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Reconstructing the reﬂective loss principle
Article in Journal of Corporate Law Studies · June 2016

DOI: 10.1080/14735970.2016.1191298
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RECONSTRUCTING THE REFLECTIVE LOSS PRINCIPLE
Alan K. Koh
When a company suffers loss due to a wrongful act perpetrated against the
company, the company’s shareholders suffer where the value of their shares or
dividends decreases. However, in the UK and in Commonwealth jurisdictions,
such shareholders have in principle no personal recourse against the wrongdoer
because their loss is merely ‘reflective’ of the company’s loss; the loss is for the
company alone to recover. This ‘reflective loss principle’ as it stands cannot be
fully justified by the policy considerations offered in its support. I argue that the
most convincing rationale for the principle is to preserve the primacy of the
company’s internal governance arrangements in the corporate litigation context.
I propose a framework reconstructing the reflective loss principle as a ‘priority
rule’ under which resolution of the company’s claim takes precedence over the
shareholder’s personal claim, but with an ‘exit exception’ that permits
shareholders who exit the company to pursue their own claims. My proposal
explains the seeming contradiction that while shareholders may not recover
reflective losses via a personal claim, they may recover what are essentially
reflective losses through a court-ordered buyout on an unfair prejudice petition,
and brings much needed balance and clarity to the law.
Keywords: shareholder remedies; reflective loss; corporate litigation; unfair prejudice; priority rule
This is an Accepted Manuscript of an article published by Taylor & Francis in Journal of

Corporate Law Studies on 23 June 2016, available online:
http://www.tandfonline.com/10.1080/14735970.2016.1191298.
Citation: Alan K Koh, ‘Reconstructing the Reflective Loss Principle (2016) 16 Journal
of Corporate Law Studies 373 – 401

Doktorand (Dr. iur./Ph.D. in law candidate), Goethe University of Frankfurt Faculty of Law, Frankfurt am
Main, Germany; onetime Sheridan Fellow, National University of Singapore Faculty of Law, Singapore.
ORCID-0000-0001-6305-2877. Personal website: www.alankkoh.com.
Acknowledgements: I thank Samantha Tang, Justin Tan, Tan Zhong Xing, Ernest Lim, Christian Hofmann,
Lee Pey Woan, Sandra Booysen, Yip Man, Pearlie Koh, and the anonymous reviewer for their comments,
the University of Hong Kong Faculty of Law for organizing the 2016 HKU-NUS-SMU Symposium where
I presented the paper, and the National University of Singapore Faculty of Law Faculty Conference Fund
for financial support. The usual caveats apply.
2 PUBLISHED IN JOURNAL OF CORPORATE LAW STUDIES
A. INTRODUCTION
When a company suffers loss due to a wrongful act perpetrated against the company, the
company’s shareholders suffer where the value of their shares or dividends are
diminished; such losses are ‘reflective’ of the company’s loss. In many Commonwealth
jurisdictions, shareholders have in principle no personal recourse against the wrongdoer
in respect of this ‘reflective’ loss. The loss is for the company alone to recover, even if
the company refuses to pursue recovery, or settles the claim on manifestly
disadvantageous terms, and even if the wrongdoer owed and breached duties to
shareholders distinct from that owed and breached to the company. Despite its harsh
consequences for shareholders, Commonwealth courts and scholars have persistently
supported this ‘reflective loss principle’ based on a variety of policy considerations. I
consider these considerations in turn, and argue that with one general exception and one
very limited exception, they are so flawed that taken individually or together they cannot
justify the reflective loss principle. Such flawed considerations often overemphasise the
severity of the problems supposedly rectified by the reflective loss principle, and fail to
consider the flexible and practical alternatives available to courts. The strongest rationale
for the principle, I argue, is to preserve the primacy of the company’s internal governance
arrangements in the corporate litigation context. Even so, this goal can also be achieved
by some means other than a reflective loss principle that, as it stands, unnecessarily
restricts the shareholder’s freedom to recover her own loss.
I propose a framework that reconstructs the reflective loss principle to achieve
this aim without overreach. Under this framework, the reformed reflective loss principle
comprises a priority rule under which resolution of the company’s claim takes precedence
over the shareholder’s personal claim, and an exception that permits shareholders who
exit the company to pursue their own claims. The framework I propose explains the
seeming contradiction that reflective losses may not be recovered by shareholders in a
personal claim, whereas they may recover what are essentially reflective losses through
a court-ordered buyout on an unfair prejudice petition. The proposed framework brings
much needed clarity to the law, balances the interests of the company and its internal
ordering with those of the injured shareholder, and offers beleaguered shareholders hope
and guidance denied to them by existing law.
This Article proceeds as follows. Section B explores and critiques the reflective
loss principle, and the policy considerations which purportedly support its continued
existence. Section C proposes a reconstruction of the reflective loss principle which
addresses the strongest policy considerations and mitigates its harsh consequences for
Reconstructing the Reflective Loss Principle 3
shareholders. Section D concludes.
B. REFLECTIONS ON REFLECTIVE LOSS
1. The Reflective Loss Principle
Consider a company that suffers loss from a wrong done to it by a wrongdoer. The
company has a claim against the wrongdoer for the loss. The same wrongdoer, by the
same wrong, also breaches a duty owed by the wrongdoer to a shareholder of the
company.1 The shareholder suffers loss because her shares and other benefits attached to
her shares, such as dividends, are now worth less. If the company successfully sues the
wrongdoer and recovers in full for the wrong, the shareholder would be placed in the
position she would have been in had the wrong not been committed. Suppose, however,
that the company decides not to pursue its claim, leaving the shareholder’s loss
unremedied. Can the shareholder then sue the wrongdoer and recover for her own loss
directly? The answer, with some qualifications, 2 is ‘no’, on the basis that the
shareholder’s loss is ‘reflective’ of the company’s loss. By the authority of Prudential
Assurance Co Ltd v Newman Industries Ltd (No 2),3 the progenitor of the ‘reflective loss
rule’ or ‘reflective loss principle’, the shareholder
cannot recover a sum equal to the diminution in the market value of his shares, or equal to
the diminution in dividend, because such a ‘loss’ is merely a reflection of the loss suffered
by the company. The shareholder does not suffer any personal loss. His only ‘loss’ is through
the company…4
The notion that the shareholder ‘does not suffer any personal loss’ in the above scenario
1
The nature and basis for duties owed to the shareholder personally are a separate, complex issue in and
of itself and will not be discussed in depth in this Article. This is because the reflective loss principle as it
stands does not distinguish between the nature and source of these duties. If the reflective loss principle is
successfully invoked by the wrongdoer, the claimant’s case is a non-starter and there would be consequently
no opportunity to consider the arguments on whether the duty even existed or what its ambit was in that
specific case. This Article focuses only on the reflective loss principle itself, and proceeds on the assumption
that there is a separate duty owed by the wrongdoer to the shareholder.
2
Depending on the specific law of the jurisdiction, shareholders may recover for and on behalf of the
company through the derivative action, or derivative claim mechanisms. However, derivative claims are
not the focus of this Article.
3
[1982] Ch 204 (CA) 222-224.
4
ibid 222-223.
has been roundly criticized5 and departed from in subsequent decisions. A loss suffered
by a shareholder, such as a diminution in the value of her shares or a likely diminution in
dividends, is considered a personal loss, and not a corporate loss, even if it is reflective
of the loss suffered by the company.6 However, characterising such losses as personal
losses does not assist us in determining if they are reflective losses for which a shareholder
may not recover.7
We turn now to the rules governing shareholder recovery of reflective loss. The
reflective loss principle itself was upheld and expanded8 in the seminal case of Johnson
v Gore Wood & Co (a firm).9 Lord Bingham’s now classic exposition of the reflective
loss principle is set out in the three propositions as follows:
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. No action lies at the suit of a shareholder suing in that
capacity and no other to make good a diminution in the value of the shareholder’s
shareholding where that sincerely reflects the loss suffered by the company. A claim will
not lie by a shareholder to make good a loss which would be made good if the company’s
assets were replenished through action against the party responsible for the loss, even if
the company, acting through its constitutional organs, has declined or failed to make
good that loss…
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 (if the shareholder has a cause of
action to do so), even though the loss is a diminution in the value of the shareholding…
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 a
duty independently owed to the shareholder, each may sue to recover the loss caused to
it by the breach of the duty owed to it but neither may recover loss caused to the other
by breach of the duty owed to that other.10
5
MJ Sterling, ‘The Theory and Policy of Shareholder Actions in Tort’ (1987) 50 MLR 468, 470-472; C
Mitchell, ‘Shareholders’ Claims for Reflective Loss’ (2004) 120 LQR 457, 459-460.
6
See e.g. Christensen v Scott [1996] 1 NZLR 273 (CA) 280 (Thomas J); Johnson v Gore Wood & Co (a
firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 44 (Lord Hutton) and at 53 (Lord Millett).
7
JSL Lee, ‘Baring Recovery for Diminution in Value of Shares on the Reflective Loss Principle’ (2007) 66
CLJ 537, 543.
8
The reflective loss principle was expanded to cover not only shareholders, but also other participants in
corporate enterprises such as employees (and by implication, creditors generally) of the company. See
Johnson v Gore Wood & Co (a firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 67 (Lord Millett).
9
[2002] 2 AC 1 (HL).
10
[2002] 2 AC 1 (HL) 35-36.
Proposition 1 includes the classic derivative claim scenario, in which the

reflective loss rule prevents shareholders from recovering personally where the
wrongdoer breached a duty owed only to the company but not the shareholders. While
this is relatively uncontroversial, Proposition 1 has further, more problematic implications
in situations where the shareholders are individually owed a separate duty. Consider the
opinion of Thomas J in the New Zealand Court of Appeal case of Christensen v Scott:
It may be accepted that the [English] Court of Appeal [in Prudential Assurance Co Ltd v
Newman Industries (No 2)] was correct, however, in concluding that a member has no right
to sue directly in respect of a breach of duty owed to the company or in respect of a tort
committed against the company. … But this is not necessarily to exclude a claim brought by
a party, who may also be a member, to whom a separate duty is owed and who suffers a
personal loss as a result of a breach of that duty. … The loss arises not from a breach of the
duty owed to the company but from a breach of duty owed to the individuals. The individual
is simply suing to vindicate his own right or redress a wrong done to him or her giving rise
to a personal loss.11
The court went on to hold that so long as policy reasons prohibiting recovery of reflective
loss did not apply on the facts or could be addressed using other principles, recovery for
reflective loss would be permitted.12 However, this flexible, policy-sensitive approach
was rejected by a majority of House of Lords in Johnson v Gore Wood.13 In so doing,
Lord Bingham’s Proposition 1 leaves no room for manoeuvre, deprives the shareholder
of the opportunity to remedy a breach of duty owed to her,14 and leaves the decision of
whether to remedy her loss to the company.
The ‘exceptions’ to the reflective loss principle, as laid out in Lord Bingham’s
Propositions 2 and 3, do not improve matters by much. Consider the exception in
Proposition 2, which provides that where a company suffers loss but has no cause of
action to use to recover that loss, a shareholder may bring a claim in respect of her loss if
11
Christensen v Scott [1996] 1 NZLR 273 (CA) 280.
12
ibid 280-281.
13
Johnson v Gore Wood & Co (a firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 66 (Lord Millett), 36 (Lord
Bingham), 55 (Lord Hutton). Lord Goff concurred (at 41) with Lords Bingham and Millett but did not
discuss Christensen v Scott. Lord Cooke, who was on the five-judge panel that decided Christensen v Scott
(as Cooke P), seemed to endorse Christensen v Scott (at 46) but concurred with the other Lords in the result.
Joyce Lee suggests that the divergence between the New Zealand Court of Appeal and the House of Lords
has its roots in differing interpretations of Prudential Assurance Co Ltd v Newman Industries (No 2). See
JSL Lee, ‘Baring Recovery for Diminution in Value of Shares on the Reflective Loss Principle’ (2007) 66
CLJ 537, 552.
14
The issue of when duties should be owed concurrently to the company and the shareholder individually
and separately are beyond the scope of this Article.
she has a cause of action to do so, even if her loss is a diminution in the value of the
shareholding. On its face, this exception is plainly a narrow one, albeit marginally
expanded in England with significant qualifications. The English Court of Appeal first
extended the exception in Proposition 2 in Giles v Rhind15 to situations where the harm
caused by the alleged wrongdoer had disabled the company from pursing its cause of
action against him. In Giles, the wrongdoer was a former shareholder and director of a
company. As a shareholder, the wrongdoer had entered into a shareholders’ agreement not
to use, disclose or divulge any confidential information relating to the company. After
leaving the company, the wrongdoer set up a competing business and, using confidential
information he had obtained as the company’s director, diverted the company’s most
lucrative contract to a company that he had an interest in. The company attempted to
pursue an action against the alleged wrongdoer, but the action was discontinued because
the company, left in dire financial straits due to the wrong, was unable to put up security
for its costs. The company thus undertook not to bring any further action in relation to its
claim. A shareholder of the company then brought an action against the wrongdoer,
alleging breaches of the shareholders’ agreement, and claimed damages for loss of value
in his shares and loss of remuneration he would otherwise have earned. The trial judge
had held that the claimant’s losses were not recoverable as they were reflective loss. On
appeal, the Court of Appeal held that since the company’s inability to pursue its cause of
action against the alleged wrongdoer had been caused by the very wrong he had done to
the company, the reflective loss principle did not apply, and the shareholder-claimant was
permitted to pursue his claims. As Waller LJ observed,
It seems hardly right that the wrongdoer who is in breach of contract to a shareholder can
answer the shareholder by saying, ‘The company had a cause of action which it is true I
prevented it from bringing, but that fact alone means that I the wrongdoer do not have to
pay anybody’.16
The Giles exception was applied in Perry v Day,17 where the defendant director disabled
the company from bringing a rectification claim which would have prevented loss to the
company. However, the Court of Appeal soon significantly restricted the scope of the
Giles exception in Gardner v Parker,18 clarifying that the Giles exception only applied
15
[2002] EWCA Civ 1428; [2003] Ch 618.
16
[2003] Ch 618 (CA) [34].
17
[2004] EWHC 3372 (Ch); [2005] 2 BCLC 405.
18
[2004] EWCA Civ 781; [2005] BCC 46 [47].
where the shareholder was able to show that the company’s inability to pursue its cause
of action against the wrongdoer was attributable to the wrong done to it by the wrongdoer.
Thus, the mere fact that the company had become insolvent,19 chose not to sue or had
settled with the wrongdoer does not bring the shareholder within the Giles exception.20
This effectively restricted the Giles exception to the precise facts in Giles v Rhind and
Perry v Day. The Giles extension was also not warmly received in Commonwealth
jurisdictions. In Waddington Ltd v Chan, a decision of the Hong Kong Court of Final
Appeal, Lord Millett NPJ declined to follow Giles v Rhind,21 and by way of an alternative
suggested that:
… the court could have given the shareholder leave to apply to direct the administrative
receiver to bring the action if the shareholder was willing to fund it.22
Leaving aside the substantive merits of Lord Millett’s proposal, which on its face already
looks costly for the shareholder-claimant and procedurally complex for all involved, the
Proposition 2 exception without the Giles extension seems even narrower in other
Commonwealth jurisdictions as compared to England.
Let us now consider the exception under Proposition 3, which applies where a
wrongdoer simultaneously breaches a duty to the company and a duty to the shareholder.
The shareholder may only recover from the wrongdoer where she suffers a ‘separate and
distinct’ loss from the company. This exception is again narrow, and only permits recovery
in exceptional situations. This is because generally the value of a company’s shares is
directly tied to the company’s fortunes, 23 and it would be extremely unusual for a
shareholder to suffer losses that are not a reflection of the company’s loss.24 Examples
include situations where the shareholder suffers loss due to the forfeiture of her shares, or
the unlawful alteration of class rights attached to such shares.25
Further, the boundaries of this narrow exception are uncertain. The test for
distinguishing between ‘reflective loss’ and ‘separate and distinct loss’, as propounded by
19
Webster v Sandersons Solicitors (a firm) [2009] EWCA Civ 830; [2009] 2 BCLC 542 [38].
20
[2005] BCC 46 (CA) [57]-[58].
21
His Lordship went so far as to hold that Giles was ‘wrongly decided and should not be followed in Hong
Kong’. Waddington Ltd v Chan Chun Hoo Thomas [2008] HKCU 1381; [2009] 2 BCLC 82 [86].
22
Waddington Ltd v Chan Chun Hoo Thomas [2008] HKCU 1381; [2009] 2 BCLC 82 [86].
23
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 (CA) 224.
24
B Saunders, ‘Putting the Spoils of Litigation into the Shareholder’s Pockets: When can Shareholders
bring a Personal Action against the Directors of their Company?’ (2004) 22 Company and Securities LJ
535, 544.
25
P Watts, N Campbell and C Hare, Company Law in New Zealand (LexisNexis 2011) 694.
Lord Bingham in Johnson v Gore Wood, is “to ascertain if the loss claimed appears to be
or is one which would be made good if the company had enforced its full rights against
the party responsible”. 26 Thus, where the company successfully recovers from the
wrongdoer for its loss of assets, such that the shareholder is fully compensated for the
loss in the value of her shares, the shareholder’s loss is reflective loss. But what happens
if the company recovers, but the shareholder’s loss is not fully compensated? For one,
where the company has become insolvent as result of the wrongdoer’s harm, recovery of
damages by the company will not restore the value of the shareholder’s shares.27 Further,
there may not be an exact correspondence between the company’s loss and the diminution
in the value of the shares. Joyce Lee points out that in public listed companies, where the
market evaluates the likelihood of success of the company’s claim against the wrongdoer
and accordingly prices in this information, the value of the company’s shares might not
be adversely affected by the company’s loss.28 Despite Lord Millett’s assertion that the
correspondence between the company’s loss and the loss of share value is exact in private
companies,29 share valuation in private companies may also be similarly complex, such
that the company’s loss may not fully correspond to the loss in the value of the company’s
shares.30 Considerable difficulties thus arise where Lord Bingham’s test for reflective
loss is applied in practice.31
Considering the extremely limited applicability of the exceptions to the reflective
loss principle, the principle as it now stands is undoubtedly harsh to shareholders. This is
especially so since Commonwealth courts have conceded that diminution in the value of
one’s shares is a personal loss of the shareholder. The reflective loss principle clearly
creates an undesirable state of affairs32 where there is loss but no right to a remedy, save
in rare and exceptional situations.
26
[2002] 2 AC 1 (HL) 36.
27
Giles v Rhind [2003] Ch 618 (CA) 621.
28
JSL Lee, ‘Baring Recovery for Diminution in Value of Shares on the Reflective Loss Principle’ (2007)
66 CLJ 537, 551. Lord Millet himself observed that that the market value of publicly listed shares would
depend on market sentiment, such that the company’s loss may not exactly correspond with the value of
such shares. See Johnson v Gore Wood & Co (a firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 62.
29
Johnson v Gore Wood & Co (a firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 62.
30
C Mitchell, ‘Shareholders’ Claims for Reflective Loss’ (2004) 120 LQR 457, 475-478.
31
JSL Lee, ‘Baring Recovery for Diminution in Value of Shares on the Reflective Loss Principle’ (2007)
66 CLJ 537, 550-552.
32
While acknowledging other competing interests, ‘… the court must be astute to ensure that the party who
has in fact suffered loss is not arbitrarily denied fair compensation.’ Johnson v Gore Wood & Co (a firm)
[2000] UKHL 65; [2002] 2 AC 1 (HL) 36 (Lord Bingham). See also BJ de Jong, ‘Shareholders’ Claims for
Reflective Loss’ (2013) 14 EBOR 97, 102-105, discussing Agrotexim v Greece, October 24, 1995, Series A,
No 330, 21 EHRR 250, which considers whether there might be a breach of Article 1 First Protocol of the
European Convention on Human Rights where a shareholder is denied an effective compensatory remedy,
and is not able to pursue such a remedy indirectly through the company or its liquidators.
2. Flawed and Not-So-Flawed Policy Foundations
The reflective loss principle is a creature of policy, as even its staunchest champion would
agree.33 It stands – or falls – on the strength of the policy considerations articulated in its
support. I argue that a critical analysis shows that many of these considerations are
fundamentally flawed, and do not provide a fully coherent basis for the reflective loss
principle. Only the principle that upholding the company’s internal governance structure
and autonomy is desirable as a general principle in the context of corporate disputes, and
a creditor protection rationale is applicable only in very limited circumstances.
Nonetheless, these considerations can be addressed by a more tailored rule, with the result
that whether standing individually or together, they cannot fully justify the principle as it
now stands.
a) Double recovery
Concerns with double recovery were forcefully articulated by Lord Millett in Johnson v
Gore Wood, who said that
… where the company suffers loss caused by the breach of a duty owed both to the company
and the shareholder … the shareholder’s loss, in so far as this is measured by the diminution
in value of his shareholding or the loss of dividends, merely reflects the loss suffered by the
company in respect of which the company has its own cause of action. If the shareholder is
allowed to recover in respect of such loss, then either there will be double recovery at the
expense of the defendant or the shareholder will recover at the expense of the company and
its creditors and other shareholders. Neither course can be permitted. This is a matter of
principle; there is no discretion involved. Justice to the defendant requires the exclusion of
one claim or the other; protection of the interests of the company’s creditors requires that it
is the company which is allowed to recover to the exclusion of the shareholder.34
Even if double recovery should be avoided, Lord Millett’s statement contains a false
dichotomy. If the court’s concern is purely with double recovery, there are alternative
solutions to the reflective loss principle. First, where several victims suffer the same loss
at the hands of a wrongdoer, the law can prevent double recovery by permitting any or all
33
Johnson v Gore Wood & Co (a firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 66 (Lord Millett).
34
[2002] 2 AC 1 (HL) 62.
the victims to sue the wrongdoer but hold that the wrongdoer may discharge his liabilities
to all the victims upon compensating any one of them.35 Second, by ordering a joinder
of all the victims and their claims, the court may consider the interests of each when it
rules on the wrongdoer’s liability to each of them.36 Given the possible but unexplored
alternatives, a blanket exclusion rule that unfairly deprives the victim-shareholder of
control over or participation in litigation cannot be justified.37
Fortunately, not all Commonwealth jurisdictions have rejected the possibility of
addressing double recovery using case management techniques. In Townsing Henry
George v Jenton Overseas Investment Pte Ltd,38 the Singapore Court of Appeal opined
that it would have permitted a reflective loss claim by the claimant parent company to
continue if it procured an undertaking from its wholly-owned subsidiary to the court not
to sue the defendant39 so as not to receive double recovery.40
b) Double jeopardy
Closely related to but conceptually distinct from double recovery is the concept of ‘double
jeopardy’. The scenario envisioned is this: suppose a shareholder disposes of her shares
at a lower value reflecting the loss incurred by the company, and recovers under a personal
claim. Subsequently, the company sues and recovers as well. The now ex-shareholder
does not receive double recovery, as she would not benefit from the increased value of
the company’s shares post-corporate recovery, but the wrongdoer bears the risk of making
compensation twice, with the acquirer of the exiting shareholder’s shares receiving the
windfall. 41 Proponents of this argument would conclude that it would be unfair and
undesirable for the wrongdoer to risk paying double for the same wrong.42
The perceived injustice to the wrongdoer disappears once we consider that the
wrongdoer could have agreed to or contemplated the risk of double jeopardy. As Professor
35
C Mitchell, ‘Shareholders’ Claims for Reflective Loss’ (2004) 120 LQR 457, 463.
36
ibid 464.
37
ibid 464 and footnote 36.
38
[2007] 2 SLR(R) 597 (Sing CA).
39
The defendant was a director of both the parent and subsidiary companies, and therefore owed duties to
each.
40
[2007] 2 SLR(R) 597 [85]-[86]. The Singapore Court of Appeal opined that the undertaking would
‘disappl[y] the principle of reflective loss as there would be no possibility of double recovery’ (at [86]), but
the court also curiously preferred the restrictive English approach over the more flexible New Zealand
approach (at [77]). The tide may be turning in Singapore; see Ng Kek Wee v Sim City Technology Ltd [2014]
4 SLR 723 (Sing CA) [61]-[70] (suggesting a move towards a more rigid distinction between corporate and
personal claims).
41
BJ de Jong, ‘Shareholders’ Claims for Reflective Loss’ (2013) 14 EBOR 97, note 10.
42
E Ferran, ‘Litigation by Shareholders and Reflective Loss’ (2001) 60 CLJ 245, 247.
Watts succinctly points out in his comment on Johnson v Gore Wood, “[if], as a fact, a
promisor has undertaken obligations which might contemplate its having a double
liability upon default, it is not plain that the law should be unduly concerned.”43 In other
words, if double liability is foreseeable – either through specific obligations undertaken
to both the shareholder and the company by the wrongdoer or imposed by law – there
should be little cause for objection. The real issue is whether there is such an obligation
on the facts of the particular case, and this question surely deserves the proper hearing at
trial – a hearing that a successful invocation of the reflective loss principle would deny.
Finally, even if it is conceded that double jeopardy may be harsh and therefore
undesirable, it can – similarly to double recovery – be eliminated with legal rules designed
to prevent the subsequent acquiring shareholder from receiving the ‘windfall’ instead of
depriving the exiting shareholder from receiving personal recovery. This would not be
unjust as it is the exiting shareholder who suffered the reflective loss when the
wrongdoing took place while she was still a shareholder.44 The reflective loss principle,
therefore, is a clear case of judicial overreach with respect to the double jeopardy concern,
but it is happily an overreach that can be corrected with my proposed reconstruction of
the reflective loss principle.
c) Promotes settlement
In an ideal world, claims would not be litigated; parties would settle their claims and
liabilities with a minimum of fuss and legal process. However, life is not ideal, but
settlement is still to be encouraged. The reflective loss principle, in this regard, arises
from
the need to avoid a situation in which the wrongdoer cannot safely compromise the
company's claim without fear that he may be met with a further claim by the shareholder in
respect of the company's loss.45
However, the reflective loss principle as it now stands fails to provide clear guidance to
wrongdoers seeking to compromise the company’s claim. As explained in Section B.1,46
the reflective loss principle as it stands is unclear in its application especially when the
43
P Watts, ‘The Shareholder as Co-promisee’ (2001) 117 LQR 388, 390.
44
Also, the acquiring shareholder may have paid less for the shares, taking into account the loss caused to
the company by the wrongdoing and on the basis that the acquirer would not share in any recovery.
45
Giles v Rhind [2002] EWCA Civ 1428; [2003] Ch 618 [79] (Chadwick LJ).
46
Especially notes 23-30 above and text thereto.
requirement of ‘separate and distinct loss’ in Lord Bingham’s Proposition 3 is involved.

Whatever constitutes a ‘separate and distinct loss’ is recoverable by the shareholder in her
personal capacity, but what precisely constitutes ‘separate and distinct loss’ remains
disputed. 47 As such, even the reflective loss principle as it stands provides limited
guidance on when the wrongdoer may safely settle the company’s claim without fear of
other claims by shareholders.
Further, it is important to remember that settlement should not be encouraged for
its own sake, but only to the extent it makes economic sense as a whole.48 From the
perspective of the company and its shareholders, settlement only makes economic sense
if the net recovery from settlement exceeds the expected net recovery from litigation,
taking into account chances of success and the expenditures incurred during the legal
process. For a wrongdoer who wishes to ensure that a settlement she enters into would
not be subsequently challenged by disgruntled shareholders, her best course of action is
simply to offer an amount that would compensate the company or its shareholders in full
for the loss – or as close to it as possible – without the hassle of extended legal proceedings.
However, the reflective loss principle as it stands almost completely removes incentives
for the wrongdoer to do so: even a lowball settlement with only the company discharges
the wrongdoer’s liability to both the company and the shareholders. Instead of promoting
win-win settlements, the reflective loss principle as it stands entrenches a ‘heads up
wrongdoer wins, tails up shareholders lose’ situation.49
d) Prejudice to corporate creditors
Lord Millett in Johnson v Gore Wood stated that “protection of the interests of the
company's creditors requires that it is the company which is allowed to recover to the
exclusion of the shareholder”.50 In similar terms, Lord Bingham felt that “the court must
47
For an analysis of the issues see JSL Lee, ‘Baring Recovery for Diminution in Value of Shares on the
Reflective Loss Principle’ (2007) 66 CLJ 537, 550-551.
48
GL Priest and B Klein, ‘The Selection of Disputes for Litigation’ (1984) 13 J Legal Studies 1, 4 (“The
most important assumption of the model is that potential litigants form rational estimates of the likely
decision ... ”).
49
In any event, settlement on any terms is not an unqualified good, as Fiss powerfully puts it: “I do not
believe that settlement as a generic practice is preferable to judgment or should be institutionalized on a
wholesale and indiscriminate basis. It should be treated instead as a highly problematic technique for
streamlining dockets. … Consent is often coerced; the bargain may be struck by someone without authority;
the absence of a trial and judgment renders subsequent judicial involvement troublesome; and although
dockets are trimmed, justice may not be done. … settlement is a capitulation to the conditions of mass
society and should be neither encouraged nor praised.” OM Fiss, ‘Against Settlement’ (1984) 93 Yale LJ
1073, 1075.
50
[2002] 2 AC 1 (HL) 62.
… ensure that the company's creditors are not prejudiced by the action of individual
shareholders”.51 Although plausible at first glance, this concern with creditor protection
does not justify the reflective loss principle in all situations; the extent of the need for
creditor protection must depend on the existence and extent of a credible threat to creditor
interests. At this juncture, it is important to note that Johnson v Gore Wood was decided
in an earlier era when rigid doctrines of capital maintenance were generally taken
seriously as a creditor protection device. One Australian court interpreted Lord Millett’s
speech52 as reflecting the concern that
If a shareholder is permitted to recover for the same matter for which the corporation might
itself have recovered, then the capital of the corporation is depleted in favour of the
shareholder.53
It is suggested that the connection with capital maintenance54 could explain why their
Lordships neither clearly defined situations in which there is real prejudice to creditor
interests nor circumscribed the ambit of the reflective loss principle to those situations.
But since then, the tide has gradually turned against capital maintenance,55 and with the
Companies Act 2006, return of capital to shareholders in the private limited company is
no longer dependent on legal capital, but rather solvency.56 In this context, Lord Millett’s
solicitude for creditors in Johnson v Gore Wood is better explained as one rooted in
doctrinal constructs of a bygone era, and ought to be treated with caution. The general
position at law today (and not just English law) is that creditors have no special right
simply qua creditor to interfere in intracorporate affairs or corporate litigation when the
company is solvent.57 As Pearlie Koh pithily puts it, “the risk of non-payment to the
51
ibid 36. See also the comments by Lord Cooke (at 45) and Lord Hutton (at 55).
52
[2002] 2 AC 1 (HL) 62.
53
Mercedes Holdings Pty Ltd v Waters (No 2) (2010) 186 FCR 450; 78 ACSR 118; [2010] FCA 472 [110].
The court later declined to extend the reflective loss principle to trusts on the basis that the doctrine is aimed
at preventing unauthorized capital reductions: ibid [112] (‘the principle of “reflective loss” does not have
any application outside a context in which there exists a prohibition on unauthorised capital reduction’).
54
See also Lord Millett’s comments in Stein v Blake [1998] 1 All ER 724, 730 (Millett LJ).
55
See generally J Armour, ‘Legal Capital: An Outdated Concept?’ (2006) 7 EBOR 5 (arguing that legal
capital is no longer appropriate for the purpose of creditor protection). However, capital maintenance
doctrine remains vibrant in Germany, and it is still used to justify the no reflective loss rule in Germany. BJ
de Jong, ‘Shareholders’ Claims for Reflective Loss’ (2013) 14 EBOR 97, 107.
56
Companies Act 2006 (UK), ss 641-643.
57
I exclude special debt covenants, which are a matter of contract interpretation as opposed to general
corporate law and policy. There are also limited exceptions in other jurisdictions. In Japan, for example,
creditors have the right of subrogation, which permits them to enforce debts owed to their debtors in certain
situations. Article 423, Civil Code, Law No 89 of April 27, 1896 (Japan). Creditors of the company may
therefore in some situations sue the wrongdoer debtor of the company directly. For a concise introduction,
see H Oda, Japanese Law (3rd edn, Oxford University Press 2009) 144-145. The similarity of this (albeit
creditors is abstract and any fear of adverse consequences for the company’s creditors is
merely theoretical”.58 The current reflective loss principle, being a blanket rule that does
not take into account the solvency of the company, is an aberration that is difficult to
justify when the company is solvent.
Things are slightly different where the company is insolvent, or of doubtful
solvency. But even so, Pearlie Koh points out that it is trite that the company and its
shareholders are separate legal persons with distinguishable rights and obligations. It
follows that corporate creditors’ claims against the company must be satisfied from the
company’s own pool of assets, which is separate and distinct from the individual
shareholder’s. It is whether and to what extent the company pursues its claim against the
wrongdoer that affects this pool of assets and creditors’ interests, not what the shareholder
can do or actually does with her individual claim. In theory, the company’s solvency –
doubtful or otherwise – is irrelevant to whether the shareholder should be permitted to
pursue her own personal claims against the wrongdoer.59
In practice, in the absence of a reflective loss principle, situations are foreseeable
in which the insolvent or doubtfully solvent company and the shareholder bring
concurrent claims against the wrongdoer. In this limited and clearly defined situation,
conflict can arise between shareholders and creditors when the common wrongdoer has
limited resources with which to pay out claims. 60 Even in this very limited set of
situations, the reflective loss principle is unnecessary. What is necessary and sufficient
for creditor protection purposes is a rule that prioritises creditor interests over shareholder
interests in this specific class of situations, and this can be achieved by granting the
company’s claims priority over the shareholder’s claims against the same wrongdoer.
e) Respect for the company’s internal governance structure and autonomy
The reflective loss principle has been defended on the grounds that it reinforces the idea
one not discussed in the literature) to that of personal claims by shareholders against wrongdoer debtors of
the company should not escape the attentive reader.
58
P Koh, ‘The Shareholder’s Personal Claim: Allowing Recovery for Reflective Losses’ (2011) 23
Singapore Academy of LJ 863, 872. See also C Mitchell, ‘Shareholders’ Claims for Reflective Loss’ (2004)
120 LQR 457, 464-465.
59
Singapore Academy of LJ 863, 871.
60
that the company’s decision making processes are not to be interfered with.61 In Lord
Bingham’s words: “The court must respect the principle of company autonomy”.62 Taken
to the extreme, this justification can support the extreme position as judicially articulated
in one case:
It is not simply the case that double recovery will not be allowed, so that, for instance if the
company's claim is not pursued or there is some defence to the company's claim, the
shareholder can pursue his claim. The company's claim, if it exists, will always trump that
of the shareholder. Accordingly the court has no discretion.63
It is certainly possible that the board in its exercise of business judgement decides that it
would be unwise to pursue a damages claim against the wrongdoer, or that a settlement
for part of the claim value would suffice. The reasoning would then go that the individual
shareholder should not be permitted to second-guess the business decision of the board
or subvert the legal regime providing separately for personal claims (unfair prejudice)
and corporate claims (derivative claim) by bringing a personal claim, thereby justifying
the absolute bar against recovery by the shareholder. 64 This line of reasoning seems
defensible to this point, but even so, it is difficult to justify this result on the basis of
corporate (and especially board) autonomy when the company deliberately leaves money
on the table and shareholders are denied the opportunity to take what is left. This would
be tantamount to allowing the board to limit a personal right of the shareholders,65 and
do so without their consent. It is one thing to say that the company should have the first
bite at the proverbial cherry, but it is quite another to say that even if the company does
not wish to bite, the shareholder cannot have it either. It would be nothing more than a
61
PL Davies and S Worthington, Gower’s Principles of Modern Company Law (9th edn, Sweet & Maxwell
2012) [17-31] (‘A final argument might be that the initiation of a decision to distribute is normally entrusted
by the articles to the board and certainly is not given to individual shareholders. The “no reflective loss”
principle thus supports the principle of centralised management of the company through the board.’); J
Mukwiri, ‘The No Reflective Loss Principle’ (2005) 26 Company Lawyer 304, 307 (‘In requiring the
shareholder to sue the company rather than recover directly by suing the wrongdoer, the policy ensures the
rule in Foss v Harbottle is enforced such that the proper claimant is heard and company management is not
interfered with.’).
62
63
Day v Cook [2001] EWCA Civ 592; [2003] BCC 256 [38]-[39] (Arden LJ).
64
‘… in order to circumvent the rule in Foss v Harbottle (1843) 2 Hare 461 in a case where the nature of
the complaint is misconduct [i.e. wrong to the company] rather than mismanagement is, in my opinion, an
abuse of process.’ Re Chime Corp [2004] 7 HKCFAR 546 [63] (Lord Scott NPJ).
65
H De Wulf, ‘Direct Shareholder Suits for Damages Based on Reflective Losses’ in S Grundmann et al
(eds), Festschrift für Klaus J. Hopt zum 70. Geburtstag am 24. August 2010: Unternehmen, Markt und
Verantwortung Band 1 (De Gruyter 2010) 1557.
waste of a perfectly good cherry, and creates yet another ‘legal black hole’.66 However,
the autonomy concern could justify giving the company priority over the disposition of
its claim, such that shareholders would only be allowed to sue after the company has
litigated a claim to its conclusion or arrived at a final settlement with the wrongdoer.
To summarise, writers engaging with the topic of reflective loss – whether in
support or critically – face difficulties because the policy considerations articulated in
support of the reflective loss rule seem to be partly on point, but ultimately do not squarely
address the law’s true concerns. It is therefore necessary to read between the lines to
salvage – and develop – what are actually sound policy considerations that are poorly
served by the reflective loss principle as it stands. I offer below at Section C.1 a gloss on
the most promising policy consideration, and argue that the law’s true concern is with
ensuring the compliance of all shareholders in the corporate enterprise with the
company’s internal governance structure and constitutional order, so long as a shareholder
chooses to continue participating in the corporate enterprise. As I argue above at Section
B.2.d, a further consideration, creditor protection, does not apply to all companies, but
rather only within a clear and certain context: the limited class of situations in which the
company is insolvent or of doubtful solvency, and the wrongdoer has insufficient
financial resources to satisfy both the company’s loss (which would go towards paying
off the company’s creditors) and the shareholder’s loss separately. As properly articulated
and contextualised, these two policy considerations offered in support of the reflective
loss principle have merit.
Nevertheless, just because the ends are appropriate does not mean that the means
are as well. As the means by which these policy considerations are given effect in the law,
the reflective loss principle as it stands goes far beyond what is necessary. Completely
subordinating the interest of shareholders in recovering their loss to the company’s
interest and barring shareholders from personal recovery through a general rule that is
insensitive to the specific context, as the reflective loss principle does, is expropriation
without adequate justification.67 The law can and should achieve its goals with a more
carefully designed rule to fit the demands of policy without using Mjölnir to crack a nut.
The critical analysis of the policy justifications above suggests that a rule incorporating
66
The term is more popularly used in the context of third party enforcement of contracts, or the privity
problem, since as early as GUS Property Management Ltd v Littlewoods Mail Order Stores Ltd, sub nom J
Dykes Ltd v Littlewoods Mail Order Stores Ltd 1982 SLT 50 (OH) 54 (Lord Stewart); 1982 SLT 533 (HL)
538 (Lord Keith, quoting Lord Stewart) and popularized by legal literature such as H Unberath, ‘Third
Party Losses and Black Holes: Another View’ (1999) 115 LQR 535, 536.
67
Verantwortung Band 1 (De Gruyter 2010) 1546.
some concept of the company’s claims having ‘priority’ over the shareholder’s personal
claims in certain circumstances is a promising line of inquiry; developing this concept of
priority will be the subject of Section C. But before we begin the process of designing a
nutcracker proper, one puzzle remains to be solved.
3. The Curious Case of Unfair Prejudice
A remaining problem with the reflective loss principle is with how it seemingly stands in
conflict with another major part of company law: the unfair prejudice remedy. This
remedy, as enacted in many Commonwealth jurisdictions, permits a shareholder to
petition for relief on the ground that an act or omission of the company (actual or
proposed), or that the company's affairs are being or have been conducted in a manner
that is unfairly prejudicial to the interests of one or more shareholders including the
petitioner. Successful unfair prejudice petitions often have as their basis the breach of
directors’ duties.68 Two examples will suffice here.69 In Re London School of Electronics
Ltd,70 a shareholder obtained relief for unfairly prejudicial conduct by the company’s
controllers, who had misappropriated the company’s assets by diverting them to a
business they owned. Further, in Dalby v Bodilly,71 Blackburne J held that a shareholder-
director, in allotting himself an additional 900 shares, had acted “in flagrant breach of his
fiduciary duty to the company”, which “unquestionably amounted to unfairly prejudicial
conduct”.72 In Atlasview Ltd v Brightview Ltd73 Judge Jonathan Crow noted that
the law reports are full of cases in which petitioners have complained successfully under
[the unfair prejudice provision] about unfairly prejudicial conduct which has involved a
majority shareholder stripping out the company's assets. …
[A] petitioner is entitled to complain not only about conduct which has a discriminatory
effect on his own interests, but also about conduct which has a uniformly adverse effect on
the interests of all members of the company. The classic example of such conduct is where
68
D Kershaw, Company Law in Context: Texts and Materials (2nd edn, Oxford University Press 2012)
692; A Dignam and J Lowry, Company Law (8th edn, Oxford University Press 2014) [11.54].
69
Others examples include Lloyd v Casey [2002] Pens LR 185 (ChD); Clark v Cutland [2003] EWCA Civ
810; [2003] 2 BCLC 393; Allmark v Burnham [2005] EWHC 2717 (Ch); Gamlestaden Fastigheter AB v
Baltic Partners Ltd [2007] UKPC 26; [2007] All ER (D) 222.
70
[1986] Ch 211 (ChD).
71
[2004] EWHC 3078 (Ch); [2005] BCC 627 (Companies Court).
72
ibid [18].
73
[2004] EWHC 1056 (Ch); [2004] BCC 542 (Companies Court).
a company’s assets are stripped out for the benefit of some transferee. Any such stripping
out will inevitably involve conduct (or possibly omissions) of the company, acting (or
possibly not acting) through its directors. Their conduct (or inaction) in facilitating such a
transfer would in all probability amount to a breach of their duties to the company. To
suggest that, in such a case, [the unfair prejudice provision] is powerless would in my
judgment be to deprive the amendment [of 198974] of much of its value.75
Similar examples can be found in other jurisdictions of the Commonwealth.76

The unfair prejudice remedy is extremely flexible as matter of statutory design,
and a wide array of reliefs are available for the successful petitioner. 77 In practice,
however, the most commonly sought remedy is a buyout order, pursuant to which the
petitioner has her shares bought out at a judicially determined price. 78 In valuing the
petitioner’s shares, the court’s overarching commitment is to achieving fairness by
remedying the unfair prejudice suffered by the petitioner. Unless fairness requires
otherwise, as a starting point the petitioner’s shares are to be valued on the date which it
is ordered to be purchased (i.e. the judgment date).79 However, courts have departed from
74
Section 459 of the Companies Act 1985, as amended by Companies Act 1989, c 40, Schedule 19, para
11, is the direct forerunner of the modern unfair prejudice provision, section 994 of the Companies Act
2006.
75
[2004] BCC 542 (Companies Court) [60]-[61].
76
Such examples include Tullamore Holdings Ltd v The Shelby Shoe Co Ltd (1986) 3 NZCLC 99,759
(NZHC); Shum Yip Properties Development Ltd v Chatswood Investment & Development Co Pty Ltd (2002)
40 ACSR 619 (NSWSC); Woodley v Edwards (2002), 32 BLR (3d) 155 (Ont SCJ).
77
Section 996 of the Companies Act 2006 (UK) is as follows:
996 Powers of the court under this Part

(1) If the court is satisfied that a petition under this Part is well founded, it may make such order as it
thinks fit for giving relief in respect of the matters complained of.
(2) Without prejudice to the generality of subsection (1), the court's order may—
(a) regulate the conduct of the company's affairs in the future;
(b) require the company—
(i) to refrain from doing or continuing an act complained of, or
(ii) to do an act that the petitioner has complained it has omitted to do;
(c) authorise civil proceedings to be brought in the name and on behalf of the company by such
person or persons and on such terms as the court may direct;
(d) require the company not to make any, or any specified, alterations in its articles without the
leave of the court;
(e) provide for the purchase of the shares of any members of the company by other members or
by the company itself and, in the case of a purchase by the company itself, the reduction of
the company's capital accordingly.
78
J Lowry and A Reisberg, Pettet’s Company Law: Company Law and Corporate Finance (4th edn,
Pearson 2012) 360.
79
Re London School of Electronics [1986] Ch 211 (ChD) 224.
this default position, and ordered the petitioner’s shares to be valued as if the unfairly
prejudicial conduct had not occurred. In Scottish Co-operative Wholesale Society Ltd v
Meyer,80 the House of Lords held that the petitioner’s shares were to be purchased at the
value that they would have had if the oppression against the petitioner had not occurred.
The price received by the petitioner for her shares would include her pro rata share of
what the company would have ‘recovered’ for the wrong/prejudicial conduct. Hence,
where the petitioner obtains a buyout on such terms for unfairly prejudicial conduct
arising from a breach of directors’ duties, it is as if she has effectively succeeded in a
claim for reflective loss.
The unfair prejudice ‘exception’ to the reflective loss principle has been received
coolly by academics, although it has also found reluctant acceptance for its practical
merits.81 At least one Commonwealth jurisdiction has gone so far as to expressly provide
in legislation that the unfair prejudice remedy may not be used to seek relief that is
functionally equivalent to damages for reflective loss,82 although crucially buyout orders
of the type described here are still not caught by statutory prohibition.
The question, therefore, is this: how can the reflective loss principle be
reconciled with the unfair prejudice ‘exception’? The unfair prejudice remedy (or its
forerunner, the oppression remedy), is of legislative origin and considerable vintage. The
‘exception’ itself, which is based on clear, sound, and practical considerations of fairness
and policy, has a storied history dating back to 1958.83 By comparison, the reflective loss
principle in its present form is traceable earliest to 1981, 84 and suffers from various
weaknesses as explored above in Section B.2. Any attempt to reconcile the two competing
doctrines should be slow to disregard or dismiss the unfair prejudice ‘exception’; instead,
80
[1959] AC 324.
81
S Griffin, ‘Shareholder Remedies and the No Reflective Loss Principle – Problems Surrounding the
Identification of a Membership Interest’ [2010] JBL 461, 473 (arguing that ‘the law's current tolerance of a
petition under s.994 may be misguided and erroneous in circumstances where the substance of the
petitioner's complaint is reflective’, but advocating a ‘judicial redefinition of a membership interest’ ‘to
facilitate the practical objectives of the s.994 provision and give theoretical authenticity to a shareholder's
ability to obtain a personal remedy for a reflective loss’.); J Payne, ‘Sections 459-461 Companies Act 1985
in Flux: The Future of Shareholder Protection’ (2005) 64 CLJ 647, 672-673 (arguing that the problem of
reflective loss is relevant to the unfair prejudice buyout setting and should be judicially revisited, but
nonetheless ‘hope[s] that the courts would err on the side of shareholder protection’); B Hannigan,
‘Drawing Boundaries Between Derivative Claims and Unfairly Prejudicial Petitions’ [2009] JBL 606, 615-
618 (conceding the practical merits of the purchase order but expressing reservations).
82
Notably, section 726(5) of the Companies Ordinance (Cap 622; Ordinance No 28 of 2012) (HK)
expressly provides that ‘a member, past or present, of a company is not entitled to recover, by way of
damages …, any loss that solely reflects the loss suffered by the company that only the company is entitled
to recover under the common law’ pursuant to an unfair prejudice petition.
83
Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 was decided on July 24, 1958.
84
The judgement in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 was
handed down in 1981.
it should endeavor to explain and justify it within a proper framework. It is the goal of
Section C to supply a solution.
C. RECONSTRUCTING REFLECTIVE LOSS: A PROPOSAL
The problem of reflective loss arises in the first place because both the company and a
shareholder have overlapping losses resulting from the same wrong, and both have
legitimate legal claims against the wrongdoer. The reflective loss principle as it now
stands elevates the interests of the company such that the legitimate interests of the
shareholder are disregarded and made entirely contingent on the company’s course of
action – which a shareholder might have no influence over. This is unnecessarily and
unjustifiably harsh on shareholders who have no direct means of recovering loss that is
ultimately personal to them. Further, as I argue in Section B.2, many of the policy
considerations that the reflective loss principle was built on are flawed or even at their
best overstated. At the same time, however, it is necessary to address the considerations
that do have merit either generally, such as the company’s internal governance discussed
at Section B.2.e, or in specific contexts, such as creditor protection at B.2.d – but without
overstepping the bases of these meritorious considerations. A further burden placed on
any serious attempt to engage with the reflective loss principle is the necessity of
reconciling it with the unfair prejudice ‘exception’ I analyse above in Section B.3 under
which what would appear to be reflective loss could be recovered by way of an unfair
prejudice buyout order.
To achieve these goals, I propose to reconstruct the reflective loss principle as a
rule that balances the interests of the corporate entity and the shareholders as a whole with
the interests of individual shareholders who have suffered loss. My starting point is that
the company’s internal governance arrangements – which usually give the board the final
say over matters such as initiating corporate litigation – should be respected so far as it is
reasonable and efficient as a whole. The company should have priority when it comes to
deciding the proper disposition of the wrong done to the company. Accordingly, the board
should have sufficient time to consider its legal position and plan its litigation strategy, or
to decide to abandon or settle the company’s claim against the wrongdoer. While the
company’s decision-making processes are still under way, it would be duplicative,
wasteful, and inefficient if the shareholder were to commence her own set of proceedings
against the same wrongdoer. Further, where the shareholder wishes to remain part of the
corporate enterprise, she must necessarily subject herself to the corporate governance
arrangements she has explicitly or implicitly agreed to.
I therefore propose the following two-stage rule: where a shareholder wishes to

commence a cause of action in respect of her ‘reflective’ loss, she must first give notice
to the company of her intentions. The shareholder may only proceed with her cause of
action after the company makes its decision on whether to pursue its cause of action
against the wrongdoer. Where the company decides not to pursue its claim against the
wrongdoer, the shareholder is at liberty to proceed. Where the company pursues or settles
the claim against the wrongdoer, but does not obtain complete recovery in respect of its
claim, such that the shareholder is not fully compensated for her loss, the shareholder may
only recover for her shortfall in compensation. I call this the ‘the priority rule’.
The situation is different if the shareholder exits the company, and then wishes
to recover for her ‘reflective’ loss. Here, the former shareholder may independently
pursue a claim for reflective loss, but does not share in any of the company’s recovery (if
any), but neither can the company interfere in her own legal action against the wrongdoer.
I call this the ‘exit exception’ to the priority rule. I elaborate on the rationale for the rule,
describe the operation of the rule and its exception, and round off this Section by showing
why the proposal works.
1. Policy Rationales of the Priority Rule
As considered in Section B.2.e above, the court in principle will not interfere with the
internal decision-making arrangements of the company, which usually gives the board the
final say on disposition of the company’s claim. 85 I argue there that this policy
consideration is the most promising of the justifications offered in support of the reflective
loss principle. However, it requires further explication and development, and must be
balanced with the concurrent need to ensure that a shareholder suffering loss is not
deprived of just compensation without good justification.86 To that end, I offer a gloss
here.
85
The company’s power to commence litigation is generally prima facie vested in the board of directors,
pursuant to the relevant provisions in the company’s constitution or statutory legislation. See Breckland
Group Holdings v London & Suffolk Properties (1988) 4 BCC 542 (Ch) 546-547; Massey v Wales (2003)
47 ACSR 1 (NSWCA) [45] and [47] (Hodgson JA); Hedley v Albany Power Centre Ltd [2005] 2 NZLR
196 (NZHC) [36]. See also PL Davies and S Worthington, Gower’s Principles of Modern Company Law
(9th edn, Sweet & Maxwell 2012) [17-2].
86
Verantwortung Band 1 (De Gruyter 2010) 1546. Even Lord Bingham, one of the architects of the restrictive
reflective loss principle, expressed that sentiment. Johnson v Gore Wood & Co (a firm) [2000] UKHL 65;
[2002] 2 AC 1 (HL) 36 (Lord Bingham).
Policy considerations invoked in support of a legal rule must themselves have

basis. The basis of a policy consideration affects its permissible limits, and consequently
the boundaries of the legal rule it supports. What then is the basis of the consideration
that the company’s internal governance structure should be respected? I argue that it is
consent: the shareholders are deemed to have accepted the subordination of their interests
to that of the company.87 For shareholders to challenge whether directly or implicitly the
board’s disposition of the company’s loss is therefore rightly perceived as a subversion
of the hierarchical internal ordering that is at the core of company law. Permitting
shareholders to reap the benefits of participation while refusing to abide by the internal
hierarchical order would encourage opportunism, especially if the shareholder can
recover both through the company and through her own personal claim.88
Although I argue in Section B.2.e above that the reflective loss principle is an
overreach, I acknowledge that ringfencing the company’s loss from the shareholder’s
competing claim does ensure the primacy of the company’s decision as taken through the
proper channels over that of its individual shareholders. Judicial language of the
company’s claim ‘trump[ing]’89 that of the shareholder despite the shareholder having
her own personal cause of action is consistent with this understanding. The gloss I have
set out above further explains – but without fully justifying – why the principle as it stands
denies shareholders the opportunity to litigate their own claims even where the company
has settled 90 or dropped 91 its own claim. Without proper justification and limits,
allowing shareholders to pursue personal claims in parallel to the company undermines
the primacy of the company and its internal governance arrangements. However, these
concerns are adequately – and better – addressed by the priority rule I propose. Above all,
the priority rule enshrines the principle that the company’s internal decision-making
processes must come first. There is no room for the shareholder to pursue reflective loss
claims completely unbeknownst to the company. Where doing so does not interfere with
the company’s priority, the shareholder remains free to pursue personal recovery of loss.
In so doing the priority rule achieves the main goal of the old reflective loss principle, but
87
See H De Wulf, ‘Direct Shareholder Suits for Damages Based on Reflective Losses’ in S Grundmann et
al (eds), Festschrift für Klaus J. Hopt zum 70. Geburtstag am 24. August 2010: Unternehmen, Markt und
Verantwortung Band 1 (De Gruyter 2010) 1559-1560.
88
It should not surprise that double recovery is also strongly featured as the standard justification for the
reflective loss principle.; see Section B.2.a.
89
Day v Cook [2001] EWCA Civ 592; [2003] BCC 256 [38].
90
Johnson v Gore Wood & Co (a firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 66 (Lord Millett); Gardner
v Parker [2004] EWCA Civ 781; [2005] BCC 46 [58].
91
Johnson v Gore Wood & Co (a firm) [2000] UKHL 65; [2002] 2 AC 1 (HL) 66 (Lord Millett); Gardner
v Parker [2004] EWCA Civ 781; [2005] BCC 46 [60].
does so without making a sacrificial lamb of the shareholder.

The priority rule also addresses the second policy consideration that has merit in
very specific contexts: creditor protection. As explained above at Section B.2.d, where
the company is solvent, creditor protection is not a concern as no shareholder-creditor
conflict arises. There is a need to safeguard creditor interests only 1) when the company
is insolvent or doubtfully solvent, 2) the wrongdoer has limited ability to satisfy claims,
and 3) the shareholders and the company bring concurrent claims against the wrongdoer,
as this is when shareholder and creditor interests conflict.92 To address this conflict, the
priority rule makes it clear that in insolvency, the company’s claims – which form part of
the pool of assets available to satisfy creditors’ claims – take precedence over those of the
shareholder’s personal claims.
Further, the ‘priority rule’ explains and justifies the unfair prejudice ‘exception’,
which is a perceived circumvention of the classical reflective loss principle through
shareholder recovery of what would seem to be reflective loss by buyout orders under the
unfair prejudice remedy. The ‘priority rule’ draws the distinction between shareholder exit
and non-exit, creating for the former case an ‘exit exception’. The policy rationale that
shareholders should respect the integrity and primacy of the company’s internal
governance arrangements while they remain shareholders properly denies a shareholder
who consents to those arrangements cause for complaint against the company’s
disposition of the company’s claim. This rationale, however, has a necessary corollary:
the shareholder’s ‘consent’ to delegate the matter of recovery to the company’s proper
organs – and their respect for the company’s internal governance arrangements – should
subsist only as long as they choose to remain in the company. The shareholder who
chooses to exit the corporate enterprise renounces her intention to be bound by the
company’s constitutional arrangements. With a complete separation between the
company and the former shareholder, the company can no longer appeal to the ‘best
interests’ of the company to deny the former shareholder full autonomy and agency over
her own destiny. This demarcates the boundary of the priority rule. Upon a decision to
exit the company, the now ex-shareholder trades her rights and interests as a shareholder
(which includes participation as well as economic rights) and the attending obligation to
submit to the company’s internal rules for the right to pursue her own economic interests,
which would include personal recovery for her loss. As Sterling points out:
The basic reason for insisting that sale should be a condition precedent to a personal action
92
in tort is that while the shareholder still holds his shares he can bring a derivative action
whereby both he and the company can be restored to their original position in the same set
of proceedings.93
Since by exit the shareholder loses even the possibility of bringing a derivative claim,94
there is no longer a good reason to obstruct the former shareholder – who, after all, did
suffer loss – from recovering it herself.
This concept of exit is key to understanding and rationalising the unfair prejudice
‘exception’ described in Section B.3 above. In the context of the unfair prejudice remedy,
a buyout order ipso facto facilitates the exit of the petitioner from the company. The
shareholder’s express intention to exit – made manifest by the unfair prejudice petition
seeking buyout as the desired relief – also clearly evinces the shareholder’s intention to
renounce her submission to the authority of the board as the proper constitutional organ
of the company.95 Given that the shareholder is bearing her own litigation costs and the
risk of adverse cost orders in her attempt to recover her own losses, there is no reason for
the reflective loss principle or its reconstruction, the priority rule proposed in this Article,
to apply where a buyout order is made. This feature of unfair prejudice buyout orders is
therefore consistent with the ‘exit exception’ to the priority rule that applies where the
shareholder seeks to leave the company.
Having explained the basis of the priority rule and shown its consistency with
the unfair prejudice ‘exception’, we now turn to how it would work in action.
2. The Operation of the Priority Rule
a) The ‘priority rule’
Consider first the scenario in which the shareholder chooses to remain in the company
(the non-exit scenario), but wishes to pursue her own personal claim against the
wrongdoer. She must first give notice to the company of her intention to pursue personal
recovery against the wrongdoer, and abstain from action for a reasonable period (e.g. sixty
93
MJ Sterling, ‘The Theory and Policy of Shareholder Actions in Tort’ (1987) 50 MLR 468, 485.
94
Ex-shareholders have no standing to bring derivative claims, even if the cause of action that is the subject
of the derivative claim arose while the ex-shareholder was still a shareholder. See sections 260(1) and 265(1),
Companies Act 2006 (UK).
95
Even if the buyout order is not sought by the petitioner and is instead granted by the court exercising its
discretionary power, or the relief sought by the petitioner is damages in respect of the prejudicial conduct-
cum-wrong to the company, the company would suffer no additional prejudice, and there is also no reason
for this rationale not to apply.
or ninety days) while the company decides on its response. If the company fails to
commence an action within the notice period, the shareholder may then proceed to file
suit against the wrongdoer.
Next, suppose the company takes action against the wrongdoer within the notice
period. One of three possible scenarios will occur. The first has the company making full
recovery of the company’s loss, which has the effect of remedying the shareholder’s loss
as well. Here the shareholder loses her personal claim, as she can no longer prove any
loss. Under the second scenario, the company makes partial, but not full recovery. Here
the shareholder would be able to sue on her personal claim to recover the shortfall
between her pro rata share of the company’s recovery and the full extent of her own loss.
The third and final possibility is that the company completely fails to recover anything
from the alleged wrongdoer. Here, the shareholder would be free to pursue personal
recovery for the entire extent of her own loss.96
If the company commences action after the notice period expires and after the
shareholder has commenced personal litigation, the court should order a joinder of the
two cases so that the dispute may be disposed of by the same judge in the same set of
proceedings. This would make it possible for the court to apportion any recovery from
the wrongdoer properly between the company and the shareholder. The court has two
options. The first is for the company to recover in full the loss caused by the wrong, and
for the court rendering judgment (or in the case of settlement, the court to which the
company may apply) to order a permanent stay or dismissal of the shareholder’s personal
action. The second is for the company to recover the loss minus the share that the
shareholder would have been entitled to pro rata. This is to avoid double jeopardy to the
wrongdoer. To avoid double recovery, should the shareholder pursue and succeed in
personal recovery, she should not receive any share of any corporate recovery prior or
subsequent to the resolution of her own action.
The functional similarity of the proposed procedure to the design of many
statutory derivative claim or action mechanisms is deliberate. It strikes a balance between
efficiency considerations and recognition of the board’s pre-eminent authority as the
proper constitutional organ of the company on the one hand, without necessarily denying
even the chance of recovery to shareholders who did after all suffer personal losses.
A preliminary objection to this approach may be addressed here. Should the
shareholder’s proper course of action be a derivative claim against the wrongdoer instead?
96
This last scenario is no different from the current position under Lord Bingham’s Proposition 2 in
The recent proliferation of statutory derivative action mechanisms that supposedly

alleviate the difficulties caused by Foss v Harbottle 97 and its progeny across
Commonwealth jurisdictions98 seems to provide additional ammunition for this line of
argument. This argument has merit insofar as it appears doctrinally elegant, as recovery
through a derivative claim is still recovery by the company, and the shareholder does not
feature as a separate litigant in her own right. There is also the added benefit of ensuring
recovery is shared with the shareholders as a whole, or the company’s creditors if the
company’s solvency is doubtful. 99 However, enforcement by the company against a
wrongdoer via a derivative claim is a veritable obstacle course.100 I acknowledge that one
possible approach might be to address the deficiencies in the derivative claim regime
directly instead of reconstructing the reflective loss principle. 101 However, any attempt
at remedying the state of derivative claims would have to be comprehensive and wide-
ranging,102 and involve a complex balancing exercise that raises its own host of issues.
It is not the purpose of this Article to reinvent the statutory derivative claim mechanism,
an exercise that would require at least a monograph.103 By contrast, the priority rule
advanced in this Article is a targeted, simpler solution for the very specific problem of
empowering a shareholder to enforce personal claims that are not derivative of the
company’s. I present in Section C.3 below other strengths of the approach I propose.
b) The ‘exit exception’
Consider now the alternative scenario in which the shareholder wishes to exit the
company (the exit scenario). The shareholder could do so by finding a buyer for her shares.
97
(1842) 2 Hare 461.
98
For a brief sampling of the relevant statutory provisions in the following Commonwealth jurisdictions,
see ss 238-240, Canada Business Corporations Act (RSC, 1985, c C-44); ss 216A-216B, Companies Act
(Cap 50, 2006 Rev Edn) (Singapore); ss 165-166, Companies Act 1993 (No 105, 1993) (NZ); ss 236-242,
Corporations Act 2001 (No 50, 2001) (Australia); ss 260-264, Companies Act 2006 (UK).
99
A Reisberg, Derivative Actions in Corporate Governance: Theory and Operation (Oxford University
Press 2007) 282-283, 285; B Hannigan, ‘Drawing Boundaries Between Derivative Claims and Unfairly
Prejudicial Petitions’ [2009] JBL 606, 616.
100
A Reisberg, ‘Shadows of the Past and Back to the Future – Part 11 of the UK Companies Act 2006
(in)action’ (2009) 6 ECFR 219, 242–243 (considering the many obstacles faced by shareholders in bringing
a derivative claim under the statutory procedure in the Companies Act 2006). See also Section C.3.d below,
which gives reasons for shifting the burden of enforcement from directors to wrongdoers.
101
I thank the anonymous reviewer for raising this point.
102
This is especially so in the UK, which has a notoriously restrictive derivative claim regime. For an
example of a recent, extensive reform proposal, see A Keay, ‘Assessing and Rethinking the Statutory
Scheme for Derivative Actions under the Companies Act 2006’ (2016) 16 JCLS 39.
103
Indeed, even the leading monograph has only begun, rather than concluded, the conversation. A
Reisberg, Derivative Actions in Corporate Governance: Theory and Operation (Oxford University Press
2007).
Once the sale is complete and exit effectuated, the now-former shareholder can proceed.
The company’s right to take legal action to recover its own loss is not prejudiced. To
address double recovery concerns, the exiting shareholder would have no claim to any
proceeds of the company’s recovery (if any), while the company’s recovery will be
reduced to exclude the share that would have gone to the exiting shareholder had she not
exited. For example, if the exiting shareholder held ten percent of the shares, the company
would recover a sum that is ninety percent of the total assessed loss caused by the wrong.
The transferee to whom the former shareholder has transferred her shares would be
excluded from the company’s recovery; this would prevent double jeopardy to the
wrongdoer.
Further, the shareholder’s exit from the company allows her reflective loss to be
quantified with greater certainty. Where a shareholder intends to continue her
participation in the corporate enterprise, a decrease in the value of her shares may not
cause actual harm to her. Her situation is comparable to a creditor facing a decrease in the
value of her debtor’s assets. In theory, the chances that the debtor will default on her loan
have increased, but so long as the debtor does not fail to pay the creditor, the creditor
cannot claim damages from the debtor. However, where the shareholder exits the
company and sells her shares, she would obviously suffer if the value of her shares has
decreased, not least because she would receive less from the buyer of her shares.104 Her
reflective loss crystalizes as at the time of exit; the damage caused to her is no longer
merely hypothetical, but real.105
It is possible that the crystalized loss – that is, the difference between the share
value before the wrong was committed and what the share value was at the point of exit
– could be substantially different from the shareholder’s pro rata ‘share’ of the assessed
total loss to the company. It is difficult to determine what the measure of recovery on the
shareholder’s personal claim should be in this situation. If the company does not pursue
its own cause of action, the shareholder’s crystalized loss should be the measure of
recovery as the issue is then solely between her and the wrongdoer, with the company
completely out of the picture. If the company is pursuing its own action against the
wrongdoer, the interests of the shareholders who have chosen to remain in the company
104
Assuming the sale was at or close to market price, or based on a valuation taking into account the impact
of the loss caused by the wrong.
105
Verantwortung Band 1 (De Gruyter 2010) 1546-1547. The relative ease of quantifying reflective loss upon
exit may provide another persuasive explanation for why Commonwealth courts have permitted such losses
to be claimed by shareholders through a buyout order under the unfair prejudice remedy.
should be taken into account. I suggest that the approach most consistent with the priority
rule is to cap the individual shareholder’s recovery at the pro rata corporate loss, provided
the wrongdoer can prove the pro rata corporate loss is lower than the shareholder’s
crystalized loss.106
The shareholder exit exception not only rationalizes within a coherent
framework the existing ‘circumvention’ of the reflective loss principle de lege lata by the
unfair prejudice remedy, but further extends it such that shareholders may obtain relief
for wrongdoing that does not fall within the boundaries of the unfair prejudice remedy.107
3. Why the Priority Rule Works
a) Efficiency
All things being equal, dispute resolution is more efficient between two as compared to
more parties. Hold out, free-riding, collective action and other coordination problems
become more serious when more parties are involved. As a starting point, it is preferable
that the company litigates or settles the dispute both for itself and on behalf of every
affected shareholder, especially where the wrongdoer has breached a duty owed to each
and every one of the company’s shareholders. By granting priority to the company –
acting through its constitutional organs – to manage the dispute, duplicative litigation and
other wasteful actions are minimized. Fears that the priority rule will ‘open the floodgates’
to opportunistic shareholder litigation are more illusory than real.
b) Incentive for wrongdoer to make full compensation
Perhaps most importantly, my theory of reflective loss gives the company priority over
its own claim, while retaining the threat of claims from residual individual shareholders.
This creates a powerful incentive for the wrongdoer to pay the company – and pay in full.
If payment in full to the company discharges the entirety of the wrongdoer’s obligation
106
This is less radical than the alternative. See KJ Hopt and M Roth, ‘§ 93’, H Hirte, PO Mülbert and M
Roth (eds), Großkommentar Aktiengesetz Bd. 4/2 (5th rev edn, De Gruyter 2015) [645]; H-J Mertens and
A Cahn, ‘§ 93’, W Zöllner and U Noack (eds), Kölner Kommentar zum Aktiengesetz Bd 2/1 (3rd rev edn,
Carl Heymanns 2010) [215] (suggesting that even where the wrongdoer has made full compensation in
respect of the company’s loss to the company, it should remain open to shareholders to sue for any
remaining uncompensated personal loss).
107
An example of a wrong that does not fall under the unfair prejudice remedy would be a solicitor’s breach
of professional duty towards a shareholder personally. See e.g. Johnson v Gore Wood & Co (a firm) [2000]
UKHL 65; [2002] 2 AC 1 (HL).
to compensate,108 it is difficult to imagine how a wrongdoer would prefer to lowball the

company in settlement only to face a barrage of individual residual shareholder claims
subsequently; surely it must be preferable to litigate or settle the matter once with a single
opposing party, the company. Naturally, the wrongdoer would prefer to obtain a full
release of liability from all potential shareholder-claimants if possible. In a closely-held
company, it would be possible to obtain the binding agreement of all shareholders to settle
all claims in a single tripartite settlement of wrongdoer, company, and shareholders.109 In
a widely-held company, the wrongdoer’s best cause of action is to pay in full, or as much
as she reasonably can, so that the shareholders would either have such a low residual
claim amount so that it is not worthwhile for them to sue, or in any event find it not worth
suing a nearly financially-exhausted wrongdoer.
The objection may be made that if the burden of recovery can be passed onto
shareholders, the wrongdoer would have ample incentive to pay in full, but the board
would have less incentive to press the company’s claim and undertake litigation or other
legal measures. Insofar as the board’s decision not to zealously pursue compensation
(made in the exercise of business judgment and without obvious bad faith or conflict of
interest) rarely results in a successful derivative claim against the board,110 this objection
has force. I will address the question of director incentives and liability below, but for
now I will simply say that such is the cost of protecting director discretion and judicial
non-interference with intracorporate matters – the cost of ‘business’, as non-lawyers
might say.
108
That the shareholders should be barred from pursuing personal claims when the company has been
compensated is uncontroversial. See e.g. H De Wulf, ‘Direct Shareholder Suits for Damages Based on
Reflective Losses’ in S Grundmann et al (eds), Festschrift für Klaus J. Hopt zum 70. Geburtstag am 24.
August 2010: Unternehmen, Markt und Verantwortung Band 1 (De Gruyter 2010) 1555 (‘Of course, I agree
that the shareholder should be barred from bringing a claim if the company has received compensation from
the tortfeasor.’ [italics in original]). But while commentators have not always been very clear as to whether
partial recovery by the company discharges the wrongdoer’s liability to both the company and the
company’s shareholders, I take the position that only full, or nearly substantially full (with some leeway
for costs) recovery should discharge the wrongdoer’s liability.
109
Where the wrongdoer also owns shares, an elegant solution might be for the wrongdoer to transfer his
shares to the other shareholders pro rata, increasing their proportionate shareholdings in the company and
offsetting the decrease in the value per share caused by the wrongdoer. Other than the possibility of parties
contracting as such, it would be interesting if the law developed squeeze out or expulsion remedies (as a
mirror image to the classic unfair prejudice buyout) at general corporate law for wrongdoing shareholders.
110
A Reisberg, ‘Shadows of the Past and Back to the Future – Part 11 of the UK Companies Act 2006
(in)action’ (2009) 6 ECFR 219, 242-243 (considering the many obstacles faced by shareholders in bringing
a derivative claim under the statutory procedure in the Companies Act 2006); JP Sykes, ‘The Continuing
Paradox: A Critique of Minority Shareholder and Derivative Claims under the Companies Act 2006’ (2010)
29 CJQ 205, 209 (‘The entitlement to bring a derivative claim has been interpreted restrictively, hence cases
are relatively rare.’).
c) Low practical risk of multiple suits
The nightmare scenario no doubt envisioned by judges and lawyers would be that of many
individual shareholders dumping their shares on the market and bringing personal claims
after hearing news of wrongdoing that causes loss to the company (or more likely, seeing
the share price fall in response to the news). However, for the average shareholder, it
would not be economically worthwhile to bring a personal claim.
Shareholders who own only a small fraction of the company’s issued shares
suffer a correspondingly small reflective loss, and therefore possess only a small claim
value. Given the presently low-powered incentives to bring derivative claims for
shareholders in most jurisdictions,111 it would be rational for such a shareholder to take
no action and free-ride if and when the company recovers, either directly or by virtue of
a derivative claim brought by another shareholder. The regime proposed in this Article is
therefore unlikely to cause problems in practice even for public companies with numerous
shareholders. The shareholders who would possibly bother would be those holding many
shares, but the chances of them liquidating their shareholding quickly so as to bring a
personal claim are minimal in light of the consequences that would follow the sudden
dumping of large quantities of shares on the market.112 There would be ample time for
the company to seek recovery first, as it arguably should.113 In any event, situations in
which shareholders in a widely-held company are individually owed duties are likely to
be rare in practice.114
In a closely-held company setting with few shareholders, multiple suits can be
easily resolved. The court could order joinder of all separate personal shareholder claims
111
DW Puchniak and H Baum, ‘The Derivative Action: An Economic, Historical and Practice-Oriented
Approach’, in DW Puchniak, H Baum and M Ewing-Chow (eds), The Derivative Action in Asia: A
Comparative and Functional Approach (Cambridge University Press 2012) 1-2. The major exception, of
course, is the United States, with its unique incentives. A Reisberg, ‘Funding Derivative Actions - A Re-
examination of Costs and Fees as Incentives to Commence Litigation’ (2004) 4 JCLS 345, 347-351.
112
Another reason why shareholders in a company with liquid shares would have little incentive to sue is
because they can ‘settle’ their personal claims by selling their shares to buyers who would pay them a
premium for the chance that the company would subsequently recover its loss. In an efficient securities
market with arbitrageurs, the share price would be stabilized quickly by arbitrageurs who, betting on
subsequent recovery by the company, would buy in. Not all jurisdictions offer the possibility of such
arbitrage, as it turns on whether arbitrageurs can buy into a company and then bring a derivative claim for
a wrong committed before the arbitrageur became a member. For example, the Companies Act 2006 does
not expressly deny standing to shareholders pursuing derivative corporate causes of action arising before
the fate of their membership. See sections 260(4) and 265(5), Companies Act 2006 (UK); PL Davies and S
Worthington, Gower’s Principles of Modern Company Law (9th edn, Sweet & Maxwell 2012) [17-17].
113
The possibility exists that the company’s managers exercising a good faith business judgment that it
would not be commercially desirable to pursue recovery.
114
For a rare exception, see Heron International Ltd v Lord Grade [1983] BCLC 244 (CA) (takeover
situation).
into one consolidated set of proceedings. Alternatively, a wrongdoer could easily obtain
a release from all shareholders in question in exchange for recompensing the company.
The threat of multiple lawsuits from disgruntled unfair prejudice petitioners or former
shareholders who have exited by finding transferees is a powerful force that, far from
drawing the misplaced sympathies of the courts for wrongdoing company controllers,
should be embraced as a solution to the woefully inadequate incentives and consequent
rational apathy/freeriding of shareholders to bring derivative claims.
d) Reduces incentives for shareholders to sue directors
Much of the rhetoric in discussions of derivative claims and the ‘business judgment rule’
masks the fundamental concern with directors’ liability. Even if one surrenders to the
wisdom of director protection, it does not follow that this concern should manifest in legal
rules such as the reflective loss principle, which operates on top of other doctrinal
restrictions, such as the rule in Foss, and statutory ‘safeguards’ in derivative action
regimes across various jurisdictions.
By creating options for shareholders to pursue personal claims in situations
where the company through its proper organ, the board of directors, has declined to pursue
or pursued recovery with insufficient vigour for a wrong to the company, the proposal
advanced herein would channel a subset of shareholder complaints away from the board
of directors and towards the relatively more culpable wrongdoers directly. This would
reduce the incentive of the shareholders to sue the (non-wrongdoing) board, as well as
alleviate pressure for reform of the derivative claim regime, which would be fraught with
great difficulty. 115 Thus, the reflective loss rule as reconstructed in this Article offers
directors greater protection by making the board’s actions or nonfeasance far less relevant
to the shareholder’s ultimate recovery. Whether the board does anything or recovers much
of the loss is irrelevant to a shareholder who is prepared to exit and risk litigation with
the wrongdoer in a personal capacity. Such a shareholder – provided she is acting
rationally in pursuit of her economic interests116 – would not bother to sue the board.
Staunch defenders of directors’ interests should have little to object to.
115
See notes 100-102 above and text thereto.
116
This assumption may be readily challenged, but is beyond the scope of this article. See M Blair and LA
Stout, ‘Trust, Trustworthiness and the Behavioral Foundations of Corporate Law’ (2001) 149 University of
Pennsylvania LR 1735; DW Puchniak and M Nakahigashi, ‘Japan’s Love for Derivative Actions: Irrational
Behaviour and Non-Economic Motives as Rational Explanations for Shareholder Litigation’ (2012) 45
Vanderbilt Journal of Transnational Law 1.
D. CONCLUSION
The reflective loss principle poses a major obstacle for shareholders who seek to recover
losses that overlap with those of the company when the company fails to recover in full.
Despite the authority of the House of Lords (in Johnson v Gore Wood) and continued
support from scholars, the reflective loss principle as it stands in English and
Commonwealth law has serious flaws. This Article has analysed the policy considerations
traditionally articulated in its support and found them wanting. The most convincing
policy consideration – the primacy of the company’s internal governance arrangements
and the shareholder’s submission to it for the duration of her participation – can be
addressed without unnecessarily restricting the shareholder’s freedom of action. Under
the framework I propose, the reconstructed reflective loss principle takes the form of a
priority rule giving the company the right of first refusal in recovering the loss, and an
exit exception where shareholders who choose to exit the company may pursue personal
recovery without further ado. By clearly defining when and how shareholders may pursue
personal recovery, and reconciling the apparent conflict between unfair prejudice buyouts
and reflective loss, the framework advanced here brings clarity and balance to the law,
and just as importantly, hope to shareholders.
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Reconstructing the reﬂective loss principle

Article in Journal of Corporate Law Studies · June 2016

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This is an Accepted Manuscript of an article published by Taylor & Francis in Journal of

shareholders. Section D concludes.

B. REFLECTIONS ON REFLECTIVE LOSS

1. The Reflective Loss Principle

Proposition 1 includes the classic derivative claim scenario, in which the

2. Flawed and Not-So-Flawed Policy Foundations

requirement of ‘separate and distinct loss’ in Lord Bingham’s Proposition 3 is involved.

d) Prejudice to corporate creditors

e) Respect for the company’s internal governance structure and autonomy

3. The Curious Case of Unfair Prejudice

Similar examples can be found in other jurisdictions of the Commonwealth.76

996 Powers of the court under this Part

C. RECONSTRUCTING REFLECTIVE LOSS: A PROPOSAL

I therefore propose the following two-stage rule: where a shareholder wishes to

1. Policy Rationales of the Priority Rule

Policy considerations invoked in support of a legal rule must themselves have

does so without making a sacrificial lamb of the shareholder.

2. The Operation of the Priority Rule

a) The ‘priority rule’

The recent proliferation of statutory derivative action mechanisms that supposedly

b) The ‘exit exception’

3. Why the Priority Rule Works

b) Incentive for wrongdoer to make full compensation

to compensate,108 it is difficult to imagine how a wrongdoer would prefer to lowball the

c) Low practical risk of multiple suits

d) Reduces incentives for shareholders to sue directors

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