By Patrick Glennie (Partner), Brendan Cash (Partner) Ella Arbuckle Page (Associate), and Caitlin Hogan (Solicitor) in Dentons New Zealand’s Major Projects and Construction team.
On 25 August this year the Supreme Court released the “last say” on directors’ liability arising from the collapse of Mainzeal Property and Construction Limited (in liquidation).
Mainzeal has been a hot topic for company directors since it went into liquidation on 28 February 2013, and this final decision is a cautionary tale.
Many construction contractors here operate as limited liability companies. As such, they have directors responsible for overseeing the company’s affairs. These directors owe certain duties under the Companies Act 1993.
The duties owed by directors include not carrying on the business of the company in a manner likely to create a substantial risk of serious loss to the company’s creditors, and not agreeing to the company incurring an obligation – unless there are reasonable grounds to believe that the company will be able to perform.
In the Mainzeal case, the Supreme Court ultimately found that four of the company’s directors breached these duties by continuing to trade and incur new obligations once the company was insolvent in reliance on unenforceable assurances of support. The result was that the four directors were found personally liable for a total of $39.8 million (although the liability of three of the directors was limited to $6.6m plus interest and costs each).
While your standard owner-operator might not be making decisions of the same financial magnitude as those discussed in Mainzeal, the Supreme Court’s guidance is still relevant in providing practical guidance, and a warning, for directors of companies in financial distress.
Financial health checks are critical to business viability
Conducting comprehensive financial health checks both in times of financial uncertainty and of financial stability is a cornerstone of good decision making:
Directors need to be armed with a thorough understanding of the company’s financial position to make informed choices. This can be more difficult in smaller companies, where the director is involved in the day-to-day operations, but being able to take a step back and assess the financial health of the company holistically is crucial.
Scrutinising cash flow is an important part of a financial health check. This will allow any trends to be identified, and irregularities flagged, and it goes a long way to ensuring cash flow remains as steady and sustainable as possible.
Directors should make sure they have understood and evaluated all of the company’s debt. Understanding the nature, structure and repayment obligations of outstanding debt helps with effective management of financial obligations.
Equally, if the company is relying on support from the bank or other group companies, the directors need to be comfortable that that support will be forthcoming.
In Mainzeal, a key finding was that the directors had relied on non-binding assurances of financial support from Mainzeal’s parent company.
Being aware of cash flows and debts helps directors project their company’s future finances and identify potential risks and opportunities well in advance. Comprehensive financial health assessments serve as a guiding compass that no prudent director should go without.
Directors then need to keep records showing they have made these checks and what they showed (e.g. regular minuted Board meetings that record steps taken, annex supporting papers etc).
Consider creditors interest when addressing financial crises
In normal circumstances, a director’s duties are owed to the company and to its shareholders. However, once there is a substantial risk of serious loss to the company’s creditors or that the company might incur obligations it can’t perform, the directors need to start having regard to the interests of creditors.
In this situation directors need to consider carefully whether the company should continue trading. If the company can’t be salvaged, don’t trade on. Take advice and consider the appointment of administrators or liquidators.
It is not sufficient for directors to trade on and incur further obligations on the basis that doing so may improve the net position of the company compared to immediate liquidation. There needs to be a plan to return to solvency.
It can be tempting to trade through insolvency in an attempt to revive the financial position of the business, but without a clear and realistic plan back to solvency (preferably with the benefit of professional advice), this is to be advised against.
As above, any decision to trade on should be well documented, including the reasons why, the plan being adopted and similar.
Seek expert advice when making decisions in times of financial crisis
Amid financial uncertainty, expert advice becomes invaluable. The Supreme Court in Mainzeal confirmed that directors of insolvent, or nearly insolvent, companies are entitled to ‘take stock’ while they obtain advice.
That is, they will not (usually) be criticised for not rushing to put the company in liquidation and instead considering their options.
To get the benefit of this leeway: directors of companies should be consulting experts, be that financial advisors, accountants, or legal experts, as soon as possible once they recognise serious financial issues are developing; making a plan based on that advice – this strategy should directly address the financial challenges the company is facing and set realistic objectives to bring it out of the red; and continuously monitoring progress against this strategy, and reviewing the decision to continue trading at regular intervals.
Seeking advice pro-actively, and acting on the basis of that advice, may help the company avoid insolvency and/or liquidation.
If liquidation can’t be avoided, it will also help to protect directors from personal liability. Again, copies of the advice received should be kept and the directors’ consideration and response to the advice properly documented.
Some relief for directors
Much of the discussion following the Mainzeal decision has been about the uncertainty facing directors when making decisions in hard times, and the risk of personal liability if they get it wrong. However, it’s not all bad news.
The Court, while imposing stricter standards on directors’ financial oversight of their companies, also acknowledged that directors can find themselves in the position of making intricate decisions under pressure, often without access to complete information.
While there is always the risk that directors will be judged with the benefit of hindsight, the courts are aware of this trap and will consciously try to avoid falling into it.
The decision confirms that directors will usually be allowed a reasonable window of time to take stock and decide what course of action they should take without being legally liable.
The job of directors is not an easy one, they face a delicate balancing act between their business goals, financial responsibilities and legal duties.
This remains the case, and there are calls for reform of the law to allow directors to take more business risks without risking personal liability, but the Mainzeal decision has at least given some certainty as to how directors’ legal duties will be interpreted and some practical guidance about what this looks like.
Embracing the takeaways discussed and adopting a proactive stance to financial management will help with navigating today’s financial uncertainties and securing the future of companies. This is all too important given the intricate web of dependencies in the construction industry where maintaining the flow of cash is crucial to keep the wheels of the industry turning.
• This publication is not designed to provide legal or other advice and you should not take, or refrain from taking, action based on its content. Dentons Kensington Swan does not accept any liability other than to its clients, and then only in relation to specific requests for advice. For specific advice, contact your legal advisor or the Major Projects and Construction Team at Dentons Kensington Swan on (09) 379 4196.