Mainzeal directors won one court battle, lost another and could now lose the war over multi-million dollar penalty payments for their role in the collapse of the firm. Nikki Mandow reports
Former Prime Minister Jenny Shipley and three other directors of failed construction company Mainzeal could end up having to find millions of dollars of their own money (on top of money they can get from their directors’ insurance) to pay back creditors who lost out to the tune of $110 million when the company collapsed in early 2013.
A Court of Appeal judgement released on Wednesday makes it possible - even likely - the directors will end up paying more than the $36 million originally awarded against them.
Which means their directors and officers' liability insurance won’t be enough to cover what they owe.
Getting more money from the settlement would be good news for creditors, more than half of whom are tradies and other construction industry sub-contractors who worked on Mainzeal projects and have waited almost a decade to get paid what they are owed.
But at the same time, the Appeal Court judges’ decision delays even further the day when they actually get their money.
That’s because the case now has to go back to the High Court to determine exactly how much the payment will be.
More time in court inevitably means more of any final settlement - albeit potentially a larger one - being eaten up in legal and other fees.
Mainzeal 101
The sorry saga of the demise of Mainzeal and the shafting of the contractors dates back to 1995, when Richina, a consortium with a focus on investments in China bought a majority shareholding. Richina was led by Richard Yan, a Chinese-born Kiwiphile who first came to New Zealand in 1981 on a Rotary scholarship and worked for Mainzeal in his school holidays.
Jenny Shipley, New Zealand’s Prime Minister from December 1997 when she ousted Jim Bolger in a coup, to December 1999 when she lost to Helen Clark in the election, became chair of Mainzeal In April 2004 and joined the Richina board.
Having a former PM on both boards gave Yan high kudos when it came to dealing with China.
But almost immediately things started to go wrong for Mainzeal and its directors. Over the next eight years they loaned millions of dollars to Richina and related parties without any clear idea of what money was going out and what it was being used for. They relied on legally unenforceable “letters of comfort” to get the annual accounts through the auditors. And when they in turn asked questions about who was responsible for the liabilities being incurred, they were fobbed off.
Then in 2012, when things got tough with the business in New Zealand - leaky building claims, a multi-million dollar dispute with German industrial conglomerate Siemens, and a series of adjudications under the Construction Contracts Act - Mainzeal’s bank BNZ got twitchy, and Richina refused to come to its subsidiary’s aid.
When BNZ finally pulled the plug in February 2013, Mainzeal owed $110 million and had been trading while insolvent for at least four years. (For more details, read Newsroom’s story The Mainzeal tragedy: a story in 10 chapters.
The Appeal Court ruling
Cases like this are long and tortuous. This new judgement alone runs to 186 pages.
And decisions - and their appeals - can turn on seemingly small points of law. In this case it’s sections 135 and 136 of the Companies Act.
The High Court judgment, and the $36 million penalty, focused on breaches of s135, which deals with reckless trading.
“Many creditors were put into serious financial difficulty when the directors, including Dame Jenny Shipley and Richard Yan knowingly, and recklessly exposed creditors to illegitimate risk and allowed the company to continue trading while insolvent over an extended period of time,” Mainzeal liquidators Andrew Bethell and Brian Mayo-Smith of BDO argued. And the High Court agreed.
At its most basic, the appeal came down to two things. First, the directors appealed the amount of the liability - basically saying $36 million was too much. Then the liquidators - funded by litigation funders LPF - cross-appealed.
They argued $36 million wasn’t enough and that Dame Jenny as chair, and Richard Yan, as the head of Mainzeal’s Chinese parent company Richina, should have been liable for more.
You are both right
In a bizarre twist, the latest judgment “allows” (accepts) the appeals from both sides.
The directors were right to argue they shouldn’t have to pay $36 million under s135, the three Appeals Court judges said. Although the directors traded recklessly, the creditors didn’t end up worse off. So no compensation is owing.
But hold your horses, it’s a different story under section 136, the judges said. By using money from clients on one construction job to pay subbies and others on a different job, Mainzeal was in effect “robbing Peter to pay Paul” and that breached s136, as the liquidators argued.
“Section 136 states directors must not incur any obligation unless they believe on reasonable grounds the obligation can be met,” liquidator Andrew Bethell says.
And the judges agreed - opening up the Mainzeal directors to having to pay compensation under s136.
“This latest decision is likely to lead to a significant increase in the award for damages,” Bethell says.
The trouble for creditors is that the final numbers have been crunched only for s135 breaches, not for s136 ones. Hence having to go back to the High Court.
Still, the liquidators are looking for $63.5 million, plus interest. Significantly more than the original $36 million.
Mainzeal liquidator Andrew Bethell says the new judgment also makes it possible that Dame Jenny and the two other New Zealand-based directors, Clive Tilby and Peter Gomm, could be liable to pay more than their share if the very significant overseas assets held by Shanghai-based director Richard Yan, remain inaccessible in China.
“The Court has also opened up the real prospect of all directors being jointly and severally liable for the full amount of damages,” Bethell says.
“This is likely to be substantially higher than the D&O insurance policies held by the directors and will facilitate recovery of creditors’ losses,” he said.
Director and officers liability insurance would have covered much if not all the original award against Shipley, Gomm and Tilby, which was capped at $18 million.
Did the Appeal Court get it right?
Bell Gully partners David Friar and Tim Fitzgerald aren’t surprised by the Court of Appeal’s decision to overturn the High Court finding on loss under section 135.
“The High Court had departed from the orthodox approach of looking to the deterioration in the company's financial position between the date of the breach and the date of liquidation,” Friar told Newsroom. “Instead, it applied a novel approach of adopting a starting point of loss based on the entire amount of the deficiency in liquidation ($110 million), and then adjusting this figure on the basis of discretionary factors such as the duration of the breach and the directors' culpability.
“The Court of Appeal said that this novel approach was wrong.”
Instead, the Court of Appeal looked at a “new debt” approach - namely the amount of new debt that the company took on after it got into trouble.
“The message for directors of companies in Mainzeal’s position is that, even if the company does not cease trading immediately, it should not incur any significant new long term commitments until its solvency issues are addressed,” Friar says.”
What does it mean for directors?
Felicity Caird heads the Governance Leadership Centre at the Institute of Directors. She says the Mainzeal appeal decision is causing a lot of interest - and some trepidation - on the country’s boards, particularly as there have not been many cases on director duties heard in the higher courts.
“This is very meaningful. The Mainzeal case highlights the complex roles and responsibilities - including personal liabilities - that directors face,” Caird says.
“There is a high level of personal and reputational risk. Directors should always do robust due diligence around the roles they might take on and the potential risk.”
One practical impact of the long-running Mainzeal case is the increased cost of D&O liability insurance. Institute of Directors research last year found 34 percent of directors on publicly listed companies had faced premium hikes of 20-50 percent; 8 percent of the directors saw their insurance go up more than 50 percent.
“And coverage is decreasing. Some insurers are pulling out of D&O altogether.”
Caird worries the focus on director liability from the Mainzeal case will make boards more risk averse - thus stifling innovation and growth.
“Maybe it’s time to look at the Companies Act and see if it’s fit for purpose for the needs of companies.”
The Court of Appeal raised the same issue.
““The legislation governing insolvent trading in New Zealand is unsatisfactory in a number of respects,” the judgment says. “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.”
It remains to be seen, says David Friar, whether the Government will review the current law in light of the Court of Appeal’s comments.
