The Supreme Court has released its long awaited judgment in the Mainzeal case (Yan v Mainzeal Property and Construction Limited (in liquidation)  NZSC 113), ruling that the four directors of what was one of New Zealand’s biggest construction companies breached their duties as directors, and are liable for payment of the sum of $39.8m plus interest to the liquidators.
Facing an increasing number of leaky building claims, Mainzeal’s financial position was precarious. Mainzeal was balance sheet insolvent from 2005, reliant on short-term bank facilities and reliant heavily on cash injections from parent companies. The latter arrangements were never formally recorded, and therefore never enforceable.
In 2013 Mainzeal went into receivership, owing $110m to unsecured creditors. The liquidators brought proceedings against the directors for reckless trading under section 135 of the Companies Act 1993 (Act) and for entering into contracts they could not reasonably believe the Company would be able to fulfil, breaching their duty under section 136 of the Act.
The directors argued that when assessing liability under section 135, it is not the court’s role to use hindsight to assess the correctness of business judgement, and that a more subjective approach should be taken. They argued the threshold for liability requires a director to recognise that certain actions are likely to create substantial risk of serious loss, and despite knowing this, continuing to act anyway. The Court rejected this and held that a subjective approach is inconsistent with the scheme of the Act, which requires directors to act with reasonable skill, care and diligence. They adopted a fault based approach, where negligence results in liability. The Court held that the directors should have stopped trading on 31 January 2011, and that trading beyond that date was reckless and a breach of section 135.
In appealing their liability under section 136, the directors argued that liability required affirmative action by specifically agreeing to incur an obligation, and that section 136 did not extend to obligations incurred in the ordinary course of trading. The Court held that when interpreting section 136, ‘agreeing to obligations’ has its ordinary meaning and therefore extends to obligations that are an inevitable consequence of continued trading. Accordingly, the Court found all obligations entered into after 5 July 2012, and the 4 major contracts entered into after this date constituted a breach of section 136. The Supreme Court took the view that the directors did not have reasonable grounds to believe that the Company would be able to continue to meet these obligations in the medium to long term.
One of the key shortcomings of the directors was the reliance on the unenforceable and informal assurances from the parent company that Mainzeal would continue to receive financial support. Whilst trading insolvent, it was unreasonable to rely on these unenforceable assurances of support without further investigation and obtaining a binding commitment from the parent company to provide that support.
This judgment reaffirms what a director should do when faced with a company in difficult circumstances and reinforces the Act’s requirements that a director act reasonably and diligently.
As a director, you have a continuing obligation to monitor the performance and prosperity of the company. Sections 135 and 136 require you to consider the economic interest of creditors when you are making decisions. When making these decisions the Courts have confirmed that you can take the time needed to take stock of the situation and properly consider your course of action. However, if you believe that there is risk of loss to creditors or have doubts that your company will be able to meet its obligations, then you need to be proactive in addressing these. This may require taking professional or expert advice from someone independent of the company to consider how those risks can be properly managed.
If you have concerns, or wish to discuss your obligations as a director, please contact one of the members of our Business team in the first instance.