Directors’ duties – Court makes substantial wrongful trading and misfeasance award against former directors

Seven years after the British Home Stores Group Limited, a well known high street retailer, and its operating subsidiaries entered liquidation, the High Court has found two former directors liable for wrongful trading and misfeasance.

Background

Prior to March 2015, the BHS Group was owned by the Taveta group of companies. It had been profitable but started incurring losses from 2009 onwards. In March 2015 it was sold to Retail Acquisitions Ltd and four individuals were appointed as directors of the BHS group companies – the two individuals who are the subject of this judgment, a third, the claims against whom have been dealt with separately by the court, and a fourth who settled with the liquidators. In April 2016 the board resolved to put the group companies into administration, and the companies subsequently went into liquidation.

The liquidators brought proceedings against the former directors for wrongful trading and misfeasance, alleging among other matters that, from the date of the acquisition in March 2015, they knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation.

The two former directors that were subject to this action have been ordered to pay substantial sums by way of recompense: at least £10.4 million and £8.1 million respectively. The High Court declined to limit the award by reference to the former directors’ insurance cover or ability to pay, saying that to do so would send “the wrong message” to risk-takers.

The High Court did not in this judgment determine the liability of the third former director and the liquidators’ claims against him have been considered separately. Press reports indicate that he has been found liable to contribute at least £50 million to the companies’ assets, but no judgment or court order is yet available.

Wrongful trading

Wrongful trading is continuing to trade when the directors knew or ought to have known that there was no reasonable prospect of avoiding insolvency (section 214 of the Insolvency Act 1986). Where the court finds that there has been wrongful trading, it can require the directors to make a contribution to the company’s assets.

Key to the High Court’s findings in this case was what is referred to as the “Knowledge Condition”: in order for there to be wrongful trading, the individuals must have known or ought to have concluded, at some point before the commencement of the winding up, that there was no reasonable prospect that insolvent liquidation would be avoided.

In light of the Supreme Court’s decision in BTI v Sequana [2022] UKSC 25 (read more on our RTI blog here), the High Court observed that “the bar is a very high one” for wrongful trading and the liquidators have to demonstrate that the individuals knew or ought to have known insolvency “was inevitable”. The judge went on to say that a court must be satisfied that any prospect of trading out of insolvency was “more than fanciful” and “rational”, and that “blind optimism” is not sufficient to defeat liability.

On the facts in this case, the High Court held that the Knowledge Condition was satisfied in September 2015 (but not the earlier dates the liquidators had also pleaded) and therefore that the directors should contribute to the assets of the company to the extent the financial condition of the BHS Group worsened from that date until it was put into administration. There is a statutory defence for directors – that they took every step to minimise potential losses to creditors – but, again on the facts, it was held that the defence was not made out and both directors were ordered to pay £6.5 million each to the assets of the company.

Misfeasance

A court can order a director to restore company property or contribute to its assets if in the course of a winding up it appears that a director has misapplied any property of the company, or been guilty of any misfeasance or breach of duty in relation to the company (section 212 of the Insolvency Act 1986). The liquidators of the BHS Group brought claims for misfeasance on the basis that the directors had breached their directors' duties under section 171 to 177 of the Companies Act 2006.

The High Court held that the former directors had breached their duties under the Companies Act 2006 in and from June 2015, including the duty to act within their powers and for a proper purpose (section 171), the duty to promote the success of the company (section 172), and the duty to exercise reasonable care, skill and diligence (section 174). These breaches related to the decisions not to place the companies into insolvent liquidation immediately and instead to enter into new finance arrangements, with high interest rates and that were secured ahead of other existing creditors.

In holding the directors liable for breach of the duty to promote the success of the company from June 2015 – an earlier date than the Knowledge Condition was satisfied in respect of the wrongful trading claims – the High Court focused on when the insolvency became probable (but not necessarily inevitable), and so at what point the directors should have had regard to the interests of creditors when considering their duties.

Liability in relation to smaller individual misfeasance claims was also made out (bringing the amounts to be contributed to the companies so far up to at least £10.4 million and £8.1 million respectively). A full assessment of the appropriate measure of loss for the trading misfeasance is still to be determined and therefore another hearing has been scheduled to hear submissions on the point.

For more information, please see our litigation blog here.