Sin has not articulated any basis for claiming any loss which is separate and distinct from that allegedly suffered by Best Year.

Coleman J, adopting the principle in Sevilleja Garica v Marex Financial Ltd [2018] BCC 940, rejected Sin’s attempt to circumvent the principle by making a distinction between a past and present member of the Company. Moreover, Coleman J emphasised the justification of prevention of double recovery is “equally relevant in situations where double recovery is not strictly in issue i.e. where a company chooses not to pursue a remedy against the defendant, or has settled the claim.” It is clear the Court is concerned that a successful claim by a shareholder or other individual might prevent the company from recovering funds which would otherwise be available to meet the company’s liabilities. 

The loss allegedly suffered by Sin is clearly “reflective”. There is no way for Sin to get around the principle by saying that he has disposed of his shares in Best Year so his loss would not be made good even if Best Year enforced its rights. 

Once again, litigants ought to be reminded that the principle is absolute and not a matter of discretion. Coleman J expressly confirmed that the reflective loss principle involves no discretion and “if the principle is offended, the claim should be struck out.” 

Abuse of Process: 
Res Judicata and Henderson

The classic formulation of the principles relating to Res Judicata estoppel were summarised in Capital Wealth Finance Group Limited v Lai Yueh-Hsing (unreported, HCA 686/2012, 31 July 2015) and we are not going to repeat them here. It is settled that a summary judgment can give rise to Res Judicata. The question is whether Sin, who is not a party to the summary judgment in the 2017 Action and has disposed of his shares in Best Year, has some kind of interest in such litigation.

Considering the facts that: (1) before the 2017 Action, Best Year was solely owned and controlled by Sin; (2) even after Sin disposed of his shares in Best Year, the instructions to Best Year’s solicitors obviously came from Sin; (3) Sin was the one who sought to adduce further evidence for the appeal against the summary judgment; (4) Sin now seeks to rely on the same factual allegations and cause of action that was advanced by Best Year, in which Sin had a clear interest, Coleman J held that Sin is a privy to the 2017 Action and he shall be bound by the Court’s decision in that case.

As to Henderson abuse, the essence of such doctrine is that a party should not be permitted to raise in subsequent proceedings claims or issues which could and should have raised in earlier proceedings.

Noting that the Alleged Conspiracy allegations have been raised (by Best Year) repeatedly in the 2017 Action, 1st 2018 Action, 2nd 2018 Action and 2019 Action, Coleman J was satisfied that Sin’s claim is a collateral attack on the finality of the summary judgment and the fact that the parties to those proceedings are not entirely the same does not change such analysis. Coleman J held that “Sin is a privy, the person with all knowledge and the instigator/director/instructor/driver of the Best Year position”. 

Conclusion

This decision importantly illustrated the limits of claims that can be brought by a shareholder in respect of loss suffered by a company. The Court will not entertain claims that are clearly vexatious or frivolous. Failure to appreciate these fundamental legal principles may lead shareholders to costly litigation and adverse costs order. 

It is also important to appreciate that in considering the privity of interest in the context of abuse of process, the Court will look into the substance rather than the form. And the assessment may not necessarily require the piercing of corporate veil, it may be sufficient for the Court to consider the practical realities of the case. 

Jurisdictions: 

Partner, Litigation and Regulatory Department at DLA Piper Hong Kong

Harris is a Partner in the Litigation and Regulatory Department at DLA Piper Hong Kong. He has over 20 years’ experience in commercial litigation. His practice covers advising on shareholders’ and directors’ disputes, winding-up proceedings, banking and investment disputes, derivative actions, internet fraud, and employment and administrative law matters. He is acknowledged by ultra-high-net-worth clients for his breadth of experience in multi-jurisdictional civil disputes, regulatory and white collar crime matters. He has been recommended as a ranked lawyer in Legal 500 Asia Paci c and Chambers and Partners, and is named as a 2020 Acritas Star.

Of Counsel, Litigation and Regulatory Department at DLA Piper Hong Kong

KC is an Of Counsel in the Litigation and Regulatory Department at DLA Piper Hong Kong. With more than 10 years’ experience in litigation practice, KC’s core practice covers a wide range of commercial litigation, white collar crimes and regulatory matters. He brings extensive court experience across all court levels in Hong Kong. He has substantial experience in advising and representing nancial institutions, listed companies and high-net-worth client. He is named as a lawyer to note in Legal 500.