The latest chapter in the Mainzeal saga played out last week with the Supreme Court hearing the directors' appeal (and the liquidators' cross-appeal) against the Court of Appeal's decision in Yan v Mainzeal Property and Construction Ltd (in liq) [2021] NZCA 99.
The Mainzeal litigation has attracted profile because of the prominence of the (now liquidated) construction company involved, its former directors (including Rt Hon Jenny Shipley) and the significant liability faced by those directors following the High Court and Court of Appeal decisions. The case is particularly important to the corporate community in New Zealand given its implications for corporate governance and company directors facing an increasingly uncertain economic environment in 2022.
Background
The demise of Mainzeal is well-known. The company went into receivership and then liquidation in 2013 owing approximately $110 million to unsecured creditors. The liquidators brought proceedings against its directors alleging that the directors had traded recklessly (in breach of s 135 of the Companies Act 1993) and allowed Mainzeal to commit to obligations without reasonable grounds for believing it could meet them (in breach of s 136 of the Act).
"At the heart of this case," the Court of Appeal said in its judgment last year, "is the question whether the way in which the directors of Mainzeal managed the company's affairs was within the sphere of legitimate business risk-taking, or whether they stepped outside the acceptable bounds of business risk-taking and should be responsible for some or all of the losses suffered by Mainzeal's creditors".
The Court of Appeal held that the directors of Mainzeal had breached their duties under both ss 135 and 136 of the Companies Act. The Court considered it was "wishful thinking" for the directors to continue to trade on as usual when Mainzeal was in a very vulnerable state. While the Court of Appeal found that the directors' breaches of s 135 did not result in any loss to the company, it held that, as a result of their breaches of s 136, the directors were liable to the company for the obligations that they had agreed to Mainzeal undertaking which the company failed to perform. The liquidators lost part of the appeal but still prevailed.
The Supreme Court hearing
The appeal and cross-appeal were heard in the Supreme Court last week before a panel of Winkelmann CJ, Ellen France, Glazebrook, O'Regan and William Young JJ. Over five days, the parties' counsel made submissions to the Court regarding the degree of risk-taking by company directors that should be permitted in the face of the threat of insolvency, as well as the appropriate measure of damages for breaches of ss 135 and 136, among other matters.
The directors sought to persuade the Court that, when faced with threats to a company's solvency, the directors should be afforded a wide discretion to manage the company as they see fit – and should only face liability under ss 135 and 136 where they have acted irrationally. By contrast, the liquidators submitted that the directors of Mainzeal, to avoid liability, would have had to reasonably believe that they could return the company to solvency, not just improve its financial position. Here, the liquidators said the directors continued to trade even when Mainzeal was far past the "twilight zone" of solvency, which amounted to a "policy of insolvent trading" and meant the directors were in breach of their duties under ss 135 and 136. The liquidators also sought to persuade the Court that the "new debt incurred" measure of damages should be applied in respect of breaches of both ss 135 and 136.
Whatever the outcome, the Supreme Court decision will have significant ramifications for company directors, the insurance industry, insolvency professionals and policymakers. The Court of Appeal called for a general review of the directors' duties provisions operating in this case and the outcome may impact on that review.
Key messages for Directors
The Court's judgment seems likely to be some months away. In the meantime, directors of many companies are facing more turbulent trading and economic conditions than New Zealand has faced in many years. Directors should continue to proceed with extreme caution when faced with uncertain economic conditions and bear the following key messages in mind:
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No assumptions: Directors should not make assumptions when it comes to a company's financial position. If financial difficulties/uncertainties are apprehended, then directors must squarely face up to the company's situation, obtain expert advice on its financial position and assess the risk of loss to creditors.
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Critical assessment: Directors must thoroughly and critically consider the company's forward-looking trading strategy. A decision to trade on in the face of uncertainty regarding a company's solvency should only be made after undertaking a professional assessment of the range of potential (and likely) consequences of doing so and the prospects of enabling the company to service its existing debt and meet the new commitments that ongoing trading will attract. This may include agreeing formal arrangements with various stakeholders across the company's capital structure.
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Formal insolvency may be inevitable: If, following a proper assessment, the directors form the view that trading on is likely to create loss to creditors, then trading on in that manner is not permitted. It is not open to directors to continue to trade while attempting to rescue all or part of the business if there is a risk of loss to existing creditors and new debts are being incurred which will not be able to be paid in full.
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Consider protective mechanisms if to trade: There are methods to protect against risk under s 136, for example by obtaining the consent of secured creditors to enable new trade creditors to be paid in priority while pursuing a restructure or asset realisation strategy. This will not entirely protect against s 135 risk, which will need to be addressed in the underlying business stabilisation and turnaround or recovery strategy (and which may require the support of stakeholders across the company's capital structure).
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Resignation an option: Directors should always bear in mind the last resort – resignation.
Above all else, when business performance is suffering for an extended period and in all near-insolvency situations, directors should consider seeking professional legal and financial advice about their options both for the company and in respect of their own duties and obligations. At the very least, impartial advisers will assist directors to make the "sober" assessment required.
This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.