This morning, after much anticipation, the Supreme Court has released its judgment in Yan v Mainzeal Property Construction Limited (in liq) [2023] NZSC 113, largely upholding the Court of Appeal's decision, and awarding damages of $39.8m against the directors collectively, with specified limits for certain directors. The decision signals that a strong emphasis on 'creditor protection' is now embedded in New Zealand company law. This legal alert provides a brief overview of the Supreme Court's judgment.
The key points are:
- Creditor protection: Sections 135 and 136 of the Companies Act 1993 (Act) are premised on the policy that when a company is insolvent or bordering on insolvency, creditors have an economic interest in the company which requires consideration by directors. While creating duties owed to the company, the sections are to be construed and applied as having the purpose of creditor protection.
- Standards of reasonableness and diligence: Sections 135 and 136 of the Act are to be construed as imposing standards of reasonableness and diligence upon directors. Directors are not permitted to trade on at the risk to future creditors if the company is insolvent. However, they will be permitted time to 'take stock'.
- Court's discretion: The Court has a discretion, under section 301 of the Act, to enable the court to respond to the facts of particular cases, making it appropriate for the courts to be free to tailor relief in ways that respond to the particular breach or wrong, to the harm that flows from that and to, at least to some extent, the culpability (particularly as amongst themselves) of the directors. The Court found there was support for the argument that breaches of sections 135 and 136 will be advanced by liquidators, rather than a company, and thus ordinarily dealt with under section 301. Although the Court did not express a firm view, the Court appeared to contemplate that the discretion should always be available under section 301 of the Act (rather than in just those cases in which a liquidator relies on it) (see paragraphs 338-340 of the judgment).
Background / facts:
Mainzeal Property and Construction Ltd (Mainzeal) was a prominent construction company in New Zealand that went into liquidation in February 2013. The liquidators of Mainzeal brought proceedings against the company's directors, alleging that they breached their duties to the company and its creditors under sections 135 and 136 of the Companies Act 1993. The directors were accused of carrying on the company's business recklessly and incurring obligations without reasonable belief that the company would be able to perform them. The litigation has attracted substantial public attention by imposing significant penalties on the directors of the former construction giant.
In 2019, the High Court found the directors of Mainzeal liable under section 135 for reckless trading, leading to losses of $110m. On appeal, the Court of Appeal found the Director's breached section 135 but disagreed with the High Court's findings on causation and the quantification of losses. Additionally, the Court of Appeal found the directors breached section 136 and adopted a 'new debt approach' to determine damages. This approach implicates the directors for new obligations undertaken by the company from the date of insolvency until liquidation. The amount of compensation payable by the directors was sent back to the High Court for determination, although these proceedings were stayed pending the outcome of the Supreme Court appeal.
The Supreme Court has dismissed the directors' appeal and allowed the liquidators' cross appeal, by awarding damages of $39.8m against the directors collectively, with specified limits for certain directors (rather than remitting an assessment of damages to the High Court).
We set out the Supreme Court's key findings below. Further detailed analysis by our team on this matter will follow.
Implications of appeal
- Directors have an obligation to monitor the performance and prospects of their company. Directors must squarely and soberly assess the company's solvency position and take professional advice as appropriate. A long-term strategy of trading while balance sheet insolvent is generally not acceptable. Directors are entitled to a short period to 'take stock', during which trading while insolvent may be legitimate.
- New Zealand law requires company directors to consider the interests of creditors if the company is insolvent, or near-insolvent, or of doubtful solvency, or if a payment or other course of action would jeopardise its solvency. A substantial risk of serious loss to creditors exists when there would be loss to those trading with the company in the future, irrespective of whether trading on may benefit existing creditors.
- The Supreme Court emphasised the importance of creditor protection in section 136. Liability under sections 135 and 136 may arise well before it becomes apparent that there is no reasonable prospect of avoiding liquidation. This represents a departure from what the UK Supreme Court found in Sequana[1] and Stanford[2] in relation to when liability will be incurred. Under the equivalent UK legislation, liability is not triggered until it is practically inevitable that there will be an insolvent liquidation.
- Section 136 applies broadly: Section 136 can apply to obligations undertaken in the ordinary course of a company's business as a result of directors agreeing to continue to trade. The section is "not confined to obligations of a particular kind, and may be invoked in relation to a course of trading to which the director has agreed."
- The 'new debt' approach which found favour in Debut Homes[3], and in the Court of Appeal decision in Mainzeal was endorsed by the Supreme Court. Whilst the Supreme Court found that the appropriate measure of loss under section 135 was a 'net deterioration' approach, the Supreme Court agreed that it was appropriate to apply a 'new debt' approach to loss under section 136 in the circumstances.
[1] BTI 2014 LLC v Sequana SA [2022] UKSC 25
[2] Stanford International Bank Ltd (in liq) v HSBC Bank plc [2022] UKSC 34, [2023] AC 761
[3] Madsen-Ries (as liquidators of Debut Homes Ltd (in liq)) v Cooper [2020] NZSC 100, [2021] 1 NZLR 43.
