Directors duties after the BHS decisions

Introduction

In March 2015, BHS was sold for to Retail Acquisition Limited for the princely sum of just £1. Dominic Chappell (a thrice bankrupt former racing driver with no experience in retail) and his fellow directors took the helm of the struggling group. A little over a year later, in April 2016, BHS collapsed into administration and later insolvent liquidation by which point the net deficiency was a staggering £1.3 billion).

Unsurprisingly, the Joint Liquidators brought actions against the directors for wrongful trading (pursuant to s.214 of the Insolvency Act 1986) and misfeasance under s.212 (including breach of the duty to consider the interests of creditors, the “Creditor Duty”).

In two controversial judgments: Wright v Chappell & ors [2024] EWHC 1417 and [2024] EWHC 2166 (“the BHS cases”), Mr Justice Leech held that the directors were liable not just for wrongful trading (for which they were liable for -variously- £6m or £21m) but also for breach of the Creditor Duty from an earlier date. As a result of the breach of the Creditor Duty (which the judge termed “the misfeasant trading”), the directors were held liable for the net increase in the deficiency of the company’s assets (“the IND”) from the date of breach in the sum of £110 million – the same amount that they would have been liable for had they been liable for wrongful trading from that date.

The BHS cases raise a number of issues:

1. Have the lines between wrongful trading and breach of the creditor duty been impermissibly blurred?
2. Is “misfeasant trading” a new cause of action?
3. Is the outcome incompatible with fostering a “rescue culture”?

Blurred Lines

The Creditor Duty was considered by the Supreme Court in BTI 2014 LLC v Sequana SA [2022] UKSC 25 (“Sequana”). In Sequana, consensus amongst the Justices was that the Creditor Duty is triggered where a company was ‘bordering’ on a formal insolvency process or that a process was ‘probable’ or that entering into a particular transaction would make it so.

However, opinions diverged as to what weight was to be given to the interests of creditors. Competing analyses included ‘a duty not to materially harm creditor interests’ or ‘to be satisfied that the creditors would be no worse off than if company immediately into liquidation or administration’ (Lady Arden); a duty to give the creditors interests ‘appropriate weight’ as against the interests of shareholders (Lord Reed) and, in certain (unspecified) circumstances, act in the interests of the creditors (Lords Briggs and Hodge).

However, there was broad consensus that the interests of creditors did not (usually) become predominant until insolvent liquidation or administration was ‘inevitable’. The exceptions (in the view of Lady Arden and Lord Hodge) arise where: (i) a formal insolvency process is more probable than not and (ii) the only prospect of avoiding insolvency was engaging in a risky transaction which would put the company’s remaining assets at risk (i.e. an insolvency deepening activity). In those circumstances, requiring directors to give primacy to creditors’ interests was ‘a necessary constraint on directors’ and plugged a ‘lacuna’ in the law prior to the point of section 214 being engaged.

Section 214 is engaged when a notional director knew or ought to have known that insolvent administration was ‘inevitable’. Once that threshold is met, a director is under an active duty to take every step to minimise loss to creditors.

In Sequana, Lord Reed compared the Creditor Duty and Wrongful Trading. He noted the following differences: (i) the Creditor Duty applies at an earlier point in time that s.214; (ii) there is no knowledge requirement for the Creditor Duty to be engaged (unlike wrongful trading); (iii) the duty under s.214 is more onerous in that it requires the director to demonstrate taking objective steps to minimise loss whereas the Creditor Duty is discharged if the director acts in good faith; and (iv) different loss principles applied (equitable compensation vs. contribution to IND in the case of wrongful trading). Lord Reed concluded that breach of the Creditor Duty and Wrongful Trading do not yield the same result.

The BHS cases show that the distinction may be more difficult to draw in practice. In BHS, having found that the directors were liable for wrongful trading from 26th August 2015, the Judge considered whether the Creditor Duty was breached at an earlier point. He held that by 23 June 2015 (before entry into the ACE II facility), the directors knew it was probable that BHS would enter a formal process. The directors were therefore obliged to consider creditors’ interests before entering into the ACE II transaction but did not do so.

Had the directors considered the interests of creditors in good faith and still entered into the ACE II facility they might have escaped the consequences of breach (because an honest but misguided view will suffice provided that an intelligent person in that position could have held it). However, where no consideration is given to creditor interests, the question is what would the notional director have done?

The Judge held that a notional director would have not entered into the ACE II facility because it was an onerous transaction which put the last of the property assets at risk and all of the risk was carried by the creditors (i.e. it was the type of insolvency deepening activity referred to by Lord Hodge and Lady Arden).

In terms of loss, the Judge had to consider what would have happened if BHS had not entered into ACE II? On the facts of the case, he found the BHS group would have been placed into a formal insolvency process almost immediately. As a consequence, applying the principles of equitable compensation, the directors were liable for the IND from that point.

Much of the controversy surrounding the case is that, on this occasion, the loss for breach of the Creditor Duty is the same as if the directors had been liable for wrongful trading. That outcome might be a surprise to Lord Reed but is not inconsistent with Lord Hodge or Lady Arden who were concerned about protecting creditors from the risks associated with “insolvency deepening behaviour”.

 Is “Misfeasant Trading” A New Cause Of Action?

Much has been made of the use by Mr Justice Leech of the phrases “misfeasant trading” and “trading misfeasance”. However, looking at the underlying mechanics of the decision, there is scant support for a new duty to avoid “misfeasant trading”. The BHS cases are best viewed as an application of the Creditor Duty and a salutary reminder of the potential consequences of breach.

Rescue Culture

There are concerns that BHS will discourage directors from making good faith attempts at corporate rescue for fear of incurring personal liability. That is possible but perhaps unlikely. The notion that defaulting directors may face significant financial liability for their conduct is not new – the Creditor Duty has been with us for some time. What is more likely (or to be hoped for) is that BHS will encourage directors to obtain advice from insolvency professionals at an earlier stage.

Article by Aileen McErlean – first published by ThoughtLeaders4 FIRE Magazine