Failed construction company Mainzeal was bought by reluctant investors, ruled by a “democratic dictatorship” from China, ripped off by its parent company, and traded while insolvent for at least four years.
Directors lent millions of dollars to related parties without any clear idea of what money was going out and what it was being used for. They relied on legally unenforceable “letters of comfort” to get the annual accounts through the auditors. And when they asked questions about who was responsible for the liabilities being incurred, they were fobbed off with misleading information.
When the company finally collapsed, creditors were owed $110 million. Nearly half of the money is owed to trade contractors who did construction work and weren’t paid for it. These creditors will be lucky to get a quarter of the money they are owed.
The Mainzeal court judgment, written by a newish judge, Justice Francis Cooke, and released late last month, reads a bit like a Dickens novel. Cliff hangers, red flags, frightened protagonists, bullying bosses, people coming in at the last minute to try to save the day.
But unlike a classic Dickens ending, the injuring parties won’t necessarily get their comeuppance. There’s a good chance at least two of the four directors who helped get the company into its dire situation will get off scot-free financially – after insurance payouts.
That will include chair and former Prime Minister Dame Jenny Shipley.
Nikki Mandow looks at the Mainzeal story, as told in Justice Cooke’s judgment.
To begin at the beginning.
Chapter one. 1995.
An investment consortium with a focus on investments in China acquires a majority shareholding in Mainzeal. The investors are led by a Chinese-born Kiwiphile Richard Yan, who first came to New Zealand in 1981 on a Rotary scholarship.
At that time Yan spent time staying with the family of Peter Menzies, one of the founders of Mainzeal and worked for Mainzeal during his school holidays, including sweeping the floor at the St James Theatre.
But Yan knew the big opportunities were in China. He had met some potential private equity investors during a stint at Harvard Business School and set up REH Capital in 1993 to buy assets in China, including some interests in leather-making.
Yan had a big personal holding in REH Capital and effective control of the day-to-day running of its investments. He called it a “democratic dictatorship”.
Why exactly Yan decided to buy Mainzeal isn’t completely clear. True, he wanted leather technologies for his Chinese operations and Mainzeal owned leather-maker Mair Astley. But buying a New Zealand construction company could be seen as an extreme way to get hold of a bit of tanning equipment.
Certainly other REH investors weren’t keen.
“Many shareholders in the consortium didn’t like the idea from the beginning,” Yan said in court. “But they trusted me in making the best deal for them.” Naysayers included Sir Paul Collins, better known for his role in another fallen Kiwi company, Brierley Investments.
Almost two decades after speaking out against the purchase of Mainzeal, Collins would be brought onto the board as an attempt to save the company. He would be horrified by what he found, and unsuccessful in his mission.
Chapter two. Good years.
As in any good movie, things go well for a while. Mainzeal makes money – there is even some evidence of a dividend paid in 1999 by the Kiwi company to its Chinese parent, by then called Richina Pacific. Richina helped Mainzeal out when it needed some money to complete the Mobil on the Park building in Wellington, now Dimensions Data Tower. Richard Yan boasted to investors in the 2003 annual report that owning a New Zealand construction company was a good idea because it didn’t require much equity capital. As Justice Cooke put it in the judgment: “The significant cash flows involved in the construction industry operated as a kind of working capital.”
In retrospect, this view of the building trade could be seen as the first red flag. When Mainzeal becomes technically insolvent (its assets are worth less than its liabilities), the company uses the money paid upfront by construction clients, but not yet handed over to subcontractors, as working capital. It’s a dangerous modus operandi.
Chapter three. Dame Jenny Shipley
In April 2004, Mainzeal gets a new independent board. Jenny Shipley is invited to chair Mainzeal and join the Richina Pacific board. Clive Tilby, another director found liable in the Mainzeal court action, joins the Mainzeal board.
Shipley had been New Zealand’s Prime Minister from December 1997, when she ousted Jim Bolger in a coup, to December 1999, when she lost to Helen Clark in the election. Having a former PM on the board gave Yan high kudos when it came to dealing with China.
But it wasn’t a one-way street. As well as earning her directorship fees, the Mainzeal and Richina contacts were a part of Shipley getting a reputation as something of a China hand. Over the next 15 years she was appointed to the boards of the huge China Construction Bank, the Beijing-based International Finance Forum, the prestigious BOAO Forum for Asia, the NZ China Council, and Kiwi food export company Oravida.
Shipley also invests US$50,000 in Richina. According to numbers quoted by Richard Yan during the court case, Shipley’s investment in the Chinese company could now potentially be worth US$14 million ($22 million), on paper at least.
In July 2011, by then Dame Jenny decides to resign as Mainzeal chair, but is persuaded into staying by Richard Yan. It’s a decision she may have regretted since.
Chapter four: Debt
In most tragic stories involving debt, it’s the little guys who get into trouble because they borrow money from the big guys – loan sharks or others – and then can’t pay the money back. With Mainzeal, the situation was reversed. Mainzeal lent money to its bigger, richer parent. But from there the outcome was as dire as in the best Dickensian novel.
Richina didn’t (couldn’t? wouldn’t?) pay back the money. Instead the debt sat on Mainzeal’s balance sheet looking like a juicy asset and molifying the auditors. But actually, without that cash Mainzeal sunk deeper and deeper into balance sheet insolvency, and eventually collapsed altogether.
The first loan came in 2004 – the same year Jenny Shipley became chair of Mainzeal. The New Zealand company lent its parent US$2.37 million to help buy the Shanghai Leather Company, a former government-owned company. What was genius about the purchase was not the decision to buy a rundown Chinese leather factory. It was that SLC also had extensive land-use rights in Shanghai. And as Shanghai’s population and business exploded, so did land values.
It might be too simplistic to suggest, as lawyers did in the court case, that with land values being worth 148 times the purchase price, the Shanghai Leather Company assets could now be worth more that US$700 million. For a start, the assets are not truly tradeable. However, as Justice Cooke said, noting that Yan was reluctant to come up with an alternative figure: “It is plainly a very valuable holding.”
“The reality was that before that time there had not been a clear record of the funds flows in and out of Mainzeal under the control of Richina Pacific.”
Over the next few years, Mainzeal lent its parent more and more money. A few million here, a few there. And the interest payments due stacked up. Even as Mainzeal’s fortunes declined, Richina still used its subsidiary as a cash cow. By the end of 2007, Richina Pacific entities owed Mainzeal $39.4 million.
What was extraordinary was none of the Mainzeal directors appeared particularly worried about how much money was going out, or what it was being used for. They never sought independent legal advice about the loans. And in fact, for a while after the first purchase, no one seemed to pay much attention to how much Mainzeal was lending Richina.
It wasn’t until August 2010 that Dame Jenny was able to tell other board members that they now knew what funds were going out. This meant they knew what they could expect to get back “when required”, Dame Jenny told them.
As Justice Cooke said in his judgment: “The reality was that before that time there had not been a clear record of the funds flows in and out of Mainzeal under the control of Richina Pacific.”
What Shipley and the other directors (excluding Richard Yan, presumably) didn’t appear to notice at the time, was that the loans were carefully structured through two loss-making subsidiary companies, not through Richina itself. This meant when push came to shove and Mainzeal was desperate, its wealthy parent could wash its hands of the debt – not its problem, legally speaking.
“It is significant that whilst the funds were being used by Richina Pacific itself to obtain significant assets in China, [sister company] MLG was being used as the borrowing party,” Justice Cooke said in the judgment about the first lot of borrowings. “Whilst it was suggested by the defendants that this arose because MLG was used as a funds transfer vehicle, and may have been inserted for tax reasons, using MLG meant that Richina Pacific itself had no legal liability to repay.”
And MLG and RGREL, the other company Richina used to borrow money from Mainzeal, didn’t have any money.
“Although RGREL was of greater financial substance than MLG, neither were in a position themselves to repay the Mainzeal loans.”
Chapter five: Letters of (no) comfort
New Zealand law is pretty clear. Under section 135 of the Companies Act 1993, directors have a statutory duty “not to cause, allow, or agree to the business of the company being carried on in a manner likely to cause a substantial risk of serious loss to the company’s creditors”.
Trading while insolvent doesn’t of itself breach the act – some companies choose to trade on through a short sticky patch, believing that once business conditions improve, the creditors will get their money.
That wasn’t how it went with Mainzeal. Evidence presented in court suggested the construction company was technically insolvent for a good deal of the eight years after it started lending money to Richina. And from 2008 it was loss making; double-digit loss-making in 2011 and 2012.
The situation was dire. So how did it keep trading? How did it persuade the auditors to sign off the annual accounts?
The answer was “letters of comfort” from parent company Richina. These letters, and verbal expressions of support, kept coming.
We can pay. We will pay.
“We knew that [Richina Pacific] had the ability to support Mainzeal, including by repaying those debts if required,” Dame Jenny told the court, talking about the situation in 2010.
And Richard Yan kept telling the board everything was fine.
“Mainzeal has always operated and continues to operate under a shareholder/parent guaranty,” he wrote to Clive Tilby in July 2010, after Richina had asked for yet another loan from the then loss-making Mainzeal – this time for $1.2 million “to be paid tomorrow”.
“Under the guaranty, the group has always been willing and so far able and will only be more able going forward to guaranty all its obligations.”
Judges don’t use words like “bollocks”, at least not in judgments. But if they did, Justice Cooke might have used the word in his opinion on Yan’s reassuring email. Instead he suggests that “a number of aspects… were misleading”.
“It was incorrect to say that there was a guarantee which meant that ‘the shareholders [ie Richina]’ were ‘on the hook for everything’,” Justice Cooke says.
“Not only was this not true, but matters were structured in a way that meant there was no such legal responsibility.”
It wasn’t just that Richina didn’t have to pay; complex foreign exchange rules in China meant even if they had wanted to, the company was highly unlikely to be able to send money out of China.
In particular, Chinese authorities weren’t keen on their companies wasting valuable foreign exchange on loss-making overseas subsidiaries. As former MFAT official and China expert Charles Finny said in the court hearing:
“There was every chance that approvals for repatriation of these funds might not be forthcoming. If I were commenting on the company’s risk register, I would see this issue as being one of the highest risks.”
A director is required to look beyond the numbers to consider their reliability and test the risks.
Of course, Mainzeal didn’t have a risk register, or an audit and risk committee, or even a board big enough to have one. In fact, as Justice Cooke said in his judgment “the directors had no formal procedures for addressing risk”.
The fact that the company’s auditors had enough faith in the Chinese guarantees to sign off on each year’s accounts didn’t diminish the directors’ responsibility, veteran company director Sandy Maier said in his evidence in court.
“The role of a director is not simply to rely on the auditors’ figures without questions or separate assessment. A director is required to look beyond the numbers to consider their reliability and test the risks.
“I would have expected to see the collectability of the MLG loans identified as a key risk … In fact, I would have expected to see concerted efforts to secure repayment.”
Chapter six: Powerlessness
When Oliver Twist stands in front of workhouse staff and asks for more gruel, he is powerless. But when a former Prime Minister and experienced business figures like Mainzeal directors Peter Gomm and Clive Tilby attempt to get control and information about their business, they shouldn’t be powerless.
Yet they appeared to be.
Again and again, they ask for guidance from Richard Yan and Richina Pacific chair John Walker about their roles and responsibilities in terms of ensuring Mainzeal is trading within the law.
Take just one year, 2010.
“Mainzeal directors wish to clarify whose overall duty it is to make sure the NZ division is operating while solvent going forward and who are the directors who carry this obligation?” Dame Jenny wrote in February 2010. When she didn’t get a reply she wrote again.
These issues were very important “and do need our attention, as I am personally not comfortable with things as they are”.
Again, no reply.
In August Dame Jenny “has very real concerns”, and Tilby also writes to Yan: “We appear to be at an overly flexible situation right now and I am somewhat uncomfortable as an independent director.”
In October, Mainzeal CFO Reegan Pearce also writes to Walker about the problems with governance and transparency at the company. When he hears nothing he writes again in November.
Pearce remains “deeply concerned about the activities that are happening down here”, and that in connection with cash flows “as CFO, this is alarm bell material for me” and “I know this is blunt but I find the whole thing deeply frightening”.
Walker reassures Pearce there will be full and frank discussion.
And then … nothing happens.
Chapter seven: Mainzeal really gets into trouble
If the directors thought they had problems in 2010, they just needed to wait until 2012 for the shit to really hit the fan. In the past, worries had centred around balance sheet or paper insolvency. But in 2012 the company got into real trouble with its cash flow. Leaky building claims from several sites, including the Botany Town Centre and Wellington’s Bay Point block went to court. And Mainzeal got into dispute with German industrial conglomerate Siemens over a big Transpower electricity network upgrade contract. Siemens refused to make payments. A series of adjudications under the Construction Contracts Act mostly went against Mainzeal. There were millions of dollars involved, and Mainzeal’s bank, BNZ started to get twitchy.
As newly-appointed director Sir Paul Collins commented in an email in July, Mainzeal’s cash flow was in a “precarious position to say the least”.
Chapter eight: Richina has a plan
Over the years, Richina’s ideas to sort Mainzeal’s problems read like something from the Cultural Revolution or a sci-fi novel.
The first, “Project Citron” in 2011, was a plan for Richina to repay its debt to its subsidiary, not in much-needed cash, but in building materials. Richina bought Chinese construction materials, particularly cladding, and shipped them to New Zealand through a related company called King Façade.
The scheme seemed a good way to get around Chinese forex regulations and the companies optimistically reckoned the whole $33 million debt could be eliminated by 2014.
It didn’t work. The pre-paid goods arrangement didn’t solve Mainzeal’s immediate insolvency problems, the goods received were worth far less than the debt owed, and Mainzeal ended up tied to a single supplier. Ernst & Young had warned Mainzeal of the risks inherent in a Chinese supply chain and Justice Cooke said EY was proved right.
“These risks came to fruition as the supply of building materials from King Façade became a very significant problem, causing significant losses to Mainzeal.”
Next up was “Project Shutter”, an idea to save the company by building up New Zealand entities outside Mainzeal to provide a stronger capital base. They argued this meant Mainzeal wouldn’t be so much of a target for leaky building claims, because its assets would be shifted into these new entities. The assets would also have been outside the reach of creditors.
Within a few months, Project Shutter morphed into a similar restructuring plan, Project Blue Sky. Two multi-million dollar properties were identified for sale, and there was discussion about creating a new entity called Mainzeal Group Ltd.
But it was too late.
Chapter nine: The cliff
In July 2012, three months after Sir Paul Collins joined the Mainzeal board, he wrote an email to Richard Yan, which pretty much sums up the position of Mainzeal at the time. I’ve seen a heap of trouble in my years in business, including with Brierley Investments, Sir Paul says. But I ain’t seen nothing like this.
“I have dealt with a lot of bad news stories over the years and have found that matters can be worked through when you have all the cards on the table. I don’t have that confidence here.”
Mainzeal director Sir Paul Collins
“I am at my wits end. I joined the board under the impression Mainzeal was solvent. I accept Siemens came from left field but equally I accepted all your representations re support… As you will well appreciate I have dealt with a lot of bad news stories over the years and have found that matters can be worked through when you have all the cards on the table. I don’t have that confidence here.”
Mainzeal needed $10 million of additional equity and it needed it now, Sir Paul said.
By early December, subcontractors were complaining Mainzeal wasn’t paying its bills. Sir Paul was saying that if the company lost the support of the BNZ it would be insolvent, and the board finally decided to seek independent legal advice about its duties and responsibilities.
The advice was that “trading out” would normally require more equity and full information.
Nothing new there.
There was a bit of good news. Some money – $86.5 million – came in from Siemens, easing the immediate cash flow issues. But it was a settlement where Mainzeal had “a gun to its head”, Walker said, and the company was still under extreme financial pressure.
By Christmas, the normally optimistic Richard Yan was worried. Yan tried to get his wife out of a personal guarantee with the BNZ, then wrote an email to the directors seeking an urgent board meeting and suggesting Mainzeal was no longer a going concern. He said a resolution should be drafted inviting BNZ to appoint receivers.
Although the other directors said they were surprised at this turn of events and that Yan was being too pessimistic, the die was cast.
BNZ heard about the email and suspended any further advances.
In February 2013, Mainzeal went into receivership, owing $110 million.
Chapter 10: The denouement
After the collapse, Dame Jenny wrote to Walker and Yan hoping they would cough up money to meet obligations to creditors. She asked that “the undertakings that Richina has given on many occasions in audit letter signings to EY and other directors that the receivables outstanding to [Mainzeal] and in particular the money owed to staff and subcontractors will be honoured”.
Unsurprisingly they were not.
The years since then have seen a complex and drawn out court case, and a judgment. But is this likely to be the end of the story?