Supreme Court findings on the claim against the Mainzeal directors

Tuesday 29 August, 2023

Mainzeal, once a leading construction company in New Zealand, entered receivership and subsequently liquidation in 2013, leaving debts of around $110 million to unsecured creditors. The liquidators brought proceedings against its directors, alleging reckless trading under section 135 of the Companies Act 1993 (Act) and for allowing Mainzeal to commit to obligations it could not meet under section 136 of the Act. The liquidators also sought relief under section 301 of the Act.

Both the High Court and Court of Appeal previously determined that Mainzeal's directors had breached their duties under the Act, though they differed on the reasons for their decisions. The matter eventually escalated to the Supreme Court.

The Supreme Court's decision

The Supreme Court upheld the decision of the Court of Appeal, determining that the directors of Mainzeal had breached sections 135 (reckless trading) and 136 (assumption of obligations) of the Companies Act 1993.

The Supreme Court, like the Court of Appeal, reviewed in detail the legislative history to sections 135, 136, and 301 of the Act. In respect of s 135, the Supreme Court held:

• An objective approach is to be taken in determining whether the business of the company was carried on in the prohibited manner.
• However, when assessing whether the actions of the directors in agreeing to, or causing or allowing that trading were in breach of s 135, the courts will proceed on the basis of those facts and circumstances of which the directors were aware, or should have been aware, if exercising appropriate care, skill and diligence.
• The more complex the company the higher the level of skill and diligence expected of a director.

For section 136, the Supreme Court considered that directors ought not to commit a company to obligations unless confident on reasonable grounds that they will be honoured. And, for section 301, the Supreme Court held that the section allows for a direct claim by creditors for breaches of sections 135 and 136 for losses that they have suffered as a result of those breaches. An award for compensation under section 301 is subject to the Court’s discretion to tailor relief in ways that respond to the particular breach or wrong, to the harm that flows from that and, at least to some extent, the culpability (particularly amongst themselves) of the directors. The starting point for exercising that discretion and assessing compensation under section 301 will be that liability is capped at the losses suffered under sections 135 or 136.

The Supreme Court’s key factual findings leading to the decision included the following:

• Over a period of many years, Mainzeal was balance sheet insolvent and largely unprofitable.
• Mainzeal had advanced significant funds to other Richina Pacific group members in circumstances where there was no likelihood that those funds would be repaid.
• While Mainzeal’s founder, Mr Yan, and the Richina Pacific group pledged support to Mainzeal, those assurances were neither enforceable nor credible.
• The directors did not seek sufficient external advice on the solvency issues facing the company.  When advice was obtained in January 2011, the recommendations were never implemented. 
• The directors were aware of the company's precarious position but did not press their concerns sufficiently.  They were also found to be too operationally focused and did not pay sufficient attention to the broader strategic issues faced by the company.
• From 2010, the directors should have recognised that without a substantial injection of capital or reliable assurances of support, continued trading by Mainzeal posed a likelihood of substantial risk of serious loss to creditors.
• The directors were aware that counterparties may not contract with Mainzeal if they knew the weakness of Mainzeal’s balance sheet meaning that the directors were aware that counterparties were taking on more risk than they had bargained on in dealing with Mainzeal.

The Supreme Court ruled that from 31 January 2011, the manner in which the directors allowed Mainzeal to trade exposed creditors to a substantial risk of serious loss (section 135 breach).  It therefore also followed that when the directors agreed to Mainzeal entering into four major projects after that date, they did not have reasonable grounds to believe that the commitments associated with those projects would be met (section 136 breach).

Turning to the issue of compensation, the Supreme Court held that Mainzeal suffered no loss from reckless trading, as there was no net deterioration in the company’s finances between 31 January 2011 and the date of liquidation. However, the directors were required to compensate the company for all new debts incurred from 31 January 2011 that were unpaid as at the date of liquidation.  Exercising the discretion under section 301, Mr Yan was found to be mainly responsible and therefore liable for the full $39.8 million. The Supreme Court capped the financial liabilities of Dame Jennifer Shipley, Mr. Tilby, and Mr. Gomm at $6.6 million each and interest.

Our comment

As with all Court decisions, time will tell whether the Supreme Court has struck the right balance between the cloak of limited liability for companies and the desire to leave business judgement to directors on the one hand and, on the other hand, the protection of creditors.

As a takeaway, the Supreme Court commented that a director who has acted honestly and reasonably will not be liable under sections 135 and 136. Plainly, the reasonableness of the director’s actions will depend on the facts and the Mainzeal directors were found to be on the other side of the line notwithstanding the Supreme Court believed they had acted honestly. However, many a director may find comfort that if they act honestly and reasonably they will not be liable under a breach of duties. Directors will also find comfort in the affirmation that they are entitled time to take stock of the situation and obtain advice when a company is insolvent or near-insolvent.  There is no expectation that directors cease to trade immediately once the company enters choppy waters.

The Supreme Court endorsed the Court of Appeal’s view that there is a general incoherence in relation to sections 135, 136 and 301 and a review of the relevant provisions by the legislature of would be appropriate. We are supportive of a review and the need to give certainty to both directors and creditors through a clear and coherent legislative framework.

Recommendations for Directors

• Vigilance and Awareness:  If the company is facing financial instability, directors should fully assess the company's position based on all available information.
• Strategies: In uncertain times, directors are entitled to take time to take stock of the situation of the company. This may necessitate operating insolvently for a period of time, whilst identifying a path forward so that the directors can be satisfied that trading on is not likely to create a substantial risk of serious loss to creditors. Long-term trading on an insolvent balance sheet is unacceptable and the period of time to take stock will depend on what is reasonable in the circumstances.
• Information:  Directors should ensure that they are well informed, particularly during periods of financial instability, and question and challenge information presented to them by management.  Directors should exercise a healthy degree of scepticism.
• External Advice and Support:  When financial challenges are foreseen, directors should confront them head-on and seek professional advice.
• Regular Reviews: The company's financial health should be monitored regularly, and decisions regarding its operations and viability should be frequently reassessed.
• Consider Resignation: Directors lacking control over a distressed company might need to consider resignation or liquidation as ways to induce necessary changes.

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