In late August New Zealand’s Supreme Court released its decision in Yan & Ors v Mainzeal Property and Construction Limited (in liq) [2023] NZSC 113. The decision is the last stop on the line which commenced when Mainzeal Construction collapsed in 2013.
Section 135 | Reckless Trading
Section 135 of the Companies Act 1993 (“the Act”) requires that a director of a company must not cause or agree to the business of a company being carried on in a manner “likely to create a substantial risk of serious loss to the company’s creditors”. The Court ruled that from January 2011 onwards the directors of Mainzeal breached section 135 of the Act by trading while insolvent.
The Court explained that determining whether business was conducted in a way that caused substantial risk of loss required an objective approach. However, when assessing whether a director agreed to, or caused, business to be conducted in that manner required a more nuanced approach focusing on what the directors were aware of, or should have been aware of if exercising appropriate care, skill, and diligence. The Court also noted that the more complex the company and the business being conducted, the higher the level of skill and diligence expected of a director.
The question of reckless trading (or trading while insolvent) also raises the issue of when trading must cease. The Court explained that directors of a company in or nearing insolvency are entitled, for a reasonable time, to take stock of the situation of the company and to obtain advice. In Mainzeal, the Court held that the directors permitted Mainzeal to trade beyond a reasonable time.
Section 136 | Incurring Obligations
The Court also considered a claim against the Mainzeal directors under section 136 of the Act which prevents a director from allowing a company to incur an obligation “unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.”
The Court held that Section 136 could apply to all new obligations undertaken in the ordinary course of Mainzeal’s business, not just to specific obligations.
Outcome
The Court found that the Directors of Mainzeal had breached the Act by permitting Mainzeal to continue trading while insolvent, failing to protect the interests of Mainzeal’s creditors, and by allowing the company to enter into obligations it was not capable of meeting.
The Court awarded damages against the Directors in the amount of $39.8m together with interest and costs.
What it means for you
The Mainzeal decision is of fundamental importance to the business community. The Supreme Court took the opportunity to set out the implications of its decision for all directors in the future. All directors should familiarise themselves with their obligations which are set out at paragraphs 269 to 273 of the decision. To summarise:
- All directors are under an ongoing obligation to monitor the performance and prospects of their company. They must “squarely address” any risks which that monitoring reveals;
- In the event of potential risk or loss to creditors, or doubt as to whether an obligation may be met, directors must decide how to avoid potential breaches of sections 135 and 136. Directors are entitled a reasonable opportunity to take professional or expert advice;
- Directors must recognise that a long-term strategy of balance-sheet insolvency is not acceptable; and
- The Courts must import a standard of reasonableness when assessing decisions of directors including recognising that those decisions will involve business judgment.
Mainzeal is a significant decision with-wide ranging application affecting every director of every company in New Zealand. All directors should take the opportunity to consider their obligations, seek independent expert or professional advice if necessary, and adopt a careful approach to the operation of their businesses.