The Prudential principle and reflective losses

The principle established by the Court of Appeal in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 is that a shareholder cannot sue to recover damages for themselves in relation to wrongs done to the company. The proper course is to bring a derivative action on behalf of the company. Any recovery will flow through to the shareholders in the form of an increase in the value of their shares. The primary justification for the rule is said to be to avoid double recovery.

Application of this principle arose for consideration in David Ballard v Multiplex Limited [2008] NSWSC 1019 with respect to two heads of damages: liability as a guarantor; and deprivation of income and dividends. Mc Dougall J held that the principle did not apply in the first case but did in the second.

In relation to the guarantee, this was a liability that the shareholder was legally obliged to pay because the company was incapable of meeting its obligations. If the shareholder were to recover judgment for the payments, there would be no question of the defendants being exposed to double liability. Nor would there be any question of the company's assets being depleted by the recovery.

However McDougall J classified the shareholder's claim for loss of income and dividends arising because the company had lost earnings (as a consequence of the actions of the defendants) as a reflective claim. The shareholder submitted that because the company had been wound up and dissolved, there was no prospect that it would sue or recover the underlying losses, so that the policy reasons underlying the Prudential principle did not apply and nor should the principle. The court rejected that submission.

Comment

The Prudential principle was considered by the House of Lords in Johnson v Gore Wood & Co (a firm) [2002] 2 AC 1. In that case, the House of Lords recognised that there were exceptions to the principle, one of which applied where the shareholder's claim was based on lost dividends or a fall in value of the plaintiff's shares, but the company did not have a cause of action. The reason for the exception was that on these unusual facts there is no risk of double recovery. Indeed if the shareholder were unable to pursue their personal action, there would be no recovery at all (direct or indirect). However, the House of Lords qualified this exception by saying that the shareholder can sue to recover their losses assuming they are quantifiable; not too remote; and there is a separate duty owed to the shareholder.

This final requirement, namely that there be a separate duty owed to the shareholder, arguably explains the court's decision in Ballard v Multiplex. Another way of expressing the policy operating in this situation might be to say that the loss to the shareholder is caused by the company's failure/inability to pursue its remedy and not by the defendant's wrongdoing.

In some situations, the effect of this decision might be able to be overcome by reinstatement of the company.