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Published on July 9, 2024
The importance of directors’ knowledge in establishing the largest ever wrongful trading award and the first ever award for “misfeasant trading”

The High Court recently issued its judgment against two former directors of BHS Group Limited, Mr Henningson and Mr Chandler (together, “the Respondents”), following the BHS group’s (“BHS”) entering into administration in April 2016 (Re BHS Group Ltd [2024] EWHC 1417 (Ch)). The case originally involved a third director, Mr Chappell, but proceedings against him were severed due to his imprisonment in 2020 for failure to pay tax. This judgment is notable as it represents the largest-ever wrongful trading award, and the first ever award for “misfeasant trading” on the basis that the Respondents failed to consider the interests of the creditors.

Key to both the wrongful trading and misfeasant trading claims was the question of if and when the Respondents knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation or insolvent administration – this was termed the ”Knowledge Condition” in the judgment. As the Respondents’ liability could only be established from the date at which the Knowledge Condition was met, the judgment (spanning nearly 550 pages) saw the Court conduct a detailed and extensive analysis of the timeline and facts of the case – especially directors’ correspondence (including emails, board minutes, handwritten notes of meetings and text messages) both between themselves and with their legal and other advisers – for the purpose of providing an exact date for the satisfaction of the Knowledge Condition.

The Facts

As a high-level overview, in March 2015, Retail Acquisitions Ltd acquired the loss-making BHS for £1 in March 2015, and new directors were appointed. One year later, in March 2016, creditors approved a company voluntary arrangement, and in April 2016, four BHS companies entered into administration. The Pensions Regulator issued warning notices to various BHS parties in November 2016, and entered into a settlement agreement in February 2017. In December 2020, joint liquidators commenced proceedings against the Defendants, for misfeasance (including breach of directors’ duties) and wrongful trading, under s.212 and s.214 of the Insolvency Act 1986 respectively.

As wrongful trading and misfeasant trading were separate heads of claim, independent analysis of the Knowledge Condition was conducted for both.

When was the Knowledge Condition met?

Directors (or former directors) may be found liable for wrongful trading under s.214 Insolvency Act 1986 if the director knew, or ought to have known, that the there was no reasonable prospect that the company would avoid insolvent liquidation or administration, unless from that date the director took every step with a view to minimising potential losses to the company’s creditors.

The liquidators suggested six different dates on which the Knowledge Condition was met in respect of the wrongful trading claim. The Court accepted the last of these dates – 8 September 2015 – as the Court’s analysis of the contemporaneous documents found that by this point BHS was cash flow insolvent. Therefore, the directors knew or ought to have known that there was no reasonable prospect of avoiding insolvent administration or liquidation. Notably, the Court refused to impose a requirement that directors in this situation actually enter the company into administration or liquidation immediately or within a short period of time following satisfaction of the Knowledge Condition, stating that it would create “a real difficulty” if it “laid down a time limit or bracket even as a rule of thumb”.

Misfeasant trading

S.212 Insolvency Act provides a procedure for the recovery of property or compensation by a liquidator, against a director for (i) misfeasance or (ii) breach of fiduciary or any other duty. This was the first time the English Courts have handed down a judgment in a claim of this type.

Directors’ duties are set out in ss.170-177 of the Companies Act 2006.  On the facts, the Court found a breach of each of those duties (which involves too extensive an analysis for the scope of this note); the Knowledge Condition was considered in regard to s.172, which imposes a duty to promote success of the company.  Following BTI 2014 LLC v Sequana SA [2022] UKSC 25, the Court held that when a company is insolvent, bordering on insolvency, or an insolvent liquidation or administration is probable, the s.172 duty should be understood as including the interests of its creditors as a whole. The liquidators alleged that, had the Respondents considered the creditors’ interests, they would have filed for administration immediately, in March 2015.

Again analysing the contemporaneous documents, finances, and communications, the Court found that by May-June 2015, the Respondents:

  • knew that if BHS did not enter into new financing agreements, it would not be able to pay its rent checks (despite the financing agreements being on onerous terms), and that there was no reasonable prospect of restoring short-term trade credit insurance; and
  • ought to have known that the Group would more likely than not enter into insolvency proceedings, and therefore a duty to consider the creditors’ interests had arisen.

Therefore, the Knowledge Condition was met in May/June 2015, and subsequently, the Respondents’ liability for failure to have regard to creditors’ interests arose from this date. This was the case despite the fact that BHS’ cash flow insolvency did not arise until September of that year (as above).

The Court found that the Respondents did not consider the risks to the creditors from this date, and that, if they had done so, they ought to have concluded that the creditors’ interests were paramount (or at the very least, more important than those of its shareholder Retail Acquisitions Ltd), and that it was in the creditors’ interests to put BHS into administration immediately.

Quantum

Wrongful trading

The Court has a statutory discretion to declare that a director is liable to make such contribution (if any) to the company’s assets as it considers proper. However, the maximum liability of a director for wrongful trading is the increase in the net deficiency in the assets generated by continuing to trade between the date on which the Knowledge Condition is met and the date on which the company goes into insolvent administration or liquidation. The Court found a £45 million increase in net deficiency in the companies’ assets between 8 September 2015 and April 2016. On an analysis of the facts, the Court found it inappropriate to hold the directors equally liable (on a joint and several basis), and so evaluated each individual’s involvement and culpability to create a percentage for each’s liability. The two Respondents were required to contribute £6.5 million each to BHS’ assets; the remaining £32 million could potentially be ordered against other directors, including Mr Chappell, at a later date. This is the largest-ever wrongful trading award in the English courts.

The Respondents argued that their liability should be reduced on the basis that BHS’ D&O insurance was not sufficient to cover the claims against them. However, the Court refused to do so, saying that to do so would ”send the wrong message to risk-taking directors that they could escape liability if they did not obtain adequate cover to indemnify themselves against wrongful trading”.

Misfeasant trading

The Court declined to use its discretion under s.1157 Companies Act 2006 to relieve a director from liability for breach of duty, on the basis that the Respondents failed to demonstrate that they acted reasonably in all the circumstances, or that it would be fair to do so.

The Court reserved judgment as to the quantum of damages for the misfeasant trading claim, pending further arguments from the parties. This quantum could be as much as £133.5 million (representing the increase in net deficiency between May/June 2015 and April 2016).

However, the Court did order the Respondents to pay a total of £5.6 million, in respect of nine ”individual misfeasance” claims relating to specific transactions and assets.

Summary

The 550-page judgment contains a significant amount of legal analysis not considered in this note; also considered  was the ability of directors to rely on outsourced professional advice, the ability of directors to delegate their duties, and the standard expected of directors, among a number of other aspects. This note has focussed on the Court’s treatment of the Knowledge Condition; the judgment shows that, at times when there is a subjective question of actual or constructive knowledge, the Court will not be afraid to conduct an extensive analysis of directors’ correspondence in order to answer it. It presents a stark reminder that any and all communications between directors or – as happened at times in this case, between directors and their legal advisers – may be subject to scrutiny by the Court in the event of insolvency proceedings.

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