Former directors of BHS liable for wrongful trading and misfeasance

The collapse of UK retailer British Home Stores ("BHS") in 2016 remains one of the most high-profile corporate insolvencies of recent times. It went from being a household name across the UK, with over 11,000 employees, to having reported debts of £1.3 billion, including a pension deficit of nearly £600 million. The group's demise saw the closure of some 164 stores nationwide and significant job losses.

Eight years on, the High Court has delivered a 533-page judgment ruling in favour of BHS's Joint Liquidators in claims brought against the company's former directors for wrongful trading and misfeasance: Wright v Chappell [2024] EWHC 1417 (Ch).

The two former directors who were the subject of this judgment were ordered to pay substantial sums by way of recompense, at least £10.4 million and £8.1 million respectively, making it already one of the largest successful claims of its kind to date. That liability is expected to rise significantly in respect of the so-called "misfeasance trading" claim, the quantum of which will be determined in due course.

Among other things, the judgment provides guidance as to the circumstances in which directors can successfully defend a wrongful trading claim by relying on the advice of external advisers as to whether the company has a reasonable prospect of avoiding insolvent liquidation or administration. In the judge's view, it was irrelevant that the company's external lawyers and financial advisers had not provided advice on this point, as it was a "question of individual judgment for the directors". It was not something on which the company's external advisers "could or should have been expected to express an opinion".

These findings beg the question of the extent to which company directors should rely on the advice of external advisers which does expressly address the question of whether the company has a reasonable prospect of avoiding insolvent liquidation or administration. According to the judge, the weight which the courts will attach to professional advice which directors take will depend on a number of factors, including the scope of the engagement, the instructions which the adviser was given, the knowledge which the adviser had or the assumptions they were asked to make, the advice which the adviser gave (or did not give) and the extent to which the directors did or did not rely on that advice.

Background

Until 11 March 2015, the BHS Group was under the ownership of the Taveta group of companies which was, in turn, owned by Sir Philip Green. The BHS Group had been profitable but had started incurring losses from 2009 onwards.

On 11 March 2015, Taveta sold the entire issued share capital of the BHS Group to Retail Acquisitions Ltd ("RAL") for £1. On the same date, Mr Chappell and Mr Henningson were appointed as directors of four companies within the BHS Group. Shortly thereafter, Mr Chandler was also appointed to be a director of those companies.

Following their appointment, the directors engaged in a series of further transactions on behalf of the relevant companies, including entering into new financing arrangements. Despite the efforts to secure further funding and to enter into a creditors' voluntary arrangement, all four companies filed for administration on 25 April 2016 and the Joint Liquidators were appointed.

In December 2020, the Joint Liquidators commenced wrongful trading and misfeasance claims against the three (now former) directors. The Joint Liquidators alleged that from the date of their appointment, Mr Chappell, Mr Henningson and Mr Chandler either knew or ought to have known that there was no reasonable prospect of the companies avoiding insolvent liquidation or insolvent administration, and therefore by continuing to trade they were liable for wrongful trading under section 214 of the Insolvency Act 1986.

The Joint Liquidators also brought claims under section 212 of the Insolvency Act 1986, which allows a court to order a director to restore company property or contribute to its assets if the director has misapplied company property, or been guilty of any misfeasance or breach of duty in relation to the company. The Joint Liquidators argued that, even if the directors were not liable for wrongful trading, they failed to have proper regard to the interests of the companies' creditors, in breach of their duties as directors. Had they done so, it was said, the companies would immediately have filed for administration rather than continuing to trade and exacerbating the impact of the insolvencies (so-called "misfeasance trading"). The Joint Liquidators also made nine other misfeasance claims in relation to individual specific transactions.  

The case against Mr Chandler and Mr Henningson was heard before Mr Justice Leech in a 5-week trial in late 2023 and judgment was given on 11 June 2024.

The Joint Liquidators' claims against Mr Chappell were considered separately at the end of June 2024. Press reports indicate that he has been ordered to contribute at least £50 million to the companies' assets, although no judgment or order is yet publicly available.

Wrongful trading

The law

To succeed in the claim for wrongful trading, the Joint Liquidators had to satisfy the court that the following conditions had been met:

1. the companies had gone into insolvent liquidation (section 214(2)(a));
2. at some time before the commencement of winding up, the defendant directors "knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or entering insolvent administration" (referred to as the "Knowledge Condition") (section 214(2)(b)); and
3. the defendants were directors of the relevant companies at that time (section 214(2)(c)).

In evaluating whether directors have met the Knowledge Condition, section 214(4)(a) provides that the relevant standard is that of a reasonably diligent person (referred to in the judgment as the "Notional Director") having both: (i) the general knowledge, skill and experience reasonably expected of a person carrying out the same functions as the director; and (ii) the general knowledge, skill and experience of the director in question.

Decision on wrongful trading

The High Court found that all three of these conditions were met. Leech J's judgment included the following observations:

(A) No real prospect of avoiding insolvency

Following BTI v Sequana [2022] UKSC 25 (see our previous update here), the bar for satisfying the Knowledge Condition is a "very high one". According to Leech J, it must be established that the directors knew or ought to have known that insolvent liquidation or administration was inevitable.

Given the defence under section 214(3) of the Insolvency Act (see further below), where a company is insolvent, the usual question for the court is whether the directors honestly and reasonably believed that they could trade out of insolvency and, given time, avoid liquidation or administration altogether. As Lord Briggs put it in Sequana, the critical question here is whether there is "light at the end of the tunnel". According to Leech J, the prospect of successfully trading out of insolvency must nevertheless be "more than fanciful and a reasonable one": "blind optimism", he said, is not sufficient to defeat liability.  

Of the six so-called "Knowledge Dates" which the Joint Liquidators had identified, the judge found that the Knowledge Condition was satisfied on only the last. This was 8 September 2015, when the directors had authorised the companies to enter into a new finance arrangement (known as the Grovepoint Facility), which carried high interest rates, was secured ahead of other existing creditors and risked significantly prejudicing those creditors in the event that financing failed.

Although, as discussed below, the earlier Knowledge Date of 26 June 2015 was considered relevant for the purposes of the separate misfeasance claim, the judge accepted that insolvent administration was not inevitable on that date because there was at that stage still some light at the end of the tunnel. Accordingly, the wrongful trading claim in respect of that Knowledge Date was dismissed.

(B) The timing point

Section 214(2)(b) requires that the directors have the relevant knowledge "at some time before the commencement of the winding up of the company". The directors submitted that, for the Knowledge Condition to be met, it must be established that they knew or ought to have known that the companies could not avoid going into liquidation or administration either by a specific date or within a very short period of time. They also submitted that knowledge that the companies would go into liquidation or administration at some vague point in the future was not sufficient.

In the judge's view, each case will depend on its own facts. Although he acknowledged Lord Hodge's use of the expression "near the onset of insolvency" in Sequana, in Leech J's view it would create a "real difficulty if the Court laid down a time limit or bracket even as a rule of thumb."

The judge found that, if the directors fully appreciated that the companies would enter insolvent administration after continuing to trade for a year or so, there was no reason why the directors should escape liability simply because they were unable precisely to predict when that administration would occur. However, the court did accept that the lapse of time between the relevant knowledge date and the decision to put a company into administration is still an important evidential factor which the court must weigh in the balance.

(C) Delegation

The duties and responsibilities of a company director are personal and cannot be delegated. However, management functions may be delegated to other directors or company employees. As is now trite law, there is a difference between proper delegation and division of responsibility, on one side, and total abrogation on the other. 

Where directors delegate management functions to other directors or employees, it remains their duty to monitor and supervise the discharge of those functions. In this case, Mr Henningson had submitted that his responsibilities were limited to only two areas of his expertise. Leech J, however, found that it was not open for him to leave to his fellow directors those decisions which were required to be made collectively by the relevant company board.

(D) Professional advice

The judge accepted as a general proposition that, if directors commissioned and relied on professional advice in the context of their decision-making, they will prima facie have fulfilled their duties.

However, he explained that the weight the court will attach to that professional advice will depend on various factors. These include the scope of the engagement, the instructions the adviser was given, the knowledge the adviser had or the assumptions they were asked to make, the advice they gave (or did not give), and the extent to which the directors relied on that advice (or not).

If the substance of a director's defence is that the professional adviser did not advise the board to put the company into administration or liquidation, the weight to be attributed to the absence of that advice will depend on a detailed assessment of the facts.

Here, the judge concluded that the directors had failed adequately to consider the external advice they had received prior to approving entry into the Grovepoint Facility.  

Specifically, the company's lawyers, Olswang LLP, had raised various points for consideration by the directors, such as whether the new financing would actually improve the companies' financial position. Olswang had also advised the directors to balance the prospect of a successful financing against the fact that unsecured creditors would be prejudiced due to the reduced assets available if it failed. The judge found that this advice was never tabled or discussed at a board meeting before the decision was taken to enter into the Grovepoint Facility.  

In the judge's view, if the directors had properly considered that advice, they would have concluded (based on a proper consideration of the issues raised in that advice) that there was no reasonable prospect of the company avoiding insolvent liquidation or administration.

Separately, Grant Thornton had been responsible for producing weekly cashflow updates in connection with the BHS Group's turnaround plan. In the judge's view, a Notional Director carrying out the functions of Mr Chandler and Mr Henningson would fully have understood that the assumptions underpinning those cashflow updates (and the turnaround plan more generally) were unreasonable. It also would have been obvious from Grant Thornton's cash flow update in early September 2015 that the BHS Group was cashflow insolvent because it stated in terms that BHS management had begun withholding payments. It was not necessary in these circumstances for Grant Thornton to have spelt out the obvious that the group was defaulting on its payment obligations.  

In the judge's view, it was irrelevant that neither Olswang nor Grant Thornton had advised on whether the companies had a reasonable prospect of avoiding insolvent liquidation or administration. This was not something on which either adviser "could or should have been expected to express an opinion". Rather, this was a question of individual judgment for the directors of those companies and those advisers could not have been expected to do more than identify the legal issues the directors had to consider and the severity of the financial position in early September 2015 and in the intervening period before the directors' formal decision to enter into the Grovepoint Facility.

(E) Defences

Section 214(3) of the Insolvency Act 1986 absolves directors of liability where, although the Knowledge Condition has been met, the directors nevertheless then took every step they ought to have taken with a view to minimising the potential loss to the company's creditors.

Section 1157 of the Companies Act 2006 exculpates directors in relation to breach of duty claims where it appears to the court that they acted honestly and reasonably and ought fairly to be excused.

The judge noted that section 214(3) imposes a high hurdle. It is not enough, he said, for directors to prove that they continued trading with the intention of reducing the net deficit of the company. They must also show that the steps they took were designed to minimise the risk of loss to creditors.

The meaning of "every step" in section 214(3) will depend on the facts of each case. Leech J accepted that it doesn't necessarily require taking specialist insolvency advice or considering whether to put the company into insolvency proceedings. But, in that case, it will be more difficult for the directors to show that they properly considered whether continuing to trade would reduce the deficiency and what the risks were to creditors.

On the facts, the judge held that the section 214(3) defence was not made out.

The judge also found that the directors could not rely on section 1157 to obtain relief from liability. This was because the judge was not satisfied that they had acted reasonably or that it would be fair in all the circumstances to relieve them from the liability for wrongful trading.

(F) Liability

Where wrongful trading is established, the court has discretion (under section 214(1)) to declare that a director is liable to make such contribution (if any) to the company's assets as it considers proper.

It was common ground that the maximum amount the court could declare the directors liable to contribute was the increase in net deficiency between 8 September 2015 (ie the relevant Knowledge Date) and the date of administration in April 2016. The judge set the maximum liability at £42 million (having given credit for certain sums paid by a fourth director, Mr Smith, who had previously settled claims brought by the Joint Liquidators and was therefore not party to these proceedings).

Of this total, the judge concluded that primary liability rested with Mr Chappell and ordered that he should bear responsibility for 50% of the loss. This was because Mr Chappell had:

• agreed to purchase the BHS Group for £1 without a sustainable working capital facility or any prospect of obtaining one;
• promised Sir Philip Green that he would not put the group into administration for three years, which the judge found was "no doubt to enable Sir Philip Green and Arcadia to distance themselves from the pension deficit and reduce the risk of a moral hazard investigation";
• used the year before administration as "an opportunity to plunder the BHS Group as and when he could"; and
• kept the group trading by adopting an "insolvency deepening, degenerative strategy of expensive loans."

Of the balance of the loss, the judge ordered Mr Henningson and Mr Chandler each to contribute £6.5 million to the companies' assets in respect of their wrongful trading, there having been earlier settlements in respect of claims against two other directors whom the judge also found to bear responsibility. The judge noted in this context that a strong board "composed of astute and experienced directors" might have prevented Mr Chappell from embarking on his strategy and protected the group's creditors. The judge declined to limit the award by reference to the directors' insurance cover or ability to pay, saying that doing so would send the "wrong message" to risk-takers.

Misfeasance

The Law

As Leech J noted, section 212 of the Insolvency Act 1986 does not create a new cause of action or new substantive rights. Rather, it simply enables a liquidator to enforce an existing cause of action which vests already in the company.  

The judge observed that the Joint Liquidators' misfeasance case against the directors had been pleaded "in the most general terms" and by reference to the directors' ongoing duties throughout the relevant period. Under this head of claim, the Joint Liquidators had asserted that, by continuing to trade at a time when the companies should have been in administration (so-called "misfeasance trading"), the directors were each in breach of their statutory duties under sections 171 to 176 of the Companies Act 2006.

Decision on misfeasance

The judge assessed the Joint Liquidators' case in respect of each of the pleaded statutory duties in turn. Of the six Knowledge Dates identified by the Joint Liquidators, he found that Mr Henningson and Mr Chandler were liable on two of them. These were, again, 8 September 2015 in relation to the Grovepoint Facility, and 26 June 2015, in relation to a separate earlier facility (ACE II).

In the judge's view, breaches of sections 171, 172 and 174 occurred on these Knowledge Dates for the following reasons:

(a) The decision of Mr Henningson (and Mr Chappell) to enter into the ACE II facility was an exercise of their powers for improper purposes (including to obtain the payment of an arrangement fee), in breach of section 171(b) (duty to act within powers).

(b) By 26 June 2015, both Mr Chandler and Mr Henningson knew that the company which entered into the ACE II facility was cashflow insolvent. By 8 September 2015, in respect of the Grovepoint Facility, both directors ought to have known that there was no reasonable prospect of avoiding insolvent liquidation or administration.

Accordingly, on both of those dates the directors were required to have regard to the interests of creditors in promoting the success of the company, pursuant to section 172(3) (ie the so-called "creditor duty").

Their decision, however, to enter into both the ACE II and the Grovepoint Facilities constituted "insolvency-deepening activities" in breach of that duty. In this regard, the judge noted the approach in Sequana, in which it was agreed that "insolvency-deepening activity" could amount to a breach of duty by directors even if insolvent liquidation is not inevitable and there is no liability for wrongful trading. The judge acknowledged that, in Sequana, both Lord Reed and Lady Arden had left open the question of whether, for the creditor duty to be engaged, it is necessary to establish knowledge on the part of the directors that insolvency was probable. However, in this case, the judge was satisfied that the directors did have such knowledge. The ACE II and Grovepoint Facilities were said to be insolvency-deepening because both carried onerous terms (including high interest rates) which would exhaust the group's assets if the new financing proved unsuccessful (which it ultimately did). Applying Sequana, the judge held that, not only was the creditor duty engaged, but at the relevant Knowledge Dates the directors ought to have concluded that the interests of the BHS Group's existing creditors were paramount, or at least have prioritised those interests over those of RAL, its sole shareholder.

(c) The directors' failures to call relevant board meetings, attend board meetings, properly minute decisions and reasoning, and adequately consider professional advice constituted breaches of their duty to exercise reasonable care, skill and diligence under section 174.

In the judge's view, if the directors had complied with the above duties, the companies would not have continued to trade and would have gone into administration earlier. The directors were therefore liable for misfeasance under section 212.

The judge also found for the Joint Liquidators in relation to three out of nine other individual misfeasance claims advanced against the directors. These concerned the sale of company assets and payments to related parties.  Although the judge accepted that the directors had acted in breach of their duties in relation to certain of the other six claims, he did not consider that those breaches were causative of the companies' losses.

A full assessment of the appropriate measure of loss for the misfeasance claim is still to be determined and therefore another hearing has been scheduled to hear submissions on the point.