Mainzeal - Directors' LiabilityPosted on March 26, 2019 in Commercial (Tags: Building subcontractors, Mainzeal, construction, liquidators)
Building subcontractors will take little comfort from the most recent case litigated in the wake of the collapse of construction giant Mainzeal. When Mainzeal collapsed, owing at least $110m, at least $18m of that was for "retentions," partial payments owed to sub-contractors for work they had completed but which was still under warranty.
In determining a civil case taken by liquidators, Justice Cooke has ordered four of Mainzeal's directors to pay creditors $36 million because they let the company trade while it was insolvent.
Justice Cooke’s decision highlights rather than solves a number of issues paralysing the construction sector at present. The first is the obvious one of director liability, particularly in an industry where cashflow is challenged and health and safety risks are at the forefront of every prudent director’s mind. Justice Cooke’s decision demonstrates that relying on verbal assurances from group companies is not sufficient, and the directors need to go to greater lengths to ensure that inter-company loans are recoverable.
The decision has implications for company directors across all sectors, and is a reminder that while the taking of risks is an accepted part of a company’s existence, the directors still need to regularly evaluate those risks and consider the position of the company’s creditors, and not just the position of the company itself. Failure to do so may result in one of the few situations where the directors are personally liable for their actions when acting on behalf of the company.
One of the criticisms of the Mainzeal Board was that the governance procedures of the Board were poor, that they had no formal procedures for assessing risk (in fact no audit and risk committee) and they were too operationally focussed.
The decision will undoubtedly be appealed by one or more of the directors given some of the methodology employed by Cooke J in reaching his decision on liability of the directors involved, and the significant sums involved, but it is a timely reminder that directors are under significant obligations in a constantly changing trading environment, and need to be able to assess the company’s financial position and its ability to meet its obligations to creditors.
One of the more concerning aspects of the Mainzeal debacle is the implications for sub-contractors who had completed their work on projects but who were waiting for retentions funds, usually 10% of the contract value, to be paid out by Mainzeal. Justice Cooke was particularly critical of the Mainzeal directors for using the subcontractors funds as working capital, leaving them significantly out of pocket following the collapse.
Changes to the Construction Contracts Act were rushed through after the Mainzeal collapse and were supposed to create a trust structure to ring fence sub-contractors’ retentions, but the legislation was poorly drafted and lacks clarity and sanctions. The Construction Contracts Act amendments require principal contractors for building projects to hold "retentions" in trust but specifically states that retention monies do not need to be paid into a separate trust account; and may be commingled with other moneys. They are required to keep accounting records but there is no effective sanction if they don’t.
In the first decision following implementation of this regime, the receivers in the Ebert Construction receivership sought directions from the High Court in November 2018 as to how the Act applied to the funds held by the receivers. The decision demonstrated that only sub-contractors who had been paid their invoice amounts less retentions can claim on the fund, so if the retentions had not been made by the principal contractor, the subcontractor missed out. Perhaps more galling for the subcontractors is that the receivers were able to take their own fees from the “trust” funds before paying the subcontractors, which is hardly likely to be the intention of parliament is creating this ring-fenced structure, however poorly it was done.
While the civil prosecution of the Mainzeal directors may give some creditors some moral comfort, it also reminds us that there is further work to be done to provide a fair system of security for the large number of trade creditors who take credit risk every day in tendering for commercial construction work. In the meantime, those subcontractors must hold the principal contractors to account by asking for accounting evidence that their retentions are held in an appropriate account pending expiry of the warranty period.