Insolvent for nearly a decade from 2005 through to its collapse in 2013 leaving creditors owed some $110 million, Mainzeal was weakly capitalised relying on related-company promises of financial support; promises which were variously worthless or unenforceable. Changes of auditor, ‘window-dressing’ of Mainzeal financial statements and attempts to disguise the level of irrecoverable loans to companies controlled by entrepreneur Richard Yan came to light in liquidators claim for damages following reckless trading by Mainzeal directors.
Insufficient working capital meant it was problems with one single contract which finally pushed Mainzeal over the precipice, into receivership and then liquidation: a dispute over work jointly undertaken with Siemens on an upgrade of Transpower’s inter-island transmission link. Mainzeal extracted itself from the dispute in late 2012 at a cost of up to $16 million to its anticipated cashflow. Short of cash, Mainzeal shut up shop.
The High Court was told of Mainzeal being milked of cash by Yan-controlled Richina Pacific to fund projects in China. As early as 2005, $20.2 million had slipped out the back door. Two years later, $39.4 million had gone. In return, Mainzeal was promised repayment in vague terms; promises never formalised into legally binding agreements enforceable against Yan-controlled companies having any economic substance.
Richina Pacific provided formal ‘letters of support’ in 2008 to then auditors PwC, avoiding an audit ‘going concern’ qualification. As Justice Cooke pointed out, these audit-related letters of comfort promising future financial support are of no legal effect. They are not legally enforceable.
To mask the level of Mainzeal loans to Richina Pacific companies, short-term inter-company cash transfers totalling five to six million dollars were made around balance dates during 2010 and 2011. Mainzeal’s own board papers openly described these cash movements as ‘window dressing’.
PwC was replaced as auditor of Mainzeal by Ernst & Young. Purely on the grounds of cost, Mr Yan said. Ernst & Young put up a proposal to deal with the potential problem of Mainzeal loans to Richina Pacific group being uncollectable: Project Citron. Operating as a ‘pre-paid goods agreement’ Project Citron envisaged the then $42.4 million owed by Richina Pacific companies be used to purchase building materials in China for supply to Mainzeal. The debt due to Mainzeal would be ‘paid’ in kind. While this took loans totalling $33.1 million off Mainzeal’s books, it left the company exposed to a single supplier of building materials and the vagaries of a Chinese supply chain. ‘Payment in kind’ raised tricky issues of whether goods to be supplied equated to the value of loans written off. ‘Payment’ would take time with supply of $33 million in building materials spread over many years. Mainzeal liquidators argue the ‘pre-paid goods’ arrangement was of considerably less value than repayment of the loans.
Compounding Mainzeal’s difficulties was a mounting list of ‘leaky building’ claims from 2009 onwards. In Mainzeal financial statements, directors took into account the legal costs then incurred to date, ignoring any potential final liability: in 2009 only three million dollars was provisioned on notified ‘leaky building’ claims totalling $23 million.
Justice Cooke ruled Mainzeal directors were liable for reckless trading. Short of working capital, it was not reasonable for Mainzeal directors to rely on letters of support provided by Richina Pacific in connection with annual audits. The promised support was not enforeceable and in any event was given by Richina Pacific entities which did not have significant assets. Loans by Mainzeal were made to Richina Pacific entities which did not themselves have the ability to repay. Directors reliance on shareholder support was not reasonable in the circumstances, he said.
Damages for reckless trading are at the discretion of trial judges. Justice Cooke imposed joint liability, awarding Mainzeal damages totalling $36 million: Richard Yan liable for up to $36 million, chair of the board of directors Dame Jenny Shipley up to six million dollars and fellow directors Peter Gomm and Clive Tilby also each liable for up to six million dollars.
Mainzeal Property and Construction Ltd v. King Façade Ltd – High Court (26.02.19)
19.049