Mainzeal Property and Constructions Ltd (in Liq) v Yan and Others  NZHC 255
In February of this year, the High Court upheld claims of reckless trading against the former directors of Mainzeal Property and Construction Limited (Mainzeal). The Court held the former directors had to pay $36 million, approximately one third of the $110 million owed to unsecured creditors. The decision is important for a number of reasons, including an adoption of a novel approach to assessing the quantum of the award against the directors.
Mainzeal, a construction company, went into liquidation in 2013. Mainzeal’s majority shareholding was acquired in 1995 by an investment group referred to as Richina Pacific Group (Richina Pacific). Richina Pacific is controlled by Mr Richard Yan, who was also a director of Mainzeal.
Richina Pacific used Mainzeal’s cashflow to pursue investment opportunities to benefit Richina Pacific, for example, having Mainzeal contribute USD $2.37 million to purchase MLG Limited, a Chinese company with significant land usage rights in Shanghai. The relationship was not entirely one-sided, as Richina Pacific provided Mainzeal with construction bonds.
Justice Cooke found the former directors had breached s 135 of the Companies Act 1993 (the Act). Section 135 provides that a director of a company must not agree to or cause or allow the business of the company to be carried on “in a manner likely to create a substantial risk of serious loss to the company’s creditors.”
The Court held that the directors had allowed as the standard business operating procedure a policy of trading while balance sheet insolvent. The Court did not see this, in itself, as a breach of s 135, provided the directors could be reasonably assured of the support from the shareholding group, Richina Pacific. However, the Court found the assurances made by Richina Pacific were vague, conditional, and subject to Chinese law, which restricted the flow of capital out of China and into New Zealand.
Further, the Court saw that the balance sheet insolvency and weak parent support would not have led to a breach if Mainzeal had maintained a strong trading performance. Unfortunately, this was not the case. Mainzeal’s trading performance was generally poor, including significant one-off losses from particular projects, such as the Siemens project.
The Court found a breach of the statutory duty from mid-2010. It said the fault lay not in putting Mainzeal into liquidation at that point, but rather not taking a hard stance with Richina Pacific to force the parent to ‘put up or shut up’, that is the directors ought to have threatened to resign if concrete support was not provided. The Court observed, perhaps controversially, that “the threat of resignation would have been a powerful tool”.
We understand the main points of contention from the decision, which is currently being appealed, is whether Justice Cooke was entitled to draw this inference from the evidence and take the approach he took to calculation of damages.
The Approach to Quantum
Having established s 135 was breached, the Court moved to determine the amount of compensation under s 301 of the Act. Under s 301, a breach of s 135 requires a director to “contribute an amount to the assets of the company by way of compensation in the amount that the Court thinks just.”
Two approaches to quantifying the compensation were submitted by the liquidators. The first was the traditional approach based on the case of Mason v Lewis and was based on the loss created by the directors continuing to trade. In Mainzeal’s case, the company’s financial position improved between the date of breach in mid-2010 and the date of its eventual collapse. But the Court justified not taking the traditional approach in this case by saying that the directors’ breach was not failing to put Mainzeal into receivership or liquidation in 2011 but in not taking steps to put Mainzeal on a more solid footing.
The other approach proposed by the liquidators was also rejected. This was called the ‘new debt approach’ and set the compensation as the amount new creditors lost after the date in 2011 the creditors say the directors should have caused Mainzeal to cease trading. The Court considered this approach inappropriate for New Zealand, as s 135 imposes obligations owed to the company, not to individual creditors.
The Court considered that the wording of s 301 allowed an expansive and discretionary approach to quantum of compensation. The Court started at 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 manner in which they caused Mainzeal to trade. This was not the case for Mr Yan who was held to be conflicted and personally benefited.
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 Court considered but dismissed the insurance available to the directors as one of the discretionary touchstones. The Director’s and Officer’s Policy provided a policy limit of $20 million in the aggregate. The Court ultimately concluded the cover would be relevant in a scenario where directors would have difficulty in meeting a judgment. Here, there was no evidence on ability to pay provided and the Court held it was not relevant to determining the amounts payable.
Comment - Philippa Fee
Partner of Fee Langstone, Philippa Fee, says that there must be a significant question mark over whether the Court was correct to calculate damages in the way that it did. In the usual run of cases against directors for breach of their duties under the Act, damages are based on the deterioration in the financial position of the company after the date when the company ought to have been liquidated. That was not the case here, as the financial position of Mainzeal improved after the date of breach. Instead the breach the Court relied on was in failing to use the threat of resignation to get better support by the parent company.
It will be interesting to see whether the Court of Appeal is satisfied that the evidence establishes this counter-factual and whether the correct approach to damages was taken.