The Rule Against Reflective Loss After Hlumisa: What Shareholders and Their Advisers Need to Know

There is a category of claim that finds its way into South African litigation with persistent regularity, and with persistent failure: the shareholder's action for diminution in share value caused by the misconduct of the company's directors or auditors. It arrives dressed in the language of section 218(2) of the Companies Act 71 of 2008, and it is advanced with considerable ingenuity. It rarely succeeds. The Supreme Court of Appeal's judgment in Hlumisa Investment Holdings RF Ltd and Another v Kirkinis and Others 2020 (5) SA 419 (SCA) has, for the time being, explained why.

Understanding what the SCA decided — and, just as importantly, what it did not decide — is essential for shareholders, directors, auditors and their legal advisers. The stakes in the Hlumisa litigation were R721 million and R1.3 billion respectively. The stakes in the broader question are higher still.

The Rule and Its Rationale

The rule against claims for reflective loss is not a recent South African invention. It is a common law principle of long standing, recognised in this jurisdiction both before and after the promulgation of the Companies Act 2008. Its rationale is straightforward: a company is a distinct juristic person. Property that vests in the company does not vest in its shareholders. When the company suffers loss — through the misconduct of its directors, or the negligence of its auditors — the loss is the company's. The shareholder's diminished share value is a consequence of that loss, not an independent loss suffered by the shareholder in his or her own right.

The practical consequence is that the claim for that loss belongs to the company. It is the company that should sue. If the company declines to do so, or is unable to do so because the same directors who caused the loss control the litigation decisions, there are remedies — derivative action under section 165 of the Companies Act being the most obvious. But the individual shareholder does not have a freestanding right to sue for the diminution in the value of their shares merely because that diminution was caused by someone else's wrong.

This principle was not in serious dispute before the SCA in Hlumisa. What was in dispute was whether section 218(2) of the Companies Act had changed it.

The Section 218(2) Argument

Section 218(2) provides that any person who contravenes any provision of the Companies Act is liable to any other person for any loss or damage suffered by that person as a result of the contravention. The appellants in Hlumisa argued that this provision was a statutory cause of action that operated independently of the common law — and that it extended to shareholders who had suffered loss as a result of directors' contraventions of sections 22(1), 45, 74 and 76(3) of the Act.

The argument had a certain textual plausibility. 'Any person' is broad language. 'Any loss or damage' is broad language. If the section means what it says on its face, a shareholder who can point to a director's contravention of the Act and establish that the share value diminution flowed from that contravention would appear to have a claim.

The SCA was not persuaded. Its reasoning proceeded on several grounds, each independently sufficient to defeat the claim.

First, the presumption against the abrogation of common law principles. Statutes do not abrogate established common law principles unless they do so expressly or by necessary implication. Section 218(2) does neither. It creates a liability for contraventions of the Act, but it does not expressly abolish the reflective loss rule, and its terms do not necessarily imply such an abolition.

Second, the nature of the duties the directors owed. Directors' duties under the Companies Act are owed to the company, not to individual shareholders. The SCA noted that section 77(2)(b) makes directors liable 'in accordance with the principles of the common law' — a deliberate preservation of common law principles, including the principle that the remedy for breach of directors' duties lies in an action by the company, not by its shareholders individually.

Third, in relation to the auditors' liability, the SCA emphasised that the auditors owed their duties primarily to the company as a body, not to individual shareholders. Imposing liability to individual shareholders would raise the spectre of indeterminate liability — liability to an unascertainable class of persons for an unascertainable quantum — which the law has consistently declined to countenance.

What Hlumisa Does Not Decide

The SCA's judgment is careful about its scope. It does not hold that section 218(2) is a dead letter. It holds that the section does not create a cause of action for reflective loss — loss that is properly the company's. Where a shareholder has suffered loss that is genuinely independent of the company's loss — a direct wrong done to the shareholder in their capacity as shareholder, not a wrong done to the company whose consequences flow through to the shareholder — the analysis may be different.

The judgment also leaves open the question of whether the rule against reflective loss might be modified or abrogated in particular circumstances by other provisions of the Companies Act or by the development of the common law. These are questions for another day and, no doubt, another set of appellants with another set of facts.

The Practical Consequences

For shareholders who believe they have been damaged by the misconduct of directors or auditors, Hlumisa is a significant constraint. The instinct to sue personally — to bring a claim in one's own name for the diminution in share value — is understandable. But it is, in the ordinary case, the wrong instinct. The right question to ask is whether there is a claim that belongs to the company, and whether that claim can be brought on the company's behalf.

The derivative action under section 165 of the Companies Act exists precisely for this situation. It allows a shareholder to bring proceedings on behalf of the company where the company itself has failed or refused to do so. It is a procedurally demanding route — there are notice requirements, leave requirements, and costs considerations that do not arise in a direct action — but it is the route that the law has provided.

For legal advisers, the lesson of Hlumisa is not simply that reflective loss claims fail. It is that the framing of the claim matters from the outset. A claim that is properly characterised as a derivative action, brought under section 165, is a fundamentally different legal exercise from an attempt to plead around the reflective loss rule under section 218(2). Getting the framing right at the pleading stage avoids the exception that the defendants in Hlumisa brought with eventual success — and the years of litigation that followed.

For directors and auditors, Hlumisa provides a measure of comfort. It confirms that their exposure to individual shareholder claims is not as broad as section 218(2) might appear to suggest on its face. Their exposure remains significant — the company itself can sue, and derivative actions remain available — but the spectre of indeterminate liability to all shareholders for every contravention of the Act has, for now, been laid to rest.

A Note on the Future

South African company law is a young body of jurisprudence relative to its English and Australian counterparts. The Companies Act 2008 is a sophisticated instrument, and the courts are still working through the implications of its various provisions in combination with the common law that preceded it. Hlumisa is an important data point, but it is not the end of the analysis.

It is worth watching whether future litigants develop arguments based on the constitutional right to just administrative action, the development of the common law under section 39(2) of the Constitution, or novel pleadings that attempt to characterise the shareholder's loss as genuinely independent of the company's. The SCA has closed one door. Others remain, at least partly, open.

Don Mahon SC is a Senior Counsel practising from the Maisels Group at the Johannesburg Society of Advocates, of which he is the current Chairperson. His practice encompasses company law, insolvency and business rescue, construction law, constitutional law and customary law. He appeared in the Hlumisa litigation.