COMMENT:

The $36 million liability decision against four Mainzeal directors looks like a blockbuster but is it too light?

Why should the four directors, including former Prime Minister Dame Jenny Shipley, pay only $36m when Mainzeal's unsecured creditors are still owed $110m?

Why is Mainzeal director Richard Yan required to pay only $18m of the $36m when he played a major role in extracting funds from Mainzeal and appears to have benefited from the use of this money in China?

Advertisement

This story begins in December 2004 when NZX-listed Richina Pacific, with Shipley and Yan on the board, purchased 90 per cent of Shanghai Leather for US$20.6m.

Shanghai Leather is a former Chinese Government-owned company with extensive land use rights in Shanghai.

Mainzeal loaned Richina Pacific US$2.37m ($3.47m) to part fund the Shanghai Leather acquisition. Shipley was chairperson of Mainzeal, which was 100 per cent owned by Richina Pacific.

According to this week's High Court judgment, Richina Pacific borrowed a further US$5m from Mainzeal in November 2005 to buy a subsidiary of Shanghai Leather.

Richina Pacific, which remained listed on the NZX but had moved its registered office to Bermuda, continued to borrow from Mainzeal.

By the end of 2005 it had loans of $20.26m from the NZ construction group.

These loans were channelled from Mainzeal through MLG Ltd to Richina Pacific.

At the end of December 2008, NZ-registered MLG owed Mainzeal $28.6m even though MLG had no assets. Shipley and Yan were the only MLG directors.

Advertisement

Mainzeal had also made additional advances of $10.8m to Richina Pacific through other entities.

These advances from Mainzeal to Richina Pacific, which mostly ended up in China, were at the centre of this week's High Court judgment.

The relationship between Richina Pacific and Mainzeal was further complicated by the listed company's acrimonious shareholders' meeting on December 15, 2008 which approved the delisting of the company and a post-delisting restructure of the group.

Shipley spoke strongly in favour of the proposals and the motions were passed by a large majority, mainly because of the support of Yan and the US investors he attracted to Richina Pacific.

Under the new post-delisting structure, the ownership of Mainzeal moved from Richina Pacific to Richina (NZ) LP, with the latter being a less substantial entity than the former NZX-listed company.

PricewaterhouseCoopers, Richina Pacific's auditor, was concerned about the new structure and proposed a capital raising for Mainzeal. This capitalisation never took place.

The plaintiffs, primarily Mainzeal's liquidators financed by litigation funder LPF Group, made the following arguments:

• Mainzeal was insolvent because Richina Pacific had extracted considerable funds from the company for investment in China.
• There was no formal or legally binding agreement that would require this money to be returned from China.
• The Chinese Government had strict requirements regarding the remittance of money out of the country.
• Meanwhile, Mainzeal was effectively using subcontractor money to fund its business. This was because of its ability to receive construction payments well before it was required to pay subcontractors. The plaintiffs argued this was inappropriate, particularly as Mainzeal was vulnerable to significant operating losses.
The defendants argued:
• It was wrong to consider Mainzeal individually without assessing its position as part of the wider group.
• Richina Pacific had provided very substantial financial support to Mainzeal over the years and the directors acted reasonably in reliance upon that support.
• The defendants rejected the allegation that Mainzeal was insolvent and that they acted unreasonably by relying on Richina Pacific's support.
• They also argued that Mainzeal only failed because of a perfect storm of adverse factors.

Justice Cooke decided that four defendants — Shipley, Yan, Peter Gomm and Clive Tilby — acted in breach of their duties under section 135 of the Companies Act for the following reasons:
(a) Mainzeal was trading while balance sheet insolvent because the loans to Richina Group entities were not, in reality, recoverable.
(b) There was no assurance of group support on which the directors could reasonably rely if adverse circumstances arose.
(c) Mainzeal's financial trading performance was generally poor and prone to significant one-off losses, which meant it had to rely on a strong capital base or equivalent backing to avoid collapse.

Mainzeal's unsecured creditors, mainly subcontractors, construction contract claimants and uncovered employees, are still owed $110m yet the liability of the four directors is only $36m, mostly covered by insurance.

Justice Cooke decided to substantially discount the $110m starting point because additional factors contributed to Mainzeal's failure. He arrived at a total figure of $36m, being approximately one third of the total loss to creditors and comparable to the funds extracted by Richina Pacific from Mainzeal.

The anticipated financial outcomes are as follows:

• Mainzeal's unsecured creditors will receive approximately $25.2m, or 22.9 per cent of the $110m owed to them, after the litigation funder receives up to 30 per cent of the $36m in return for financing the proceedings.
• The four Mainzeal directors are covered by $20m of insurance, presumably $5m each, with the three non-executive directors — Shipley, Yan and Tilby — having an additional $1m each of coverage. Thus, Shipley and Tilby are expected to have their full $6m covered by insurance, Gomm will have $5m of his $6m covered while Yan is expected to have $6m of his $18m covered.

But what happened to the money that went from Mainzeal to China and who benefited from this?

At least some of it went to purchase Shanghai Leather, which the Richina Pacific 2004 annual report compared with the famous 1803 Louisiana Purchase.

This was a transaction whereby the US Government purchased a massive area of land west of the Mississippi River, more than eight times the size of New Zealand, for only US$11.25m from the French Government.

Shanghai Leather's land use rights were valued at US$30.8m in 2004 and there were several references to their current value in court.

Yan told the court: "I don't know where you got the US$700m but the last sale we made, compared with the cost, would be 145 times (148 times was used during the rest of the hearing)".

Justice Cooke wrote: "Mr Yan was most reluctant in cross-examination to place a present-day value on this holding (Shanghai land use rights), including because it is not truly tradeable. At one point, reference was made to the land being worth 148 times its acquisition price. It was suggested to Mr Yan in cross-examination that it would now be worth more than US$700m. He did not accept that, but did not indicate any alternative figure in response. It is plainly a very valuable holding."

Shanghai land price increases since 2004 indicate that the figure could be well north of US$1000m and in keeping with Yan's Louisiana Purchase analogy in Richina Pacific's 2004 annual report.

NZ shareholders who opposed the 2008 delisting, when Richina Pacific had a sharemarket value of only $36m, would love to know who has benefited from the massive uplift in Shanghai land prices.

This columnist, who still owns 1026 Richina Pacific shares, hasn't received an annual report or any detailed financial information from the company since 2008.

Yan is clearly one of the main beneficiaries of the massive uplift in Shanghai land prices as he told the High Court proceedings he owned about 25 per cent of Richina Pacific.

There is a strong argument that Shipley, Gomm and Tilby have got off lightly because $17m of their combined $18m liability will be covered by insurance.

Yan has also got off lightly because he was the main architect of the transfer of funds from Mainzeal to China and has been a major beneficiary through his 25 per cent Richina Pacific holding.

The big losers are Mainzeal's unsecured creditors who will receive only $25.2m of the $110m owed to them, a figure that would have been much higher if the country's regulators had initiated the High Court proceedings, instead of a litigation funder.

- Brian Gaynor is a director of Milford Asset Management.