In March 2015 the major high street retailer British Home Stores (BHS) was acquired for £1 by Retail Acquisitions Limited (RAL), a company owned by Mr Dominic Chappell. Mr Chappell became a director of the BHS entities upon completion of the purchase, together with three other individuals.
A year later BHS collapsed into insolvency proceedings with the loss of 11,000 jobs, a pensions black hole in excess of £500m and creditors owed substantial amounts. Over the past eight years the resulting numerous proceedings and investigations have included a House of Commons select committee inquiry and director disqualification proceedings and have resulted in reform of the pensions legislation.
Now the English court has upheld claims made by BHS’ joint liquidators (JLs) against certain of the BHS directors, finding two directors liable for wrongful trading and breach of duty, including, for the first time, for “misfeasant trading”. The decision sees a substantial award for wrongful trading of £13m (reported by the JLs to be the largest award for wrongful trading since its introduction) as well as awards totalling £5.6m for individual breaches of duty. The quantum of liability for misfeasant trading has yet to be established, but could, theoretically, be in the magnitude of £133m (being the increase in net asset deficiency during the period in which the directors were in breach).
At 533 pages in length, there is much to digest in the judgment. Below we extract the initial key takeaways from the decision. There may be more to follow, coming both from the quantum of the to-be-determined award for misfeasant trading and because unusually the proceedings against Mr Chappell were severed. The findings of fact in this decision are not binding on Mr Chapell: the decision in his case is expected imminently.
Background
The background to the collapse of BHS is complex, with Mr Justice Leech taking some 180 pages to set this out. Below is a high-level summary of the key dates.
- March 2015: RAL acquires BHS entities
- June 2015: Court finds that by this date the directors knew BHS required new financing to fund, amongst other things, rent payments, and that there was no reason to think the position would be better by the next rent payment date. Further, because BHS had been unable to find a sustainable working capital facility sufficient to enable it to execute a turnaround plan, it was more probable than not that the BHS group would enter insolvent administration. Accordingly, from this time the directors owed a duty to consider creditors’ interests, notwithstanding that the relevant BHS entities were neither cash flow nor balance sheet insolvent and insolvency was not inevitable.
- September 2015: Court finds that BHS entities were cashflow insolvent and that at this date the directors knew or ought to have known that the companies had no reasonable prospect of avoiding insolvent liquidation.
- April 2016: BHS entities enter administration
- December 2016 and January 2018: BHS entities enter insolvent liquidation
Liquidators’ claims
The JLs’ claims fell into three buckets:
- Wrongful Trading Claim
- Trading Misfeasance Claim
- Individual Misfeasance Claims
Wrongful Trading Claim
Amongst other things, section 214 Insolvency Act 1986 (IA) required the JLs to identify the date prior to the entry into insolvent liquidation at which the directors knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration (which the court called the “Knowledge Condition”). The JLs identified six alternative “Knowledge Dates” at which they alleged this condition was satisfied. The first occurred just one month after RAL’s acquisition of BHS and the last in September 2015 (six months post-acquisition and six months before the companies entered administration). The court rejected the directors’ argument that the JLs had to show that for each proposed Knowledge Date the directors knew or ought to have known that insolvency proceedings would commence by a specified date or within a very short period of time, saying “it would create a real difficulty if the court laid down a time limit or bracket even as a rule of thumb”.
The court found that for the purposes of the Wrongful Trading Claim the Knowledge Condition was satisfied only on the last of the proposed Knowledge Dates, in September 2015. In assessing the Knowledge Condition, the court applied the “notional director” test, being the standard of a reasonably diligent person who had the knowledge, skill and experience both of a person carrying out the same functions and, where higher, of the directors themselves. Applying the Knowledge Condition sets a high bar: the JLs had to demonstrate that insolvency proceedings were inevitable. But on the other hand, whilst the directors were entitled to continue to trade if there was light at the end of the tunnel, that light had to be more than wishful thinking.
The court held that the Knowledge Condition was satisfied on the September Knowledge Date despite the directors having sought external advice and none of the advisors advising that there was no reasonable prospect of BHS avoiding going into insolvent liquidation or insolvent administration. The court carried out an in-depth analysis of the directors’ notes, board minutes, emails and text messages, and said “…the weight which the court will attach to the professional advice which directors take will depend on the scope of the engagement, the instructions which the advisor was given, the knowledge which they had or the assumptions which they were asked to make, the advice which they gave (or did not give) and the extent to which the directors relied on that advice (or not).” In considering whether the directors had taken “every step” with a view to minimising the potential loss to the creditors that they ought to have taken, the court gave little weight to the advice received here because, amongst other things, the evidence suggested that the directors had not carefully considered nor relied on it. The court gave even less weight to transaction-specific minutes which had been drafted by external counsel or to generic statements regarding the consideration of creditors’ interests, which the court found were repeated into the minutes of meetings.
The maximum amount which the court could hold the directors liable for under the Wrongful Trading Claim was, crudely, the amount by which the net financial position had worsened (how much the debts had increased and how much the assets had reduced) between the knowledge date and the date of entry into administration. Unusually the experts for both the directors and the JLs agreed on that amount: for the September Knowledge Date this was £45.5m. The court has the discretion to decide whether to impose joint and several or several liability on the directors, with factors including the degree of culpability of the director and their role in making the relevant decisions (their place in the “hierarchy of decision-making”) influencing the exercise of the court’s discretion. Here, having weighed those factors, the court held the two directors were severally liable for £6.5m each.
Trading Misfeasance Claim
Section 172 of the Companies Act requires a director to act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. Following the Supreme Court’s decision in BTI 2014 LLC v Sequana SA, when a company is insolvent or bordering on insolvency, or an insolvent liquidation or administration is probable, the director’s duty under section 172 is modified to require him to consider the interests of the company’s creditors as a whole (the so-called “creditor duty”) (see our previous briefing here).
The JLs claimed that, in continuing to trade, the directors had not considered the interests of creditors and were therefore in breach of duty under section 172. The court tested this proposition on each of the proposed Knowledge Dates, finding that in June 2015 the modified duty under section 172 had arisen, that the directors knew (or ought to have known) that insolvency was probable and that it was more probable than not that the BHS entities would go into insolvent administration because it had not been able to find a sustainable working capital facility which gave it sufficient runway to implement the proposed turnaround plan.
Looking to the guidance given in Sequana, Mr Justice Leech found that in June 2015 at the very least the interests of the group’s creditors should have carried more weight than the interests of RAL, its sole shareholder, because RAL had “no skin in the game”. Instead, the decisions which the BHS board took to enter into two finance transactions on onerous terms amounted to “insolvency-deepening” activity.
This is a helpful example of the way in which breach of duty actions under section 172 can fill the “lacuna” identified by Lord Briggs in the Supreme Court decision in Sequana: those cases where the shareholders have nothing to lose from the adoption of a risky transaction as a last roll of the dice, but where the criteria for wrongful trading have not yet been met. Lord Briggs stated that a requirement that the directors consider and, if appropriate, give priority to the interests of the company’s creditors in their decision-making in such circumstances “appears to be a necessary constraint on the directors”.
Individual Misfeasance Activities
The JLs claimed that the directors had further breached their duties, under sections 171-177 Companies Act, in relation to a series of specific transactions. Four of these claims failed: the court found the directors liable for the remaining claims and ordered them to pay £5.6m in total.
Lessons
Whilst the complex fact pattern surrounding the downfall of BHS and the nature and background of the directors involved are hopefully an aberration, the case provides some useful reminders of more general application:
- Obtaining expert advice is not a get-out-of-jail-free card for directors: they must ensure they consider such advice, that it is properly scoped and the advisors given the proper background and information. The directors must also properly consider and rely on that advice and they must still exercise independent decision-making.
- Accurate, contemporaneous record-keeping is essential: the court was prepared to scrutinize the records in detail.
- Directors must actively consider whether individual transactions are, or continuing to trade is, most likely to promote the success of the company, including giving appropriate weight to the interests of the creditors (which may outweigh the interests of shareholders) where the company is insolvent or bordering on insolvency, or where entry into an insolvency process is probable.
Tim Carter
Joanna Charter