A new approach taken by the Court of Appeal in the recent Mainzeal judgment?

Background


Mainzeal was placed in receivership on 6 February 2013, with liquidation following soon thereafter.  Unsecured creditors at that time were about $110m.  The liquidators brought claims against the directors for breaches of s135 (reckless trading) & s136 (incurring an obligation without reasonable grounds the company will be able to perform it when required to do so) Companies Act 1993 (CA).  On 26 February 2019, Cooke J issued his judgment.1  He found the directors:

  • Liable for breaches of s135 CA on an ‘entire deficiency’ approach for the full $110m. This was on the basis that liquidation could have been avoided.  His Honour found that if the directors had threatened to resign, Richina Pacific would have provided legally binding support sufficient to restore solvency.
  • Were required to pay compensation of $36m in total after consideration of factors under s301 CA. Mr Yan was responsible for that entire sum, with the other three directors liable for $6m each (being $18m of the $36m).
  • Not liable for breaches of s136 CA.

The directors appealed.  The liquidators cross-appealed.  The Court of Appeal (Court) issued their judgment 31 March 2021.2  Although there was some success for both sides, ultimately the directors remain liable, but for breach of a different duty, and a different assessment of loss, from that found at first instance.

Section 135


The directors remain liable for a breach of s135, but the Court rejected an assessment of loss on the ‘entire deficiency’ approach.   The correct approach to loss was the traditional ‘net deterioration’ assessment.  This involved considering whether the company was in a worse position between the date on which it is alleged liquidation should have occurred (the counterfactual date), and when it actually occurred.  Although he applied the ‘entire deficiency’ approach, Cooke J found if the ‘net deterioration’ approach were adopted, there was no loss as Mainzeal was slightly better off by continuing to trade beyond when the liquidators maintained the company should have ceased doing so.  On the ‘net deterioration’ approach, the s135 breach caused no loss.
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As mentioned, the ‘entire deficiency’ approach to assessing loss was that favoured by the trial Judge.  However, this was neither pleaded, was not a feature of the evidence, nor was it apparent in the liquidators’ opening.  Unsurprisingly, the Court found it was therefore not open for the High Court to find for the liquidators on a materially different approach to loss than that pleaded.  Fairness required the theory of loss (as found) to be properly pleaded and put to the relevant witnesses.  It was not.  The High Court could not have found them liable on that basis.

Section 136


The liquidators’ cross-appeal on s136 succeeded.  The Court held the directors liable for a breach of s136, by incurring obligations under four significant construction contracts entered into after the counterfactual date of 31 January 2011, and for all obligations entered into from 5 July 2012 until the date of actual liquidation.  The Court accepted, relying on Debut Homes3 that s136 is not concerned only with entry into specific obligations, and there was no reason the provision should be read this way.

Although it was accepted that the directors believed Mainzeal would be able to meet these obligations, such belief was found to be unreasonable.  Mainzeal should have only taken on significant new long-term commitments after 31 January 2011 if the directors first took steps to address the company’s serious balance sheet insolvency, and succeeded in obtaining further capital or (at least) assurances of support on which they could reasonably rely.   Further, by 5 July 2012, Mainzeal was failing to meet new short-term obligations when they fell due, with significant overdue debt.  The directors knew the company’s precarious position could result in failure at any time, so they lacked reasonable grounds for believing Mainzeal could meet any newly incurred obligations when they fell due after that date.

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Following Debut Homes, the Court found that the appropriate measure of compensation for a breach of s136 is the amount of new obligations entered into after the dates referred to above, to the extent they remain unsatisfied (the ‘new debt’ approach).  In that case, the Supreme Court found that a different approach (to ‘net deterioration’) to assess compensation would generally be needed for considering a breach of s136.  It adopted the ‘new debt’ approach.

The proceedings have been remitted to the High Court to quantify the appropriate compensation, although it was said that it seemed likely the relevant figure would be “a substantial proportion of” about $63.6m.  Once that figure is assessed, the High Court will also need to address the question of whether any deduction should be made in the exercise of the s301 CA discretion.   The Court seemed split on this point, without needing to determine it.  Goddard J considered the discretion could be relatively confined, whereas Kos P and Miller J provisionally favoured a broad discretion, including concepts of causation, culpability and duration of any breach.

Comment


The Court of Appeal expressed the view that the insolvent trading legislation in NZ is unsatisfactory in a number of respects.  While opining that the Companies Act should be reviewed, it appears the Court has taken an approach to s136 on the basis of what it considers that review might achieve.

Rather than considering the position of the company in relation to a potential breach of s136, it has instead looked at the position of individual creditors by adopting the ‘new debt’ approach to loss.  This fails to take into account that, by continuing to trade, existing liabilities were discharged, while new debt was being incurred.  The Court justified this approach by (arguably artificially) treating the new debts as being a form of harm to the company.  However, this seems inconsistent with the net deterioration approach proving that the position of the company improved between 30 January 2011 and the date of liquidation in February 2013.

In addition, the directors appear again to be in a position where findings have been made against them on aspects of the case which were not pleaded and not the subject of evidence, particularly in relation to the four construction contracts entered into after 31 January 2011, the basis on which they were embarked upon, and the directors’ knowledge of them.  This is relevant to the reasonableness of the directors’ belief that the obligations arising under those contracts could have been met when they fell due.  However, that was not the subject of any focus in the High Court.

The directors may well consider seeking leave to appeal to the Supreme Court.  However, the extent to which the facts in Debut Homes will govern the approach taken to s136 in light of the circumstances as they existed in Mainzeal, remains to be seen.



  1. Mainzeal Property and Construction Ltd (in liq) v Yan [2019] NZHC 255
  2. Yan v Mainzeal Property and Construction Ltd (in liq) [2021] NZCA 99
  3. Debut Homes v Cooper [2020] NZSC 100

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