Some relevant authorities
15 In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] 1 Ch 204 a shareholder brought a derivative action, alleging conspiracy by directors to defraud a company. He also claimed personally, relying upon the same facts. At 222-223 the Court of Appeal said:
"In our judgment the personal claim is misconceived. It is of course correct, as the Judge found … that (the directors) in advising the shareholders to support the resolution approving the agreement, owed the shareholders a duty to give such advice in good faith and not fraudulently. It is also correct that if directors convene a meeting on the basis of a fraudulent circular, a shareholder will have a right of action to recover any loss which he has been personally caused in consequence of the fraudulent circular; this might include the expense of attending the meeting. But what he cannot do is to recover damages merely because the company in which he is interested has suffered damage. He cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend, because such a 'loss' is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. His only 'loss' is through the company, in the diminution in the value of the net assets of the company, in which he has (say) a 3 per cent shareholding. The plaintiff's shares are merely a right of participation in the company on the terms of the articles of association. The shares themselves, his right of participation, are not directly affected by the wrongdoing. The plaintiff still holds all the shares as his own absolutely unencumbered property. The deceit practised upon the plaintiff does not affect the shares; it merely enables the defendant to rob the company … .
Counsel for the plaintiffs sought to answer this objection by agreeing that there cannot be double recovery from the defendants, but suggesting that the personal action will lie if the company's remedy is for some reason not pursued. But how can the failure of the company to pursue its remedy against the robber entitle the shareholder to recover for himself? What happens if the robbery takes place in year 1, the shareholder sues in year 2, and the company makes up its mind in year 3 to pursue its remedy? Is the shareholder's action stayed, if still on foot? Supposing judgment has already been recovered by the shareholder and satisfied, what then?"
16 Prudential establishes that even if the shareholder has a personal cause of action apart from that of the company, he or she cannot recover for a diminution in share value which reflects a loss suffered by the company as a result of the same conduct.
17 In Australia the leading authority is the decision of the High Court in Gould v Vaggelas (1983-1985) 157 CLR 215. In that case a husband and wife (the "Goulds") were induced by misrepresentation to purchase a tourist resort on terms which included the transfer to the vendors of valuable property and a mortgage-back to them to secure the balance of the purchase price. A company (the "company") was formed and the purchase completed, using it as the purchasing vehicle. The Goulds were the only shareholders. They funded the purchase, their advances being treated as loans in the books of the company. They also guaranteed its obligations to the vendors ("Vaggelas"). The company defaulted in repaying the purchase price. Vaggelas exercised his power of sale under the mortgage, also suing the husband and wife as guarantors. They counter-claimed for damages for deceit. The company was wound up. The liquidators had no funds with which to proceed against Vaggelas. The Goulds did so, claiming loss of funds advanced, including those advanced to, or on behalf of the company. Relying on Prudential, Gibbs CJ said at 219-220:
"Any loss suffered by (the company) as a consequence of the fraud can be recovered only by the company itself. Even if the company had not commenced an action within the limitation period, its failure to enforce its own rights would not have enhanced the rights of the Goulds … . However, although the Goulds cannot recover damages merely because (the company) has suffered damage, and cannot recover damages which are merely a reflection of a loss suffered by the company, they may recover damages for the loss which they personally have suffered and which is separate and distinct from the loss suffered by the company."
18 At 245-6 Wilson J, after referring to Prudential, said:
"The facts of Prudential Assurance do not present any analogy with the present case. The Goulds do not sue as shareholders of (the company). They sue in their personal capacity as individuals who were induced by Mr Vaggelas' fraudulent misrepresentations to part with their own property. They have suffered personal loss by making their own property available to enable (the company) to complete the purchase unless it be that the value of that advance to the company was offset by the value of the debt owed to them by the company. They also suffered personal loss if it be held that the fraudulent misrepresentations induced them to give the personal guarantees and securities which have deprived them of their property."
19 At 253, Brennan J (as his Honour then was) said:
"The Goulds cannot sue in their own names for the company's loss …; they can recover only the loss suffered by them in acting upon the fraudulent misrepresentations which Mr Vaggelas made. They did not act upon those representations by becoming the purchasers of the resort but by forming the company, by providing it with funds to complete the contract to purchase the resort and by guaranteeing the company's borrowings needed to improve the resort and provide working capital. No doubt it was a matter of indifference to the Vaggelas interests whether the Goulds chose to buy the resort personally or by forming a company to be the purchaser, but the terms of the contract show that the formation of the company to complete the purchase and conduct the resort was contemplated by the parties. The representations were calculated to induce the Goulds either themselves to buy or to form a company to do so and, in the latter case, to provide to or procure for the company the funds it would need to complete the purchase of the resort and to conduct the resort. It is the loss, if any, suffered by the Goulds in acting in this way which is recoverable in this action. The Goulds' loss is the loss suffered by a creditor of the company which, apart from its cause of action in deceit, is worthless.
If a defendant, D, by fraudulent misrepresentations made to a plaintiff, P, induces P to lend money to a worthless company, C, whereby the money lent is lost, D is liable for damages in deceit to P. That is clear enough where C is under D's control and there is no difference in principle when C is not under D's control."
20 At 256-258, Brennan J summarized the views as to measure of damages expressed by members of the Full Court of the Supreme Court of Queensland in the decision under appeal, namely that the company had a cause of action, the value of which would have been translated to the Goulds had it prosecuted its cause of action. His Honour then continued (at 257-8):
"In my respectful opinion, these approaches fail to take account of the distinct causes of action vested in the company and the Goulds respectively … . Once it is recognized that the Goulds' cause of action is distinct from the company's there can be no question of the Goulds' appropriating the company's cause of action or of measuring the Goulds' damages by what the company could have recovered at some earlier time. In assessing the Goulds' loss, the value of the company's cause of action is relevant to the value of the company debt so far as it might show what the company was likely to pay the Goulds; but the value of the company debt is a matter of fact, not to be ascertained by reference to the measure of damages which might have been recovered by the company if it had sued. The relevant question in determining the Goulds' damages was whether the company would more probably than not be able to pay some or all of what it owed the Goulds. In fact, the company has never been likely to pay the Goulds anything."
21 It seems that the shares in the company were never worth anything. At the point of incorporation the company had no assets and thereafter, the value of such assets as it had was exceeded by value by its debts. In any event, with the benefit of hindsight it was clear that the Goulds would derive no financial benefit from that source. Brennan J considered that the Goulds' status as shareholders did not affect their entitlement to recover amounts lost. Any claim which they may have had against the company was relevant only to the extent that it went in reduction of the loss which they had otherwise suffered.
22 Dawson J dissented. At 268-270 his Honour said:
"It is essential to bear in mind that what the Goulds initially did was to subscribe for two shares in the capital of Gould Holdings and to lend, in effect, a sum of money to that company. They did not purchase the tourist resort in reliance upon Vaggelas's fraudulent misrepresentations; the purchase was by the company. Nor did the Goulds continue to run the tourist resort for some time after the purchase was made; it was the company which did that. There is no reason why the calculation of the Goulds' loss should not be made at the time at which the expenditure which was said to result in loss to them was made. …
At the time Gould Holdings purchased the tourist resort it suffered a loss as a direct result of the fraudulent misrepresentations which induced the purchase. The business was worth less than it was represented to be and at that time, upon the findings of the trial judge, the company had a cause of action in deceit against the Vaggelases and the vendor companies. … What is important is that the company suffered loss at the time of purchase as a direct result of the inducement fraudulently offered by Vaggelas. It was tricked into buying the tourist resort by statements representing it to be something which it was not and its worth was less than it was represented to be. With this may be contrasted the position of the Goulds. They were not tricked into subscribing for shares in the company by any representations that the shares were, or would be, something which they were not. … Moreover, at the time they acquired the shares and made the loan, the Goulds suffered no loss. They received exactly what they had bargained for. Even if their position is assessed at the time of the purchase of the tourist resort by the company and by reference to that event, the Goulds suffered no loss by reason of what they did. The company suffered a loss at that time but that loss gave rise to a good cause of action which, if pursued to judgment, must, it appears from the evidence, have allowed recovery by enabling the amount of the judgment to be set off against the amount of purchase price which remained to be paid. The Goulds, as the sole shareholders in Gould Holdings, were entitled to the benefit of the company's assets, which must be taken to have included the cause of action in deceit. Upon this basis, their investment in the company caused them no loss. See (Prudential) … . It is true that the investment turned out to be less profitable than the Goulds anticipated but that was because of the events which ensured; it was not a direct consequence of the fraudulent misrepresentations made by Vaggelas, however much it may have followed as an indirect consequence.
The expenses which the Goulds incurred after their initial investment were for the purpose of keeping the company trading. They were not tricked into giving guarantees or mortgaging property by the deceit of Vaggelas nor could their losses in this regard be said to be the direct consequence of the fraudulent misrepresentation of the tourist resort. … It was the company, not the Goulds, which continued to carry on business, thereby necessitating further financial contribution by the Goulds. If the company suffered direct consequential loss from Vaggelas's deceit in addition to paying more for the business than it was worth, then any action to recover that loss must be by the company. It cannot be recovered indirectly by the Goulds in an action to recover their investment.
The majority in the Full Court, in rejecting the conclusions of the trial judge, recognized the distinction between the position of Gould Holdings and that of the Goulds themselves but sought to overcome the problem by 'identifying the respondents with the company and depriving the company of the right to further relief'. On any view such an approach cannot be sustained. The result would be to afford to the Goulds a derivative action for which there is no legal basis and which would, in any event, be defeated by the rule in Foss v Harbottle … . Moreover, even if it could be done, it would be quite wrong to bar any claim for deceit which Gould Holdings might have. That company has substantial creditors who ought not be deprived of the benefit of such a claim. …"
23 The New Zealand Court of Appeal considered a similar question in Christensen v Scott [1996] 1 NZLR 273. The plaintiffs were shareholders in a company (the "company") which grew potatoes. They caused it to take a lease of land for that purpose. The land was mortgaged, but those advising both the company and the plaintiffs (the "advisers") did not ensure that the mortgagee's consent to the lease was obtained. The plaintiffs guaranteed an advance to the company. The lessors defaulted under the mortgage, and the mortgagee went into possession, denying the company access to its potato crop. The mortgagee then went into liquidation, and the company went into receivership. The company claimed damages from various parties, including the advisers. The plaintiffs commenced their own action against the advisers and sought to prosecute it. Those proceedings were struck out. On appeal Thomas J, with whom the other members of the Court agreed, referred to Prudential and continued at 280:
"We do not need to enter upon a close examination of (Prudential). It has attracted not insignificant and, at times, critical comment. …. It may be accepted that the Court of Appeal was correct, however, in concluding that a member has no right to sue directly in respect of a breach of duty owed to the company or in respect of a tort committed against the company. Such claims can only be brought by the company itself or by a member in a derivative action under an exception to the rule in Foss v Harbottle … . But this is not necessarily to exclude a claim brought by a party, who may also be a member, to whom a separate duty is owed and who suffers a personal loss as a result of a breach of that duty. Where such a party, irrespective that he or she is a member, has personal rights and these rights are invaded, the rule in Foss v Harbottle is irrelevant. Nor would the claim necessarily have the calamitous consequences predicted by counsel in respect of the concept of corporate personality and limited liability. The loss arises not from the breach of the duty owed to the company but from a breach of duty owed to the individuals. The individual is simply suing to vindicate his own right or redress a wrong done to him or her giving rise to a personal loss.
We consider, therefore, that it is certainly arguable that, where there is an independent duty owed to the plaintiff and a breach of that duty occurs, the resulting loss may be recovered by the plaintiff. The fact that the loss may also be suffered by the company does not mean that it is not also a personal loss to the individual. Indeed, the diminution in the value of Mr and Mrs Christensen's shares in the company is by definition a personal loss and not a corporate loss. The loss suffered by the company is the loss of the lease and the profit which would have been obtained from harvesting the potato crop. That loss is reflected in the diminution in the value of Mr and Mrs Christensen's shares. They can no longer realize their shares at the value they enjoyed prior to the allege default of their accountants and solicitors. …
In circumstances of this kind the possibility that the company and the member may seek to hold the same party liable for the same loss may pose a difficulty. Double recovery, of course, cannot be permitted. The problem does not arise in this case, however, as the company has chosen to settle its claim."
24 The House of Lords has recently considered the same question in Johnson v Gore Wood & Co (a firm) [2002] 2 AC 1. The plaintiff carried on business through a number of companies. One of his businesses involved property development which he carried on through a company called Westway Homes Ltd ("WWH"), of which company he was managing director and holder of all but two of the issued shares. The plaintiff instructed the defendant, a firm of solicitors, to act for WWH in connection with the proposed acquisition of land for redevelopment. The plaintiff had previously retained that firm to advise him personally with regard to the same transaction. WWH held an option to purchase the land and instructed the defendant firm to serve a notice exercising that option. They did so, but the validity of such exercise was challenged. WWH successfully obtained an order for specific performance. However there was significant delay in the conveyance of the land to WWH, and it suffered substantial loss as a result. WWH sued the defendant. A duty of care was admitted, but breach was denied. After further delay and a lengthy trial, the claim was compromised, the defendant paying a substantial amount to WWH. In subsequent proceedings the plaintiff claimed personal loss. He had participated in the conduct by WWH of the earlier proceedings and in the settlement negotiations.
25 The heads of damage claimed by the plaintiff appear from the judgment of Lord Bingham of Cornhill at pp 36-37. They included:
(1) Sums lost as a result of the plaintiff's investment in certain companies, acting on the advice of the solicitors;
(2) Costs of borrowing loan capital and interest at punitive rates to fund personal outgoings and those of his businesses;
(3) Diminution in value of pension arrangements and majority shareholding in WWH;
(4) Loss of 12.5% of the plaintiff's shareholding in WWH, which shares were transferred to a lender as security and could not be redeemed because of lack of funds; and
(5) Additional tax liability.
26 Lord Bingham said at 35-36:
"As the Court of Appeal pointed out in (Prudential):
"A derivative action is an exception to the elementary principle that A cannot, as a general rule, bring an action against B to recover damages or secure other relief on behalf of C for an injury done by B to C. C is the proper plaintiff because C is the party injured, and, therefore, the person in whom the cause of action is vested."
Here, it was argued, Mr Johnson was seeking to recover damages which had been suffered by WWH.
Mr Johnson's response was equally simple. It was accepted, for purposes of the application to strike out the damages claim, that (the defendant) owed a duty to him personally and was in breach of that duty. Therefore, subject to showing that the damage complained of was caused by (the defendant's) breach of duty and was not too remote, which depended on the facts established at trial and could not be determined on the pleadings, he was entitled in principle to recover any damage which he had himself suffered as a personal loss separate and distinct from any loss suffered by the company.
…
These authorities support the following propositions: (1) Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder's shareholding where that merely reflects the loss suffered by the company. A claim will not lie by a shareholder to make good a loss which would be made good if the company's assets were replenished through action against the party responsible for the loss, even if the company, acting through its constitutional organs, has declined or failed to make good that loss …. (2) Where a company suffers loss, but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in value of the shareholding. … (3) Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it, but neither may recover loss caused to the other by breach of the duty owed to that other. …
These principles do not resolve the crucial decision which a court must make on a strike-out application, whether on the facts pleaded a shareholder's claim is sustainable in principle, nor the decision which the trial court must make, whether on the facts proved the shareholder's claim should be upheld. On the one hand the court must respect the principle of company autonomy, ensure that the company's creditors are not prejudiced by the action of individual shareholders and ensure that a party does not recover compensation for a loss which another party has suffered. On the other, the court must be astute to ensure that the party who has in fact suffered loss is not arbitrarily denied fair compensation. The problem can be resolved only by close scrutiny of the pleadings at the strike-out stage and all the proven facts at the trial stage: the object is to ascertain whether the loss claimed appears to be or is one which would be made good if the company had enforced its full rights against the party responsible, and whether (to use the language of Prudential …) the loss claimed is "merely a reflection of the loss suffered by the company". In some cases the answer will be clear, as where the shareholder claims the loss of dividend or a diminution in the value of a shareholding attributable solely to depletion of the company's assets, or a loss unrelated to the business of the company. In other cases, inevitably, a finer judgment will be called for. At the strike-out stage any reasonable doubt must be resolved in favour of the claimant."