Avoiding personal liability for wrongful trading

Linton Bloomberg at Reed Smith explains how directors should respond to the largest wrongful trading judgment in the English courts

There have not been many retail failures that have caused as much public interest as BHS’ collapse into administration in 2016. While it may have been unique in many aspects given some of the high-profile individuals involved, it seems unlikely that any future closure of high street stores will lead to Parliament launching an inquiry. BHS’ demise saw 11,000 employees made redundant and the closure of 164 stores nationwide. Amid all this, the legal repercussions are still being felt some eight years later.

In June, the High Court issued what is considered to be the largest ever wrongful trading judgment by an English Court and the impact of the judgment should be noted by all directors in boardrooms across the country. Following a 25-day hearing with many days of cross examination, a 533-page judgment sets out a change in approach by administrators and the Courts and, as a result, a potential change in day-to-day practice for directors who want, understandably, to avoid personal liability with potentially eye-watering fines.

The decision saw certain directors being ordered to pay in excess of £10 million for failing to put BHS into administration at an earlier date with a second judgment following some days later ordering over £110 million be paid for trading misfeasance – continuing to trade without considering the interests of creditors.

Such sums are likely to arouse the attention of directors and lead to reviews of D&O insurance policies to ensure they are fit for purpose. As important will be the key lessons that can be learnt and what practical steps can be taken to help avoid such liabilities arising in the future. 

Directors’ duties

Given potential liability if things go wrong, agreeing to be a director should not be taken lightly. Directors owe numerous duties and obligations set out in the relevant legislation (the Companies Act) but also at common law. 

In every case a director must carry out their obligations with the skill, knowledge and experience that may reasonably be expected of a director, or, if a higher standard, their own actual skill, experience or knowledge. Further, a director must exercise independent judgment - that is make their own mind up on key facts. ‘Group-think’ is not a defence and neither is refraining from asking difficult questions.

Why directors should not rely on external advisors

A good board is likely to have directors with different skills or backgrounds. Additionally, where required, the board will (or should) engage external professional advisors who possess additional specialist skills (insolvency lawyers being one notable example!). For many years Courts actually took the view that relying on professional advisors went a long way towards evidencing that a director had performed their duty with reasonable care.

That has changed to a certain extent. The BHS decision made it clear (in case it was not obvious) that, in itself, this is not enough. In particular, the judge considered the scope of the advisors’ engagement, their instructions, and the facts and information provided to them. In short, if you don’t provide the full picture, you cannot rely upon the advice. Further, obtaining advice is just one part of the story – acting upon the advice is another. Clearly taking advice and then not following it will not provide any defence.

Instead, best practice would be to take professional advice from someone that is an expert in their field, but to note and consider carefully any qualifications, assumptions or caveats. It’s also vital that any professional advisors are given the full facts so that they have the opportunity to reach a frank, objective assessment of matters rather than being offered limited facts and short-term engagements.

Why board minutes must be detailed

Whilst a professional advisor is likely to know more about their area of expertise, it is the director who knows (or should know) more about the day-to-day position of the company. When it comes to a decision as to whether to carry on trading, it is those in day-to-day management who are best placed to know whether a potential funder is likely to fund or whether a creditor is likely to petition. Ultimately the decision therefore, for example, as to whether to file for administration is that of the director, and not the professional advisor, and the decision and risk cannot be delegated accordingly. 

Additionally, to rely upon the advice, directors must be able to demonstrate that they fully considered the advice. In the BHS case, a number of professionals were instructed but, at certain points, there was little evidence that the board engaged with these opinions in a meaningful way. 

The board minutes produced were, in some cases, generic and barren of any specific consideration of issues or warnings raised.

Instead, board meetings and minutes should discuss matters and concerns fully and frankly, with the minutes that are produced reflecting the substantive discussion of the meeting. Minutes or a detailed agenda should also be circulated in advance of a board meeting so the directors can review matters to be discussed.

Why directors cannot delegate difficult decisions 

It is established law that a director’s duties and responsibilities are personal and cannot be delegated. However, directors can delegate management functions; either to one another or to employees who are not directors. Naturally there is an inherent tension between these two positions.

A director however is a full-time member of the board and as such has a duty to keep themself informed of the affairs of the company.

A director should be explicit in which tasks are being delegated, to whom they are delegated and why that person is an appropriate choice to carry out that responsibility. Directors should also ensure they regularly review both the tasks they have delegated and how the delegated functions are being exercised.

Confirmation of established principles

Whilst the BHS judgment did not rip up decades of established case law, it took a microscope to many of the established ‘rules’ and common business practices underlining where a director could comply with market standards but fall short in their statutory duties. 

Given the significant personal liability that has flowed from the judgment, boards of directors up and down the country are reviewing their board room policies and best practices to ensure that they take a fresh view as to any risk and, just as importantly, ensure that their D&O insurance is up to date.

Linton Bloomberg is a Partner at Reed Smith

Main image courtesy of iStockPhoto.com and BrianAJackson