Yan v Mainzeal Property and Construction Ltd (in liq) [2021] NZCA 99

On 31 March 2021, the Court of Appeal delivered a 186-page judgment in the much-publicised and lengthy Mainzeal litigation.

In the High Court, the liquidators sought damages from the directors for breaching their statutory duties to protect creditors from insolvent trading under both s 135 (reckless trading) and s 136 (incurring obligations unreasonably) of the Companies Act 1993 (the Act). The appeal and cross-appeal turned on these statutory provisions, and the novel approach taken in the High Court to measuring damages awarded to liquidators under s 301 of the Act.

Ultimately, the Court of Appeal upheld the High Court’s finding that the directors had traded recklessly in breach of s 135 but disagreed with the High Court’s approach to measuring damages arising from that breach, instead finding that no loss was attributable to the breach.

The Court of Appeal held that the directors had caused Mainzeal Property and Construction Ltd (Mainzeal) to commit to obligations without reasonable grounds for believing that it would be able to fulfil those obligations, in breach of s 136. The Court considered there was loss attributable to these actions and referred the case back to the High Court to determine the damages to award to reflect this. It is likely that this damages award will exceed the original award of $36 million, with further consideration as to the appropriate apportionment between directors.

Background

Mainzeal was one of New Zealand’s most significant construction companies. It was placed in receivership on 6 February 2013. Liquidators were appointed on 28 February 2013. The secured creditor that appointed the receivers, Bank of New Zealand, was repaid in full. The receivers also paid the preferential creditors. However, on completion of the receivership, the liquidators received approximately $8 million from the receivers to meet liquidation expenses and some $110 million of outstanding claims by unsecured creditors.

High Court

Our earlier article on the High Court decision can be found here. In summary, the liquidators’ s 135 (reckless trading) claim was successful in the High Court. The s 136 (incurring obligations unreasonably) claim failed. For the s 135 breach, the High Court awarded a total amount of compensation of $36 million.

The High Court took a novel approach to s 301 and allowed an expansive and discretionary approach to measuring the damages arising from the breach of s 135 of the Act. The High Court started with the total loss on liquidation of $110 million, then applied discretionary factors. Looking at the culpability and duration of the directors’ actions, the Court considered the directors had been trading in good faith and had not personally been advantaged by the way they caused Mainzeal to trade. The exception to this finding was Mr Yan who was held to be conflicted and to have personally benefitted. The judge concluded Mr Yan’s liability should be the full $36 million, but that the three remaining directors should have their liability capped at $6 million each, and each be jointly liable for their $6 million with Mr Yan. Practically this meant $18 million for Mr Yan alone, and the remaining directors jointly liable for each director’s share of the remaining $18 million.

The directors appealed. The liquidators cross-appealed, seeking an increased damages award under s 135. They also sought a finding that the directors had breached s 136, and sought compensation for that breach.

Court of Appeal

The Court of Appeal agreed that the directors breached s 135 of the Act and had exposed the company’s creditors to a substantial risk of serious loss. However, it was held that the risk did not materialise as there was no net deterioration in the company’s position between 31 January 2011 and the date of liquidation in February 2013. The Court of Appeal held that this approach to assessing damages was appropriate in the circumstances, and that the “entire deficiency” approach was not relevant because the breaches in question did not cause the company to become insolvent. On the only relevant measure, the breach did not cause loss. There was, therefore, no recoverable compensation in respect of the directors’ breach of s 135.

The Court of Appeal’s decision differed from the High Court’s decision in that it held that the directors were, in fact, in breach of s 136 of the Act by entering into certain obligations: “four significant construction contracts entered into after 31 January 2011, certain obligations to subcontractors on those projects, and all obligations entered into from 5 July 2012 onwards”.[1] The Court held that the directors were liable to pay compensation in respect of those breaches, assessed on a “new debt” approach (as preferred by the liquidators and endorsed recently by the Supreme Court in Debut Homes [2]) to be quantified by the High Court. The judgment suggests that it is likely that the directors’ liability will increase from the original award of $36 million, with further consideration as to the appropriate apportionment between directors. It appears that the directors may be exposed to liability exceeding their D&O liability cover.

Comment (Tom Pasley)

The Court of Appeal’s decision builds on the Supreme Court’s recent decision in Debut Homes Ltd (in liquidation) v Cooper [2020] NZSC 100 and is significant in terms of the current law on insolvent trading and directors’ duties.

The Court of Appeal’s decision will be reviewed widely and with concern by directors around the country. The case demonstrates the intense nature of directors’ duties and the consequent risks directors face if they get their assessment wrong, with personal and reputational damage likely, along with financial liability.

Where carrying on business (and therefore taking on new contracts) did not lead to a deterioration in the company’s financial position it can also lead to inconsistent results. In such a scenario, there may not be liability under s 135, but potential liability under s 136.

The Court’s judgment provides directors with further guidance as to the appropriate steps to take in situations of near insolvency, to discharge their duties and protect the company, its shareholders and creditors. This case, like Debut Homes, emphasises that it is not open to the directors of a near-insolvent company to trade on, as part of an informal administration or liquidation, unless they obtain the consent of affected creditors and/or ensure that creditors who have not consented are paid in full. To do otherwise is inconsistent with the scheme of the Act.

The Court also reaffirms that should directors breach their insolvent trading duties, the courts will take an orthodox approach to measuring those damages.

Importantly, the Court commented that: “The legislation governing insolvent trading in New Zealand is unsatisfactory in a number of respects. The Act should be reviewed to ensure that it provides a coherent and practically workable regime for the protection of creditors where directors decide to keep trading in circumstances where a company is insolvent or near-insolvent.”[3] Hopefully consideration will be given to legislative reform of the laws on insolvent trading and directors’ duties.

The decision will also have obvious effects on the nature of D&O liability cover being provided in the New Zealand market, with decreasing cover at higher premiums required to reflect the risk profile of directorships.