BHS: Key Takeaways for Insolvency Practitioners

The dust has now settled since Justice Leech handed down his judgment on the claim issued by the liquidators of BHS against certain of its former directors for wrongful trading and misfeasance. This included a novel claim for misfeasance trading.

In this article, we examine the key takeaways for insolvency practitioners (IPs) arising out of this decision in light of the significant amounts ordered to be paid by the directors personally to the high street retailer's insolvent estate for the benefit of creditors.

Background

In March 2015, the British Home Stores Group (the Group) was purchased by Retail Acquisitions Ltd (RAL) (the Purchase). Notwithstanding the Group's longstanding status as a UK retail stalwart, the Purchase was completed for a nominal price of £1 reflecting the Group's significant pension deficit and successive trading losses. Shortly after, following an unsuccessful attempt to negotiate a CVA with their creditors, the four companies which comprised the Group went into administration in April 2016.  Those companies then subsequently entered liquidation. The Group's inability to meet its liabilities and, in particular, its pension obligations, meant that individuals and entities connected to the business including its directors, shareholder and former shareholder were subject to significant regulatory scrutiny. Separately, in December 2020, the joint liquidators of the Group (the Joint Liquidators) issued claims against certain of its former directors (the Directors) in connection with their running of the business alleging that they were liable for misfeasance and wrongful trading under sections 212 and 214 respectively of the Insolvency Act 1986 (the IA 1986) (the Claims).  

The Claims

s.212 IA 1986

The Joint Liquidators' route to establishing liability for misfeasance was twofold. They argued that the Directors had breached (i) various of their statutory duties in connection with various individual transactions and also (ii) their duties under section 172 of the Companies Act 2006 (CA 2006), by continuing to trade more broadly (the Misfeasance Trading Claim).

s.214 IA 1986

Under section 214 IA 1986, the Joint Liquidators argued that the Directors knew or ought to have concluded that the Group had no reasonable prospect of avoiding insolvent liquidation or administration (the Knowledge Condition) from their appointment on or about the date of the Purchase or, alternatively, by some later date prior to the Group entering into administration. The Joint Liquidators further particularised their claim following an interim hearing and put forward six specific dates on which they considered the Knowledge Condition to be satisfied between 17 April 2015 and 8 September 2015 (the Knowledge Dates).

The Decision

s.212 IA 1986

The Misfeasance Trading Claim was, in part, based on the Directors' failure to have regard to the interests of the Group's creditors by approving entry into a secured loan facility on 26 June 2015 (the Secured Loan) in breach of their duty under s172(3) CA 2006 (the Modified Duty).

The judgment of the Supreme Court in Sequana sets out key principles governing the engagement of the Modified Duty.  We have previously commented on this in a separate article.

In essence, Sequana confirms that there is a common law rule requiring directors, once a company reaches a certain level of financial distress, to consider and to give appropriate weight to the interests of creditors, balancing them against shareholders' interests where they may conflict.  This duty is triggered once a company is insolvent, bordering on insolvency or an insolvent liquidation or administration is probable.  This can potentially be at an earlier time than when directors may face liability for wrongful trading under section 214 IA 1986.

Justice Leech found that the Directors did not consider the interests of the Group's creditors prior to approving entry into the Secured Loan. On this basis, he had to consider, applying the Notional Director Test (described below), whether reasonable directors, who had properly considered the interests of creditors and given them appropriate weight, would have decided that the interests of those creditors were paramount and, if so, whether it was in their interests to enter into the Secured Loan.

It was noted that, at the time the Secured Loan was approved by the Directors, the unsecured creditors (and not RAL) were exposed to considerable risk.  This was because the cost of the onerous and expensive Secured Loan would erode and then exhaust the Group’s property assets if it could not be repaid. It was also noted that the Directors should have known that there was no reason to believe that the Group's financial situation would be better by the next quarter because its parent company had been previously unable to obtain a sustainable working capital facility. Justice Leech therefore held that reasonable directors would have concluded that the interests of the Group's creditors were paramount and that entry into the Secured Loan was not in their interests. As such, the Directors were in breach of their statutory duties.  The judge considered that, had the Directors complied with their duties, the Group should have gone into administration and not entered into the Secured Loan. At a separate hearing in August 2024, the Directors were ordered to pay £110,230,000 on a joint and several basis into the Group's insolvent estate. We have explored the key takeaways from this decision in this article.

Justice Leech also found that the Directors were in breach of their statutory duties in respect of 4 individual transactions which, broadly, related to the payment of monies to the Directors themselves or various connected parties such as RAL.

s.214 IA1986

In deciding whether the Knowledge Condition was satisfied, the court determined that the correct test to be applied was the standard of a reasonably diligent person having both (i) the general knowledge, skill and experience reasonably expected of a person carrying out the same functions as the Directors and (ii) the general knowledge, skill and experience that they actually have (the Notional Director Test).

Applying the Notional Director Test, Justice Leech dismissed the Joint Liquidators' Claim in respect of the first five Knowledge Dates.

However, he accepted that by 8 September 2015 the Knowledge Condition was satisfied on the basis that, among other things, the Directors were aware that the Group’s business had been loss-making for some time and its funding options were severely limited especially because RAL was not able to replicate the financial support provided by the Group's former shareholder. As such, the Directors were found guilty of wrongful trading in respect of the final Knowledge Date (8 September 2015).  They were ordered to pay £6.5 million each towards the increase in the net deficiency of the Group's assets between 8 September 2015 and 25 April 2016 when the Group went into administration.

Key takeaways for IPs

Misfeasant Trading and timing

This case was highly significant in that it was the first time that the directors of a company have been found guilty of the novel claim of 'misfeasant trading'.  The financial quantum of the award was also of note, with the Directors, prima facie, facing judgment of circa £110 million.

The Knowledge Condition provides a high bar for establishing liability for wrongful trading requiring that directors know or ought to know that a company has no reasonable prospect of avoiding insolvent liquidation or administration. However, the Trading Misfeasance Claim relied on the directors' breach of their statutory duties, including the Modified Duty, which may potentially be engaged at an earlier point in a company's financial distress, such as when insolvent liquidation or administration is merely "probable" (adopting Lady Arden's formulation in Sequana).

The effect of this is demonstrated in the BHS case where liability for misfeasance trading was established approximately three months before the Directors' liability for wrongful trading. Whilst each claim will be fact specific, the fact that liability for misfeasance trading can be established earlier than a claim for wrongful trading does, arguably, make such a claim easier to bring.  We therefore expect that IPs may, when there is a suggestion of director wrongdoing, carefully analyse whether there are grounds for bringing a misfeasant trading claim in addition to any action for wrongful trading. 

Professional advice

The Directors sought to rely on the fact that the Group received advice from prominent professional service firms, including in relation to directors' duties, to avoid liability for wrongful trading.

Whilst such action usually provides some level of insulation to directors against claims of wrongful trading and misfeasance, Justice Leech rejected the arguments put forward by the Directors in this instance. In consequence, the decision has led some commentators to question the value of professional advice and suggest that it will encourage IPs to bring claims against directors even where thorough advice has been received.

However, in the BHS case, it was clear from Justice Leech's findings that the Directors did not properly consider the advice that they had received at board meetings and that they had failed to provide all of the relevant information to their advisors. It is therefore unsurprising that the judge placed limited weight on the advice.  It is notable that he commented that, in ordinary circumstances, namely, where advice is received, considered and followed, a director goes a long way towards discharging their duties. As such, IPs will continue to need to carefully evaluate the full factual and legal position when assessing potential wrongful trading claims where directors have clearly received, assessed and followed informed professional advice.

D&O cover

The Directors argued that their liability should be capped by reference to the amount of D&O cover they had or the amount each could afford to pay. However, this argument was rejected as Justice Leech observed that it would leave creditors without recourse and encourage directors to take risks. This is good news for IPs who can take a certain level of comfort from this judgment that their recoveries will not be limited as a result of a director's failure to obtain adequate insurance coverage or their inability to pay any sums awarded although the recovery of any residual direct liability will be limited to the value of the defendant's personal assets.