By Tim Bates, Legal Vision
In this month’s article I wish to review some of the findings of the recent Mainzeal High Court decision.
The decision is a lengthy one so I have condensed the key findings.
• The proceeding was brought by the liquidators of Mainzeal against the directors of Mainzeal which fell into liquidation owing creditors $110 million.
• One of the directors, Mr Yan, through a collection of companies broadly known as Richina, gained control of Mainzeal.
• Mr Yan ensured significant sums of money were advanced from Mainzeal to Richina to purchase assets overseas, including land and leather businesses in China.
• These funds were advanced on the strength of verbal understandings and letters of comfort as between Richina and Mainzeal.
• Absent these verbal assurances and letters of comfort, Mainzeal was left balance sheet insolvent.
• Ultimately, Richina did not honour the letters of comfort and verbal assurances.
The claim brought against the directors was on the basis that they had breached sections 135 and 136 of the Companies Act 1993.
The claim based upon section 136 was unsuccessful. Section 135 states that a director cannot agree to or cause the business to be carried on in a manner that is likely to create a substantial risk of serious loss to the company’s creditors.
First key ruling
The first key ruling of the High Court was in respect of the letters of comfort and oral assurances of comfort as between Richina and Mainzeal.
The court held that the letters of comfort, particularly when provided in connection with an annual audit, were not legally enforceable. That was because they did not exhibit an intention to create legally binding relations or provide an enforceable undertaking or guarantee.
The court, in analysing the criteria contained in section 135, namely “substantial risk”, ruled that this phrase “requires a sober assessment by the directors as to the company’s likely future income stream”.
The reality in the context of Mainzeal was that once the letters of comfort were taken away as being able to be relied upon, then it had been balance sheet insolvent for a significant period of time.
The court concluded that:
• Mainzeal was trading while balance sheet insolvent as the inter-company debt was not, in reality, recoverable.
• There was no assurance of group support that the directors could reasonably rely upon if adverse circumstances arose.
• Mainzeal’s financial trading performance was generally poor and prone to significant one-off losses (e.g. the Botany Town Centre leaky building claim), which meant it had to rely on a strong capital base or equivalent backing to avoid collapse.
Each of these elements were required to be established to find the directors liable pursuant to section 135.
So each director was found liable for breach of section 135 of the Companies Act 1993, and the court thereafter had to decide, pursuant to section 301, how much compensation was payable by each director.
The court ruled that the total deficit on liquidation was the starting point in terms of assessing liability.
The court ruled that there were three discretionary factors that should apply — namely, causation, culpability, and duration of trading.
Risk of serious loss
In addressing these factors, the court held that the directors had exposed creditors to the risk of serious loss for a number of years. The breach of duty was continuous.
They had many opportunities to correct the manner in which Mainzeal’s business was being conducted, but they had failed to do so. As a factor, this counted towards a significant contribution.
In respect of the independent directors, the court accepted that they had acted in good faith with honesty, and did so throughout, but their breach arose from their failure to fully appreciate and address the risks they were exposing creditors to.
In addition, it arose from the unreasonable reliance on assurances, expressed in loose terms, that had been given to them.
Mr Yan, the first defendant, was ruled to have acted honestly yet in a way that led the other directors to breach section 135.
He was in an inherent conflict of interest. He gave assurances to the fellow directors that were misleading.
The eventual findings were that each independent director was liable for $6 million jointly with Mr Yan, whereas Mr Yan was also found severally liable for $18 million.
The High Court decision is on appeal, and a cross appeal has been filed by the liquidators seeking higher awards.
Note: This article is not intended to be legal advice (nor a substitute for legal advice). No responsibility or liability is accepted by Legal Vision or Building Today to anyone who relies on the information contained in this article.