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OPINION: Mainzeal - Object lessons in corporate governance

March 28, 2019

Contacts

Partners James Caird, James Hawes, Don Holborow, Michael Pollard, Andrew Matthews

Corporate governance

“Submarines don’t sink for one reason, but because of 10 years of poor maintenance”, so said an ex-Royal Navy submariner once. The collapse of Mainzeal - not a submarine, but nonetheless a large entity with many moving parts - is a case in point, with lessons.

What went wrong?

The story of what went wrong at Mainzeal is long and convoluted, told dispassionately and with the (sometimes) wince-inducing precision of a High Court judge.[1] It started in 2004 when Richina Pacific (which had acquired a majority stake in Mainzeal in 1995) established a new independent board for Mainzeal, with Dame Jenny Shipley as Chairperson. The story ended nearly 10 years later, with the company’s collapse.

The catalyst for the collapse was a letter from Richard Yan, CEO of Richina Pacific and a Mainzeal director, sent to the board at the end of January 2013. He sought an urgent board meeting, suggested that Mainzeal was no longer a going concern and proposed a resolution inviting the BNZ to appoint receivers. The bank got wind of this letter and, unsurprisingly, swiftly suspended all further advances. Within a week, the independent directors had all resigned and receivers were appointed.

Mainzeal was placed into liquidation at the end of February 2013, owing over NZ$110 million to its sub-contractors, employees and other unsecured creditors.

The liquidators looked to recover some of this loss from the directors - alleging so called “reckless trading”: breach of the duty imposed on directors under NZ company law requiring directors to focus on a company’s creditors (rather than the company itself).[2] Specifically, directors must not permit the company to operate in a manner which creates a substantial risk of serious loss to the company’s creditors. This duty arises when the company has solvency issues.

The Court decision

Ultimately the directors were found wanting in their conduct: held liable for reckless trading and ordered to pay $36 million in damages.

Three things primarily led the Judge to conclude that the directors had breached their duties. The company was (over a period of years) trading whilst balance sheet insolvent, having made loans to related parties which the Judge found were not genuinely recoverable. During that time, there was no assurance of group support on which the directors could reasonably rely when needed, and the company’s trading performance was poor – prone to significant one-off losses (eg under construction adjudications). That all three happened together is what, in the Judge’s view, established the directors’ liability: [3]

The policy of trading whilst insolvent is the source of the directors’ breach of duties, however, such a policy would not have been fatal if Mainzeal had either a strong financial trading position or reliable group support. It had neither.”

The judgment is now under appeal. The directors are claiming that there was no breach of the “reckless trading” duty at all, and if there was a breach, that the damages award was wrongly calculated (and so was too high). The liquidators are likely to cross-appeal - we anticipate at least on the damages issue, essentially seeking a higher damages payment from the directors. The appeal process is likely to take some time, with current indications of a hearing late this year.

Lessons in corporate governance

The findings of fact in the Mainzeal case represent an object lesson in corporate governance. Even though the judgment is under appeal, we believe there are some lessons that can already be taken from the case:

  1. Know and trust your fellow board members. Every now and then, stand back (far enough to get some perspective). Ask yourself whether you still feel your trust is well- placed, and require yourself to think objectively on this point. Understand whether there is a particular skill set or value proposition you bring. Is the desire to keep you there affecting how other board members or key stakeholders behave towards you?

  2. Understand your duties as a director and what those require in context. This sounds obvious but it is crucially important, and the position is not always straightforward. This is particularly so if you are an independent director of an entity forming part of a corporate group. Do not be frightened to get independent advice, including legal advice, and to act on it. Understand your position under your D&O insurance arrangements.

  3. Ensure any mission-critical shareholder support arrangements are effective. If the company is reliant on shareholder support arrangements, ensure the support arrangements are clear, enforceable, reliable, and provided by an entity or person with both the means, and the practical ability, to provide them. Pointing to verbal assurances from shareholders is not enough. Letters of support provided by a parent entity in an audit context may also be insufficient to address a fundamental solvency issue. Such letters are generally unenforceable and may be focused on the wrong issue (ie whether the company is a “going concern” for accounting purposes).

  4. Tread VERY carefully if there is any question of insolvency. The relevant directors’ duties do not require directors to stop acting when there is a solvency issue. Rather, they require directors to be extra-vigilant, and with an eye to the interests of creditors. Remember that “technical insolvency” (where the company’s assets are less than its liabilities) is still insolvency, even if there is cash available to cover day-to-day payments as and when they fall due. Trading in this position is inherently risky, whether on a short or long-term basis, so take advice - for the company, and for yourself.

  5. Insist on appropriate corporate governance disciplines. Understand the company’s risk profile, and take appropriate steps to manage risks that arise. If there are related party transactions, know where the assets are going. Ensure the terms are acceptable to the company, formally documented and enforceable where appropriate. Get advice on the company’s legal position when in doubt. Require complete and accurate company record books (minute books, share registers etc), and be thorough in following up on action items from board meetings. And remember, the board’s purview is governance and risk issues; it must not become a management committee.

What should directors do?

Many directors facing an insolvency situation must grapple with the familiar dilemma: bail out for your own sake, or stay on board and do what you can to help - this being the situation when the company needs good leadership the most. Deciding to stay is not fatal, but it should be a conscious decision based on a “sober assessment” of the company’s position, and its realistic (not overly optimistic) future prospects. Staying requires directors to be cautious, have clear knowledge of what is important, and to observe high standards of governance.

Not the last word

We do not expect that the appeal process will detract from the lessons which can already be drawn from the case, as set out above. However, there may be further development of the legal principles as the appeal proceeds, so watch this space.

 

[1]      Mainzeal Property and Construction Ltd (in liq) v Yan [2019] NZHC 255, per Cooke J.

[2]      Companies Act 1993, s 135.

[3]      Mainzeal Property and Construction Ltd (in liq) v Yan [2019] NZHC 255 at [188].