In the recent case of Wright and Rowley, BHS and others v Chappell and others [2024] EWHC 1417 the liquidators of British Home Stores ("BHS"), a well-known high street retailer, successfully argued that the directors should be held liable for wrongful trading, misfeasant trading and individual acts of misfeasance.
The eagerly awaited judgment of Mr Justice Leech of 11 June 2024, which is 533 pages long, provides useful guidance on how the duties of directors of companies in financial difficulty will be assessed by the Court. It also builds on the Supreme Court's observations in BTI v Sequana [2022] in relation to the duties owed by company directors towards the company's creditors.
We have set out below 5 key takeaways for directors of companies in financial difficulty having regard to the impact of the judgment:
Seeking professional advice
Where a company is in financial difficulty, the risk of liability for wrongful trading will often act as a catalyst for seeking professional advice. Directors should take specialist advice (including legal and financial advice) at an early stage. However, the BHS case confirms that the mere act of taking advice is not enough to prevent liability for wrongful trading. Directors must also ensure that they give clear instructions to their advisers about the scope of the advice required (including maintaining a distinction between advice required by the company and advice required by the directors about potential personal liability) and provide complete information. They must also ensure that the advice is carefully considered and discussed at board level independently of the advisers. The directors' discussions about the advice available and any subsequent decisions should also be properly minuted.
Delegation of duties
In the BHS case the Court reiterated that board decisions are a matter for the directors (not a matter for their advisers, or third parties). Although directors can delegate certain functions, any delegation of duties must be lawful and have a reasonable basis. Any delegated functions must also be adequately monitored and supervised otherwise the directors will remain personally responsible for discharging duties to the company. This should be borne in mind by directors who are appointed to deal with limited functions.
Balancing power at board level
Company directors must ensure they fully understand and comply with their duties to the company at all times. The BHS case confirms that when considering claims for wrongful trading and the knowledge of the directors, the Court will look at the knowledge of each individual director, not the knowledge of the board as a whole. It is therefore important that there is a suitable balance of power at board level. Company directors should avoid allowing certain individuals, or small groups of individuals, to dominate board decisions, particularly in times of financial distress.
The creditor duty
Where a company is approaching insolvency, the company directors have a duty to consider and give appropriate weight to the interests of the company's creditors. In BTI v Sequana, the Supreme Court held the creditor duty is engaged when the directors know, or ought to know, that either the company is insolvent or bordering on insolvency, or an insolvent liquidation or administration is probable. The threshold for wrongful trading claims is even higher. It is only engaged when there is no reasonable prospect of the company trading out of insolvency and insolvency is inevitable. However, in the BHS case the directors were found to be personally liable for "misfeasant trading" from 26 June 2015 onwards at a time when the BHS companies were not cash flow insolvent and insolvent administration/liquidation could have been avoided. The Court held that the directors of the BHS Group ought to have placed the BHS companies into an insolvent administration in June 2015, prior to the trigger for wrongful trading in September 2015, to comply with their Companies Act 2006 duties (specifically, the duty to promote the success of the company under section 172(1) of the Act). This aspect of the judgment is surprising and may be appealed, but it demonstrates the importance of considering the interests of creditors in times of financial distress and giving appropriate weight to those interests. The finding of personal liability in the BHS case appears to reflect the unique facts of the case, including the Court's criticism of the directors' decision to enter a substantial secured debt facility on 26 June 2015 which ranked above some of the existing creditors. However, the decision does open the door to new claims for "misfeasant trading" or "trading misfeasance" thereby creating an increased risk of personal liability for company directors where their conduct can be constructed as "insolvency-deepening activity" and insolvency is probable (but not inevitable). This highlights the importance of directors exercising reasonable care, skill and diligence when making decisions in relation to a company in financial difficulty, particularly where additional borrowing is being proposed and the interests of existing creditors may be affected later down the line. Even if the company has a reasonable prospect of avoiding an insolvent administration or liquidation, the directors may still be personally liable if their actions prejudice the interests of creditors.
Insurance cover
The BHS case also serves as a reminder that directors should ensure that adequate Directors & Officers insurance cover ("D&O") is in place to reflect the size of the business. In the BHS case, the Court refused to apply a cap to the personal liability of the directors by reference to the amount of D&O cover, or the amount individual directors could afford to pay. The Court determined that this would leave creditors exposed and send the wrong message to "risk taking" directors.
Conclusion
There are a number of lessons to be learnt from this landmark judgment. Whilst the outcome of this particular case is fact specific, it does highlight the significant consequences that can follow if directors do not exercise their duties properly and fail to take appropriate advice. It also serves as a useful reminder of the importance of the duties owed by company directors to creditors in times of financial distress.
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