The Court of Appeal is currently considering its verdict in a case that could have wide-ranging consequences for directors of companies that became insolvent through the actions of a third party.
What is Reflective Loss and why does it matter? If you were one of these directors then it would matter greatly.
It’s a legal precedent that most simply means that the loss of individual shareholders is inseparable from the general loss of the company. That is that a shareholder cannot bring a claim for a loss suffered by the company – their loss is said to be a “reflection” of the loss suffered by the company and the company itself (or its liquidator) is the proper claimant.
It was intended to stop conflicts of interest which could arise if a company decided not to settle a case if other claimants had a separate right to claim. There are also implications on company autonomy and avoiding prejudice to minority shareholders and other creditors.
Here’s an example:
Company A becomes insolvent through the actions of make-believe bank. Company A was lent large amounts of money by make-believe bank, who knew there was little chance of them being able to pay it back. Make-believe bank were happy to provide this service, taking their fees, interest and repayments regardless on whether company A continued to be viable because they knew that if company A went into administration and ultimately liquidation, they would be repaid through assets sales.
If a director of company A discovers this practice and believes make-believe bank have been negligent then you may assume that they would have legal recourse. They would actually have none.
Once an insolvency practitioner has been appointed then interested parties such as directors, shareholders or other creditors would be unable to take action against make-believe bank. The claim lies exclusively with the insolvent company and can only be pursued through a duly appointed insolvency practitioner.
Now this could be a problem if you are a creditor. Firstly, the insolvency practitioner may be prepared to settle any claims at a lower value than you would prefer.
Additionally, the insolvency practitioner may have been appointed by make-believe bank, the “wrongdoing” creditor in the first place, creating a perceived conflict of interest. Like a football team getting to choose their own referee for their match.
A lot of small but viable companies went out of business in the aftermath of the 2007/08 financial crisis and subsequent recession. Some of these entirely due to questionable practices from banks and lenders who supposedly had their interests at heart.
The story of the Reading branch of HBOS was probably the most egregious example. It began as a simple tale of fraud and malfeasance but quickly spiraled into a multi million pound financial scandal involving Mediterreanean cruises, sex parties and, most incredibly, Noel Edmonds.
The details of the case beggar belief. Lynden Scourfield, head of HBOS’s impaired assets division took advantage of companies they were involved with either through improper lending, and/or insisting they hired a management consultant called David Mills as a condition of loans being granted many at exorbitant rates. Mills himself was an accomplice of Scourfield and they would both sometimes take control of a distressed company themselves, running it purely for their own financial benefit.
Scourfield, Mills, his wife and two others received sentences totalling more than 47 years for their criminal enterprise while Lloyds Bank, who consequently took over HBOS after the events had occurred, are continuing to work with the Financial Conduct Authority to determine if they have any responsibility to pay compensation to the victims of the scam.
Although best known as a radio and TV personality, Noel Edmonds was also a successful businessman in his own right.
His company, the Unique Group, was an umbrella corporation for his various business interests, TV shows and spin offs. The group went into receivership in 2007 although it later transpired as a result of the activities of the HBOS cartel.
Edmonds has been seeking compensation from Lloyds ever since the criminality was revealed including setting up an online radio station dedicated to denigrating Lloyds’ conduct, the behaviour of its board and highlighting other financial misdeeds. Just this week he attended and disrupted the annual shareholders meeting, asking how many separate police forces were investigating them for criminality.
We should point out that he’s not pursuing Lloyds as the former director and main shareholder of the Unique Group as Reflective Loss doesn’t allow this. His action is based on a separate compensation fund set up by the bank to compensate customers.
The legal status of the reflective loss rule has recently come under challenge from an unusual source.
A group of MP’s who make up the All-Party Parliamentary Group on Fair Business Banking have taken the unique step of intervening in an active court case and are asking the Supreme Court to consider whether the rules on reflective loss should be changed.
Kevin Hollinrake, MP for Thirsk and Malton and Co-Chair of the group said: “We are delighted the Supreme Court have allowed us to make this unprecedented intervention.
“The mechanisms in place for the directors and shareholders of insolvent businesses to obtain redress and receive compensation for creditor misconduct are unsatisfactory.
“We hope to establish that the rule against reflective loss must not restrict the rights of these individuals to bring a claim, and must not restrict them from accessing justice when their business has been taken from them through misconduct of their bank.”
Noel Edmonds’ story is just one example that might meet the legal criteria of reflective loss but fails the fairness test. Explain the details to a layperson and they would probably share his outrage that directors who had sometimes dedicated their entire lives to building a business have no redress if it’s destroyed by third party actions.