A new risk for company directors? Initial thoughts on Mainzeal
The judgment in Mainzeal Property and Construction Limited (In liquidation) & Ors v Yan & Ors ([2019] NZHC 255) has just been released. The judgment will doubtless be the subject of considerable comment by more august commentators than I.
However, there is at least one aspect of the judgment that immediately will give directors significant cause for concern. That is the way in which Justice Cooke assessed the contribution to the Mainzeal companies that he ordered the directors pay.
Mainzeal Case and Directors' Duties
Directors owe duties to the company they direct, not the individual creditors of that company. In cases involving breaches of a director’s duty not to trade recklessly (s135 of the Companies Act 1993), the quantum of damages (in very general terms) is the amount by which the relevant company’s financial position has deteriorated in the period between the director’s breach of duty and the company ceasing trading. The Court of Appeal in the leading New Zealand case, Mason v Lewis expressed it thus:
[109] The standard approach has been to begin by looking to the deterioration in the company’s financial position between the date inadequate corporate governance became evident (really the “breach” date) and the date of liquidation.
[110] Once that figure has been ascertained, New Zealand Courts have seen three factors - causation, culpability, and the duration of the trading - as being distinctly relevant to the exercise of the Court’s discretion
Director's Liability
In Mainzeal Justice Cooke found that the directors had breached s135 of the Companies Act. However, he also found that the relevant companies’ financial positions had not worsened in the relevant period (from January 2011 until liquidation). They had, if anything, slightly improved.
On a conventional Mason v Lewis analysis, that would have resulted in no contribution being payable by the directors. In simple terms, their breach of s135 did not cause the company’s financial position to worsen.
Justice Cooke took a different approach. He took the starting point for damages as being all the debts of the companies at liquidation. He then applied a number of discretionary factors, such as the fact that the directors acted in good faith and did not personally benefit from their actions. He then arrived at a figure that, in his words, avoids the appearance of “…spurious precision…”, of one-third of the liquidation debts, or $36 million.
This figure was then apportioned between the directors, in accordance with how Justice Cooke assessed their individual culpability.
The rationale for this approach was summarised by Justice Cooke (paragraphs 396 to 398 of the judgment) as being:
…I accept the strongly expressed views of the defendants that there was no reason for the directors to have put Mainzeal into receivership or liquidation at the January or July 2011 dates
… The very act of ceasing to trade would have created huge further losses…
…The breach of the directors’ duties in this case did not arise because the directors failed to cease trade and put Mainzeal in liquidation or receivership in January 2011. The breach of directors’ duties arose because they caused, agreed or allowed Mainzeal to engage in trade in a vulnerable state — being balance sheet insolvent, with a poor financial trading position, and depending on assurances of support [from the parent company] in a way I have found to be unreasonable. As previously indicated, s 135 is directed to the “manner” in which the business of the company is being carried on. The manner in issue in this case involves trading in this vulnerable state. It is not focused on continuing to trade a company that was likely to fail in any event and thereby creating further losses.
Implications for Directors
Where does this leave directors? Justice Cooke agreed that the companies ought not to have been liquidated in January 2011. Doing so would have resulted in “huge further losses”. He also found that the directors’ decision not to liquidate in 2011 resulted in an improvement of the companies’ financial position. Yet, having avoided these further losses and improved the companies’ positions, the directors are still ordered to contribute $36 million to the companies.
This decision is likely to make any director trying to improve the position of a company in difficulty very nervous. On Justice Cooke’s analysis, even if a director succeeds in improving a company’s position, that might not be enough to avoid a successful claim for breach of directors’ duties.
An appeal appears very likely. As well as the divergence from Mason v Lewis noted above, the judgment also highlights some highly unconventional procedural matters that arose during the trial. If there is an appeal, I would imagine that most directors will be cheering the appellants on.