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Mainzeal judgment brings lessons in corporate governance

Thursday 28th February 2019

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Company directors, insurance companies, liquidators and litigation funders will likely be running a fine tooth comb over Tuesday’s Mainzeal decision from the High Court - regardless of whether or not there’s an appeal.

In a decisive victory for the Mainzeal liquidators, Justice Francis Cooke ordered the directors of the failed construction company, including former prime minister Jenny Shipley, to pay $36 million to creditors.

While many think an appeal is likely, Institute of Directors chief executive Kirsten Patterson says there’s food for thought aplenty for directors in Justice Cooke’s clearly-argued judgment.

Particularly around corporate governance.

“The decision highlights the importance of directors focusing on the complex risks they may be facing and making sure they are spending adequate time in the boardroom mitigating that risk,” Patterson says.

“It highlights the complexity of some of these operational environments and the responsibility that comes with some of these governance roles.”

At the heart of the Mainzeal failure, Justice Cooke ruled, was that the directors allowed the company to trade for years while “balance sheet insolvent”.

Although Mainzeal chair Jenny Shipley and her fellow directors argued that millions of dollars of debt to Chinese parent company Richina Pacific was an asset on the books, it became increasingly unlikely that any money would be forthcoming from China.

So when expensive leaky buildings claims, a $22 million loss on the Vector Arena project, and a bitter battle with German industrial conglomerate Siemens produced significant losses, the company could no longer pay its bills.

The failure cost subcontractors $45.5 million; overall creditors lost $110 million.

The directors should have been aware the risk was high, Justice Cooke said. But corporate governance was poor.

“The directors had no formal procedures for addressing risk,” Justice Cooke says in his decision. There was no audit and risk committee, and the board was too small to have one. Neither was there any formal risk register.

“By itself, that would not matter if risks were otherwise appropriately addressed. But... they were not.”

Instead, operational matters dominated boardroom discussion - contracts won and lost, cashflow and profit forecasts.

“The more significant structural and governance risks were not given the same attention,” Cooke said. “The board operated more as a management committee.”

Henri Eliot is a corporate governance expert and chief executive of consultancy Board Dynamics. He says lack of industry knowledge, and commercial or financial inexperience can be a problem on some New Zealand boards.

“The judgment will definitely impact on directors being better informed and having the right skill set and experience,” Eliot says. “Corporate governance in NZ is maturing and the ‘wild west’ of the past will have to change. Otherwise, we will see more cases like this in the court system."

Directors can also expect to be in the firing line more often. The case brought by the Mainzeal liquidators was funded by LPF, a so-called ‘litigation funder’.

Litigation funding involves a third party stepping in to pay for a case which otherwise probably wouldn't go to trial because of the high cost. Overseas, it is often used to allow a bunch of smaller plaintiffs to take on a big organisation. The litigation funder takes a cut - often a substantial one - of any award.

The success of litigation funding in this case, and in another recent LPF case - the action by kiwifruit growers against the Ministry for Primary Industries over the kiwifruit disease PSI - is likely to see an increase in class action-type cases in New Zealand, Patterson says.

Particularly given the high-profile nature of this case involving the former prime minister.

“It’s an international trend that is starting to play out in New Zealand, though it’s not common at the moment,” Patterson says.

She says she wouldn’t want to see a litigation-happy environment develop in New Zealand, as it has done in the US. However, it’s important that directors are held to account when necessary.

“It’s important people have access to justice; this is part of a director’s responsibility.”

Meanwhile, directors will be looking carefully at their ‘directors and officers’ - D&O - liability insurance cover.

Patterson says the Institute of Directors/ASB’s 2018 Director Sentiment Survey found only 76 percent of directors have D&O insurance.

“We think that’s too low. It’s not only about ensuring cover for the individual directors, but it’s important for the market that creditors have that assurance.”

The growth of class actions and litigation funding, to a lesser extent in New Zealand but more importantly in Australia, has already seen D&O insurance premiums rise.

The four Mainzeal directors involved in the reckless trading case have $20 million in D&O insurance between them - just over half of what is required. It’s not clear, however, how that $20 million is allocated.

Out of the total compensation of $36 million, Shipley and two other directors - Peter Gomm and Clive Tilby - should pay up to $6 million each, Justice Cooke said. The rest, $18 million, must be made up by Richina founder and boss Richard Yan.

David Friar, a partner in the litigation department of law firm Bell Gully, says Cooke took a “novel approach” to establishing a figure for damages in the Mainzeal case.

Traditionally judges have looked at the deterioration in the company’s financial position between the date of the breach and the date of liquidation, Friar says. But in this case, Justice Cooke took as his starting point the total amount the creditors were owed - $110 million.

“Then he adjusted this figure on the basis of discretionary factors such as the duration of the breach and the directors’ culpability. It remains to be seen if this novel approach will be accepted by the higher courts if this case goes to appeal.”

Friar says he won’t be surprised if there is an appeal - either in relation to the damages award, or the main reckless trading finding.

Directors have 20 working days to appeal.

(BusinessDesk)

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