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Reflective loss and trusts – some clarity at last

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Reflective loss and trusts – some clarity at last

Paul Buckle, Director at Trust Corporation International, part of the Ocorian group, examines the principle of reflective loss and how it interacts with trusts in the Crown Dependencies.

Readers may be aware of a principle of company law in the Crown Dependencies known as ‘reflective loss’. This says that where a company suffers a loss due to the actions of another party, the company and not the shareholders can bring a claim for recovery.

This principle has gradually encroached into other contexts in recent years. This includes the scenario where a trust owns an underlying company that suffers a loss and the beneficiaries sue the trustee for failure to supervise the affairs of the company, or to make the best use of its controlling shareholding. In that event, reflective loss may provide a complete defence for the trustee. However, the point has been doubted in Guernsey and Jersey.

UK Supreme Court provides clarity on reflective loss

Thankfully, a 2020 UK Supreme Court (the Supreme Court) decision, where the reflective loss defence was raised against a company unsecured creditor, found the defence held only where a shareholder brought the claim and not a creditor or, by implication, anyone else (such as a beneficiary).

The reasoning was that reflective loss was a rule of company law that applied only to shareholders and prevented them from personally claiming a loss that was the loss of the company alone. Company law established that a shareholder entrusted the company’s management to its directors or, if the law or the articles so provided, to the shareholders acting by majority in general meeting. It was for those persons alone to decide whether to cause the company to recover its loss. To allow a shareholder a concurrent claim to the same loss would subvert that fundamental rule.

The position was therefore clear: only shareholders could be barred by the rule from proceeding, and the minority still had the remedies of a derivative action or an unfair prejudice application to address unlawful or irresponsible management. That the Supreme Court confirmed the rule applied only to shareholders should mean it can no longer be an answer to a claim for breach of trust by a beneficiary against a trustee.

In May this year, following trial in September 2019, McMahon, Bailiff, issued a judgment in the Guernsey case of Pilatus (PTC) Limited v RBC Trustees (Guernsey) Limited. The judgment confirmed the rule against reflective loss was part of Guernsey law but followed the approach in the Supreme Court to say it did not offer a former trustee a defence when it was sued by its successor. That should be the position where, for instance, the directors cause the company to make a disastrous investment; where the beneficiary’s claim is against the trustee for improperly causing the company to sanction or ratify the directors’ conduct or for dishonestly assisting the directors in a breach of their fiduciary duty.

If for some reason the rule does still apply in the trust context, the best option for the trustee is to take steps to remove the directors or, if a minority shareholder, to pursue an alternative remedy.

You may be wondering how all this squares with the trustee’s Bartlett duty of conducting trust business with prudent care and the anti-Bartlett clauses by which most trusts seek to oust that duty. Given that reflective loss is no longer available as a defence to an action for breach of trust, a trustee’s ability to rely on any anti-Bartlett clauses and the extent they are fully effective, even post-DBS, becomes all the more important where an underlying company suffers loss. 

Trusted solutions

Our Private Client team consists of trust, company and foundation specialists, administrators, lawyers and accountants, whose skills and experience add value during the full life cycle of wealth structures and who can help you to develop and implement solutions that comply with all legal and regulatory requirements.

Contact Paul below to discuss your trust arrangements.

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