Insolvency insights: Misfeasant trading scope widened

BHS highlighted the importance of what advice directors received and whether they adequately considered it in the years leading up to insolvency, says Jude Howson.

June 2024 saw the landmark decision handed down by Mr Justice Leech in relation to wrongful trading and misfeasance pursuant to the provisions of the Insolvency Act 1986 (IA86) against the directors of the BHS Group of companies (the group) following the group’s insolvency in April 2016 (Wright v. Chappell [2024] EWHC 1417 (Ch)).

While it was decided in the English court, the insight that the hefty 533-page judgment gives IPs acting as office-holders in the UK is invaluable. The judgment widens the scope of being able to pursue directors not just in terms of the provisions of s214 IA86 (wrongful trading) but also introduces ‘misfeasant trading’ via a novel application of s212 IA86 (remedy against delinquent directors, liquidators), therefore expanding the tools in the office-holder’s toolkit to challenge directors at an earlier stage than the provisions of s214 might allow.

The BHS judgment arguably fills the void left by the Sequana case (BTI 2014 LLC v. Sequana SA [2022] UKSC 25). Sequana set a really high bar for proof of wrongful trading and introduced a sliding scale of the balance between the interests of shareholders and creditors before insolvency became inevitable (known as the ‘creditor duty’ or ‘shareholder duty’ respectively). When insolvency is inevitable, creditor interests are paramount. Following BHS, the duty to creditors takes priority when insolvency is probable, and misfeasant trading will arise if directors continue to trade and are not thinking of the creditors’ interests all of the time from that point onwards. Post-BHS, misfeasant trading is possible as soon as the creditor duty is engaged, at a much earlier stage and at a time when there could still be a reasonable prospect of avoiding insolvency. Also, misfeasant trading does not have the strict knowledge test that liability for wrongful trading does.

The high bar for proof

As an IP with almost 30 years of insolvency experience, 20 of those in Scotland, I can categorically say I have never seen a successful wrongful trading action proceed through the courts on one of my cases. The bar is too high, and the legal costs are often prohibitive in an insolvency process of an owner-managed company, which are the insolvencies I typically come across. The provisions of s214 IA86 are often used as a threat against a director, but the facts of the case would need to be cast-iron to be proven through the court, so often a commercial settlement is reached outside of the judicial system.

Looking at the BHS case, which was fact-specific, there was no requirement to take into consideration all elements of s214 IA86, which sets a high bar for proof of wrongful trading. Indeed, at the point the court determined misfeasant trading had taken place, ‘insolvency was not inevitable’ and the group was not insolvent on a cash flow or balance sheet basis (s123 IA86). This, therefore, arguably, gives office-holders a wider scope to challenge directors’ conduct and actions in the lead-up to an insolvency at a much earlier stage and may result in more successful recovery action for creditors through the courts or via commercial settlement. Of course, though, every case turns on its own facts and is considered on its own merits.

Insolvency-deepening activity

How the company enters insolvency should also be a consideration. For example, the IP approached by a director with a view to commencing a creditors’ voluntary liquidation process will need to consider carefully the advice given in light of the BHS judgment. We cannot think purely in terms of IA86 considerations but need to consider in much more depth any potential contravention of the provisions of the Companies Act 2006 (CA06) and, especially if the directors’ actions could be seen as ‘insolvency-deepening activity’ by not acting in the interests of creditors or adhering to their fiduciary duties.

Directors need to be made aware of how certain actions could be construed as misfeasant trading long before insolvency is inevitable and the provisions of s214 IA86 are satisfied. IPs are well-versed in record keeping, but it is ever more important to keep contemporaneous records of meetings and discussions with directors prior to any formal insolvency, as these could be scrutinised following an insolvency and the advising IP could be held to account.

What guidance does the BHS decision and this new concept of misfeasant trading give office-holders conducting investigations and building a case for the recovery of funds for creditors of an insolvent company? On a practical level, investigations need to be framed around certain key considerations laid down in CA06 as well as IA86. Office-holders are very experienced in conducting investigations with a view to litigation and submitting the directors’ conduct report to the Insolvency Service. However, it might be worth giving a few examples from ‘Chapter 2 of CA06- General Duties of Directors’, which should be considered in a bit more detail in light of the BHS judgment:

• S172 CA06– duty to promote the success of the company. This is a consideration of when the directors should have realised that certain decisions were not in the interests of creditors and constituted ‘insolvency-deepening activity’. An example could be paying shareholder dividends but not contributing to the company pension scheme or paying trade creditors. Another example could be taking out a ‘risky loan’ to continue to trade, which was not going to benefit creditors in any way;
• S174 CA06– duty to exercise reasonable care, skill, and diligence. This involves similar considerations to those laid down in s214, but is potentially challengeable at a much earlier stage and looks for evidence of commercially unviable decisions, given the company’s financial position. Acting ‘honestly’ is not necessarily a defence; the court will scrutinise the director’s actions and consider how much knowledge the directors had. A director cannot delegate powers and absolve themselves of responsibility. If they delegate, they need to supervise who they delegate to, and if those actions do not consider creditors’ interests once that duty is triggered, then they could be held liable for misfeasant trading;
• S175 CA06– duty to avoid conflicts of interest. Here, look for actions of the directors which advance their personal interests to the detriment of the company, such as connected party transactions and large payments to directors.

What will help the office-holder to conduct these investigations and satisfy their statutory duties and the provisions of SIP2 (investigations by office-holders in administrations and insolvent liquidations)? Secure books and records as soon as possible—both paper and electronic. Important records would include bank statements, accounting records, management accounts, financial forecasts, board minutes, emails between the directors and shareholders/senior management (consider de facto and shadow directorships), and records providing the details of directors’ remuneration and benefits.

Most importantly, the BHS judgment highlighted the importance of what advice (legal/accountancy/insolvency) the directors received in the years, months and days leading to insolvency, and whether they adequately considered and acted upon it. It sends a clear message to directors to follow professional advice at this crucial juncture. Securing this information will allow the office-holder to scrutinise key transactions, decisions made and who benefited. When all this investigatory work has been done, to bring a successful claim against some or all of the directors individually, the loss will need to be quantified and the merits of bringing the action reviewed by solicitors or, if the insolvency is bereft of funds, an insolvency litigation funder could be approached.

Director defence

There is a potential defence against misfeasant trading at s1157 CA06 if the court can be satisfied that the directors acted honestly and reasonably and that, having regard to all the circumstances of the case, they ought fairly to be excused. This could excuse the poor judgment of a director when taking a decision, he or she thought was in the best interests of the company (s172 CA06) but turned out not to be, this is why record keeping and documenting decisions is so important. If directors can evidence that they considered the interests of creditors continuously as soon as insolvency was probable, for example after taking out a loan and continuing to trade, and that their actions were genuinely in good faith, they may have a defence. This is where minuting fully every step taken at this crucial stage and keeping detailed board minutes becomes essential.

Caution must be exercised by directors when using standard board minutes and templates; the more detailed the documentation setting out thought processes and actions the better. And if directors took legal or other financial professional advice, they need to document whether they followed it and, if they did not, why they chose not to.

To my knowledge, there have not been any further misfeasant trading claims brought before the court, so only time will tell how this new concept will develop.

This article was featured in the R3 Summer 2025 magazine.

If you have any queries on this topic, please do not hesitate to get in contact with Judith Howson or your usual AAB contact.