Does “Reflective Loss Principle” Applies Across The Board?
Does the reflective loss principle apply across the board or only to a specific group of people? This issue was recently dealt with by the high court in Agathisfour Sdn Bhd v Papparich Group Sdn Bhd. We will briefly look at it in the article below.
Brief facts of the case
Agathisfour entered into a share sale and subscription agreement and a shareholder agreement with Papparich Holding and Papparich Malaysia. TLDR, both agreement dictates that:
- Agathisfour acquires shares and new ordinary shares in Papparich Malaysia from Papparich Holding who was that time the holding company of Papparich Malaysia;
- Papparich Malaysia will be the holding company for the Malaysia Paparich Group; and
- Papparich Holding will settle any intercompany advances owed to them and their subsidiaries to Papparich Malaysia and its subsidiaries.
As a result (stemming from both agreements), Agathisfour became a ‘first-degree’ shareholder in Papparich Malaysia and a ‘second-degree’ shareholder in Papparich Malaysia subsidiaries.
Papparich Holding fails to settle the advances they owed. Aggrieved by Papparich Holding’s failure to settle the advances, Agathisfour commences two winding-up petitions against Papparich Holding. They were also sued in another suit in which Agathisfour compelled them to pay up the advances owed to Papparich Malaysia (via an application of specific performance) and its subsidiaries.
Agathisfour claimed that Papparich Group’s failure to uphold its end of the agreement has cause Agathisfour to suffer loss in the form of a diminution in share value in Papparich Malaysia. Agathisfour also claimed damages against Papparich Group as a ‘second-degree’ shareholder for the loss it suffered as the shareholder in Papparich Malaysia subsidiaries.
The court’s decision
The court did not entertain Agathisfour’s claim. The court (amongst others) noted that the principle of reflective loss applies in this case and that the principle applies broadly i.e. to both ‘first degree’ and ‘second-degree’ shareholders and not just first degree shareholders of a company.
The court’s rationale
So why does the reflective loss principle apply to a second-degree shareholder as well? The reason, as the court puts it, is as follow:
“But I do not agree that the reflective loss principle has no application to a second or third-degree shareholder… It is a strange result indeed that a claim by a second-degree shareholder for loss in the diminution of his share value or its distribution is recognized as a separate and distinct loss when the rule bars the first-degree shareholder from pursuing its claim against the wrongdoer (even if the loss-suffering company does not pursue its own right of action) on the ground that the first-degree shareholder does not suffer a loss which is recognized in law as having an existence distinct from the loss-suffering company’s loss. The rationale for not recognizing a separate and distinct claim vested in a first-degree shareholder for his loss in diminution of his share value is that the company’s control over its own cause of action would be compromised and the rule in Foss v Harbottle could be circumvented. In my opinion, this rationale applies with equal force in the case of the second-degree shareholder’s claim in that the first-degree shareholder company’s claim would be compromised if the second-degree shareholder’s claim is recognized as a separate and distinct claim.”
Essentially, if a so-called ‘first-degree’ shareholder is barred from claiming loss (based on the reflective loss principle), why would a ‘second-degree’ shareholder be treated any differently?
Back to our question: Yes, the reflective loss principle applies across the board.