The High Court has found two former directors of the BHS group of companies liable for wrongful trading and misfeasance under the Insolvency Act 1986 (the Act). Relief against the directors has been ordered in the amount of £18m, with further rulings still to come.
The judgment was hotly anticipated following trial in December 2023. While the particular facts of the case are extreme, the careful examination of directors' obligations when a company's solvency is in the balance provides essential lessons. The case serves as a reminder to all directors to ensure that they scrutinise board decisions, act independently, and properly consider the impact on shareholders together with (where appropriate) creditors. Where significant intragroup transactions, refinancing and reorganisation are envisaged, directors should ensure that they are not merely delaying the inevitable.
Background
The British Home Stores Group comprised four companies, British Home Stores Group Ltd (BHSGL), the holding company of the group, British Home Stores Ltd (BHSL), the principal operating company, Davenbush Ltd and Lowland Homes Ltd (together the Companies).
BHS was a well-known high street retailer. In 2015 it had around 11,500 employees. However, its profitability had been in decline. Between 2009 and 2014, BHSL had made losses every year, but management remained optimistic the group's fortunes could be turned around.
Until March 2015, the BHS Group was owned by the Taveta group of companies. On 11 March 2015 Taveta agreed to sell and Retail Acquisitions Ltd (RAL) agreed to buy the entire issued share capital of BHSGL. On the same date, Mr Dominic Chappell and Mr Lennart Henningson were appointed directors of the four Companies. On 18 March 2015, Mr Dominic Chandler was appointed a director of BHSGL. Two days later he was also appointed a director of BHSL. On 17 April 2015 he was appointed a director of the remaining two companies.
On 25 April 2016 the board resolved to put the BHS Group into administration. Each Company has subsequently entered creditors voluntary liquidation.
The events that led to this decision were the subject of this litigation. The joint liquidators (JLs) brought proceedings against Mr Chappell, Mr Henningson and Mr Chandler for wrongful trading under s.214 of the Act and misfeasance under s.212 of the Act. The JLs alleged that from the date RAL acquired the BHS Group and they were appointed directors, these individuals either knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation. In consequence, they should be required to make a contribution to the Companies' assets.
This trial and judgment concerned Mr Henningson and Mr Chandler. The case against Mr Chappell will be heard at a later date.
Wrongful trading
The conditions for liability for wrongful trading are set out in s.214 of the Act: if a company has gone into insolvent liquidation and a director of that company knew or ought to have known at some earlier date that there was no reasonable prospect the company would avoid going into insolvent liquidation or insolvent administration, the court may order them to make a contribution to the assets of the company in such amount as the court thinks proper.
In this case, to establish that Mr Chandler and Mr Henningson were liable for wrongful trading, the JLs therefore had to show that (1) the Companies had gone into insolvent liquidation; (2) Mr Chandler and Mr Henningson were directors of the Companies at the time the third condition is satisfied; and (3) at some time before the commencement of the winding up, Mr Chandler and Mr Henningson knew or ought to have concluded that there was no reasonable prospect insolvent liquidation would be avoided. The third condition is referred to as the Knowledge Condition. The date at which it must be satisfied is referred to as the Knowledge Date.
Initially the JLs had suggested that the Knowledge Date was "by 17 April 2015 or alternatively by some later date prior to 25 April 2016". However, following an interim judgment they were required to plead the point more specifically. They therefore put forward six alternative Knowledge Dates.
The Knowledge Condition could be proved either by establishing actual knowledge on the part of the directors, being that they subjectively concluded the Companies had no real prospect of avoiding insolvent liquidation. Or it could be proved by showing that the directors should have so concluded based on an objective evaluation of the facts they knew or information that was provided to them at each Knowledge Date.
The judgment provides useful guidance on how this may be evaluated.
- The test for knowledge is applied to each individual director, not the board as a whole.
- The court's enquiry into the functions performed by each director (and therefore what they ought to have known or understood) will go beyond their title and look to the substance of what they actually did.
- The standard expected of a director is commensurate with the size and sophistication of the company.
- Considering what a director ought to have known, the court may take account of material to which the director could with reasonable diligence have had access.
- Directors must ensure they receive and consider key management information and it will be no excuse that management information is voluminous or provided to them late.
- A director is expected to obtain sufficient financial information to monitor the company's solvency, but it is well-known that they are not liable for continuing to trade simply because a company is cash flow or balance sheet insolvent. The question for wrongful trading is whether there was no reasonable prospect of avoiding insolvent liquidation or administration (i.e. whether that outcome is inevitable – this is discussed further below).
- Directors might properly conclude that a company should continue to trade at a loss if they have a reasonable and well-founded view that the company can trade out of difficulty. Their belief must, however, have a rational basis and they cannot engage in blind optimism.
- The court does not wish to encourage directors to put companies into administration or liquidation at the first sign of trouble and must avoid hindsight when scrutinising directors' decisions.
The court reviewed the comments made by the Supreme Court in BTI v Sequana [2022] UKSC 25 (Sequana). The Supreme Court had made some useful observations contrasting the threshold for wrongful trading with the threshold for engagement of an obligation to consider the interests of creditors as part of the duty to promote the success of a company.
The judge concluded that in light of the comments in Sequana, the bar for wrongful trading is set very high. It is engaged when the directors no longer have a rational basis for continuing to trade and insolvency is inevitable.
The judge endorsed prior commentary that it is unhelpful to use terms such as insolvency being "imminent" for wrongful trading, as this is not the test and could misleadingly imply some specific timing is necessary. In fact, there could be a considerable lag between when insolvency becomes inevitable and its actual onset. Thus, if a director thought that they could keep a company alive for a year or so through asset sales, but early on in this process it became clear that this was only delaying the inevitable, liability would attach.
The judge also had to consider argument on the standard expected of the directors. The judgment confirms that while a directors' particular knowledge, skills and experience are relevant and can raise the standard expected of them, there is also a minimum base level. The test, referred to in the judgment as the Notional Director standard, is therefore the standard of a reasonably diligent person having the general knowledge, skill and experience expected of a person carrying out the same functions, or such higher standard as is appropriate to the individual in question given their own particular background. In this case, Mr Chandler fell short and did not possess the knowledge, skill and experience needed for a director of the Companies. But this did not excuse him, and his decision making would be compared with the Notional Director for the purposes of the JLs' claims. The order made against each director reflected their individual involvement and liability.
It is a reflection of the complexity of the case that the JLs' claims failed with regard to the first five Knowledge Dates pleaded. Despite there being many indicators of financial difficulties for the Companies, the judge decided that it was not until 8 September 2015 that the directors ought to have concluded insolvency was inevitable. The directors would therefore be liable for any increase in net deficiency in the Companies' financial positions from that date unless they could avail themselves of the statutory defence in s.214(3) of the Act that they took every step to minimise potential losses to creditors.
In finding that the directors could not benefit from that defence, the judge commented on the very high bar that must be overcome for the defence to succeed. It is not enough for a director to show they continued trading with the aim to reduce the net deficit of a company; the burden is on the directors to demonstrate that they intended to minimise the risk of loss to individual creditors and that they took every step to do so.
The court also said that while what constitutes "every step" will depend on the facts, "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".
However, it is not sufficient to rely on the fact that the directors took professional advice. It is the duty of the directors themselves, and not their advisers, to decide whether there is a reasonable prospect of avoiding insolvent liquidation. In many cases, directors will receive professional advice, and this can be a sound basis for dismissing a wrongful trading claim if directors have carefully considered and followed the advice received, but the judge emphasised that that is not what happened in this case. The judge explained that all the Companies' auditors and lawyers could do was to identify the legal issues which the directors had to consider and the severity of the financial position. The weight the court will attach to professional advice will depend on the scope of the engagement, the instructions given, the knowledge they had or assumptions they were asked to make, the advice they gave, and the extent to which the directors relied on it.
On a similar theme, the court recapped that it is trite law that a director can delegate their management functions but not responsibility for meeting their own personal duties. If directors delegate some functions either to other directors or to employees, they are still required to monitor and supervise the discharge of those functions.
Trading misfeasance
The liquidators also brought claims for misfeasance under section 212 of the Act, on the basis that the directors had breached their duties under section 171 to 177 of the Companies Act 2006.
The liquidators made an original argument that, irrespective of the wrongful trading claims, the directors should have entered an insolvency process in order to comply with their "creditor duty". The creditor duty (as recently confirmed by the Supreme Court in Sequana) refers to the requirement for a director to consider the interests of a company's creditors (in addition to shareholders) when exercising their usual duty to promote the success of a company under section 172(1) of the Companies Act 2006, in certain circumstances where continued solvent trading is in doubt.
The duty has a significant subjective element: the judge confirmed that a director who has taken into account the relevant interests and considered them in good faith will generally be in compliance with section 172. However, the liquidators claimed that the directors had failed to meet that standard and, if they had complied with their creditor duty under section 172, then they would have placed the Companies into an insolvency process at each of the relevant Knowledge Dates. The duty under s.172 therefore bites sooner than a claim for wrongful trading which is triggered when insolvency is inevitable.
The liquidators also argued that a failure to place the Companies into administration was in breach of the duty to exercise powers only for the purposes for which they are conferred (under section 171(b) of the Companies Act 2006). This, too, has a subjective element in assessing the director's actual motive for (and therefore purpose of) exercising the power.
The judge agreed. He found that, as at 26 June 2015, if the directors had complied with their duties to promote the Companies' success and exercise powers for a proper purpose then they would have placed the Companies into insolvent administration immediately. This was despite the judge's finding that insolvent liquidation or administration was, at least theoretically, avoidable until three months later in September 2015 i.e. the date from which wrongful trading was found to have occurred, described above.
Although liquidation or administration could have been avoided, the reality was that the directors had breached their duty (by failing to take account of the interests of creditors) and the judge decided that, had they complied with that duty, then they would not have identified any viable alternative to administration. The directors' failure during that period therefore amounted to misfeasance (under section 212 of the Act) but not wrongful trading (under section 214 of the Act).
The effect of this decision is that the directors are liable in respect of the depletion of the BHS Group's assets to the tune of a further £88m between 26 June and 8 September 2015. No doubt the directors will argue that, in the absence of a statutory wrongful trading claim covering that period, the compensation ordered against them should be more limited.
While this is an onerous decision, it should be emphasised that the facts were extreme. On 26 June 2015, BHSGL entered into a substantial secured debt facility (for £50m, plus a mezzanine loan) which was described by a senior employee as the "wonga loan". The facility had a high interest rate and ranked above (and therefore heavily penalised) many existing creditors. The judge held that it would at best prolong the path to cashflow insolvency and in fact the interest rate made a turn-around still less realistic. In any case, the Company had no prospect of restoring trade creditor insurance and faced an unsustainable rent bill.
Where directors of troubled companies look to raise new debt, they should carefully weigh the terms to ensure the borrowing will enable a realistic turnaround plan.
Misfeasant transactions
The judge also found that three transactions (of eight challenged by the liquidators) amounted to misfeasance. These related to personal commission, payments to related parties, and the purchase of the freehold to a BHS property with a view to renovation and onward sale within the group after the date on which wrongful trading had been found (November 2015). The directors were ordered to reimburse the Companies. Although a number of other transactions were not in the interests of the Companies, the judge found that that no loss was caused by any breach of duty by Mr Henningson or Mr Chandler because Mr Chappell would have entered into them regardless.
Key takeaways
This was a dense and fact-specific case resulting in a judgment which is reported to be among the longest in Chancery Division history. There are, however, several useful lessons for all interested in proper corporate governance and how to navigate solvency issues.
- The wrongful trading test for knowledge (and application of the Notional Director standard) is applied to each individual director, not the board of directors as a whole.
- When considering their duties as a director, individuals should
be concerned to:
- ensure that they regularly monitor their duties and assess whether the Knowledge Condition could be satisfied;
- ensure that they "inform themselves fully" of the affairs and dealings of the company, including receiving and carefully considering appropriate management information;
- ensure that they are documenting their decisions and reasonings properly, contemporaneously and with the benefit of professional advice tailored to considering how to minimise the risk of loss to individual creditors (although it is the directors themselves and not the advisors to decide whether the Knowledge Condition has been satisfied); and
- maintain adequate Directors & Officers insurance cover as the judge in this instance declined to exercise the court's discretion to reduce the awarded amount to the level of cover that the directors had in place to avoid creating the perception that directors taking risks can avoid liability if they have not obtained adequate cover to indemnify themselves against wrongful trading.
- It is not enough for directors of a company in poor financial condition to assess transactions and liabilities by reference to the short-term cash flow impact. A transaction that "buys time" before the onset of insolvency may nevertheless lead to personal liability for a director if it was only delaying the inevitable, particularly if existing creditors are left in a worse position down the line.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.