Wrongful trading and trading misfeasance

The High Court has found the former directors of collapsed retail chain BHS liable for wrongful trading, misfeasant trading and individual acts of misfeasance.

Although overall quantum is yet to be decided, this has been widely reported as the largest wrongful trading award the courts have made since the introduction of the Insolvency Act 1986.

This is the first time a court has considered and made an award for misfeasant trading. Insolvency practitioners investigating director actions prior to their appointment should now consider the possibility of a misfeasant trading claim even where it may not be possible to establish wrongful trading.

Background

The BHS group was acquired in March 2015 and new directors were appointed. By April 2016 four of the companies had entered administration, with a significant and newsworthy pension deficit and the ultimate loss of thousands of jobs. These four companies subsequently went into liquidation.

In December 2020, the Joint Liquidators commenced proceedings against the directors for wrongful trading; trading misfeasance; and individual misfeasance.

Practical learning points

The judgment is a hefty 533 pages long and this insight is not intended as a definitive or exhaustive summary. Instead, we have picked out some key practical learning points for IPs.

It remains difficult to establish the “knowledge date” for the purposes of a wrongful trading claim, and the court will thoroughly analyse the evidence before it. It may be appropriate to identify several different possible knowledge dates.

• The knowledge date is the date on which a director “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”.
• In the BHS case the Joint Liquidators proposed six alternative knowledge dates. The Court accepted that the date closest to the date on which the companies entered administration was the appropriate knowledge date in this case.

The prospects of recovery under any potential order, including the extent of any directors & officers insurance policy, should be considered from the outset of investigations.

• The Court may be willing to order different levels of contribution or compensation according to each individual’s involvement and culpability.
• In the BHS case the Court held that liability ought to be several, meaning individual directors were allocated liability for their own specified proportion of the relevant loss.
• While the Court may express sympathy for individuals who have acted honestly and those who may face insolvency themselves because of any order, this is unlikely to be enough to persuade the Court not to make a contribution order where wrongful or misfeasant trading has been established.
• In the BHS case the Court acknowledged that the award of compensation would be potentially financially ruinous for one director. However, the desire to avoid giving a “green light” to risk taking or dishonest directors took priority.

Evidence that the board obtained professional advice does not mean a wrongful trading claim is bound to fail.

• The Court will consider all the circumstances including the scope of engagement of advisers when determining whether the claim should be dismissed.
• In the BHS case, the Court was not satisfied that the directors carefully considered or followed the professional advice they received.
• The judgment also notes that legal and financial advisers should not have been expected to opine on whether the companies had a reasonable prospect of avoiding formal insolvency. This was a question for the directors.

Once wrongful trading has been proven it is a “high hurdle” for a director to establish a defence.

• The BHS directors were unable to establish that they took every step a director ought to have taken to minimise loss to creditors, and so were not able to rely upon the statutory defence contained in s.214(3) Insolvency Act 1986.
• The judgment notes this is a “high hurdle” to jump and that “it is not enough for the directors to prove that they continued trading with the intention of reducing the net deficit of the company. They must also show that …[their actions were]… designed to minimise the risk of loss to individual creditors.”

A misfeasant trading claim may succeed even if wrongful trading cannot be established.

• IPs should be alert to any indication that directors have at any point prior to insolvency decided to continue trading in breach of their statutory duties and in a way that risked deepening the potential insolvency of the company.
• In the BHS case the directors were found to be liable for misfeasant trading at a time when the companies were not cash flow insolvent and insolvent liquidation or administration was not inevitable (although it was considered by the Court that the directors knew or ought to have known that it was more probable than not).
• The Court held that the directors’ actions were a good example of “insolvency-deepening activity” and that the directors would have immediately moved the companies into administration if they had taken the creditors’ interests into account.
• There is a defence available pursuant to s.1157 Companies Act 2006 if the Court is satisfied that the director acted honestly and reasonably, and that having regard to all the circumstances of the case ought fairly to be excused. None of the directors were able to establish this defence in the BHS case.
• The Court did not consider the measure of compensation for misfeasance trading as part of the judgment. The Joint Liquidators claimed the whole increase in net deficiency for that period.
• The BHS case is the first where this claim was successfully pleaded. It remains to be seen whether this decision will be appealed and/or how the concept is developed in the courts.

If you would like further advice on any of the points raised in this insight please contact a member of TLT’s Restructuring & Insolvency team.