Directors' duties: causation and loss in insolvent trading

The court upheld the first instance judge's key findings against two former directors but narrowed the company's recovery. It separated the client money shortfall caused by the wrongdoing from losses generated by ordinary trading. The decision also gives a practical reading of the landmark UK Supreme Court decision in BTI 2014 v Sequana regarding "creditor duty" and claims about insolvent or loss-making companies.
In 2017, Next Generation bought 58 per cent of AFL Insurance Brokers. Before the sale, the Finches were directors of AFL. They had used client money to fund business expenses and concealed trading losses through false accounting. The High Court found fraudulent misrepresentation, dishonest breach of warranty, breaches of duties owed to AFL and unlawful means conspiracy. Those findings were not reopened on this appeal, which was limited to one question: whether AFL's trading losses were legally caused by the Finches' breaches and unlawful acts.
The Court of Appeal allowed the appeal in part. It focused on the scope of the duties that had been breached and on the distinction between a factual opportunity to incur a loss and a legal cause of loss. The fraud explained why AFL's financial position was hidden. It did not, without more, explain why the business later made losses. AFL's trading performance remained a commercial question, not a loss automatically attributable to the fraud. Losses arising from AFL's ordinary operations, including the post-acquisition losses, were not shown to be caused by the Finches' misconduct.
That conclusion was reinforced by the fact that when new management took over, further capital was injected and AFL at times traded profitably before the business was wound down. The fraud may have given AFL an opportunity to keep trading, but an opportunity was not the same as a cause. The Court of Appeal held that the law was clear that it does not generally impose upon directors a duty to ensure that their company does not trade while insolvent or at a loss, a conclusion also reached in Sequana.
Sequana concerned when directors must take account of creditors' interests as a company approaches insolvency. It confirmed that this is a modification of the directors' duty to the company, rather than a separate duty owed directly to creditors. The modified duty is engaged when the company is insolvent, or when insolvency is imminent (with creditor interests being paramount when an insolvent liquidation or insolvent administration is inevitable). A remote risk of future insolvency is not enough. In this case, the court found that the Finches did not breach their duty to give appropriate considerations to the interests of AFL's creditors in the sense discussed in Sequana; indeed, the essence of the fraud was that the Finches ensured AFL's trade creditors were paid albeit using money belonging to its clients.
This case serves as a useful reminder that directors who misuse entrusted money remain liable to restore it, but they are not insurers of the company's commercial performance.
The law does not impose on directors a duty to ensure that their company does not trade while insolvent or at a loss.
In a breach-of-duty claim, the loss must flow directly from the specific breach. It is not enough to show that the business would have ceased but for the wrongdoing and trading losses arising from the company's ordinary operations are not automatically attributable to misconduct.
While Harneys does not practise the law of England and Wales, the decision will be of general interest to practitioners in the BVI and Cayman Islands, where liquidators bringing claims against directors will need to identify the specific duty that was breached and demonstrate that the loss claimed was a direct consequence of that breach, rather than simply showing that the company continued to trade while insolvency was a possibility.