Thorts – Kenyan insolvency regime has two sides that companies must consider

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Thorts – Kenyan insolvency regime has two sides that companies must consider

Published Date: 2019-02-08 | Source: DealMakers | Author: Vruti Shah | Comments

Thorts – Kenyan insolvency regime has two sides that companies must consider

In the past six years, a number of large Kenyan companies have found themselves in financial distress. In most cases, one key reason for financial difficulties faced by these companies can be traced back to the decisions to fund their growth through foreign currency debt financing during the period between 2007 and 2012, when the economy was booming.

While the decision to fund growth through foreign currency debt financing made sense at that time, the currency fluctuations in the following years resulted in the debt becoming very expensive for these companies to service. This, among other macroeconomic reasons, such as interest rates, exchange rates, competition, corruption and a general decline in the economy, had long-term effects for companies that had invested in their growth plans, which did not pan out as expected.

Currently, Kenyan companies in financial difficulty have more options than ever before in getting back on their feet or restructuring their debt, but with these options come rules and responsibilities, particularly for directors. This is certainly the case with Kenya's new insolvency framework: although it offers companies in trouble some much-needed breathing space, this goes hand in hand with clear implications for directors' liability.

The impact of the borrowing trend is still being felt in Kenya, where one of the most recent casualties of so-called "binge expansion" is Nakumatt, East Africa's biggest supermarket chain, which owes a multiplicity of creditors.

Two years ago, ailing companies, like Nakumatt, would have had only limited options to deal with their financial crises - to enter into a scheme of arrangement with creditors under the Companies Act or to proceed to liquidation due to their inability to pay their debts as they fell due.

Kenya's new insolvency regime, under the banner of the Insolvency Act 2015 (Act), is a welcome development then, for financially distressed businesses. The Act, which came into effect in 2016, is a consolidation of laws relating to insolvency and provides for new and more detailed procedures and mechanisms relating to insolvency.

Up until 2015, a company in financial distress was often met with the liquidation culture (ignited voluntarily, or by a creditor or subject to the courts' supervision). A company that was unable to pay its debts, but did not want to ascribe to the liquidation culture, also had the option of either compromising with its creditors and/or undergoing a reconstruction through amalgamation or merger with another company, with a transfer of liabilities.

The Act provides for alternatives to bankruptcy and winding-up that can facilitate the management of a company's affairs for the benefit of employees, shareholders and creditors. This includes the introduction of rights to conduct restructurings and bankruptcy work-outs under an administration process.

One of the biggest changes ushered in under the Act is the introduction of a statutory moratorium when a company is placed under administration. This was not previously available in Kenya and gives a troubled company a 12-month breathing space to continue as a going concern while undergoing reorganisation or realising its assets.

There are three key insolvency procedures that entities incorporated in Kenya can turn to under the Act:

• Administration is used to rescue a company in financial difficulties and allow it to continue as a going concern. It is intended to enable an eligible company to undergo reorganisation or to realise its assets under the protection of a statutory moratorium. The moratorium prevents winding up petitions from being made or resolutions from being passed. Security over the company's assets may not be enforced without the court's permission. While this means that a bank with a debenture cannot crystallise a floating charge or enforce its security where the customer is in administration, the administrator can only dispose of assets with the security holder's consent, or with permission from the court. The courts in Kenya have, in recent times, made rulings on the required standard that an eligible company must show to prove that an administration order is reasonably likely to achieve the objective of administration.

• Company Voluntary Arrangement (CVA) is a process used to provide for a restructuring plan which, if it obtains sufficient creditor support, can be imposed on dissenting creditors. A CVA has great flexibility with respect to the company's proposed restructuring or scheme as there are minimum restrictions relating to it in law. The one key limitation provided in law is that no proposal may alter the rights of secured or preferential creditors without their individual consent. Creditors cannot commence a CVA.

• Liquidation results in forcing the company to cease trading and involves a liquidator collecting its assets and distributing the resulting realisations to its creditors so as to satisfy, as far as possible, its liabilities. A company can be wound up through a voluntary liquidation process or a compulsory liquidation process (which is started by a court order).

Insolvency comes with rules and responsibilities

The Act is now fully operational and we have seen a number of companies in Kenya using the insolvency procedures available under the Act.

That said, companies should be aware of the rules and responsibilities that go with making use of these procedures. For example, if a company continues to trade when it is insolvent, the legal duty of the directors changes. They are required to act in the best interests of the creditors rather than those of the company and its shareholders, as they would during the ordinary course of business.

Directors who are worried that the company is facing or is likely to face financial difficulties should keep matters continually under review, monitor the financial position and future cash flow, and seek to reduce expenditure.

If it becomes clear that action is needed to rescue a company, its directors would be well advised to take professional advice on whether insolvency procedures are inevitable and, if so, which option would be the most appropriate procedure in the circumstances.

Shah is a Partner in Bowmans' Kenya office.

This article first appeared in DealMakers, SA's quarterly M&A publication


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