Home Truths for Directors in the wake of BHS Insolvency

On 11 June 2024, in a lengthy judgment following a 5-week trial last year, it was held that the defendant directors of British Home Stores (BHS) had unjustifiably caused an already insolvent company to increase its financial deficit by £140 million. Two directors were held liable to pay over £6 million each. They may now face the prospect of personal bankruptcy.

BHS was a well-known chain of department stores selling clothes and household goods, but it had become heavily loss-making. In March 2015, BHS was purchased for £1 by a company that was controlled by Mr Dominic Chappell. Mr Chappell had a prior history of bankruptcy, and no experience in the retail sector or of running such a large company. While the sale of BHS had been agreed on the basis that the buyer would inject £5 million of new equity funding into the business, no new funding was introduced.

In June 2015, BHS’s directors decided to borrow money to cover its ongoing trading losses. BHS entered into what at the time was referred to as a “Wonga” loan, with an annual percentage interest rate as high as 33.7%. Ultimately, in April 2016, BHS went into insolvent administration, and then into liquidation in December 2016. The parties’ financial experts agreed that BHS’s net asset deficiency had increased by over £140 million in the one-year period from April 2015 (shortly after the purchase) to 2016 (the date of administration).

Judgment

In the High Court judgment, the two defendant directors, Mr Chandler and Mr Henningson, were each held liable to pay £6.5 million by way of contribution to BHS’s assets, for wrongful trading from September 2015 up to the date of administration. Following a late adjournment application, Mr Chappell himself is technically not a party to the judgment. However, the High Court recently ordered he pay an estimated £50m following a finding that he took the “opportunity to plunder the BHS Group as and when he could”.

Mr Chandler, the Group General Counsel, was a criminal barrister by training and had no prior experience of corporate law. The judge found that he was “clearly out of his depth” and able to be manipulated by others, but that he had not been dishonest. Nonetheless, Mr Chandler was held liable to pay compensation, and (initially at least) in the same amount as his co-director, Mr Henningson, whom the judge held had in fact acted dishonestly.

The judge noted that he had a statutory discretion to relieve individuals from liability. The directors had the benefit of a D&O policy with a limit of indemnity of £20 million including defence costs, which by the time of the trial had already been significantly eroded. Mr Chandler was not personally wealthy, but even though no finding of dishonesty was made against him, the judge refused to limit his personal liability.

That refusal to relieve Mr Chandler of liability, even though he was not held to have been dishonest and had only relatively limited financial means, is salutary. The judge commented that it would “send a green light to risk-taking” if the compensation payable by Mr Chandler had been reduced because he was facing bankruptcy. 

Misfeasance - Breach of the Directors’ Duties to Uphold Creditors’ Interests

When brought by the liquidators (instead of by the company), as in this case, a breach of directors’ duties claim is known as a misfeasance claim (under s.212 of the Insolvency Act 1986).

The judge held that the directors’ duties to uphold BHS’s creditors’ interests had been triggered before the end of June 2015, when it was known that BHS would not be able to regain trade credit insurance.

BHS’s insolvency had become “probable” at the point when its quarterly rental payments could only be met by entering into the “Wonga” loan on extortionate terms. It was held that BHS’s directors did not consider the interests of creditors before entering into this loan, when the creditors’ interests should, at that stage, have been prioritised.

The directors ought then to have resolved to put BHS into administration. Their failure to do so, instead deciding to borrow on extortionate terms and in breach of directors’ duties, was described as “insolvency-deepening activity”, and as “last desperate throws of the dice.”

As a matter of causation, it was held that if the directors had complied with their duties, BHS would probably not have continued to trade any longer.

The increase in BHS’s net-asset-deficiency from the end of June 2015 until the date of administration was £133 million. Before reaching a decision on quantum and apportionment between the directors, the judge invited further submissions on how this head of compensation should be calculated, given that this was recognised as a developing area of law.

Wrongful Trading – a Very High Bar

Wrongful trading is an alternative statutory remedy (under s.214 of the Insolvency Act 1986) to that of compensation for misfeasance / breach of directors’ duties. For the liquidators’ claim to succeed, they had to establish that there was “no reasonable prospect” of BHS avoiding insolvent administration or liquidation.

The judge commented: “I am satisfied that the bar is a very high one and that the Joint Liquidators have to demonstrate that [the directors] knew or ought to have known that insolvent liquidation or administration was inevitable […] The critical question […] is whether there was ‘light at the end of the tunnel’ […] Nevertheless, the Court must be satisfied that the prospect of trading out of insolvency […] was more than fanciful and a reasonable one.”

Applying this very high bar, the judge held that the directors ought not necessarily to have recognised that insolvent administration or liquidation was “inevitable” until September 2015, several months after they were held to have already breached their duties to uphold BHS’s creditors’ interests (but still 8 months before the date of administration).

The increase in BHS’s net-asset deficiency from September 2015 until the date of administration was £45 million. The judge decided that the directors’ proper contributions to this loss was £6.5 million each, even though that amount of compensation was “potentially ruinous”, and may mean that they face the prospect of personal bankruptcy.

Comment

These facts illustrate that a director’s duty to uphold the interests of creditors may often trump the statutory insolvency remedy for wrongful trading, as the duty towards creditors may be triggered long before insolvent administration or liquidation has finally become “inevitable”, namely where there is no longer any light for the survival of the company at the end of tunnel.

The courts’ approach to calculating the amount of compensation to be awarded against directors, who permit a company to continue loss-making trading in breach of their directors’ duties, awaits further development in future case law. Our view is that this is a particularly significant aspect, and insurers should closely monitor these developments.

For their part, the relevant D&O insurers will no doubt be carefully considering the insurance coverage implications of the highly critical findings in this judgment, including any applicable exclusions and the possibility of policy avoidance.

In circumstances where the defence costs up to the end of trial were said to have been very high (potentially even up to the full amount of the £20 million costs-inclusive limit of indemnity under the D&O policy), the extent to which BHS’s creditors will actually receive any financial benefit from this litigation remains to be seen. This scenario highlights the importance of keeping strategy at the forefront when defending and insuring claims against directors.

This case illustrates the need for sufficient D&O cover, as well as the potentially enormous costs of defending complex claims against directors. It also highlights that a key part of a director’s role can be to protect the company - and its creditors - from the actions of unscrupulous owners, and to demonstrate expertise and robust independence.