On 25 August 2023, the Supreme Court released its decision in Yan v Mainzeal Property and Construction Limited (in liquidation) [2023] NZSC 113. The case is relevant for anyone involved in business – but none more so than directors of companies.
It provides helpful guidance to directors, particularly directors of companies facing financial difficulties. It will also be of interest to creditors who are looking to understand the obligations of directors they are dealing with and their rights of recourse when things go wrong.
The legal journey
It is well known that Mainzeal was one of Aotearoa New Zealand’s largest construction companies prior to its collapse.
In 2013, Mainzeal was placed into receivership, and then liquidation, owing around $110 million to unsecured creditors. In 2015, Mainzeal’s liquidators brought proceedings against the directors for – among other things – breach of their directors’ duties under section 135 (reckless trading) and section 136 (incurring obligations without reasonable belief the company will be able to perform them) of the Companies Act 1993.
The High Court held that the directors;
- were in breach of section 135 and awarded compensation of $36 million
- were not in breach of section 136.
On appeal, the Court of Appeal held that:
- the directors were in breach of section 135 but awarded no compensation
- they were also in breach of section 136 and referred the matter back to the High Court to quantify the loss.
The case was appealed to the Supreme Court.
Decision was a clean sweep for the liquidators
The Supreme Court was largely in agreement with the Court of Appeal. The Supreme Court held the following:
- The directors were in breach of section 135, but they were awarded no compensation. Mainzeal had been trading while balance sheet insolvent for years in reliance on assurances of support that were not legally enforceable. The Court found that the directors could not reasonably rely on these assurances. Without a substantial injection of cash or reasonable assurances of support, continued trading posed a likelihood of substantial risk of serious loss to creditors.
- The directors were in breach of section 136 and the Court awarded compensation of $39.8 million plus interest. Given Mainzeal’s uncertain financial position, its directors did not have reasonable grounds for believing Mainzeal would be able to honour its obligations when they fell due.
Directors’ responsibilities
The Supreme Court decision has made it clear that being a director is a significant responsibility and it should not be undertaken lightly. These are some key practical tips for directors:
- Regularly assess the company’s financial position. Directors have a continuing obligation to monitor the performance and prospects of the company. The Mainzeal saga demonstrates the importance of understanding a company’s financial position. Further, directors should ensure they keep a record of their assessments of the company’s financial position and the decisions made based on these assessments.
- Be proactive. If a company is facing financial issues, directors need to squarely confront those issues and the future of the company. They should consider all options and be aware that sometimes the best option will be to enter into a formal insolvency process. Directors should take advice early and often. The Supreme Court confirmed that directors are entitled to take a reasonable time to take stock of a situation and obtain advice.
- If directors are relying on assurances of support, they need to be satisfied that it is reasonable to rely on those assurances. They should ensure that those assurances are legally and practically enforceable.
- If the company is insolvent or facing insolvency, directors should have regard to the interests of creditors.
- When agreeing to the company taking on obligations, directors should consider whether the company will be able to meet those obligations. If the company is facing financial difficulties, particular care should be exercised when entering into obligations and directors should ensure they have reasonable grounds for believing the company will meet the obligations.
- If the company is insolvent and cannot be salvaged, do not trade on - even if doing so would reduce the debt owed to creditors.
What about creditors?
The case serves as a cautionary tale and a reminder to creditors to take steps to protect themselves. Subcontractors are one example of creditors that should take such steps to ensure they are protected if a head contractor is facing financial difficulties.
Subcontractors may wish to request information from a head contractor to enable them to better understand the ability of the head contractor to meet its obligations. They should also ensure – as best as they can – that money is retained in accordance with the retentions regime and understand their contractual and statutory rights around suspension, termination and recovery of amounts owed. If in doubt, subcontractors and all creditors should take advice on their options.
Creditors should also understand their rights of recourse if a company does fail to make payments when they fall due. If a company is not in administration or liquidation, creditors may have several options for recovery, but the options have always been more limited once a company is put into liquidation, particularly for unsecured creditors.
However, the Supreme Court has recognised another avenue of recourse, confirming that creditors can bring a claim for compensation directly against directors for breach of their duties.
NOTE This article is not intended as legal advice. For specific advice, contact your legal advisor.