Former BHS directors in breach of duties and personally liable despite taking professional advice on insolvency. Where does this leave directors of distressed companies?

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Background

In March 2015, Retail Acquisitions Limited purchased the British Home Stores Group (the “BHS Companies”) for £1, debt free and with a pension deficit in the BHS pension schemes. This was well-publicised at the time and the circumstances were ultimately the subject of a government inquiry. New directors took office following the acquisition.

In 2016, the BHS Companies went into administration. Later that year, one of the companies, British Home Stores Limited, went into liquidation. The three remaining BHS Companies followed suit just over a year later. 

The liquidators of the BHS Companies issued claims against the companies’ former directors in 2020. The claims proceeded against two of the directors, Lennart Henningson and Dominic Chandler. The trial of a third director, Dominic Chappell was severed – it is reported that the High Court has recently ordered him to pay at least £50 million to cover losses incurred, following a finding that he took the “opportunity to plunder the BHS Group as and when he could”.

Liquidators’ claims

The liquidators brought three categories of claims against the former directors, under sections 212 and 214 of the Insolvency Act 1986 (“IA”), namely:

1. The “Wrongful Trading Claim”;
2. The “Trading Misfeasance Claim”; and
3. The “Individual Misfeasance Claims”.

The liquidators alleged that from the date of the acquisition and their appointment, the directors either knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation. This allegation formed the basis for the wrongful trading claim and the factual basis for the trading misfeasance claim. 

Wrongful trading

Wrongful trading occurs if a company has gone into insolvent liquidation or administration, and at a point in time before the commencement of the winding up or administration, a person who is or has been a director, knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration (the “Knowledge Condition”) but the company continued to trade and incur credit. 

Following a declaration of wrongful trading a director may incur personal liability for the increase in indebtedness arising after the point he or she knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation or administration. 

In assessing whether the director ‘knew or ought to have concluded’, the Court will apply a minimum objective test (based on what the individual director ought to have known in his position) and a more subjective test, depending on what he should have known given his personal expertise and qualifications. Accordingly, a qualified finance director is to be judged by a higher subjective standard than, say, a creative director. At the same time the minimum objective test implies some knowledge: being ignorant (wilfully or otherwise) is no excuse. 

There is a statutory defence to wrongful trading: from the moment when the director knew or ought to have reached the necessary conclusion, he or she took every step to minimise losses to creditors. Resignation and an assertion that the director acted reasonably and honestly are not defences. A finding of liability may also lead to disqualification from acting as a director.

In light of these matters, advice to directors of distressed companies will typically seek to ensure close monitoring of the insolvency position (has the company reached the point of no return?) and careful consideration of creditor interests and indebtedness. Written records of the particular decisions should be maintained.

Misfeasance

If, in the course of a winding up, it appears that a director has misapplied or retained, or become accountable, for any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty, the Court may order the director to repay, restore or account for money or property with interest or contribute to the company’s assets by way of compensation. 

Findings

Wrongful trading

The liquidators identified six “Knowledge Dates” on which they alleged that the former directors had the requisite knowledge to fix them with liability for wrongful trading. These ranged from around one month after the acquisition, to almost six months later, on 8 September 2015 (“KD6”). The Court dismissed the claim in relation to the first five dates but found that the Knowledge Condition was satisfied in relation to KD6. 

In reaching its decision in respect of wrongful trading, the Court reviewed the law and made a number of comments of note:

• The bar for establishing wrongful trading is a high one. 
• The fact of the insolvency of a company does not make the directors liable for wrongful trading – it is necessary that they knew or ought to have known that insolvent liquidation or administration could not be avoided and was now inevitable.  If the directors propose that the company can trade out of insolvency, this must be “more than fanciful”, rational and reasonable. They must also show that it was designed to minimise the risk of loss to individual creditors.
• The Court rejected the notion that it was necessary for the insolvency event to be within a specified or short period of the ‘Knowledge Date’ for wrongful trading liability to attach, finding that no time limit is imposed in section 214 IA and that each case would depend on its own facts: “it would create a real difficulty if the Court laid down a time limit or bracket even as a rule of thumb”. Conversely, a long delay between the relevant Knowledge Date and the decision to enter a company insolvency would be an “important evidential factor which the Court must weigh in the balance”.
• Section 214(4)(a) IA imposes a minimum objective standard of the general knowledge, skill and experience reasonably expected of a person carrying out the directors’ functions. If their knowledge, skill and experience is higher, then they should be held to a higher standard, but if it is lower, this does not operate to reduce the minimum standard. 
• Directors can delegate a number of functions, but it remains their duty to monitor and supervise the discharge of those functions. The Court accepted that the taking of expert advice will go a long way towards the director having performed his duties with reasonable care. However, the weight the Court might attach to the professional advice taken will depend on a detailed assessment of the facts, including the scope of engagement, the instructions, the knowledge and assumptions provided, the nature of the advice and whether it was followed. What steps should be taken at each relevant stage must depend on the facts. The Court commented that, at the point at which the conditions in section 214(2) IA are satisfied:
  
  “if the director does not take insolvency advice or consider whether insolvency proceedings should be taken immediately, it will be more difficult for the directors to demonstrate that they properly considered whether continuing to trade would reduce the deficiency and what the risks were to individual creditors (and, in the present case, the risk to unsecured creditors).”

The Court undertook a comprehensive review of the evidence in relation to the knowledge of the directors at various dates as to the status of the BHS Companies, making inferences and findings accordingly. This included analyses of witness evidence, reports, correspondence (including documents sent to personal gmail accounts), minutes, hand-written notes, financial information (including the level of financial support that the BHS Companies had previously received) and expert advice.

The Court concluded that the Knowledge Condition was satisfied in relation to KD6 because it was at this stage that the Court found that the directors knew the BHS Companies had been making a loss for some time, there was no option to finance the business, there was no prospect of achieving the target business plan and there was no strategy to deal with the pension deficit. The directors therefore should have put the BHS Companies into administration then, rather than later in the following year, by which time the net deficiency in assets had increased. 

Misfeasance

In respect of the misfeasance claims, the Court noted that section 212 IA does not create a new cause of action (unlike section 214). It permits a liquidator to enforce an existing cause of action which the company claims to have against a director. These include claims that the directors breached statutory duties arising under the Companies Act 2006 (“CA”), such as: the duty to act within powers (section 171); the duty to promote the success of the company (section 172); the duty to exercise independent judgment (section 173); the duty to exercise reasonable care, skill and diligence (section 174); the duty to avoid conflicts of interest (section 175); and the duty not to accept benefits from third parties (section 176).

The liquidators argued, amongst other things, that even if the directors were not liable for wrongful trading, they failed to consider the interests of creditors under section 172 CA and if they had done so, they would have immediately filed for administration.

In respect of the duty under section 172 CA, the Court noted the Supreme Court’s decision in BTI 2014 LLC v Sequana [2024] AC 211; [2022] UKSC 25, that in discharging their duty under section 172 to promote the success of the company, the directors must in certain circumstances (when the company is insolvent or bordering on insolvency or an insolvent administration or liquidation is probable) regard the interests of the company’s creditors as paramount. The Court agreed with the liquidators that this duty had been breached and held that, even if there is not yet a breach of section 214 IA (wrongful trading), there can still be a breach of the duty under section 172 CA and misfeasance. This is important, as it brings forward the date of potential liability. 

This novel claim – termed misfeasance trading - establishes new law and provides insolvency office holders with another weapon to establish liability, without having to satisfy more stringent requirements of section 214 IA. 

The liquidators also made nine individual misfeasance claims in relation to individual assets or funds of the BHS Companies and the Court found breaches of duty arising from specific transactions.

Consequences for directors

This case represents the largest finding for wrongful trading in history. It is the first finding of misfeasance trading. In the current economic climate and with company insolvencies at a high, we might expect more claims of this nature as director conduct and decisions made in the twilight period prior to insolvency will be scrutinised closely.

But can directors escape liability by taking (and following) professional advice? In defence of the wrongful trading claim in this case, the directors pointed to the professional advice they had received, both legal and financial, as at KD6. They sought to rely on the fact that they were not advised that there was no reasonable prospect of avoiding insolvent administration or liquidation at that time. However, the Court found that this was “no answer” to the wrongful trading claim and emphasised that it is the duty of the directors themselves, and not for external advisors, to decide whether there is such a reasonable prospect. Directors must exercise their own independent judgement.

The Court accepted that “in many cases the legal advice which directors receive may provide an evidential basis for dismissing a wrongful trading claim where those directors carefully consider and follow the legal advice which they have received”. However, the Court was not satisfied that this happened in the present case. On these particular facts, “all the right questions” were raised by advisors but were not tabled or discussed at a board meeting before key decisions were made, which was a repeat of prior behaviour. Had such discussion taken place, the Court had no doubt that the conclusion of directors in the position of Mr Chandler and Mr Henningson would have been that there was no reasonable prospect of avoiding insolvent liquidation or administration and that immediate advice from an insolvency practitioner should have been sought. Further legal advice between KD6 and administration was provided to the BHS Companies on their duties rather than to the directors personally. Further, it was based on incomplete information and did not constitute ‘positive’ advice that the BHS Companies should continue to trade. It was made clear that this was a decision for the directors themselves in all the circumstances. 

Similarly, in respect of the financial advice obtained, the Court found on the facts that the Board did not invite advice on key issues in a board meeting supervening KD6 and as at KD6, such advice was not being relied upon and the advisors had been stood down. In any event, the Court concluded that it was not necessary for the advisor to “spell out the obvious”, given the obvious financial issues the directors were contending with. 

Although each case will very much turn on its own facts, a takeaway for directors seeking advice in these circumstances is to ensure that the nature of the engagement of advisors is clear and the instructions given to the advisors are comprehensive and cover all of the prevalent issues in the business at the time. Further, it is not enough to simply take the advice, without then recording the fact of having digested it and ensured that key questions and issues raised have been carefully considered. In light of the earlier finding of liability for misfeasance trading, directors should also consider taking early advice and refreshing this regularly as matters progress.

As always, evidencing considerations is vitally important. In this case, the Court noted that the directors did not rely on any documents or advice from their financial experts in the days preceding KD6. Further, relevant board minutes were “formulaic and none of them record that there was any genuine discussion between board members about the risk of insolvency or the risks to individual creditors”. The directors were “simply going through the motions”.

Directors should also consider taking legal advice on their own personal liabilities, separate from the obligations of the company. In this case, the Court declined to cap the directors’ personal liability to the amount of the directors' and officers' liability insurance cover on the basis that it would send the wrong message to risk-taking directors, which is clearly a significant personal risk.

With risk increasing for the board, the case may herald a rise in specialist (professional) directors who take appointments in distressed companies. With adequate insurance of course.

This case involved a significant number of issues, only some of which we have touched upon. It is certainly likely that this saga will continue, given that quantum remains to be determined and the parties in this case may seek to appeal this decision. 

For a discussion on issues raised in this article, please contact Mark Lim.