Background
The Court found two former directors of ex-high street clothing giant British Home Stores (BHS) personally liable for wrongful trading and misfeasance in the lead-up to BHS' insolvency in 2016. The original judgment (a whopping 533 pages long) found that the directors must pay creditors at least £18 million for wrongful trading. On 19 August 2024, the Court also ordered the directors to pay over £100 million in respect of "trading misfeasance". The decision may introduce a new avenue to recover from directors who fail to satisfy their duties, and provides useful guidance for insolvency practitioners as to how a claim for wrongful trading and misfeasance might be assessed by the court.
When a company is wound up, a liquidator (and, in certain circumstances, a creditor or contributor of the company) can apply to the court to order a director to compensate the company for its losses under the Insolvency Act 1986 ("the 1986 Act").
When BHS collapsed, it left behind a substantial pension deficit and billions of pounds worth of trading liabilities. In Wright v Chappell [2024] EWHC 1417 (Ch) (“the BHS case”), the joint liquidators brought a claim against the directors of four of BHS' group companies for wrongful trading (Section 214 of the 1986 Act) and misfeasance (Section 212 of the 1986 Act).
The liquidators sought to prove that the directors, from the date of their appointment, either knew or ought to have known that there was no real prospect that BHS would avoid insolvent liquidation. They also alleged that even if the directors were not liable for wrongful trading, they failed to consider the interests of its creditors. If they had done so, they would have immediately filled for administration upon their appointment as directors.
Wrongful trading
Wrongful trading cases are rare, so when a case is reported it often attracts significant attention in the legal and commercial world. Wrongful trading is designed to cover situations where directors recklessly overtrade, pay themselves large fees or run up credit when the company is obviously heading towards liquidation. As commented on by the court in the BHS case, the bar for a liquidator to make a successful claim for wrongful trading is a very high one.
Under section 214 of the 1986 Act, the directors will be liable if:
1. the company is in insolvent liquidation (i.e. liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up);
2. at some time before the commencement of the winding up, the directors knew or ought to have known that insolvent liquidation was inevitable (which the court in the BHS case called “Knowledge Condition”)
However, under 214(3) of the 1986 Act, the directors will not be liable if they can show that they took every step to minimise the potential loss to the company's creditors (assuming they knew there was no reasonable prospect the company would avoid insolvent liquidation), as they ought to have taken.
When considering section 214(3) in the BHS case, the court said that directors are not liable for wrongful trading simply because the company was insolvent. They will only be liable if they have no rational basis for continuing to trade and fail to take steps to minimise loss to creditors. The critical question the court had to consider was whether the directors could show that there was "light at the end of tunnel” in that they could genuinely, and with some good reason, believe that matters would improve.
The liquidators argued that there were six dates when “the light” had gone out and the Knowledge Condition referred to above was met. The court only accepted that insolvency was on inevitable on the final date, 8 September 2015.
An interesting point that arose out of the BHS case was the extent to which directors could rely on professional advice to demonstrate that they had fulfilled their duties. The directors sought to argue that where they had relied on the advice of reputable professionals, then, on the face of it, they had fulfilled their duties and should avoid liability. Whilst the court accepted those submissions as a general proposition, obtaining advice was not enough. The court said that the weight attached to professional advice depends on the exact advice sought, the knowledge the advisers had or assumptions they were asked to make, and whether the directors had actually considered and followed that advice.
The court concluded that it was the duty of the directors themselves (not their legal advisors) to decide whether there was a reasonable prospect of avoiding insolvent liquidation.
Misfeasance claim
A misfeasance claim under Section 212 of the 1986 Act applies where directors use the company's assets for their own benefit without permission or in any other way that breaches their duties to the company.
Under Section 172 of Companies Act 2006, directors have a general duty to promote the success of the company. While that normally means they are to consider the interests of the shareholders as a whole, where the company is insolvent or nearing insolvency, the duty is modified to have regard to the interests of creditors.
Described as "the trading misfeasance claim", the court in the BHS case found that the directors had acted in breach of their duties by, amongst other things, taking expensive, fully secured loans without creditor consent to survive at a time when they knew (or ought to have known) that the company was cashflow insolvent. It was described by the court as a "degenerative strategy" and "insolvency deepening" activity that could amount to a breach of the directors’ duties even if there was no liability for wrongful trading. The court held that the directors did not consider the interests of BHS’ creditors. If they did, they would not have continued to trade but would have instead prioritised creditors' interests and gone into administration immediately.
The Court held the directors jointly and severally liable for £110,230,000 in respect of breaches of duty.
What can we learn from this case?
This was the first time a "misfeasance" trading claim had been upheld by the courts. Interestingly, the date that the directors were held to have been in breach of their duties was 26 June 2015, three months earlier than the relevant date for wrongful trading. The bar for director misfeasance, therefore, appears to be lower than wrongful trading. It may be that in the future, we see liquidators plead director misfeasance alongside any claim for wrongful trading in order to increase the chances of a successful recovery.
For directors facing financial difficulties, the key takeaway is to ensure they exercise independent judgement and follow advice. While the bar for wrongful trading remains high, directors must be aware of their duty to consider the interests of creditors when a company is nearing insolvency.
It will be interesting to see how the case law develops following this decision.
This article was written by Senior Solicitor Alex Robertson.
