NEW ZEALAND Law and Practice Contributed by: Graeme Quigley, Ashton Goatley and Erin Hickey, Webb Henderson
Section 136 – Obligations A director must not agree to the company incur - ring an obligation unless the director believes at the time, on reasonable grounds, that the com - pany will be able to perform the obligation when it is required to do so. Indications that this belief is reasonable may include: • the fact that the company is able to continue trading for a reasonable time following the incurring of the obligation; • the fact that bank finance is still available to the company; and • the fact that any downturn in the company’s performance was unexpected or sudden. Factors that count against the belief being rea - sonable include incurring long-term liabilities before the business of the company has been successfully established or incurring obliga - tions following the loss of an important revenue stream. In the Mainzeal case, the Court of Appeal held that: • Mainzeal had used funds owed to subcon - tractors as working capital in order to con - tinue to trade; • Mainzeal entered into large construction contracts without the company’s directors having reasonable grounds to believe it would be able to perform the contracts through to completion; and • the directors breached Section 136 in agree - ing to the company doing so. The Supreme Court agreed with the Court of Appeal’s approach and found that compensation for breaches of Section 136 should be assessed on “new debt” basis (ie, debt incurred once the directors did not have reasonable grounds to
continuing to trade and whether the assump - tions that underpin those forecasts are reason - able (Mason v Lewis [2006] 3 NZLR 225 at [51]); however, the benefit of hindsight should not be applied to directors’ decisions. If there is not a reasonable prospect of the company regaining solvency, formal insolvency mechanisms should be invoked (see Debut Homes) – it is not enough that the director’s decisions would reduce the overall deficit. Directors may not continue to trade in a way that favours one class of credi - tors over another. In the long-running Mainzeal litigation, the Supreme Court has upheld the finding of the Court of Appeal that four former directors of Mainzeal (a construction company) breached Section 135 (Yan v Mainzeal Property and Con - struction Limited (in liquidation)). In this case, money was extracted from Mainzeal to an over - seas parent company through intermediary com - panies that were insolvent. A director of both Mainzeal and its parent company made repre - sentations to his fellow directors that the par - ent company would financially support Mainzeal when it first became insolvent in a balance sheet sense. The representation was not legally bind - ing and the parent company did not provide the support when it was needed. The directors were found to have exposed creditors to substantial risk of serious loss by continuing to trade in reli - ance on the non-binding representations and without a substantial capital injection. However, the court did not award compensation in respect of the breach of Section 135, because the court held that the directors’ conduct during the rel - evant period did not increase the aggregate loss suffered by Mainzeal’s creditors – known as the “net deterioration” approach.
622 CHAMBERS.COM
Powered by FlippingBook