New Zealand – Director Duties – Reckless Trading – Mainzeal

BACKGROUND

Few pieces of litigation in New Zealand have attracted as much media attention as the High Court’s recent decision in Mainzeal Property and Construction Limited v Yan.

The downfall of Mainzeal Property and Construction Limited (Mainzeal) began in 2004, when Richina Pacific (Richina) established a new independent board for Mainzeal – a board chaired by Dame Jenny Shipley. Mainzeal operated for nearly 10 years under this arrangement until its collapse in February 2013, with the company owing unsecured creditors ~$110 million.

Mainzeal’s liquidators sued the directors for breach of their duty under section 135 of the Companies Act 1993 to not trade the company recklessly. Cooke J found the directors in breach of this duty, and liable for a total of $36 million.

The case is now set down for appeal, so this is certainly not the last word on the matter. Nevertheless, now that the dust has settled a little, it is an opportune time to reflect on the key learnings we can take from the High Court’s decision.

KEY LEARNINGS

Understand your Director Duties

The point is simple, yet fundamental: directors must be fully cognisant of their duties, and the obligations which flow from them in any given context. Although Cooke J found the Mainzeal directors acted honestly and in good faith throughout, they nevertheless abrogated their responsibilities in several key respects. Alarmingly, Cooke J’s recital of the minutes from a 2010 Mainzeal board meeting records the directors’ enquiry as to whose duty it was to ensure the company was solvent. This question alone exposes the directors’ lack of understanding regarding even the most basic of their duties. In other words, the directors were out of their depth.

Obtain Independent Legal Advice Early

A related critical error of the Mainzeal directors was a failure to seek independent legal advice until it was too late. Cooke J makes reference to this lack of legal advice no fewer than six times throughout his judgment. Without timely legal advice, it may very well be difficult for directors to comprehend – and abide by – the duties which New Zealand companies law imposes on them. Legal advice is most effective when obtained before it is too late, and should not be treated as an ambulance at the bottom of the cliff. This is particularly so in the context of a company experiencing financial difficulties.

Be Wary Upon Whom you Place Reliance

The Mainzeal directors asserted that they had relied on their auditors’ assessment of the company as a “going concern” to provide solace in their position, and as legitimising their decision to continue trading. Although Cooke J accepted that the directors could have taken some comfort from the auditors’ views, his Honour identified clear limitations on what exactly could be deduced from the going concern assumption. Indeed, the auditors themselves had drawn clear attention to the “material uncertainty” regarding the business’ continuing operations for the next 12 months. Accordingly, the reliance which the directors could reasonably place on the auditors’ assessment in the circumstances was seriously diminished, and certainly no substitute for legal advice.

Insolvency: a (Dark) Orange Light

Section 135 of the Companies Act is not a prohibition on trading while insolvent. Cooke J highlighted that trading while insolvent creates “a distinct possibility that the requirements of section 135 may arise”; however, the policy of trading while insolvent would not have been fatal had Mainzeal had either a strong financial trading position or reliable group support. It had neither. Continuing to trade while insolvent requires directors undertake a “sober assessment” as to the company’s likely future income and prospects. Treating creditors’ money as capital is not appropriate and will attract liability if continuing trade poses a substantial risk of loss to them. Directors must be hyper-aware of this possibility and proceed with caution.

Ensure any Important Assurances are Unimpeachable

Cooke J’s judgment gives considerable airtime to the faulty assurances provided by Richina to the Mainzeal directors. The directors’ reliance on these assurances, he said, was not reasonable in the circumstances. Directors of any company must ensure that, where the company is dependent on shareholder support arrangements, these are bulletproof – that is, the assurances must be in writing, enforceable, reliable, preferably unconditional, and proffered by persons with the credentials and ability to make them good.

Keep your House in Good Order

Strong corporate governance standards are a relevant consideration as to whether directors have engaged in legitimate business risk-taking. Expert witnesses called for the liquidators heavily criticised Mainzeal’s corporate governance arrangements, in particular drawing attention to: the lack of any formal procedures for addressing risk; the absence of an audit and risk committee; and the failure to maintain any risk register. Moreover, Cooke J accepted that the directors’ attention was too operationally focused, with the board functioning as a “management committee”, which failed to give due regard to the more significant structural and governance risks at hand.

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