Foss v. Harbottle[1] establishes the general rule that in any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself and no separate cause of action arises in favor of a shareholder. The shareholder’s loss is in effect the diminution of the value of his shares and is known as “reflective loss.” This loss is properly recoverable by the company rather than the shareholder.

The restriction on shareholders bringing claims to recover reflective loss is driven by public policy considerations to prevent a potential double recovery against the third party. If the company does not bring a claim to make good its loss, the shareholder may, in limited situations, bring a derivative action on behalf of the company.

There are some situations where a shareholder may have a personal claim which it is itself entitled to bring notwithstanding the rule in Foss v. Harbottle. These circumstances are again extremely limited and require that the shareholder has a claim which is separate and distinct from the company and that it has suffered a separate loss that is not reflective of the company’s loss.

The recent Cayman case of David Xiaoying Gao v. China Biologic[2] confirmed that such personal claims are only available in limited circumstances where the rule in Foss v. Harbottle is not engaged.

In China Biologic, the plaintiff, as a minority shareholder, brought a claim against the directors of the company on the grounds that his voting power had been diluted by an allotment of shares approved by the directors for an improper purpose. The court found that the shareholder lacked standing to assert a personal equitable claim against the directors for breach of fiduciary duty and that he should have sued the directors in a derivative capacity on behalf of the company and not in his personal capacity. The claim was therefore struck out.

The Cayman court referred to the following principles:

  • Directors are only answerable to the company for intra vires breaches of fiduciary duty because they are agents of the company and owe a duty of loyalty to the company. Shareholders are aware when they acquire shares in a company that their only means of control over that company is by passing resolutions in a general meeting. Individual shareholders cannot enforce duties which are not owed to them by the directors. However, since the company is unable to ratify an ultra vires act of a company, shareholders are permitted to bring proceedings under s.28 of the Companies Law to set aside ultra vires acts.
  • The situation is different where circumstances give rise to an individual right of action by a particular shareholder against the company in respect of a transaction which affects the shareholder, such as a contractual right to receive dividends. That is a situation of separate and distinct loss which is not reflective of the company’s loss.
  • Share allotments will usually affect all shareholders in the class in the same way and there is no basis to say that a share allotment could give rise to concurrent duties being owed to the company and the individual shareholders. Directors’ fiduciary duties are quintessentially owed to the company and any breach is therefore actionable by or on behalf of the company. Dilution of share voting rights does not therefore constitute an exception to the general rule in Foss v. Harbottle set out above.

The judgment in China Biologic is therefore ultimately a restatement of a venerable principle contained in Foss v. Harbottle.

In addition to China Biologic, the Cayman Court of Appeal also recently upheld the principles of Foss v. Harbottle in Primeo Fund v. HSBC.[3] This case added further color to the questions of capacity in which the shareholder brings the claim as well as the public policy reasons behind the reflective loss principle.

In this case, the defendant brought claims for damages against the administrator and custodian of the investments in a managed account owned and controlled by Bernard Maddoff, whose trading business turned out to have been wholly fictitious. The defendants argued that Primeo’s claims should be barred as a result of the reflective loss principle, on the basis that Primeo was seeking to recover losses suffered by way of a diminution in the value of its shareholdings in Herald and Alpha, and that Herald/Alpha were the proper plaintiffs to any claim.

In its judgment of June 13, the Cayman Court of Appeal noted the following points:

  • The reflective loss principle is not rooted solely in the avoidance of double recovery (although this is an important policy factor) and may apply where there is no prospect of that (for example, if the company’s claim is time-barred). The judgment discusses the policy reasons for barring reflective loss. In addition to preventing double recovery, including the following considerations taken from the recent English Court of Appeal decision of Garcia v. Marex Financial Ltd:[4]
    • The avoidance of conflicts of interest. If the shareholder has a separate right to claim it could discourage the company or the wrongdoer from making settlements; and
    • The need to preserve company autonomy and avoid prejudice to minority shareholders and other creditors. There is a risk that if shareholders are able to bring a direct claim against a third party, where a company also had a claim, it might “scoop the pool” by recovering from the third party in advance of the company, potentially leaving less for the other shareholders and creditors of the company.
  • The operation of the reflective loss principle does not depend on the capacity in which the plaintiff brings the proceedings. The test is whether the plaintiff’s loss would be made good if the company were successfully to pursue its claims.
  • The question of whether a loss is in fact reflective is to be tested in light of the circumstances that exist at the time when the claim is made. On this basis, the Court of Appeal dismissed Primeo’s argument that the reflective loss principle did not apply since Primeo was not a shareholder in either Herald or Alpha at the time it invested directly with BLMIS and it was irrelevant that it later became a shareholder.
  • The correct test when assessing the merits of the company’s claims is whether Alpha and Herald’s claims have “a real prospect of success” (rejecting Primeo’s argument that a more stringent merits test should be applied, whether the company’s claims were“likely to succeed”).


China Biologic and Primeo confirm that given the underlying public policy considerations guiding shareholder claims, which aim to prevent double recovery, avoid conflicts of interest and preserve company autonomy (avoiding prejudice to minority shareholders and other creditors), shareholders are unlikely to be able to bring a claim against a director or third party unless they have suffered loss due to a breach of an individual right owed to them personally by a director or third party, which is separate and distinct from the company’s loss and is not therefore reflective of the company’s loss.

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