Background
Mainzeal went into liquidation in 2013, with creditors owed in excess of $110 million. The liquidators of Mainzeal sued the company’s directors for an alleged breach of their duties not to trade the company recklessly.
The liquidators claimed that the directors allowed Mainzeal to trade in an insolvent state for many years based on non-binding assurances from Richina, its parent in China, to provide financial support.
The High Court ruled that four Mainzeal directors were liable for reckless trading and ordered them to pay compensation of $36 million between them, with $6 million payable by each of three directors and a fourth director liable for the entire $36 million.
Reckless trading
A director will be liable for a reckless trading claim if the company is insolvent and the directors’ actions will cause a substantial risk of serious loss to creditors.
The Court pointed to two key factors in reaching its conclusion that the Mainzeal directors traded the company recklessly: Mainzeal’s poor financial trading performance and its balance sheet insolvency.
Mainzeal’s poor financial trading performance
The Court ruled that Mainzeal’s trading position was unpredictable and generally very poor, making it vulnerable to failing with a consequential substantial loss to Mainzeal’s creditors. The Court pointed to the following factors:
(a) Mainzeal had consistently failed to meet its budgets by significant amounts.
(b) Mainzeal’s construction business involved a significant risk of large one-off losses, and it was entirely predictable that even one such loss would create significant financial pressure.
(c) Mainzeal’s financial problems were compounded by the growing problem of significant leaky building claims in 2010, with Mainzeal underprovisioning its liability.
(d) When it became apparent that Mainzeal’s business model was not working, the directors adopted a new business strategy. This involved significant risk in light of Mainzeal’s existing financial issues, and created a further risk of one-off losses in the short term.
Mainzeal’s balance sheet insolvency
The Court ruled that, despite Mainzeal’s poor financial trading performance, the directors continued to trade while Mainzeal was balance sheet insolvent, and that this contributed to a substantial risk of serious loss to creditors.
The directors argued that the company was solvent as a result of letters of comfort and expressions of support from its parent, the Richina group. However, the Court ruled that Richina’s letters of comfort and expressions of support were not clearly expressed and were not legally binding. Further, it said that the directors were aware that it would be difficult to access funds from China, where Richina is based. Accordingly, it ruled that the directors could not reasonably rely on any assurance of group support if adverse circumstances arose.
The directors also sought to rely on Ernst & Young’s assessment that Mainzeal was a going concern. The Court rejected this argument, ruling that whether a company is a going concern is a different question from whether it is balance sheet solvent, and that there is a lower threshold for a company to be a going concern. In any event, it ruled that Ernst & Young’s assessment was subject to a key assumption that Richina would offer financial support, which was not valid.
Damages
When assessing the damages payable by the directors, the Court rejected the standard approach of looking to the deterioration in the company’s financial position between the date of the breach and the date of liquidation.
Instead, it applied a novel approach of adopting a starting point of loss based on the entire amount of the deficiency in liquidation, and then adjusting this figure on the basis of discretionary factors such as the duration of the breach and the directors’ culpability. It remains to be seen if this novel approach will be accepted by the higher Courts if this case goes on appeal.
Insurance
The Court considered the directors’ insurance position. It ruled that the insurance position was not relevant to liability, but was potentially relevant to quantum. However, it ruled that it did not need to alter its assessment of damages on the basis of the insurance cover.
Comment
This decision will be of interest to directors, insurers, liquidators and litigation funders alike:
(a) Directors will need to consider their position carefully in light of the decision, especially where a company is in a poor financial trading position and/or close to insolvent.
(b) Insurers will be interested in this decision, given the cover they provide to directors. They may also be concerned that insurance arrangements are potentially relevant to the question of the amount of damages payable. Our view is that insurance arrangements should not be relevant in these cases.
(c) Liquidators are often looking to pursue directors to recover proceeds for creditors, but there are few cases brought by liquidators that are pursued through to trial. Liquidators will be buoyed by the outcome in this case in which the claim against the directors succeeded.
(d) The claim by the liquidators was funded by a litigation funder, and litigation funders may look to the positive outcome here to fund more cases against directors for breaches of duties.
This decision has been appealed, and so the High Court’s decision will not be the last word on the collapse of the Mainzeal group.
Please contact the authors if you have any questions about this article.
David Friar is a partner in the Bell Gully litigation team with 20 years’ experience as a commercial litigator. He has particular expertise in commercial disputes, insurance litigation, and corporate and insolvency law. David regularly represents clients in court, including the Supreme Court, New Zealand’s highest court. He represents insurers and insureds in a wide range of insurance disputes, including issues arising out of the Canterbury earthquakes. David has particular experience in professional indemnity (PI) and directors and officers (D&O) litigation. He also has experience in life and health insurance. He regularly acts for receivers, liquidators and banks. He also acts for a number of corporate clients and financial institutions. The Legal 500 Asia Pacific 2018 ranks David as a leading lawyer for insurance. Chambers Asia Pacific 2018 also ranks David as a leading lawyer for insurance. David writes and speaks extensively on directors’ duties, insurance law, insolvency, commercial law and litigation, including at professional and legal conferences and at New Zealand Law Society seminars. He is a co-author of the chapter on directors’ duties in a leading New Zealand text, Morison’s Company Law. He also co-presented the New Zealand Law Society seminar on Creditors’ Remedies in five centres across New Zealand. His international experience includes six years at Paul, Weiss, Rifkind, Wharton & Garrison in New York, during which time it was named best litigation firm in the United States by American Lawyer magazine. Prior to that, he received an LLM from Columbia University in New York, where he was a Fulbright Scholar. Contact David at david.friar@bellgully.com or connect via LinkedIn
Himmy Lui is a Senior Solicitor at Bell Gully in the Auckland office. Contact Himmy at himmy.lui@bellgully.com or connect via LinkedIn
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Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.