Arising from the dramatic collapse of what was once one of Britain's most famous high street names, British Home Stores ("BHS"), the claims brought by the liquidators of the BHS group companies (the "BHS Group") against its former directors were already newsworthy. However, following the High Court's judgments on these claims, they may also be the most significant decisions on directors' liabilities in insolvency since the Supreme Court's decision in BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25.
In two decisions handed down this year (Wright and Rowley & Ors v Chappell & Ors [2024] EWHC 1417 (Ch) and [2024] EWHC 2166 (Ch)), Mr Justice Leech found the former directors liable for various breaches of their statutory duties under the Companies Act 2006 ("CA 06") and for Wrongful Trading under the Insolvency Act 1986 ("IA 86"). As a result, he ordered that they contribute substantial sums to the assets of the companies in compensation. In the case of two of these directors, they were held to be jointly and severally liable to contribute sums well in excess of £100 million.
These decisions are particularly significant because of the approach the Judge took to the claims that the directors had breached their directors' duty to act in the best interests of the companies and their creditors by continuing to trade the companies when it was clear that insolvency was "probable". Termed "Misfeasant Trading" by the Judge, these claims applied the "creditor duty" principles set out in Sequana and tested the relationship between Misfeasant and Wrongful Trading.
Background
The BHS Group was purchased by Retail Acquisitions Limited, and the defendants were appointed as directors of the companies within it, on 11 March 2015. Just over a year later, on 25 April 2016, the companies in the BHS Group entered into administration. Shortly thereafter, they moved into liquidation.
In the intervening period, the BHS Group entered into a number of transactions which the liquidators argued contributed significantly to its ultimate collapse. Further, they argued that these transactions left the BHS Group in a significantly worse financial position than it would have been had they entered into administration instead. The liquidators of the companies in the BHS Group therefore brought claims against the former directors seeking orders that they contribute to the assets of the companies to compensate for the losses caused by these transactions.
These claims were brought on the grounds of: Wrongful Trading (under s. 214 IA 86); Misfeasant Trading (under s. 212 IA 86); and other breaches of their directors' duties in relation to particular transactions (also under s. 212 IA 86). This article focuses on the Wrongful Trading and Misfeasant Trading claims.
The Wrongful Trading claim
The requirements for, and effects of, a claim in Wrongful Trading are set out in s. 214 IA 86.
The Judge summarised these as requiring that the director knew, or should have known, from a particular date that the company "cannot avoid insolvent liquidation", but nevertheless allowed it to continue trading. However, as the Judge made clear, it is not sufficient that the company is presently insolvent. It may be appropriate to continue trading an insolvent company if there is a prospect of recovering its position, and indeed the courts should "be slow to encourage directors to put a company into liquidation or administration at the first sign of trouble". Equally, a director's decision to continue to trade an insolvenct company must have some "rational basis". It cannot be based merely on "blind optimism or micawberism". The judge defined micawberism as an "unfounded and naïve belief that something will turn up".
In this case the Liquidators argued that there were six possible dates on which it could be said that the directors knew or should have known that the companies in the BHS Group could not avoid an insolvent liquidation. These dates ranged between 17 April and 8 September 2015.
Ultimately the Judge concluded that the directors knew, or should have known, that insolvent liquidation was unavoidable as of the last of these dates (8 September 2015). As such, they directors were liable for Wrongful Trading from that date.
Misfeasant Trading
The so-called Misfeasant Trading claims, on the other hand, were claims under s. 212 IA 86.
This section provides for claims by a company's administrators, liquidators or creditors against its former directors on a number of grounds. These include "breach of any fiduciary or other duty in relation to the company".
In the case of the Misfeasant Trading claims, these were claims for breaches of the directors' duties (under s. 172 Companies Act 2006 (CA 06)) to act in the best interest of the company, as modified to include a duty to act in the best interests of the company's creditors. As firmly established by the Supreme Court in Sequana, this modified duty (the so-called Creditor Duty) arises where the company is "insolvent or bordering on insolvency".
The judge was satisfied that the BHS Group companies were "insolvent or bordering insolvency", and therefore that the Creditor Duty had arisen, as of 17 June 2015. Reviewing the discussion in Sequana, the judge noted that the Supreme Court had left open the question of whether there was a knowledge threshold that must be met for a director to be held to have breached the Creditor Duty. If there is such a requirement, the Supreme Court had indicated that it would be that the directors "knew or ought to have known that insolvency was probable". Although he did not decide whether such knowledge was required, the Judge was satisfied that, if necessary, this threshold was met as at this date as well. Accordingly, as of this date the directors were potentially in breach of their duty under s. 172 CA 06.
The Judge accepted that if the directors could show that they had actively considered the interests of the creditors and "decided in good faith" that it was in the creditors' interests to continue trading, then the Misfeasant Trading claim would not succeed. However, the Judge did not consider that the directors had given any such consideration to the interests of the creditors. Accordingly, the Judge concluded that the directors were liable for Misfeasant Trading from 17 June 2015.
Quantum of the claims
It was accepted by the parties that, in respect of both Misfeasant and Wrongful Trading, the starting point for determining what contribution the directors should be ordered to make to the companies' assets was the "increase in net deficiency" (or IND) in the assets of the company following the relevant liability being triggered.
The parties had agreed the amount of the IND at each of the proposed dates on which liability could be said to have arisen. As at the 17 July 2015 (the date on which the Judge held that the directors became liable for Misfeasant Trading), the IND stood at c. £133.5 million and as at 8 September 2015 (the date on which the Judge held that the directors became liable for Wrongful Trading), the IND stood at c. £45.5 million (ie. c.£88 million less).
Wrongful Trading
The Judge held that under s. 214 IA 86 they had a wide discretion as to what contribution to order each director should make. He also considered that the IND of £45.5 million as at 8 September 2015 was both the starting point and the upper limit to what he could order they contribute.
Due to "the difference between their involvement and culpability", the Judge held that it would not be appropriate to treat the directors as being jointly and severally liable for the losses caused by the Wrongful Trading. The Judge ultimately concluded that Mr Chappell was liable for 50% of the IND, Mr Henningson and Mr Chandler for 15% each, and two further individuals (who were not party to the proceedings) for 10% each. As a result, he ordered that Mr Chappell should contribute £21.5 million, and that Mr Henningson and Mr Chandler should contribute £6.5 million each in respect of the Wrongful Trading.
Misfeasant Trading
Given the substantially higher potential liability of £133.5 million, and the fact that "this is a developing area of law", the Judge decided to have a further hearing on the approach to be taken to the contributions to be ordered in respect of the Misfeasant Trading. Between the first judgment and this further hearing, one of the Directors, Mr Chandler, settled the claims against him with the Liquidators. As a result, the Judge only made findings as to the appropriate contributions in relation to Misfeasant Trading in relation to Mr Chappell and Mr Henningson.
The Judge held that the liquidators had to prove that the directors' breach of duty was "an effective cause" of the loss for which they sought a contribution. However, the breach need not be "the sole or only effective cause". They must also show that the losses fell within the scope of the duty owed by the directors.
Applying these principles, the Judge was satisfied that the directors' decision to continue trading the companies after 17 June 2015 was an effective cause of the entire IND between that date and the companies' liquidation, with the exception of the increase in the pension deficit of £19 million. The Judge was also satisfied that these losses fell within the scope of their duty.
The Judge also concluded that the directors should be held to be jointly and severally liable for these losses and declined to exercise their discretion to limit or apportion the liability between them. Finally, he gave credit for a sum of £3.5 million paid by another former director in settlement of claims against them.
Taking all of these issues into consideration, the judge held that Mr Chappell and Mr Henningson were jointly and severally liable for a sum of £110,230,000 in respect of the Misfeasant Trading.
Where next for claims against directors of insolvent companies?
The conclusions reached by the Mr Justice Leech in these decisions will have a significant impact on the way that claims against directors are brought in the future.
In particular, unless these judgments are successfully appealed, it now appears that there is significant overlap between claims for Misfeasant Trading and Wrongful Trading. Moreover, claims in Misfeasant Trading allow insolvency practitioners to avoid having to meet the challenge of showing that the directors knew or should have known that the company "cannot avoid insolvent liquidation"; this is a very high threshold, and so Misfeasant Trading is likely to be a significantly easier route. As a result, it is likely that Insolvency Practitioners will seek to bring both, or even just Misfeasant Trading, claims, even where they claim the liability arose on the same date for both. It is also notable that the Judge considered that there was established legal authority for the apportionment of liability in relation to Wrongful Trading, but not in relation to Misfeasant Trading (where they held the directors to be jointly and severally liable for the full amount). This also means that Misfeasant Trading claims may give insolvency practitioners more scope for recovery where they have a number of defendant directors with different levels of assets.
From a director's perspective, one crucial point arising from this is that it will be a complete defence to a Misfeasant Trading claim if they can show that they considered the creditors' interests in good faith and concluded that it was in the creditors' best interests to continue trading (even if that conclusion was wrong). Another point that can be drawn from these decisions is that, if directors wish to rely on professional advice that they received in support of their decision to continue trading, then that advice must have been given to the directors themselves (and not the company). Further, the question of whether it was justifiable for the company to continue trading must have been clearly within the scope of the advice, and the advisors must have been given sufficient information to reach a properly informed conclusion as to the financial position of the company.
In any case, in the future, directors of companies facing financial distress will have to consider carefully both Wrongful and Misfeasant Trading, and the different tests and considerations they each raise. It may also be prudent to start considering such issues, and their personal obligations and potential liabilities, more directly and at an earlier stage than previously thought.