Misfeasant Trading vs Wrongful Trading

Following the dramatic collapse of British Home Stores (BHS), once a prominent name on Britain’s high streets, the liquidators of the BHS group companies (BHS Group) brought high profile claims against its former directors. These claims, already noteworthy due to the prominence of the company, have gained further significance following the High Court’s rulings.

They now stand as some of the most consequential decisions on directors’ liabilities in insolvency since the Supreme Court’s landmark judgment in BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25.

These rulings are particularly significant for the Judge’s handling of claims that the directors breached their duty to act in the best interests of the companies and their creditors by continuing to trade when insolvency was “probable.” Referred to as “Misfeasant Trading” by the Judge, these claims drew on the “creditor duty” principles outlined in Sequana, testing the interplay between misfeasant trading and wrongful trading in the context of insolvency law.

Litigation finance, funding arrangements and insurance allow insolvency practitioners to pursue claims on behalf of their clients whilst reducing financial risks. At Annecto Legal, we can assist clients by helping them secure funding and insurance for insolvency cases.

Background

The BHS Group was acquired by Retail Acquisitions Limited on March 11, 2015, with the defendants appointed as directors. Just over a year later, in April 2016, the Group entered administration, followed by liquidation.

During this period, the Group undertook transactions that the liquidators argued worsened its financial position, accelerating its collapse. They sought contributions from the directors to compensate for these losses, alleging wrongful trading (Section 214 Insolvency Act 1986), misfeasant trading (Section 214 Insolvency Act 1986), and other breaches of directors’ duties.

Wrongful Trading Claim

Under s.214 IA 86, wrongful trading occurs when directors know, or should know, the company cannot avoid insolvent liquidation but continue trading without a rational basis. The liquidators identified six potential dates between April 17 and September 8, 2015, on which the directors ought to have known that insolvency was inevitable.

The Judge ultimately determined that the directors knew or should have known by September 8, 2015, that insolvent liquidation was unavoidable, making them liable for wrongful trading from that date.

Misfeasant Trading

Misfeasant trading claims (s.212 IA 86) addressed breaches of directors’ duties, particularly under s.172 CA 06, requiring them to act in creditors’ interests when insolvency is imminent. The Judge found that the BHS Group companies were “insolvent or bordering insolvency” by June 2015, triggering the so-called “Creditor Duty.”

Although the Supreme Court in Sequana had left open whether directors must meet a knowledge threshold for breaching this duty, the Judge concluded that the directors “knew or ought to have known” insolvency was probable as of this date.

To defend against the misfeasant trading claims, the directors would have needed to show they actively considered creditors’ interests and decided in good faith that continuing to trade was in their best interests. However, the Judge found no evidence of such consideration. As a result, the directors were held liable for misfeasant trading from June 17, 2015. 

Quantum of Claims

The Judge used the “increase in net deficiency” (IND) as the basis for damages. For wrongful trading, the IND as of September 8, 2015, was £45.5 million, with liability apportioned among directors. For misfeasant trading, the IND from June 17, 2015, was £133.5 million. The Judge found Mr. Chappell and Mr. Henningson jointly and severally liable for £110.23 million. 

Implications

These rulings highlight overlaps between wrongful and misfeasant trading, with misfeasant trading offering insolvency practitioners a lower threshold for claims. Directors can defend misfeasant trading claims by showing they acted in good faith in creditors’ interests, but professional advice must be specific and well-documented.

Going forward, directors of financially distressed companies must carefully assess their obligations and liabilities early, considering both wrongful and misfeasant trading risks.

Insolvency litigation funding options

Litigation funding, the assignment of claims and/or ATE insurance can play a pivotal role in assisting insolvency practitioners (IPs) in meeting their obligations. Insolvency practitioners involved in insolvency litigation can make use of the following methods:

After-the-event (ATE) legal insurance – ATE insurance is generally used to protect from adverse costs risks & Security for Costs requirements. After-the-event (ATE) legal expenses insurance is perhaps best thought as a similar to a ‘swap’. For either no upfront fee or a small upfront fee, the insurer takes on all of the risk of the potential adverse costs award.

The claimant has swapped their obligation to pay the defendants in the event of a loss, with the obligation to pay the insurer in the event of a win. This ‘swap’ is generally an attractive swap as the client is likely to be in a better financial position following a win than following a loss. Also, the payment to the insurer will only be a percentage of the adverse costs rather than the whole amount.

Third party litigation funding – In some cases, third party litigation funders may be willing to provide funding for a claim in exchange for a share of any financial settlement or damages awarded. This option can be attractive when there are no funds to pursue a strong case. ATE insurance is often used in conjunction with this type of funding.

Assignment of litigation – Some types of disputes can be assigned to a third party, usually for an upfront payment and a share of recoveries (after costs). This model can be useful on smaller cases when the ATE and CFA model would not deliver value. But giving up control can sometimes be costly, especially on larger claim disputes.

How can Annecto Legal help?

When handling insolvency matters, insolvency practitioners are obligated to explore all options available in such cases. At Annecto Legal, we assist a wide range of clients in finding the appropriate insolvency litigation funding, assignment options and after-the-event (ATE) insurance.

Annecto Legal regularly assists licensed insolvency practitioners who are involved in dealing with insolvency and misfeasant trading matters. If you are in the process of bringing or defending an insolvency dispute and want to find out whether we can assist in helping you fulfil your obligations and secure the right deal, then contact Annecto Legal now.