Wrongful Trading, Misfeasance, and the Emergence of “Trading Misfeasance”

Background of the Case

These were proceedings as a result of the failure of a large UK-based retailer and had to do with the actions of two of its former directors in a time when the situation was critical.

The firm did not file any formal insolvency proceedings but instead signed new financing facilities as it was still trading when it was insolvent.

The directors were also sued by the liquidators on wrongful trading and misfeasance claims alleging that the directors had violated their statutory and fiduciary duties by permitting the company to trade knowing that it had no reasonable chance of escaping insolvent liquidation.

Important Legal Questions that the Court Took into Consideration

Did the directors know or should they have known that insolvency would occur.
Whether it was a wrongful trading to continue with the trading.
Whether a new financing was a misfeasance to enter into.
Questions on how to calculate compensations on misfeasance.
The question of whether the losses are to be determined on a transaction by transaction basis or a larger basis.

Judgment in Wright and Ors v Chappell and Ors [2024] EWHC 1417 (Ch).

Both directors were found not guilty of misfeasance and guilty of wrongful trading on 11 June 2024.

The Court Held That:

The directors had gone on trading at a time when they knew or should have known, that there was no reasonable expectation of going off insolvent.
The directors also experienced new finance arrangements instead of put the company under an insolvent liquidation, thus exacerbating the financial state of the company.
This action was a violation of the obligations of directors toward the company and its creditors.

Establishment of Trading Misfeasance

In an important event, the court inculcated the concept of trading misfeasance whereby:

Misfeasance may result not only through individual unlawful acts, but even the decision to keep on trading will be a misfeasance.
A trading activity may amount to misfeasance where the directors are aware of a company trading when that company is in an insolvent state.

The court directed the directors to make compensation of 110 million pounds, which was losses incurred by the directors due to the misconduct of the directors.

Determination in Wright v Chappell [2024] EWHC 2166 (Ch).

Later, in a judgment that was issued on 19 August 2024, the High Court discussed the calculation of equitable compensation on misfeasance.

The Court Held That:

In cases where breaches of directors take place and a company is allowed to trade, the directors are under a liability to the growth of the net deficiency of assets of the company over the period in question.
The compensation must be determined based on the general deterioration of the financial situation of the company rather than on the separate transactions or separate violations.
The claims that damages can be confined to certain events or transactions were not accepted.

This explained why directors can face extremely high liability where their insolvency is increased with time as they continue trading.

Legal Connotation of the Case

This case is notable due to a number of reasons:

It broadens the misfeasance to over and above isolated misconduct.
It establishes that the fact of further trading can be part of a violation of duty.
It provides a wider compensation methodology, where successful funding is done on the basis of net deficiency, and not on individual transactions.
It enhances protection of creditors during insolvency situation.
It increases the individual financial risk of directors that postpones insolvency.

Lessons of Practical Use to Directors and Senior Management

It is the duty of directors to always determine the presence of realistic prospect of avoiding insolvency.
Trading with no objective rationale in the hope of recovery could put directors at risk of wrongful trading and misfeasance claims.
If the directors enter into new finance arrangements with insolvency this does not necessarily safeguard them.
The directors should take immediate professional advice and have to consider formal insolvency options once insolvency is inevitable.
Loss of time during action can cause a lot of personal liability.

Conclusion

Wright v Chappell cases are a significant advancement to the UK insolvency legislation. The principle that directors have to prioritise creditor interests when insolvency is inevitable has been strengthened by the High Court because it identified the concept of trading misfeasance and took a more general view of compensation evaluation.

Such decisions are a good reminder that trading in insolvency may have serious personal financial repercussions, even where the directors consider themselves to be acting in the best interests of the company.

Ref: https://www.judiciary.uk/wp-content/uploads/2024/06/Wright-v-Chappell-Ors.pdf