New Zealand: reckless trading and some governance lessons

The High Court gave judgment earlier this week in Mainzeal Property and Construction Limited (in liquidation) v Yan [2019] NZHC 255: see here or here (pdf). A summary is available here (pdf).

The principal claim before court, brought by a company's liquidator, was that the company's former directors had breached section 135 of the Companies Act 1993. Section 135 provides that a company director must not "(a) agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors; or (b) cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors". The company in question was a wholly-owned subsidiary within a larger corporate group.

The directors - including a former prime minister of New Zealand, Dame Jenny Shipley - were held to have breached section 135, the trial judge (the Hon Justice Cooke) finding that the following three factors were relevant (and all necessary) for this finding: (a) the company had traded while balance sheet insolvent because of the unrecoverable nature of intercompany debt; (b) the absence of group support on which the directors could rely; (c) the company's generally poor trading performance.  Thus, the judge noted, trading while insolvent would not have been fatal if the trading position had been strong or there had been reliable group support. The directors had taken risks that the judge held could not be regarded as "normal business risk taking" and they had allowed the company to continue trading in "highly unorthodox circumstances" (para. [284]).

The decision contains important governance lessons, particularly with regard to the way in which the company's board operated and risk was managed (against the background of the wider group operations). This makes it of interest beyond New Zealand. The court received evidence on "good corporate governance standards" in order to assist it in assessing the questions arising under section 135. In this regard, the judge accepted evidence that the directors had failed to address risk appropriately; there was no risk register and the board was too small to have committees with audit or risk responsibilities (para. [271]). The judge also accepted the evidence that the board was "too operationally focused ... [it] operated more as a management committee, and failed to properly address the governance issues and the systemic risks to the overall operation" (para. [272]).

The trial judge also rejected the argument - in what he regarded as the exceptional circumstances of the case (para. [285]) - that to hold the directors liable under section 135 would discourage individuals from becoming directors of major companies (para. [285]). To find that the directors had not breached section 135, he stated, would "undermine the purposes of s 135 ... [and] would also suggest that directors of companies within corporate groups do not need to consider the types of risks that would normally be very serious for a stand-alone company. That is simply not the case." (para. [286]).