The significant recent rise in insolvency proceedings, including the appointment of statutory managers to several Du Val group companies, and the High Court decision in Boaden v Mahoney, is a reminder of the responsibilities directors have when trading through challenging conditions. While there are a range of reasons for the rise in insolvency activity (including more activist regulators), the key takeaways from Mainzeal, the leading decision on directors duties for companies facing challenging conditions, are as important now as they were in August 2023. In this note, our PwC Legal, Business Recovery, and Insolvency teams set out some of the key legal and operational takeaways.
Background
At the point of its collapse and receivership in February 2013, Mainzeal was one of New Zealand’s largest construction companies with an annual turnover of between $350m and $400m. Following the appointment of receivers, it was revealed that from 2008 Mainzeal generated little, if any, operating profit and was “in a difficult industry while balance sheet insolvent”. Despite Mainzeal’s insolvency, its directors had allowed the company to continue trading, primarily relying on non-binding and unverified assurances of support from related companies. When Mainzeal was put into liquidation on 28 February 2013, around $100m was left owing to unsecured creditors.
The decision in the High Court was appealed to the Court of Appeal, and then to the Supreme Court - something not often seen in relation to director duties (for more detailed commentary, please see “Mainzeal - the (edge of the) cliff notes” below). Ultimately, the Supreme Court’s decision clarified and supported the Court of Appeal’s reasoning, but helpfully provided guidance for creditors and directors alike.
The decision also raised the question of legislative reform in this space. This has been picked up by the Government, who are promising change as part of their Companies Act reforms for 2025.
Key takeaways for directors
Directors who act honestly and reasonably should not have liability under ss 135 and 136. That said, in acting “reasonably”, directors have a clear obligation to monitor the performance and prospects of the company and, in doing so, must consider the interests of creditors where the company is doubtful of solvency or actually insolvent. In considering this reasonableness, director's actions (or lack thereof) will weigh into culpability and liability, including:
- Reasonable decision making: Whether directors applied reasonable care, skill and diligence in their decision to continue to trade where a company is, or is on the brink of, insolvency. The more complex the company, the higher level of skill and diligence required of the director.
- Time to investigate: Reasonable time for directors to investigate, assess and seek professional advice where necessary.
- Reliance on advice: Reliance by the directors on professional advice, or assurances of support from a related company which can be legitimately relied upon, will be factored into the reasonableness of directors actions.
- Adjusting for the benefit of hindsight: Acknowledgment of ‘hindsight bias’ and recognition of where decisions made by directors may have been reasonable at the time they were made.
- Context of decisions: Acknowledgement of the practical realities of decision-making such as time pressures and incomplete knowledge, despite best efforts.
- “Taking stock period”: Trading while insolvent may well be legitimate if the directors are using such time to take stock to identify a path forward for the company so that they can be satisfied that trading on is not likely to create a substantial risk of serious loss to creditors. This period will be what is reasonable in the particular circumstances (including the complexity of the company’s affairs and the urgency of the presenting situation), but should not be relied upon for a prolonged basis.
In the case of Mainzeal, director Sir Paul Collins was found to have acted in a manner that could be distinguished from the other directors. He expressed concerns regarding the “precarious position” of Mainzeal’s balance sheet, describing the unsecured creditors as “seriously exposed”. In addition, he requested specialist advice on solvency and the appointment of a receiver. However, when it came to holding directors liable for the loss, the court found that director Mr Yan was “far more culpable than the other directors” and consequently was held liable for a significantly higher amount than the remaining directors.
Where directors objectively become aware that continuing to trade could cause substantial loss to creditors (s 135), or doubt whether new obligations of the company will be able to be honoured (s 136), directors should seek independent advice to determine whether certain risks can be eliminated, managed or mitigated, and the required actions. At a minimum, in order to be seen to be appropriately taking into account the interests of creditors, directors should:
- Have frameworks: Have agile corporate governance frameworks to monitor, manage, prevent and respond to the company’s performance. These corporate governance frameworks (and legal and operational models) should continuously be assessed to ensure they remain fit-for-purpose.
- Monitor: Closely monitor the performance and position of the company for early warning signs that the company may be facing financial distress. Avoid governing from a purely operational perspective and remain live to broader strategic issues the company faces.
- Respond: Where a director considers that the company is (or may soon be) at risk of facing an insolvency situation:
- Address the issue head-on by undertaking an assessment of the company’s performance and position.
- Consider the risk of any loss to creditors by continuing to trade and consider whether the risks can be eliminated.
- Seriously consider whether there are reasonable grounds to believe that a company would, in the medium to long term, be able to pay its debts.
- Be realistic: Directors should not rely on the hopes of a long-term trading strategy while ‘balance sheet’ insolvent. The company should only continue to trade if the assessment shows that the company has reasonable prospects of servicing its existing and future debt obligations and returning to solvency and continuing to trade does not pose a serious risk of loss to creditors. Where this is not the case, the directors must cease trading and consider what legislative mechanisms may be appropriate (such as voluntary administration).
- Consider if incurring obligations is reasonable: When agreeing to the company incurring any obligations, directors must have a reasonable basis and expectation that the company will be able to meet those obligations. Ensure that the basis for such conclusions is documented. Mainezeal codified that directors cannot rely on vague or informal assurances of financial support from related parties to avoid liability under s 136.
- Have appropriate D&O insurance: Directors should make sure that they are comfortable with the cover of insurance in relation to the nature, size and complexity of the company’s trading activities. Directors should examine the company’s constitution to ensure that it allows for adequate protection for directors against their potential liability.
In the case of Mainzeal, the directors failed to directly address Mainzeal’s dire financial situation, and failed to make it clear that the company could not continue to trade unless changes were made to Mainzeal’s “policy of insolvent operation”. The directors in Mainzeal were found to have relied on unenforceable assurances of support from group companies, which the Court held was unreasonable. The directors also failed to undertake a “sober assessment” of the risks involved with continuing to incur obligations, with “unfounded optimism” falling short of this standard.
Legislative reform
In August 2024, the Government announced a two-phased plan to update the Companies Act and related corporate governance laws. The reforms aim to make New Zealand a better and safer place to do business by “modernising outdated laws and reducing unnecessary red tape”, while also ensuring safeguards against unethical business practices.
- Phase 1 will amend the Companies Act to reflect the modernised business environment in New Zealand, simplify compliance, discourage and identify poor business practices (for instance, company directors and shareholders would be assigned a unique identification number to enable the identification of phoenixing) and promote the use of the New Zealand Business Number. These changes are expected to be part of a bill introduced in Parliament early next year.
- Phase 2 will follow a Law Commission review expected to commence in 2025, focusing on directors’ duties, liabilities, penalties, offences, and enforcement, addressing issues highlighted in Mainzeal.
We expect these reforms will be welcomed by current and prospective directors. The Companies Act, now over 30 years old, has shown limitations in cases like Debut Homes and Mainzeal, which highlighted challenges in defining directors' duties and created uncertainties for directors of financially troubled companies and their creditors. In our view, the proposed clarifications to directors’ duties considered by Phase 2 should be addressed as a priority, rather than delayed until the proposed administrative amendments in Phase 1 are implemented. Take a look at our recent update “Proposed Company Law Reforms” for more information.
Mainzeal’s guidance and clarity for directors was underscored recently by the courts in Boaden v Mahoney. The decision has opened up an area of concern for liquidators, and avenues of potential remedies for otherwise out-of-pocket creditors. This is a development that will be keenly watched by the Government as the 2025 Companies Act reforms are debated and enacted.
Following Mainzeal, in September 2024, the High Court found that director Mr Mahoney allowed Civil Underground Ltd (in liquidation) to continue to trade for over 12 months while it was insolvent. The company had a net asset deficit and outstanding tax obligations, and had no reasonable basis on which to meet its obligations or “trade its way out of debt”. While Mainzeal continues to be the leading guidance for directors, and acts as a warning and reminder that directors need to tread carefully and seek advice when the company is insolvent or near insolvent, Boaden v Mahoney permitted remedies for creditors, where there wouldn’t have been remedies based on their priority of claims in a liquidation.
Mr. Boaden (as creditor of Civil Construction) suffered losses that the Court found were due to Mr Mahoney’s failure, as a director of Civil Underground, to ensure that Civil Construction could meet its obligations to pay rent and reinstate Mr Boaden’s property on exit of his lease. These obligations were incurred when Mr Mahoney agreed to vary the lease terms, at a point where Civil Underground was already insolvent (i.e., in breach of s 136). Mr Mahoney was ordered to pay damages based on the ‘new debt’ approach, for unpaid rent and costs arising from clearing the property. The High Court applied the Supreme Court's interpretation of section 301(c) of the Companies Act in Mainzeal, which clarified the ability of creditors to recover relief directly in relation to claims under ss 135 and 136, and allowed Mr Boaden to recover the amounts claimed in connection to Mr Mahoney’s breach.
Interestingly, Mr Boaden was not otherwise able to recover any monies in the liquidation of Civil Construction, and so this approach effectively gave Mr Mahoney recourse that other creditors did not obtain. In our view, permitting direct claims by creditors may effectively create an uneven playing field for unsecured creditors, as creditors who do not pursue direct action for payment of debts by directors may be unfairly disadvantaged compared to those who do. The result of Boaden v Mahoney impacts the well-established pari passu common law principle, codified in section 313 of the Act, which provides that all unsecured creditors share equally and proportionately in the assets of the debtor; a principle that operates within proceedings such as liquidation. Legislative change may be further required in order to ensure liquidators have the ability to enable all creditors to benefit from claims associated with a breach of directors’ duties, where they choose to take them.
The High Court also acknowledged that the effects of Covid-19 could be taken into account when assessing the conduct of a director. In this case, Mr Mahoney’s company was insolvent before Covid-19 affected New Zealand, but the High Court’s recognition that the effects of Covid-19 were unforeseeable indicates that directors may be able to defend breach of duty claims where they can demonstrate a causal link. Further analysis of the relevance of Covid-19 may arise as more decisions relating to insolvencies during the Covid-19 period come through the pipeline. However, it is clear from Boaden v Mahoney that Covid-19 won’t be a ‘Get Out Of Jail Free Card’ for insolvent traders.
During, and for a period after, the Covid-19 pandemic there was a significant decrease in corporate liquidations (which appears, in part, to be due to a general reluctance to enforce), but in recent times there has been a post-pandemic increase in liquidation applications. Inland Revenue, in particular, has become more active in collecting debt, and it is no longer as willing to enter into formal instalment arrangements. These factors mean there may be more liquidations where director actions and breaches of said duties will be tested.
If you would like to discuss any of the matters outlined in this article, please get in touch with a member of our PwC or PwC Legal team.
At the point of its collapse and receivership in February 2013, Mainzeal was one of New Zealand’s largest construction companies, with an annual turnover of between $350m and $400m. Following the appointment of receivers, it was revealed that from 2008 Mainzeal generated little, if any, operating profit and was “in a difficult industry while balance sheet insolvent”. Despite Mainzeal’s insolvency, its directors had allowed the company to continue trading, primarily in reliance on non-binding and unverified assurances of support from related companies. When Mainzeal was put into liquidation, around $100m was left owing to unsecured creditors. In this case note, we summarise some of the background to the Mainzeal saga, including the march from the High Court to the Supreme Court, and on its way, creating ambiguity and then clarity for directors.
High Court
In 2018, the liquidators brought a claim against the directors of Mainzeal alleging that the directors had breached the Companies Act by allowing Mainzeal to continue to trade, creating a substantial risk of serious loss to creditors (s 135; also known as “reckless trading”), and incurring obligations to creditors without a reasonable expectation that they could be performed (s 136).
- The s 135 claim was successful in the High Court, which found that Mainzeal was trading while balance sheet insolvent, with a long history of poor trading performance and exposure to significant one-off losses, and without a binding assurance of group support. The Court awarded compensation of NZ$36m (discounted from NZ$100m), the largest award for reckless trading in New Zealand at the time.
- The s 136 claim (incurring obligations that could not be met) failed as, in the Court’s view, the liability for a breach of s 136 focused on particular obligations under specific contracts, rather than the incurring of obligations generally, which was the focus of the liquidators’ claim. Although the Court held that the directors exposed the creditors to a substantial risk of serious loss (s 135), the Court held that Mainzeal’s failure, or likely failure, would not have been apparent to the directors, at least until very near to the point when Mainzeal failed, and consequently no loss would have been suffered.
Court of Appeal
In March 2022, the Court of Appeal held the Mainzeal directors’ decision to continue to trade was likely to have breached the insolvent trading duties under ss 135 and 136 of the Act, unless the manner in which the directors chose to trade had realistic prospects of enabling the company both to service pre-existing debt, and to meet new commitments arising from ongoing trading - essentially - leading to a return to solvency.
- The Court of Appeal agreed the directors breached s 135 (reckless trading) by continuing to trade from 31 January 2011, failing to engage in any meaningful way with the company’s financial position, which created a risk for current and future creditors. The reality of Mainzeal’s “business as usual” mode, involved a substantial risk of serious loss to creditors of Mainzeal. That being said, the Court of Appeal agreed with the High Court that there was no “net deterioration” in Mainzeal’s position from the date the directors should have stopped trading until its entry into liquidation, and therefore the s 135 breach did not cause loss.
- The Court of Appeal held that directors breached s 136 by entering into four significant construction contracts after 31 January 2011, and associated obligations in respect of those projects, and by entering into all obligations from 5 July 2012 onwards. The Court of Appeal found that for breaches of s 136, loss (and therefore compensation) would focus on the “new debt” Mainzeal assumed without reasonable basis from 31 January 2011.
Supreme Court
The decision was then appealed to the Supreme Court, which upheld the Court of Appeal findings by determining that the Mainzeal directors adopted a trading policy likely to “create substantial risk of serious loss to the company’s creditors” (a breach of s 135) from 31 January 2011, without capital injection/reasonable assurances to rely on, and took limited actions to reduce the risk to ensure compliance with s 135. The Court also held that the Mainzeal directors did not have reasonable grounds for believing that obligations entered into under four major construction contracts after 31 January 2011 would be met and all other obligations incurred after 5 July 2012 would be honoured (s 136). Ultimately, the Supreme Court found that Mainzeal’s directors were liable for insolvent trading and that compensation for the breach of s 136 should be assessed from the new debt that occurred. In agreement with the Court of Appeal, the Supreme Court held that no compensation for breach of s 135 was awarded as the Supreme Court found there was no net deterioration in Mainzeal’s financial position between 31 January 2011 and the date of liquidation in early 2013.
In the High Court, the directors argued that directors of an insolvent company should be able to continue to trade (despite substantial risk of serious loss to creditors) if continuing to trade would create a possibility of reducing or eliminating creditors’ losses. The Supreme Court rejected this proposition outright, noting that it was undesirable for a company to continue to trade and deal with others in the future, who may be exposed to substantial risk of serious loss. In light of Mainzeal’s balance sheet, it would have been appropriate for directors to view Mainzeal’s forecasts “with a degree of healthy scepticism”. The directors were ordered to pay $39.8m plus interest (at interest rates since 2013), with the liability of three of the four directors capped at $6.6m plus interest.
The Supreme Court’s decision clarifies and supports the Court of Appeal’s reasoning, but helpfully, provides further guidance for creditors and directors alike. It also raises the question of legislative reform, which has been picked up by the Government, who are promising change as part of their Companies Act reforms for 2025.
