The High Court has found that the directors of Mainzeal permitted the company to operate in a manner that was likely to create a substantial risk to creditors – but who pays for the losses?
Money down a hole? Mainzeal and its consequences – By Brendan Cash and Liam Bullen
Mainzeal Property and Construction (‘Mainzeal’) was once New Zealand’s third-largest construction company. Their projects included landmark buildings such as Auckland’s Spark Arena and Wellington’s Supreme Court. As far as most people knew, it was a large, successful contractor that principals, subcontractors, suppliers and consultants could confidently deal with. However, under the surface, all was not well.
At the heart of Mainzeal’s troubles was an insolvent balance sheet, which it had had for many years. Mainzeal gave its parent company, Richina Pacific,
around $40 million as a loan over the years and it was given assurances that financial support would be made available to it if required. These promises
were mostly made through one of Mainzeal’s directors, Richard Yan, who was also a shareholder and founder of Richina Pacific.
However, these were not binding, and when Mainzeal experienced cashflow difficulties in 2012, it became clear that it could not rely on equity coming in from China. As a result, Mainzeal was placed into receivership and then liquidation in 2013, with unsecured creditors being owed around $110 million.
A breach of duties
In February this year, the High Court found that the directors of Mainzeal breached their duties under section 135 of the Companies Act 1993. They permitted the company to operate in a manner that was likely to create a substantial risk of serious loss to creditors.
The court decided on the liability figure of $36 million, as it was around one-third of the $110 million owed to creditors and was similar to the amount loaned by Mainzeal to Richina Pacific. This is more than the amount owed to unpaid employees ($12 million) and general creditors ($9.5 million), but less than the amount owed to unpaid subcontractors ($45.4 million) and claims by principals ($43.8 million).
Dame Jenny Shipley, Clive Tilby and Peter Gomm were found to have breached their duties as directors, but it was said that they had ‘acted in good faith’. The fourth director, Richard Yan, acted honestly, but was found to be far more at fault compared to the other directors. Shipley, Tilby and Gomm were each found to be liable for $6 million. The court implied that Yan should have to pay the full $36 million amount if the other directors could not pay their share.
A defendant’s ability to pay was said to be a discretionary consideration for the court in determining compensation. Mainzeal took out a directors and officers (D&O) liability insurance policy with QBE, which means there is $23 million potentially available that the directors could use to partly pay the money they owe.
However, there is no clear precedent for how this money should be divided between the four directors. Despite the court asking for advice on how insurance money would be allocated, no findings were made on the insurance cover.
It might be said that the D&O cover may incentivise directors to act irresponsibly, since they would not have to pay any loss. However, if the D&O cover applies, this ensures some money is paid to the creditors. As Mainzeal illustrates, the amount awarded can substantially exceed insurance cover, meaning directors may have to pay personally or face bankruptcy.
The directors have appealed the judgment. The appeal is unlikely to be heard until later this year, which means the creditors of Mainzeal continue to face a long wait.
With the example of Mainzeal and other recent collapses in the construction industry, industry participants need to consider how best to protect themselves when they contract. The starting point is thinking about who you are doing business with – are they reputable, do they have finance, are they making profits or losses, what does their balance sheet look like (if published, or if the party is willing to provide it), have they usually paid on time, what is the industry gossip about them?
The next step is to put in place security – e.g. bonds, personal guarantees and parent company guarantees. However, these are not always available or can be difficult to obtain. It is also important to check contracts to see what the payment terms are – look for prompt payment terms.
An interesting approach in the English JCT Standard Building Contract is to have a common interim valuation date (IVD). This date allows for a consistent approach to payments within the whole supply chain. All payments must be made within 31 days of the IVD, which means all contractors and subcontractors will be paid in this time, seeking to reduce the gap between payments down the chain. This gap is one reason subcontractors can face being out of pocket when a contractor goes under.
During the contract, ensure payment claims are made on time and monitor payments to ensure you are paid on the due date. Follow up quickly and exercise your rights (e.g. to suspend under the Construction Contracts Act 2002) if payment is not made. Don’t let the hole get bigger.
However, Mainzeal illustrates difficulties with the above. Mainzeal was seen as reputable, no security would likely have been provided to subcontractors (even if requested), and payment terms were relatively standard. Still, subcontractors ended up two months out of pocket and lost any retentions being held against them when Mainzeal went under. What else can you do?
Getting your money back
The retention position has improved since Mainzeal, and industry participants should be aware of and enforce their rights under the new regime. After the collapse of Mainzeal, changes were made to the Construction Contracts Act to protect contractors and subcontractors.
Retention money must now be held on trust in cash or a similar liquid form, or it can be held in a complying financial instrument (like a bond). In the event of collapse, these retention amounts are protected. Industry participants should regularly check that their retentions are being held on trust.
However, retentions would make up only a small percentage of the losses of subcontractors and suppliers in relation to Mainzeal. The main loss was the two months’ worth of work not paid for. How can industry participants protect themselves from such losses?
One tool, not much used in New Zealand, but which could assist, particularly on larger projects, is the use of project bank accounts (PBAs). This has, for example, now been mandated for certain projects in Queensland. For construction projects that meet certain criteria, including where the Queensland government is involved, PBAs are used which operate under a trust structure. The head contractor and first-tier subcontractors are ‘beneficiaries’ of the account.
Progress payments, retention monies and disputed amounts are paid into and held in these PBAs. Usually, progress payments would transfer directly from the principal to the head contractor and then after a period of time to the subcontractor. However, with PBAs the payment goes into the trust account and then the financial institution transfers them to the contractors and subcontractors.
PBAs are intended to protect everyone in the supply chain from the situation where one or more parties in the chain face insolvency. They offer security because money can’t be transferred out of the PBA unless it is for the purpose of paying beneficiaries.
Overall, in a difficult trading environment, it is worth having a closer look at security of payment across the supply chain of construction projects. In order for all parties to trade with each other confidently (principals and their funders, contractors, subcontractors and suppliers) it may be necessary to have more discussions and transparency in relation to funding and payment. While not much used to date, PBAs may be one way to help secure the position of all parties.
Brendan Cash is a partner and Liam Bullen a law graduate within the construction law team at Kensington Swan kensingtonswan.com