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Cayman Islands Court of Appeal delivers an important judgment on reflective loss

If, as a shareholder, the value of your shares in a company reduces due to a wrong committed against that company by a third party, can you sue the third party?

What if the company itself is prevented from suing the third party by reason of the wrongdoing (because, for example, the wrongdoers are in control of the company, or because the company cannot, as a result of the wrongdoing, afford to bring proceedings)?

What if the third party intends to cause you damage as a shareholder?

What is the position if you are a creditor and the company's assets, which would otherwise have been available to satisfy your debt, are similarly reduced by the wrongdoing of the third party?

Such issues have troubled the common law courts for decades. The Cayman Islands Court of Appeal has recently considered them once more (Zhikun v XIO GP Ltd).

In short, the position is that the court will strive to prevent shareholders from making a double recovery, whereby:

  • If the company can sue the third party, the shareholder cannot sue, because the company's claim would restore the loss to the company and, accordingly, restore the value of its shares thereby extinguishing the shareholder’s loss (the so-called "reflective loss" principle).
  • If the company has no cause of action against the third party, but the shareholder does, there is no risk of double recovery and the shareholder can sue.
  • If both the company and the shareholder have a cause of action, and have suffered separate loss, each may sue in respect of that loss.
  • If the company has a cause of action but cannot pursue it by reason of the wrongdoing, the shareholder may in certain circumstances be able to sue.
  • If the company can sue, but chooses not to, the shareholder still cannot sue the third party, but may have a derivative claim against the directors for breach of duty because the shareholder’s loss has been caused, not by the wrongdoing, but by the company's decision not to sue in respect of that wrongdoing.

The above principles apply even when the loss caused to the shareholder is intentional. Creditors stand in the same position as shareholders in respect of reflective loss.

The decision will be welcomed in common law jurisdictions for its clarity and scholarship.

Cayman Islands Court of Appeal delivers an important judgment on reflective loss

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