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In June and August 2024, in two lengthy judgments following a 5-week trial last year, it was held that the defendant directors of British Home Stores (BHS) had unjustifiably caused the already insolvent company to increase its financial deficit by £140 million. Two of the directors were held jointly and severally liable to pay compensation of over £110 million, and 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 was called 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).
First Judgment
In the first High Court judgment, two of the defendant directors, Mr Chandler and Mr Henningson (following a late adjournment application, Mr Chappell himself was at that stage technically not a party to the judgment,) were each held liable to pay £6.5 million by way of contribution to BHS’s assets, for wrongful trading held to have been carried on from September 2015 up to the date of administration.
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, in the first judgment Mr Chandler was held liable to pay compensation, and 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 very 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, 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 the prospect of bankruptcy.
Second Judgment
Shortly following the first judgment, Mr Chandler entered into a settlement with the claimant liquidators, under which, he agreed to pay them £730,000. Following an application by the claimant liquidators, the judge ordered summary judgment against Mr Chappell, so that in effect he also then became bound by the judge’s findings in the first judgment.
In the second High Court judgment, the judge decided the amount of compensation that Mr Henningson and Mr Chappell were ordered to pay, which was calculated at over £110 million.
Misfeasance - Breach of the Directors’ Duties to Uphold Creditors’ Interests
When brought directly by the liquidators (instead of by the company), as in this case, a breach of directors’ duties claim is known as a misfeasance claim.
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, and instead, borrowing 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 factual 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 the compensation sum, 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. That was addressed in the second judgment.
Compensation
The judge found that the starting point, for assessing the compensation amount for breach of the directors’ duties to uphold creditors’ interests, was the amount of the increase in the company’s net asset deficiency during the period when the company was still trading, but should not have been. The judge found no reason to depart from that normal measure of compensation in this case.
While the judge held that “remoteness of damage” was not a relevant factor to be taken into account, he considered that the concepts of “effective causation” and “scope of duty” were relevant factors. In consequence, the directors were not held liable to pay compensation in respect of the £19 million increase in the net asset deficiency, caused by fluctuations in the pension scheme deficit. This was deemed to be “the result of movements in the bond market” and so unrelated to the directors’ breaches of duty.
The judge further held that the full amount of compensation should be paid by Mr Henningson and Mr Chappell on a joint and several liability basis, i.e. the full amount can be enforced against any one of them, as this was held to be the default legal position when compensating breach of directors’ duties.
Wrongful Trading – a Very High Bar
Wrongful trading is an alternative statutory remedy 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.
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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).
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. This is because the duty towards creditors may be triggered long before insolvent administration or liquidation has finally become “inevitable”, namely when there is no longer any light for the survival of the company at the end of tunnel.
The judge rejected the defendant directors’ counter-argument that the claimant liquidators were seeking to “shoe-horn” what was in truth a wrongful trading claim into a misfeasance claim. Instead, the judge held that it was perfectly open to the claimant liquidators to pursue alternative remedies. As it turned out, the amount of compensation awarded in the second judgment for breach of directors’ duties (over £110m) dwarfed the amount that had been awarded in the first judgment for wrongful trading (£13 million).
We predict this outcome may embolden liquidators to pursue claims for breach of directors’ duties in preference to - or in parallel with - wrongful trading claims.
For their part, the relevant D&O insurers have no doubt been carefully considering the insurance coverage implications of the highly critical findings in these judgments, 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 significant financial benefit from this litigation remains to be seen. This 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 a director’s duty to demonstrate expertise and robust independence.
Read other items in Professions and Financial Lines Brief - October 2024
Insurance and reinsurance
United Kingdom