The Mainzeal Decision and Directors’ Duties

The Companies Act 1993 (the Act”) is our primary enactment governing companies in New Zealand.  Directors duties are, for the most part, addressed in clauses 131 to 138 of the Act. 

Directors should be acutely aware of their duties in relation to company obligations, particularly following the recent Supreme Court decision of Yan v Mainzeal Property and Construction Limited. This case sets out the responsibility and liability of directors of companies that may be considered to be marginally solvent or on the road to failure.  The Mainzeal decision has set the standard on this matter for thousands of company directors around the country, and was recently dubbed “the directors’ duties case of a generation”.  

Mainzeal Property and Construction Limited was incorporated in 1993 and was once a sizeable New Zealand construction company.  Between the years 2005 to 2012, Mainzeal made profits in 2006, 2007 and 2009 totalling $15.6 million; and losses in the five other years totalling $38.8 million.  It went into receivership in 2013 leaving unsecured creditors who were owed around NZ$110 million. 

The liquidators initiated legal action against the directors, asserting breaches of sections 135 (reckless trading) and 136 (duty in relation to obligations) of the Act.

Section 135 essentially prohibits a company director from agreeing to, or causing or allowing, the business to be carried on in a way that’s likely to create substantial risk of serious loss to the company’s creditors.

Section 136 prohibits a director from agreeing to the company incurring an obligation unless he/she reasonably believes the company will be able to perform that obligation when required.

Court findings

The High Court found the directors of Mainzeal in breach of both sections of the Act and awarded NZ$36 million in compensation, at that time setting a precedent for reckless trading cases in New Zealand. The Court of Appeal upheld the decision, expanding the interpretation of section 136 to apply to various obligations. It also ruled out a net deterioration in Mainzeal's position but ordered compensation under section 136.

The Supreme Court confirmed breaches of both sections of the Act and sets out how to calculate losses.  It clarified that in most cases, loss should be assessed on a net deterioration basis for section 135 breaches, and on a new debt basis for section 136 breaches. The Supreme Court emphasised the directors' liability for creditor losses, allocating about one-third of the total owed to creditors (NZ$110 million) to the directors.  The Supreme Court ordered that compensation payable by the directors was $39.8 million plus interest.  The court considered one of the four directors particularly blameworthy, with the other 3 directors’ contribution to paying the $39.8m capped at $6.6 million each.

Some key takeaways

-          Directors of an insolvent or nearly insolvent company should “take stock” and obtain independent professional and expert advice at the earliest opportunity;

-          Directors have a continuing obligation to actively monitor the company’s financials;

-          Continuing to trade whilst insolvent carries significant risk to Directors.

Reform of the Law on Directors’ Duties?

Aside from the implications for Directors arising from the Mainzeal decision, discussions have been had amongst the business community around the need for legislative review and reform of the rules on Directors’ duties under the Act.  One comment in the Mainzeal decision was that legislation governing insolvent trading is “unsatisfactory in a number of respects”.  Any law reform to do with Director duties will need to carefully find a balance between accountability, and the ability to make commercial decisions involving risk.

Any call for reform is of little comfort, though, to directors who are presently navigating troubled companies.   If you’re a company Director, you need to be fully versed on the extent of your duties and obligations to the company.  It’s also vital that your own assets are sufficiently protected or ring-fenced from your business affiliations.

Contact our dedicated legal team at Mactodd Lawyers for further advice, and to assist with your commercial and asset protection strategy.

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