Misfeasance Trading – are directors now at greater risk?

August 22, 2024

The collapse of the iconic store chain, BHS in April 2016 was the largest UK retail failure since the implosion of Woolworths in 2008, with 164 stores being closed and 11,000 staff losing their jobs. The events leading up to its Administration raised many issues, after its original owners (Philip Green and his family) sold BHS to serial bankrupt, Dominic Chappell for just £1 less than a year before trading ceased.

Now the conduct of the Directors who served alongside Chappell in the period prior to the appointment of Administrators has created a whole new area of risk for the Directors of struggling companies. The subsequent Liquidators of BHS successfully brought a claim against the former directors. In a landmark decision, the judge found that two of the directors were not only guilty of wrongful trading, but also an entirely novel offence: ‘Misfeasance Trading’ in breach of their duties as Directors.

What is ‘Misfeasance Trading’?

The BHS decision (re Wright v. Chappell) defines this new offence as trading in breach of directors’ duties when the company should have gone into Administration or insolvent Liquidation much earlier if those duties had been complied with.

There is a high bar to establish a Wrongful Trading claim, which means that the insolvency office holder has to prove that the Directors knew (or ought to have known) that an insolvent liquidation was unavoidable. By contrast, the risk of committing Misfeasance Trading occurs much earlier than this, which arguably makes it much easier to establish.

In Wright v. Chappell, the Directors were found to have breached a number of duties imposed on them under the Companies Act 2006, including the:

  • duty to act within their powers (s171(b)),
  • duty to have regard to the interests of creditors (s172(3)),
  • duty to exercise reasonable care, skill and diligence (s174),
  • duty to avoid unauthorised conflicts (s175), and
  • duty not to accept benefits (s176).

Whether or not a Director has breached these duties is based on the action (or inaction) of the particular Director, which inevitably means that these types of decisions will most often be determined on the particular facts of each case.

Nevertheless, there are some clear indications of the key elements of Directors’ behaviour that can either expose Directors to prosecution for Misfeasance Trading, or else protect themselves against such action.

Prioritising the interests of creditors – and timing

It was confirmed that if the BHS Directors had considered the interests of creditors and decided in good faith that it was in their interests to continue trading, the claims would have been dismissed. They were not able to satisfy the judge on this point.

Importantly, the first time the BHS Directors were found to have breached their duty to consider the interests of creditors (for the purpose of the Misfeasance Trading claim) was some 6 months before the date on which the claim against them for Wrongful Trading was established.

It’s worth noting that it may be possible for Directors to be found liable for Misfeasance Trading, even if a claim for Wrongful Trading fails because the possible breaches of duty are so much wider and the bar for establishing guilt is lower.

Focusing on professional advice

Before the Wright v. Chappell ruling, it was generally thought that by taking professional advice in the period preceding a formal insolvency, Directors gained a strong measure of protection as regards Wrongful Trading. Now there are more challenging issues even when such advice has been taken:

  • what information was given to the advisers?
  • was the information accurate?
  • was the information complete?
  • was the advice taken before or after the event?
  • was the advice given discussed by the Directors?
  • was the advice followed?

In this case, the Directors were unable to demonstrate that they had ticked all or indeed any of these boxes, despite taking advice from respectable and credible professional firms.

The decision demonstrates that if Directors simply pay lip service to advice, obtain it to tick a box, don’t consider or discuss it, or don’t give their advisers the complete picture, then the level of protection against either Wrongful or Misfeasance Trading will be limited.

Meetings and minutes

Wright v. Chappell also confirms the importance of holding regular board meetings, attending them, recording what was discussed and why particular decisions were taken. The Directors were found to be in breach of their duty to exercise reasonable care, skill and diligence by failing to call board meetings, attend them, and properly minute decisions and the rationale for them. They were also found in breach of their duty to consider the interests of creditors – there was no evidence that they had at critical points.

The judge noted that keeping records is an “important discipline” but also flagged that standardised minutes that say that the directors had considered that they were acting in the best interests of creditors would be given little weight.

Instead, he commented that when making decisions, Directors should apply “rational” thought, provide “justification”, have an “honest belief”, apply “commercial judgment”, and act with “reasonableness” and in “good faith”. They should not make decisions that are “irrational”, with “blind optimism “or “wishful thinking”, or ones that are “fanciful” or “overly optimistic”.

The downside of Misfeasance Trading

The two BHS Directors were found personally liable to pay a total of £18m in respect of Wrongful Trading. The quantum of the damages to be awarded against them for Misfeasance Trading has yet to be established but will surely be substantially higher.  This is an extreme case involving a very substantial company and a very particular set of facts, but these awards are illustrative of why this risk should be taken extremely seriously once a company starts to encounter significant financial difficulties.

Being found guilty of Misfeasance Trading will likely also be considered in any Disqualification proceedings against Directors.

It is clearly even more important now to take independent professional advice at the earliest opportunity when the going gets tough and as this judgment shows, to take that advice seriously.

 


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