New Zealand: Mainzeal judgment highlights directors personal liability in insolvency

Last Updated: 28 March 2019
Article by Holly Cassin and Sam Cowan

Prior to its failure in 2013, Mainzeal Property and Construction Limited (Mainzeal) was one of the largest players in New Zealand’s construction industry. When Mainzeal was put into liquidation in February 2013, it owed $110m to its unsecured creditors.

Following its collapse, Mainzeal’s liquidators became concerned about the manner in which Mainzeal’s directors had run the company.  In 2015, the liquidators filed proceedings in the Auckland High Court alleging (amongst other things) Mainzeal’s directors had breached their duties by recklessly trading the company while it was insolvent.1  In February 2019, the High Court released its much anticipated decision regarding the reckless trading claims.  In its decision, the High Court found Mainzeal’s directors personally liable for losses to the company’s unsecured creditors of $36m.

As the High Court’s decision applies to all company directors, this article looks at how things went so wrong for Mainzeal and the duties that all company directors need to be aware of and comply with.

Mainzeal’s collapse

Mainzeal was established in the 1960’s, but by 2004 Mainzeal was wholly owned by an investment consortium, Richina Pacific Group (Richina). While a board was established Mainzeal governing documents gave Richina “ultimate power [over Mainzeal] as the owning shareholder, particularly in relation to equity and in relation to returns to the shareholder”.

Richina started extracting funds from Mainzeal to fund Richina’s purchase of assets in China.  By 2008, Richina (through related entities) had extracted loans of approximately $40 million from Mainzeal to purchase assets in China and Mainzeal had negative equity of nearly $45 million. Although, these loans were recorded as an asset in Mainzeal’s balance sheet, it was evident that if the loans could not be recovered, Mainzeal would be insolvent at that point. 

While Mainzeal Board raised the issue with Richina, it only received, in the main, verbal assurances that it would provide financial assistance to Mainzeal, if required.  Unfortunately, the Board’s reliance on Richina’s assurances was misguided as they were not documented and not legally enforceable against Richina.

During 2009 to 2012, a series of events unfolded including a dispute on large construction project and “legacy claims” in historic leaky building claims.   Due to cashflow difficulties, the Board looked to Richina to provide the financial assistance it had promised.

At that point is became apparent Richina’s assurances were worthless.  Richina had limited liquidity in China and in any event, was unable to repatriate cash from China.  Richina was unable to provide the assistance it had promised (nor was able to repay its loans) and in February 2013, Mainzeal collapsed.

The High Court’s decision

The Court found Mainzeal’s directors had traded the company recklessly because “they failed to appreciate and address the risks they were exposing the creditors to, and because of the unreasonable reliance on [Richina’s] assurances expressed in loose terms”.  The key considerations which led the Court to this conclusion were:

  • Mainzeal had traded whilst balance sheet insolvent since 2005 because in reality the loans to Richina’s subsidiaries were not recoverable;
  • Richina’s assurances (verbal and non-binding) of financial support could never have been reasonably relied upon; and
  • Given Mainzeal’s generally poor trading performance between 2005 and 2012, and the risk to significant one-off losses (for example, leaky building claims or disputes as happened here), Mainzeal required a strong capital base or equivalent backing to avoid collapse.

Having found the directors liable, the Court had to determine what losses Mainzeal’s unsecured creditors had suffered due to the directors’ reckless trading.  The Court found the entire $110 million loss was attributable to the directors’ recklessness.  The Court, however, exercised its discretion to find that the directors should be personally liable for one-third of that loss, or $36 million. 

What do you need to know about your duties as a director?

While Mainzeal was a large corporate and the directors were professional directors, the same duties apply to all company directors.  Directors’ duties are outlined in sections 131 to 138 of the Companies Act 1993 which (among other things) require a director to:

  • Always act in good faith and in the best interests of the company.  They must put the company’s interests ahead of their own where those interests may not be aligned. 
  • Comply with the requirements of the Companies Act 1993 and, if the company has one, the company’s constitution.
  • Not agree to, cause, or allow the company’s business to be carried on in such a way that will likely “create a substantial risk of serious loss to the company’s creditors”.
  • Not agree to the company incurring an obligation unless the director has a reasonable belief at the time that the company can perform the obligation when required to do so.

It does not matter whether you are a professional director or otherwise, and it does not matter whether your company is big or small.  All directors share the same duties and are expected to comply with those duties to the same standard.  The consequences of breaching these duties can be severe as the directors of Mainzeal (or their insurers) have learnt. 

If you are a director of a company but are not fully aware of your duties, then you need to become familiar with them and recognise where it could be prudent to take independent accounting and legal advice.  .

What next for the Mainzeal directors?

The High Court’s decision is likely to be appealed and perhaps even cross-appealed (appeals by both parties).  The risk for the Mainzeal directors is that the Court of Appeal may decide they are liable for more than $36 million.  The other issue is that, while Mainzeal’s directors held directors & officers’ liability insurance, that policy was limited to $23 million.  It is unclear how that policy would be apportioned amongst the directors given their differing levels of liability.

Footnote

1 It is important to note that, although a director of Mainzeal at the time of its collapse, Sir Paul Collins was not included in the main claim of reckless trading due to him not being a director at the relevant times.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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