BHS directors to pay equitable compensation for trading misfeasance of £110m

In our previous article, we considered the 11 June judgment of Mr Justice Leech in which he found two former directors of BHS liable for wrongful trading, trading misfeasance and breach of duty.

At that time, Leech J made awards against the directors of £13m for wrongful trading, as well as others totalling £5.6m for individual breaches of duty, but held over the determination of the quantum of liability for trading misfeasance to a further hearing in June. The outcome of that further hearing is now available – and the sheer size of the number will strike fear into the hearts of directors whose companies are attempting to navigate financial stress.

Mr Chappell

Proceedings against a third director, Mr Chappell, were severed from those of the other directors, and were also heard in June. When Mr Chappell did not show up, the hearings proceeded in his absence, with summary judgment given against him in respect of the wrongful trading claim, trading misfeasance claim and all of the individual misfeasance claims he faced – he was ordered to make a contribution of £21.5m in respect of the finding of wrongful trading. That left the amount of the liability for trading misfeasance outstanding.

What did Leech J have to decide?

Leech J had to determine the basis on which compensation for breach of duty in respect of trading misfeasance should be ordered. Leech J faced a somewhat unenviable task, particularly because at no stage had any of the courts in the leading directors’ duties case BTI 2014 LLC v Sequana considered the basis on which quantum for such a breach would be assessed. (This was because on the facts in that case there was no breach of duty and therefore no award to be made: for more on the Supreme Court’s decision in Sequana, see Sequana: implications for directors in the zone of insolvency). Leech J therefore had to look to the wider authorities on equitable compensation and compensation under section 212 Insolvency Act for guidance.

What did Leech J decide?

Leech J found that the remaining directors were jointly and severally liable to pay equitable compensation calculated by reference to the total increase in BHS’ net deficiency (crudely, the amount by which BHS’ net financial position had worsened (how much the debts had increased and how much the assets had reduced)) (the IND), adjusted for an increase in the pension deficit which he held wasn’t caused by the directors’ breaches of duty. He therefore ordered the directors to pay the total sum of £110,230,000 to the liquidators.

Determining the basis for compensation

The key points for Leech J to determine were:

• Is equitable compensation determined on the basis of a “but for” test or must the breach of duty have caused all the loss?
• Were the directors liable for the entire IND? Or was liability for a breach of the creditor duty limited to that which arose solely from the single transaction or venture which the director authorised?
• Must the directors be joint and severally liable, or could they be severally liable?
• Was the “floodgates” argument - that a finding that the director was liable for all of the IND would lead to liquidators bringing claims for breach of duty rather than for wrongful trading - persuasive?

Leech J’s findings

Leech J held that the starting point for the assessment of compensation for misfeasance under section 212 is the IND where the company continues to trade as a result of the individual breaches of duty. He rejected the proposition that as a matter of law compensation is limited to the loss suffered by the company arising out of a single transaction. However, it is not enough for the liquidator to prove that “but for” the breach of duty the company continued to trade and that as a consequence there was an increase in net deficiency. A liquidator must also prove that the breaches of duty were not simply the occasion for the losses which the company suffered by continuing to trade but an effective cause (although not the sole or only effective cause). Leech J was comfortable that this was the case here.

The judge also considered the scope of the directors’ duty, and was satisfied that all of the losses fell within the ambit of the Sequana duty which Mr Henningson and Mr Chappell owed to the creditors of the companies. He was satisfied that there was a clear nexus between the risk of harm against which they assumed a duty to protect the companies' creditors and the losses which the companies suffered.

Leech J was not persuaded by the “floodgates” argument: the authorities show that a liquidator is entitled to pursue alternative claims under both misfeasance provisions and for wrongful trading.

The directors were jointly and severally liable, with Leech J holding that even if he did have discretion under section 212(3)(b) of the Insolvency Act to limit or apportion liability between the directors, he declined to exercise it.

Determining the amount of compensation

Leech J looked at the total amount of the IND and considered whether there were any elements where he was not satisfied that the breaches of duty which the directors committed were the effective cause (or merely the occasion for it). He then considered the volatility of the pensions deficit and decided that this meant that certain losses attributable to the pensions deficit were not attributable to the directors’ breach of duty and so should be excluded from the award for equitable compensation.

Leech J also set out a number of alternative compensation mechanisms which would apply in the event he is found to be incorrect that the starting point for calculating the amount of compensation is the whole of the IND. Those alternatives looked to the value of properties and to the decrease in the IND resulting from a single transaction – it might be cold comfort to the directors, given that the lowest level of compensation calculated under those alternatives by Leech J is £34m.