Directors Take Note: English Court Awards Substantial Judgment Under New "Trading Misfeasance" Law
The £150 million judgment makes clear the full impact of the trading misfeasance offence for directors.
On 19 August 2024, the latest British Home Stores ("BHS") judgment set out how trading misfeasance claims were to be quantified. In awarding the companies £150 million against two former BHS directors, the English Court for the first time addressed how equitable compensation should be calculated for breaches by directors of what has been termed the "modified Sequana duty". Trading misfeasance (as the court has decided the new offence should be termed) is the failure of directors to consider the interests of creditors when a company is insolvent or bordering on insolvency, but instead carrying on trying to trade out of trouble.
BHS collapsed into administration in 2016 just 15 months after it had been sold for just £1 to a consortium with no retail experience. On 11 June 2024, the main judgment was handed down which was the largest-ever award for wrongful trading under Section 214 of the Insolvency Act 1986. The judgment also made key findings of fact and law on various issues of liability and causation for both wrongful trading and "trading misfeasance", a cause of action explored for the first time in English law in this case.
This latest judgment addresses the quantum of the liability, which was based on claims that the directors had breached their fiduciary duties by causing the companies to continue trading through increasingly expensive borrowing (rather than placing them into administration) when they knew or ought to have known that insolvency was more probable than not. The court applied a "but for" test of causation and importantly applied it on a joint and several basis against the directors. In doing so, the court rejected the complaint that the new cause of action exposed directors to a significantly greater liability than the stricter (and well established) statutory offence of wrongful trading—which had led to a much smaller quantum of just £6.5 million against two of the directors.
The court also dismissed the defendant's argument that the measure of compensation for trading misfeasance should be limited to the loss arising out of the single misfeasant transaction or venture. Instead, where the directors' breach of duty is entering into a transaction which allowed the companies to continue to trade contrary to the interests of creditors, the starting point for the loss for which they are liable is the increase in net deficiency caused (i.e. the total difference between the company's assets and liabilities at the point of (i) breach and (ii) ultimate administration).
While it was common ground that the principle of remoteness does not apply to these claims, the court held that it is still necessary to prove that the breaches of duty were the effective cause (even if not the sole cause) of the losses which the company suffered rather than simply the occasion for them. The court also introduced a common law concept of scope of duty when analysing the quantification of damages for breach of fiduciary duty. Where those losses are unrelated to the breach of duty, they will not be recoverable.
In the case of BHS, which was burdened with a substantial pensions deficit both when it was sold and went into administration, the losses arising from changes in pension fund values that fluctuated as a result of various market conditions were deemed unrelated to the directors' duties (and breach) and so not recoverable. The court held that there was no nexus between the risk of harm against which the directors had a duty to protect the companies and the increase in pension deficit. Nevertheless, the losses that could be linked to their breaches left each of the directors liable for around £150 million.
While the BHS facts are relatively extreme, the fact that directors were found liable to such an extent, when in some cases they were earning around £150,000 a year and (at least in one case) had limited involvement at board level, is a warning to all directors of companies facing financial pressure.
Jones Day acted for the liquidators of the BHS Companies, FRP Advisory.
