The High Court of England and Wales has found two directors of the collapsed department store group British Home Stores (BHS) liable to pay £110.23 million (HK$1.1 billion) after the court concluded they had allowed trading to continue when there was no hope of recovery.

The ruling followed the publication of a 533-page judgment in June finding that one of the two, and a third former director, were each personally liable to pay a combined sum of £18 million (HK$182 million) to the joint liquidators in respect of wrongdoing whilst at the group.

Mr Justice Leech in Wright and others v Chappell, Henningson and Chandler [2024] EWHC 1417 (Ch) (Re BHS) considered three main claims brought by the liquidators; wrongful trading, "misfeasance trading" and "individual misfeasance".

A sprawling store

The respondents were appointed as directors of four companies within the BHS Group (collectively, “BHS” or the “companies”) – a sprawling UK chain stocking home furnishings, clothing, lighting and furniture – in March 2015 when the companies were acquired by Retail Acquisitions Limited, after several years of losses. The companies continued trading and undertook several refinancing transactions. Just over a year later, the companies filed for administration and joint liquidators were appointed.

In 2020, the joint liquidators alleged the directors were guilty of wrongful trading.¹ The court found that the directors should have known that insolvent liquidation or insolvent administration was inevitable by 8 September 2015. Liability for wrongful trading was therefore established and record fines imposed. The joint liquidators also alleged that the directors had failed to consider the interests of the companies’ creditors by continuing to trade instead of filing for administration in a claim labelled “trading misfeasance” (see below).

Directors’ duties and misfeasance

In England and Wales, directors’ duties have now been codified and are set out in ss. 171-176 Companies Act, 2006. In Hong Kong, directors are bound by common law fiduciary duties with only one duty being codified - s.465 of the Companies Ordinance (Cap. 622) (modelled on s.174(2) of the Companies Act 2006). This provides that a director must exercise reasonable care, skill and diligence. A table comparing directors’ duties in England & Wales and Hong Kong appears at the end of this alert.

In England & Wales, there is a statutory summary remedy for misfeasance where, in the course of a liquidation, it appears that a person who is, or has been a director, has “misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company.”²

In Hong Kong, a summary procedure in the Companies Ordinance and the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO) provides that a liquidator, Official Receiver, creditor or contributory may commence proceedings against a company's directors and other officers "… in respect of the misapplication, retainer, misfeasance, breach of duty or breach of trust as the court thinks just."³ Misfeasance can attach to a breach of any of these duties, as well as to other specific offences such as unfair prejudice or transactions at an undervalue.

A person found to have been misfeasant may be ordered by the court to repay, restore or account for any misappropriated money or property of the company, with interest by way of contribution to the company’s assets.

Re BHS has coined a new phrase, however – “misfeasance trading” and “trading misfeasance”.

Misfeasance trading

At the point when a company is bordering on insolvency or where insolvent liquidation or administration is probable, the focus of the directors’ duty to promote the success of the company shifts from having to take into account the interests of the members to needing to consider the interests of the creditors when promoting the success of the company (a concept first highlighted in BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 and since referred to as the “modified Sequana duty”). The court made clear that neither of the terms “trading misfeasance” or “misfeasance trading” (both were used in the judgment) constitutes a standalone type of action.  

On 17 June 2015, the BHS directors received a cashflow forecast identifying a number of key headroom issues which indicated that with or without further funding, rent payments could not be met and there was no working capital to support the proposed turnaround plan.

Mr Justice Leech considered that - whilst the companies were not cashflow insolvent at this point and insolvency was not inevitable - the interests of the creditors should have by then been paramount. By entering into financing arrangements (described as “insolvency-deepening activities”), the directors had merely postponed the inevitable. The court found that “but for” the directors’ breach of duty, the companies would have gone into administration by the end of June 2015.

Calculation of loss

Agreeing with the liquidators’ argument that the amount of equitable compensation should be calculated by reference to the total increase in net deficiency (but making an allowance for an increase in the pension deficit and for an amount already contributed by another director who admitted wrongful trading), the court ordered two of the directors to pay more than £110 million (HK$1.1 billion) in respect of the increase in net deficiency between 26 June 2015 and 25 April 2016, the date when a formal insolvency process commenced.

The court also went on to consider two alternative bases for calculating equitable compensation for breach of duty: one based on individual increases in net deficiency, and another based on losses caused by an individual transaction or venture approved by the directors (in this case the entry into expensive lending arrangements).

The joint liquidators also claimed that the directors had further breached their statutory duties in relation to a series of specific transactions under the heading of “individual misfeasance”. Several of these claims failed on causation, however the court found the directors liable to pay a total of c.£5.64m (HK$57 million) under the remaining claims (in addition to £6.5 million in respect of the wrongful trading liability).

Re BHS – will dawn soon break on twilight trading for directors in Hong Kong?

The concept of “misfeasance trading” and the “modified Sequana duty” have not yet reached the Hong Kong courts, however the duty to consider creditor interests in insolvency has been accepted in several recent cases.⁴

Whilst it is not wholly clear whether the Hong Kong courts will adopt the same stance as in England, the Hong Kong courts are no strangers to misfeasance claims and it is likely a similar attitude to the creditor duty and "insolvency-deepening activities" could be adopted.  Where a liquidator identifies a sizeable net deficiency claim and the directors or officers concerned appear to have the means to satisfy such a claim, this case could well provide the roadmap for future claims to be pursued.

Going forward, directors need to be aware of the risks of personal liability where they decide to continue trading once insolvency is on the horizon. The decision to continue trading is a commercial one for directors to make and not one for professional advisers to take. When directors elect to continue trading, this is a conscious decision that needs to be properly reasoned and those reasons recorded. 

Directors need to exercise their own independent judgment and may be exposed to risk if they just passively follow the decisions of other board members. Directors who continue to trade whilst insolvent should be mindful of the heightened risks of ”insolvency-deepening activities" and whether further trading could make a bad situation, worse.

The Hong Kong Companies Registry guidance A Guide on Directors’ Duties sets out a series of principles which mirror many of the statutory duties of the Companies Act 2006 in England & Wales. Only one of these duties, the duty to exercise reasonable care, skill and diligence, has been brought into statute law in Hong Kong, by way of section 465 Companies Ordinance (Cap. 622).

Authored by Jonathan Leitch, Nigel Sharman, and Sophie Warren.

References

1 In England & Wales, the offence of wrongful trading is set out in s. 214 Insolvency Act 1986 and is designed to ensure that directors do not continue to trade on at the expense of creditors and dissipate assets which should otherwise be available for distribution to those creditors upon the company’s insolvency. There is no such offence in Hong Kong.

2 s.212 Insolvency Act 1986

3  s.276 CWUMPO

4  Tradepower (Holdings) Ltd v Tradepower (HK) Ltd [2010] 1 HKLRD 674, Moulin Global Eyecare Holdings Limited v Olivia Lee Sin Mei [2019] HKCFI 1715 and Cyberworks Audio Video Technology Ltd v Mei Ah (HK) Co. Ltd. [2020] HKCFI 398