In June this year, the largest ever wrongful trading award was made (£6.5m per director). This was followed in August by the largest equitable compensation award against directors for breach of duty (£150m).
That these awards came from the same set of facts and against common directors is noteworthy not just for the amounts involved, but how the two judgments dovetail to cover a potential flaw in the wrongful trading legislation.
This article explores the BHS decision, its development of the principles established in Sequana and how it opens up an entirely new route for office holders to pursue 'bad actor' directors.
Factual background
In March 2015 BHS was sold for a nominal amount by Sir Philip Green's Taveta Group to Retail Acquisition Limited (RAL), a SPV fronted by Dominic Chappell a former bankrupt with no retail experience. At the point of purchase BHS had an operating loss of £442m and a pension deficit of more than £200m. Just over a year later RAL collapsed into administration.
Many will remember the public opprobrium that fell upon Philip Green and his eventual 'voluntary' contribution to the pension fund deficit. Some may remember the director's disqualification, bankruptcy and imprisonment of Dominic Chappell. Few will have given much thought to the other Board directors of RAL. The Liquidators however, in pursuit of creditor return, brought proceedings centred on the role of these other directors and their responsibility for causing loss.
Civil claims against one director were settled in out of court negotiations, leaving claims issued in December 2020 against Chappell, Lennart Henningson and Dominic Chandler. These claims were for wrongful trading and a variety of examples of conduct, which they alleged, were in breach of the director's duty.
The misconduct claims were divided between individual acts of wrongdoing (individual misfeasance) and an overarching claim that the continuation of trading was a breach of duty owed to the creditors and causative of loss (trading misfeasance).
Wrongful trading: s214 of the Insolvency Act 1986
Under section 214, an administrator or liquidator may seek an order of the court that the directors of the company contribute to the assets of the company if:
- The director concluded, or ought to have concluded, that there was no reasonable prospect of the company avoiding an insolvency liquidation or administration.
- There is an increased deficit to the loss suffered by the creditors of the company.
The court will not make an order for contribution if the directors took every step with a view to minimising losses to creditors that they should have taken. The officeholder is tasked with establishing the 'date of knowledge', i.e. when the director concluded or should have concluded that liquidation/administration was inevitable. This requires detailed analysis of the directors' state of knowledge and the information available to the directors. The bar for establishing 'inevitable' insolvency is a high one.
Wrongful trading in BHS
It was clear from the date of RAL's purchase that significant restructuring of the business was required to turnaround the operating losses and repay accumulated debt. From that date until the date of administration the Board entered sale and leaseback arrangements, acquired short term funding, entered negotiations with HMRC and the pension regulator, and engaged teams of professionals to advice on a myriad of refinancing and restructuring options.
The directors argued that the ongoing negotiations, the formulation of various plans and the fact no professional advisor had advised them that an insolvency process was inevitable, meant that it was not until March 2016 and the rejection of a CVA proposal that it was appropriate to put BHS into liquidation.
The liquidators claimed that wrongful trading threshold i.e. 'the date of knowledge' was within 1 month of appointment, or at 5 alternatives dates up to September 2015.
Mr Justice Leech accepted that it was not until the last pleaded date that insolvency was 'inevitable.' At that stage it should have been clear to any 'notional director' carrying out their duties responsibly that creditor liability could only be met by taking on further loans (liability), trade insurance was withdrawn meaning supplier credit was vanishing and that planned property sales couldn’t achieve the required return sufficient in terms of timing or amount to achieve a turnaround.
Leech J dismissed the directors defence that they had relied on legal and accounting professional advice in continuing to trade while pursing turnaround options. The advisors were not properly appraised of all the facts and/or advice was not properly considered or relied upon by the Board. The advice did not act as bomb shelter for the Board, who ultimately were responsible the decision to continue to trade wrongfully.
Trading misfeasance: Developing the reasoning in Sequana
The wrongful trading element of the judgment is interesting but uncontroversial. More noteworthy is the finding that had the directors complied with their fiduciary duties, then BHS would not have continued to trade past 26 June 2015 (some 10 weeks earlier than the date affixed as the 'date of knowledge' when insolvent liquidation or administration was 'inevitable').
This date is relevant because on that day a highly expensive debt refinance occurred. This meant that whilst BHS was not cash flow insolvent and insolvency was not inevitable, the directors should at that date have had due and proper regard to the interests of creditors. Their failure to do so when insolvency was 'imminent' or where the business was engaged in 'insolvency-deepening activity' founded the successful claim in trading misfeasance.
Despite the extreme and unusual facts of BHS, the Judgment on this point should not be viewed as an outlier but as a development of the reasoning behind the creditor duty established in the Supreme Court judgment in BTI 2014 LLC v Sequana SA [2022] UKSC 25. Sequana itself looked at the codified statutory director's duty to promote the success of the company and the enlightened shareholder principal that runs behind this, requiring the interests of various stakeholders (including creditors) to be considered by the directors in its decision making (the so-called 'modified duty' to the company).
In Sequana, the court also looked closely at the development of the principal that the directors should have regard to the interests of the creditors when the company is insolvent. While the duty under s.214 arises where insolvency is inevitable, the court made clear that in common law and statute there is an earlier point where the directors should give thought as to the appropriate balance of weight that should be given to the shareholders interest as against the creditors interest. Each case will be highly fact specific but as Lord Briggs termed it 'who, as between creditors and shareholders, then have the most skin in the game.'
In discussing the distinction between s.214 and misfeasance Lord Hodge observed: 'A reasonable decision to attempt to rescue a company's business in the interests of both its members and its creditors would not in my view involve a breach of the common law duty. But there may be more egregious circumstances in which the absence of a remedy beyond section 214 would appear to be a lacuna in our law.'
In Sequana each Law Lord grappled with when the balance would be weighed in creditor favour, and gave examples including entering into a high risk speculative transaction which may or probably would jeopardise the company's asset base and ability to meet creditor claims, whether a 'last role of the dice' was made when shareholders were already out of the money on any insolvency event, or where the company was engaged in 'insolvency deepening activity.' What was clear however is where the balance tips the directors should consider in their decision making and, if appropriate to the facts of the case give priority to, the interest of the creditors.
In BHS Leech J saw 'direct application' of the Sequana distinction between s.214 and misfeasance. From June 2015 the directors were engaged in 'insolvency deepening activity', conducting a 'degenerative strategy' which was causative of additional loss to creditors. As a result, he stated had the directors 'considered the interests of the BHS Group's existing creditors to be paramount or had they put them before the interest of RAL, then I have no doubt that they ought to have concluded that it was in the interests of creditors to put [BHS Group] into administration immediately.'
Conclusions
What troubles some commentators about the Leech judgment is how it ties the breach of duty (to have proper regard to the interests of creditors) to an obligation to place the company into an insolvency process. This of course is the key requirement where the s.214 wrongful trading conditions are fulfilled, and it blurs the distinction such that there may be no utility in an office holder seeking to establish a date of 'inevitable' insolvency, where there is some earlier date when the directors are in breach.
This concern was amplified in the later judgment on quantum (and on Chappell's liability) which found that the loss attributable to the breach of duty was the increase in the net deficiency, a much higher sum in June than the wrongful trading net deficiency arising in September.
To some BHS is proof of the maxim that hard cases make bad law. That the facts were so extreme meant that the lacuna in s.214 was exposed which in turn justifies the novel finding of 'misfeasant trading'. This would see BHS as an outlier, easily distinguished on its facts.
A more compelling interpretation is that BHS stands as a further development in the policing of director conduct and the development of enlightened shareholder value, where the interests of stakeholders must be taken into account when promoting the success of the company. Added to this is the concept of a tipping point where the interests of the stakeholder prevail and failure to have due and proper regard to such which in term is causative of loss (to the company) will result in personal liability.
A director acting in good faith and with rationality has nothing to fear, a director engaging in risky speculative activity without taking proper account of interests of those who are likely to be harmed should be punished.
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