New Zealand: Directors liability in the spotlight

Mainzeal Property and Construction Limited (in liq) v Yan & Ors [2019] NZHC 255

When Mainzeal Property and Construction Limited (Mainzeal) collapsed in February 2013, it left behind a raft of unsecured creditors who were jointly owed just over $110 million. The proceedings brought by Mainzeal's liquidators against its former directors were for the effective benefit of these creditors.

The liquidators' principal claim was that the directors had engaged in reckless trading, and in doing so had breached their duties under s 135 of the Companies Act 1993 (Act). In finding that the liquidators' claim was made out and total compensation of $36 million was payable by the directors, the High Court has sent a strong signal against the dangers of companies continuing to trade whilst insolvent.

Background

Although complex in the detail, the key background facts can be succinctly stated:

  • In 1995, a Chinese focussed investment group (Richina Pacific) acquired a majority shareholding in Mainzeal's holding company.
  • Richina Pacific established a new independent board for Mainzeal in 2004, which comprised Mr Richard Yan, who was associated with Richina Pacific, and three independent directors, including a notable former Prime Minister.
  • Over the ensuing ten years, Richina Pacific extracted considerable funds from Mainzeal for investment in China.
  • Mainzeal was technically insolvent for much of this time, but continued trading in reliance on promises from Richina Pacific that financial support would be provided when needed. These promises were never formalised, however, nor were they legally binding.
  • Even if the promises made were legally binding, they were potentially meaningless, as the effect of Chinese capital rules meant that Richina Pacific could have been prevented from providing support.
  • Mainzeal was also able to continue to trade by using funds received in advance from construction contract principals to pay sub-contractors. This did, however, mean that Mainzeal's financial performance was vulnerable to significant losses and company failure.
  • Following a difficult period in 2012, Richina Pacific was no longer willing and/or able to fully support Mainzeal, and it collapsed.
  • The liquidators of Mainzeal subsequently commenced proceedings against its directors alleging various breaches of the Act.

Liability of Mainzeal's directors

Against this backdrop, the Court came to consider the claim against the directors under s 135 of the Act. Although several other causes of action were pleaded by the liquidators, this was the only claim that succeeded against all four of Mainzeal's directors.

The Court found that the directors had breached their duty not to engage in reckless trading, for three main reasons:

  • First, it was clear that Mainzeal had been trading while balance sheet insolvent. By itself this was not a breach of s 135, because Mainzeal was part of a wider group of companies. But it would be if the directors could not show they had other reasons (such as support from Richina Pacific) for being confident that Mainzeal's creditors were adequately protected.
  • Secondly, there was no assurance of group support on which the directors could reasonably rely if adverse circumstances arose. The support here was remote, ambiguous, conditional, and subject to the constraints of Chinese law.
  • Thirdly, Mainzeal's financial trading performance was generally poor and prone to significant one-off losses, which meant it had to rely on a strong capital base or equivalent backing to avoid collapse. Mainzeal lacked both of these so a breach of s 135 was established.

Other factors, such as the directors' failure to take legal advice, also played a part in the Court's decision, but the above three considerations were critical to the finding of liability. Had any one of them been absent, the Court would not have found the directors to be in breach of duty. This was not the case, however, and the Court found that all of the directors were in continual breach of their duties, from mid-2010 at the latest.

Compensation payable by Mainzeal's directors

Having found that a breach of s 135 was established, the Court then turned to assess whether, and if so in what sum, compensation was payable by the directors. The guiding principle was said to be, in the first place, ascertaining the loss caused by the breach, and then moving on to apply discretionary factors to determine what a just contribution would be.

The starting point in this case was an award in the sum of $110,646,126, representing the entire amount of the deficiency in the liquidation, which was directly attributable to the directors' breach. Various discretionary factors were also at play, including that:

  • The breach of duty occurred continuously over a long period of time.
  • Mr Yan withstanding, the directors had acted honestly and in good faith. Their breaches of duty arose because they failed to appreciate and address the risks they were exposing creditors to, and because of an unreasonable reliance on the assurances that had been given to them.
  • Mr Yan's liability was enhanced, because he had acted unreasonably in giving misleading assurances to his co-directors, and because he benefitted considerably from the funds extracted from Mainzeal, due to being a shareholder of Richina Pacific.
  • Other factors had also contributed to Mainzeal's failure (e.g. the company's trading fortunes).

Weighing these discretionary factors up, the Court concluded that a just contribution would be to allow the liquidators to recover $36 million from Mainzeal's four directors.

The directors were not, however, each liable in the same amount. Rather, Mr Yan's increased culpability meant that he had principal liability for the full $36 million. The other three directors, on the other hand, were only jointly liable with Mr Yan for $6 million each. This, the Court considered, was a just result in the circumstances.

Conclusion

In a statement issued shortly after the release of the Court's judgment, the three directors held to be jointly liable with Mr Yan commented that: "The Court's basis for finding liability appears to have novel aspects which will require careful consideration."

This decision of the High Court may, therefore, not be the last word on the liability of Mainzeal's directors. For the time being, however, it sends a clear message to directors of companies navigating choppy waters: the fact that a life raft may be tossed by a passing, friendly ship is not carte blanche to continue sailing.

Beyond this aspect of the decision, it will also be interesting to see how the directors' Directors and Officers (D&O) Liability Insurance, which is capped at $20 million, responds to the Court's decision to hold the directors liable for differing amounts. For a detailed discussion of the implications of this aspect of the Court's decision, see our forthcoming article.

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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