The English High Court has ordered1 two directors (the Directors) of four companies in the British Home Stores group (BHS) to make payments exceeding £18 million in connection with BHS’ trading prior to commencing insolvency proceedings.
Each director has been ordered to pay £6.5 million for continuing to trade past the point at which the Court concluded the Directors knew or ought to have known that insolvency was inevitable and there was no reasonable prospect of avoiding liquidation. This order represented the largest ever award made by an English court for wrongful trading, although it has been reported that an even larger award has been made against former owner and director, Dominic Chappell. Unusually, his trial was severed and dealt with separately to the trial of the other Directors, as Mr. Chappell was considered in poor health at the relevant time. Mr. Chappell previously had been disqualified from acting as a director for a period of 10 years and jailed for tax offences relating to BHS.
The Directors also were ordered to compensate the companies for breaching their directors’ duties by continuing to trade the companies past the (earlier) point in time at which they ought to have concluded that an insolvency process was likely. In respect of this breach, they could be ordered to pay more than £133 million, with the final sum to be determined at a separate hearing.
While the Directors were found liable for certain other breaches of duty relating to pre-insolvency transactions, this article focuses on the claims in relation to trading in the period prior to commencement of formal insolvency proceedings. It looks at the primary remedies under English law that a liquidator may pursue in respect of so-called ‘insolvent trading’, and reflects on the practical implications of the case for directors of distressed companies.
Unlike certain other jurisdictions, in England and Wales there is no requirement for directors to file for insolvency within a specific period. Likewise, there is no offence of trading whilst insolvent. Instead, the UK has adopted a more nuanced approach to companies continuing to trade in the zone of insolvency.
Under English law, directors may face personal liability for wrongful trading2 if the directors continue to trade past the point at which they know - or ought to know - that the company has no reasonable prospect of avoiding insolvent administration or liquidation and they do not take every step to minimize losses to creditors (the statutory defense).
If liability is established, the Court has a discretion to order that the directors make a personal contribution to the company’s assets. This is generally capped at the increase in the company’s net deficiency during the period of wrongful trading. This period will start from the point at which the directors knew or ought to have concluded (whichever is the sooner) that there was no reasonable prospect of avoiding insolvency and runs through the point at which the company in fact entered insolvency proceedings. The court may also exercise its discretion to make no award at all.
It is notoriously difficult for liquidators to bring successful wrongful trading claims. However, the risk of personal liability naturally focuses the minds of directors and generally serves as a deterrent for excessive risk-taking. Rarely, an alternative claim of fraudulent trading3 may be brought, although the bar for establishing liability is higher.
In the context of continuing to trade a distressed company, wrongful trading is not the only offence directors may incur personal liability in respect of. The UK Supreme Court’s landmark judgment in Sequana4 confirmed that directors and shadow directors may face liability for breaching their fiduciary and statutory duties under the UK Companies Act 2006.
The Supreme Court confirmed that the duty under the Companies Act 2006 to promote the success of the company for the benefit of members5 is modified when the company is in the zone of insolvency. Essentially, when a company is bordering insolvency, cash flow or balance sheet insolvent, or where administration or liquidation is probable, the directors must consider the interests of creditors—as well as equity owners—and carry out a balancing exercise between the two when making decisions. Once insolvency is inevitable, directors should be focused solely on the interests of creditors, as these become the stakeholders with the economic interest in the company. This is known as the Creditor Duty, albeit the duty is owed to the company rather than to creditors themselves.
The Creditor Duty is a separate cause of action from wrongful trading. This means that liability may be triggered at earlier stage in the company’s trading period and in circumstances where insolvency is not yet inevitable. Prior to the BHS case, the English courts had not made an award against directors for breach of the Creditor Duty involving ‘misfeasant trading’. This has now changed, with implications for future restructurings and insolvencies.
BHS was established in 1928 and became a household name in the UK. It specialized in the sale of clothing, homeware, home lighting and furniture, operating in 164 stores and 67 franchise stores in 16 countries.
In the decade prior to its collapse, its profitability declined, and by 2015 it had a cumulative operating loss of £442 million. In March 2015, Retail Acquisitions Limited (RAL) purchased the entire issued share capital of the parent company, British Home Stores Group Ltd, for £1. New directors were appointed to the BHS companies. These included the respondent Directors, Mr. Chandler and Mr. Henningson. Following a further unsuccessful trading period, the BHS companies entered administration in April 2016.
The liquidators brought various claims against the Directors, which for convenience can be divided into the following categories:
The liquidators argued that from the date of RAL’s acquisition of BHS, the Directors ought to have known there was no reasonable prospect of avoiding insolvency.
The liquidators proposed six potential dates at which the knowledge requirement for wrongful trading had been met (i.e. that they knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent administration or liquidation). The first five of these dates were rejected by the judge, Mr. Justice Leech. The Court found that the knowledge requirement was satisfied on 8 September 2015, six months after RAL’s acquisition. At this point, BHS was cash flow insolvent and it should have been clear that the unsecured creditors would be prejudiced by the Directors decision to continue trading. Entering into new, expensive financing had a degenerative effect on BHS’ assets because, in addition to the financing being on onerous terms, it was to fund loss-making stores, therefore increasing BHS’ debt. There was no reasonable prospect of BHS achieving its business plan, and no plan to remedy the substantial pension deficit.
The four BHS companies in fact entered administration on 25 April 2016, seven months after the knowledge requirement had been satisfied. The joint experts submitted that the interim trading period was associated with an increased net deficiency in BHS’ assets of £45.5 million.
In relation to the statutory defense to a claim of wrongful trading – i.e. that the directors took “every step with a view to minimizing the potential loss to the company’s creditors that they ought to take” - the case confirms that this is a high bar to meet. The meaning of “every step” will depend on the facts. The judge confirmed that obtaining professional advice will not always be essential, but where such advice is not taken, it will be more difficult for directors to demonstrate that they took every step.
As noted above, obtaining professional advice will assist evidentially in demonstrating that the directors discharged their duties. Procuring professional advice will also assist in demonstrating that the directors properly understood their statutory and fiduciary duties in the first place. However, the BHS case illustrates how the court will examine the circumstances and quality of the advice received. The court will be prepared to look at the scope of the engagement, the instructions to professional advisers, the accuracy of the information provided to the advisers, and the nature of the advice received. Not least, the court will look at whether the advice was in fact acted upon by the directors.
The judge observed that:
“…all the right questions… [were raised by the lawyers, but]… never tabled or discussed at a… board meeting before the decision was taken to enter into [the financing]…” and “…if Mr Chandler [as general counsel] had called a board meeting to consider each of the issues raised by [the lawyers] before entering into [financing arrangements], then I have no doubt that Notional Directors carrying out the functions of [the Directors] would have concluded that there was no reasonable prospect of avoiding insolvent liquidation or administration and that the immediate course was to take advice from an experienced insolvency practitioner”.
Well-advised boards will know the importance of documenting their decisions. Directors of financially healthy companies may be familiar with board minutes being prepared in advance of meetings. This practice is generally discouraged; especially so when a company is facing insolvency, since directors will need to carefully document not only their decisions and reasons, but also the discussions relating to those decisions (for example, the decision to continue trading or the decision to enter into certain transactions). Should a liquidator subsequently be appointed, the board minutes may be scrutinized to examine whether the directors acted appropriately.
It is therefore important that board minutes accurately describe what has occurred at the meetings. The judge stated that he assigned less weight to board minutes which had obviously been prepared in advance by BHS’ lawyers. Moreover, he attributed less weight to language or statements which had been drafted by BHS’ lawyers and simply repeated at subsequent meetings. In this case, the minutes were “formulaic and none of them record[ed] that there was any genuine discussion between board members about the risk of insolvency or the risks to individual creditors”.
It is important to note that board minutes are not the only records a judge is likely to consider when reaching a view on liability. In addition to board minutes, a Court may consider contemporaneous correspondence, including emails, handwritten notes of meetings, and text messages. These may be read out in court and parties therefore should be mindful of this possibility when discussing and commenting on company matters in crisis situations.
Acting with reasonable care and skill is a statutory duty of directors under the Companies Act 2006. As discussed above, directors also must act to promote the success of the company, as modified in the zone of insolvency by the Creditor Duty. A breach of duty may result in a subsequently appointed liquidator bringing misfeasance proceedings against the director.
In the BHS case, misfeasance proceedings were brought in relation to specific transactions (and in several cases the liquidators were successful). More interestingly, for the first time misfeasance proceedings were successfully brought against directors for breaching the Creditor Duty by continuing to trade in the zone of insolvency without taking proper account of creditors’ interests. In the case of BHS, the Court found that the Creditor Duty was engaged and breached in June 2015, ten months before the BHS companies entered administration and before the Directors were in breach of wrongful trading provisions. The Court held that the Directors ought to have known by that point that it was more probable than not that BHS would enter insolvent administration. There were several reasons for this, including that the Directors knew that if BHS did not secure sustainable new financing, BHS would be unable to cover rental payments and liabilities. However, the available financing was on onerous terms and not in the interests of creditors. Once the Creditor Duty had been engaged, the interests of creditors were not properly taken into account when the directors made important decisions.
The judge reasoned that:
“…if [the Directors] had complied with their duties on or before 26 June 2015 and on or before 8 September 2015 the Companies would not have continued to trade but would have gone into insolvent administration immediately.”
The joint experts submitted that by not filing for insolvency on 26 June 2015, the BHS companies’ net deficiency increased by £133.5 million. The actual amount the Directors will be ordered to pay in respect of misfeasant trading will be determined at a later hearing.
In summary, even when a company remains cash flow and balance sheet solvent and there is no breach of the wrongful trading provisions, directors still may face liability for ‘misfeasant trading’ by breaching the Creditor Duty.
The judge reiterated that there is a minimum objective standard of the general knowledge, skill and experience that is reasonably expected of a person carrying out a director’s functions. If a director’s actual knowledge, skill and experience is higher than the minimum level, the director will be held to a higher standard. However, a lower level of knowledge, experience and skill does not lower the objective standard. While acting in good faith is important, acting honestly alone may not be enough to avoid personal liability. This is true for wrongful trading and for breach of duty, although there is a statutory defense to breach of duty if the director acted honestly and reasonably and in all the circumstances ought fairly to be relieved of liability6. The judge commented:
“I accept that Mr. Chandler did not receive substantial rewards from being a director of the Companies [and] that an award of compensation [for wrongful trading] will be potentially ruinous for him. However, I am not persuaded that it is appropriate to take these matters into account. Again, it will send a green light to risk-taking or, even, dishonest directors if the Court reduces the amount of compensation…on the basis of his ability to pay…” [emphasis added].
Having established liability for wrongful trading, the Court ordered the Directors be equally but severally liable (given the difference between their involvement and culpability, with Mr. Chandler having done his best, albeit falling below the minimum standard to be expected). The judge considered that Mr. Chappell should bear liability for 50% of the losses, while the two Directors each should be liable for 15% of the losses incurred, being £6.5 million each.
The Directors argued the liability should be capped at the level of the Directors and Officers (D&O) policy and reflect their means to pay, rather than being based on the increase in the net deficiency of the BHS company’s assets. The D&O policy was capped at £20 million, including defense costs. Rejecting this argument, the judge considered that restricting an award to the D&O policy limit 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.” The judge also emphasized that the level of D&O coverage must be adequate for the size of the business. In the present case, the £20 million limit was clearly inadequate.
Boards of distressed companies should take note of this decision. It confirms the benefits of obtaining professional advice, particularly in the context of discharging the burden of showing that the directors acted appropriately in the period prior to insolvency proceedings being commenced. It will often be appropriate for the board of directors to obtain their own professional advice from a personal liability perspective, separate and independent to the advice obtained by the company. In certain cases, individual directors may need to take specific advice separate to the rest of the board. While the BHS companies obtained professional insolvency advice, the directors did not instruct lawyers to advise them on the risk of their personal liability.
Notwithstanding the above, the decision makes clear that obtaining advice alone will not act as a shield against personal liability. The courts will look at the quality of the information provided to the advisers, the advice received and—crucially—whether that advice was acted upon. The major problem was that the BHS Directors did not properly engage with that advice and had regarded it as a ‘tick box’ exercise.
Directors sometimes ask their professional advisers whether they ought to continue trading. This decision confirms that directors cannot delegate that decision to their advisers and they must exercise independent judgement. Directors are not expected to throw in the towel at the first sign of distress and it is usually legitimate to investigate turnaround and funding options. However, the prospect of trading out of insolvency and avoiding liquidation or administration must be “more than fanciful and a reasonable one”. As the judge noted, “blind optimism” will not be enough.
Each case will depend on its own unique facts, highlighting the need for specialized, tailored advice.
1 Re BHS Group Ltd & Others [2024] EWHC 1417 (Ch)
2 Section 214 of the Insolvency Act 1986
3 Under section 213 of the Insolvency Act 1986
4 BTI 2014 LLC v Sequana & Others [2022] UKSC 25
5 Section 172(1) Companies Act 2006
6 Section 1157 of the Companies Act 2006
Publication
While country risk cannot be avoided in cross-border transactions entirely, it can be effectively mitigated through careful transaction structuring and tailored contractual protections.
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Miranda Cole, Julien Haverals and Emma Clarke of our Brussels/ London offices are the authors of a chapter on procedural issues in merger control that has been published in the third edition of the Global Competition Review’s The Guide to Life Sciences. This covers a number of significant procedural developments that have affected merger review of life sciences transactions.
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