On 25 August 2023, the Supreme Court released its decision on the case of Yan v Mainzeal Property and Construction Limited (in liquidation). The Supreme Court found that Mainzeal's directors had breached their duties by engaging in reckless trading and trading while insolvent. The Court ordered the directors to pay $39.8 million in damages plus interest. The judgement serves as a crucial reminder for directors to be mindful of their directors duties, especially in situations of insolvency or near insolvency. This article unpacks the Mainzeal case and highlights key lessons for company directors.
What is the Mainzeal Case About?
Mainzeal, one of New Zealand's largest commercial construction companies, undertook a restructuring process in 2008–2009. As a result, Mainzeal transitioned into a stand-alone company, no longer directly supported by its overseas parent company. Around this time, Mainzeal relied on non-binding letters of support from its parent company and other related companies and unenforceable assurances of support from one of its directors, Mr Yan.
The situation worsened over time, leading to Mainzeal's collapse. From 2005, Mainzeal had consistently been in a precarious financial position, accumulating significant debt to creditors. Reports from 2011 identified solvency concerns, yet company directors continued to permit Mainzeal to trade until its collapse in 2013. By 2013, Mainzeal owed around $110 million to unsecured creditors.
Key Provisions of the Companies Act
The Supreme Court's decision focused on sections 135 and 136 of the Companies Act 1993. These two provisions relate to directors' duty not to engage in reckless trading and to not trade while insolvent.
Under section 135, a company director must not:
- agree to business that is likely to create a substantial risk of serious loss to the company's creditors; or
- allow the company to conduct business in a manner that is likely to create a significant risk of serious loss to the company's creditors.
Section 136 requires directors not to incur obligations unless they reasonably believe the company can fulfil them when due.
The Supreme Court found that Mainzeal's directors had violated both these sections. From 31 January 2011, the directors knew that the company had been insolvent for a sustained period, yet continued to allow Mainzeal to trade. Mainzeal's continued operation created a serious risk of substantial loss to its creditors. Additionally, the Supreme Court found that the directors incurred obligations by entering into four long-term contracts without reasonable belief that the company could meet those obligations.
The Supreme Court did not award damages under section 135 because compensation is assessed on a net deficiency basis. This means that the directors may only be liable for the amount on which the company's financial position worsens. Since Mainzeal had been trading while the balance sheet was insolvent for several years, there was no net deterioration in the company's overall financial position.
However, the Supreme Court assessed the directors' breach of section 136 on any new debts incurred. The focus of section 136 is the perspective of individual creditors and the loss they have suffered due to the breach of directors duties. As Mainzeal's directors entered into four long-term contracts without reasonable grounds, the new debt incurred was assessed at $39.8 million.
Lessons for Company Directors
The Mainzeal case emphasises the necessity of directors to comply with their duties, particularly when a company decides to trade while insolvent. As a company director, bear the following in mind:
- closely monitor the financial situation of your company;
- trading while insolvent can be highly risky for any director;
- always seek professional advice in relation to these situations;
- each director needs to make their own independent assessment of a company's prospects and not rely on the other directors; and
- courts are willing to impose significant penalties for breach of the rules around trading while insolvent.
While the Mainzeal decision is unlikely to discourage individuals from becoming company directors, it illustrates some of the potential risks. Directors are personally responsible for complying with their directors' duties, understanding their legal responsibilities and ensuring compliance at all times.
Consider whether obtaining Directors and Officers insurance is appropriate to alleviate some of the risks of being a company director.
As a company director, you have various legal duties to uphold, including not engaging in reckless trading and not trading while insolvent. The Mainzeal judgement provides critical lessons for directors regarding their duties and to remain vigilant in all cases, especially in situations of insolvency or near insolvency. Otherwise, you risk facing severe legal, financial and reputational consequences.