The landmark ruling, handed down on June 11, came some eight years after BHS collapsed into administration with a £571m shortfall on 25 April 2016, 13 months after being acquired by Retail Acquisitions Limited (RAL) from Sir Philip Green’s Taveta Group, and .a company controlled by Dominic Chappell, an ex-bankrupt with no retail experience.
In a 533-page judgment, Mr Justice Leech upheld the joint liquidators’ claims and made the largest ever illegal trading award and the first fraudulent trading award in the UK against two former BHS directors.
Joint liquidators commenced proceedings in December 2020 against three former directors of the group companies: Chappell, Lennart Henningson and Dominic Chandler for unauthorized trading, misappropriation in business and individual malpractice claims under the Insolvency Act 1986. The judgment is binding only on Henningson and Chandler , with claims against Chappell to be determined at a later date due to his medical condition.
A director will be liable for unauthorized trading if he knew or should have known at any time before the liquidation of the company began that there was no reasonable prospect that the company would avoid entering into insolvency liquidation (condition of knowledge), unless from that date the director took all steps to minimize any loss to creditors (§ 214 of the Act).
The joint liquidators argued that the condition of knowledge was satisfied by six “dates of knowledge” and Leech J carried out a careful analysis of the evidence (including minutes, handwritten notes and text messages) in relation to each of them. In assessing constructive knowledge, the court applied the “notional director” test, which would: be applied to each individual director; “examine the essence of what they actually did”; be adjusted depending on the size of the company; and consider not only available materials but also materials to which a director “with reasonable care could have access”, including “sufficient financial information to monitor the company’s solvency”.
S.214 will be employed when liquidation/insolvency administration was inevitable, with the critical question being whether there was “light at the end of the tunnel”. Directors are not liable simply because the company is insolvent, but rather where the directors have “no rational basis” for continuing to trade and fail to take steps to minimize loss to creditors.
Directors cannot hide behind delegation or professional advice: their duty remains to supervise the performance of the delegated functions. While it is generally the case that a director who obtains professional advice “has gone a long way towards fulfilling his duties with reasonable care”, in practice the weight a court will give to any advice will depend on the scope of the engagement, including the information. the assumptions made, the advice given and the extent to which directors rely on it.
The court found that the knowledge condition was met at the latest alleged “date of knowledge”, when the directors knew that the group was loss-making, that there was no prospect of raising finance and no plan to deal with the pension deficit. On this basis, the companies should have gone into administration in September 2015, not April 2016.
The court has a discretion under section 214 in respect of directors’ contributions, the starting point and maximum being the increase in the net deficit (IND) of the assets generated by continuing to trade between the date the knowledge condition is satisfied and the date of insolvency. Here the IND was £45m, with the court ruling that Henningson and Chandler were liable for 15%: £6.5m each. The court refused to reduce liability on the basis that the group’s D&O insurance would not cover all claims against them.
Section 212 of the Act provides for the recovery of assets or compensation by the liquidator from the director if the director has violated his obligations to the company. Unlike section 214, this does not create a new cause of action, but rather allows the liquidator to enforce an existing cause of action that the company has against the director.
The joint liquidators alleged that the directors had breached numerous obligations under the Companies Act 2006, including: section 171 (duty to act within powers); s.172 (duty to promote the success of the company, modified where there is a real risk that insolvency might occur to include a duty to have regard to the interests of creditors); and s.176 (obligation not to accept benefits). Interestingly, the court held that there will be a breach of section 172 where the directors carry out “activity that aggravates the insolvency”, even where liquidation in bankruptcy is not inevitable and there is no breach of section 214.
The court ruled that Henningson and Chandler had failed to take into account the interests of the companies’ creditors in breach of the amended duty before entering into certain loan agreements, and that if they had complied with their obligations the companies would not have continued to trade and would have gone into administration in June 2015. The amount of this the claim has not yet been determined, but could be as much as £133.5 million.
The joint liquidators also made claims of “individual embezzlement” in relation to specific transactions, including secret kickbacks; sale undervalued; and third party payments. Although not all of these claims succeeded, the court ruled that Henningson and Chandler were collectively liable for a further £5.6 million.
This judgment represents a significant victory for the liquidators. It will serve as a cautionary tale for directors, emphasizing not only the importance of exercising independent judgment, but also providing all professional advisors with full context when seeking advice.
Clare Hennessey is special counsel at Jenner & Block. Partners Lizzie Shimmin and Jason Yardley also contributed to this article