Businesses are winding up in the wake of complex liquidation laws in Kenya, with data from the Business Registration Service (BRS) indicating that 2,030 firms were removed from Companies Registrar in the FY 2022/23. Besides, 2021/2022 saw 2,189 companies close down, mainly because of financial distress beyond recovery, economic unpredictability, and Covid-19 pandemic.
Kenya’s business landscape has also witnessed its fair share of challenges, particularly in the realm of liquidation orders. One recent event captured significant attention – public service vehicles insurer, Invesco Assurance, endured a tumultuous seven-day period when the Insurance Regulatory Authority issued a liquidation notice, only to withdraw it later on. This paints a bleak picture of the intricacies and complexities surrounding liquidation orders in the country.
The Insolvency Act came into effect in 2015 to save businesses, investors, and jobs. Since then, not a single business placed under administration has come back to life. According to the managing partner of commercial law firm Cliffe Dekker Hofmeyr Kenya (CDH) Sammy Ndolo, reforming the Insolvency Act is a critical step to better align it with the goal of rescuing financially distressed businesses in Kenya. He shares his insights with the Nairobi Business Monthly on the realities of liquation/insolvency laws in Kenya.
As an expert, in the wake of widespread liquidation of businesses and dwindling number of investors, is it time to rethink liquidation laws in Kenya?
The current Insolvency Act draws heavily from the UK Insolvency Act, designed for a more developed market, and may not fully address the unique nuances of Kenya’s economic landscape, such as the protracted length of judicial processes.
Over time, there have been several amendments to the Act, aimed at providing more avenues for financially distressed businesses to restructure their operations. For instance, in 2021, the Act was modified to grant financially troubled companies temporary protection from creditors as they explore business rescue options, through the use of a pre-insolvency moratorium. The pre-insolvency moratorium prevents an application being made for the liquidation of the company or the appointment of an administrator or administrative receiver. The moratorium also restricts repayment of debt or other liability as well as disposal of property.
Why do you think businesses are shutting down? Are there still other avenues of saving businesses that are closing down besides the Insolvency Act which has since been in place for decades, with no success? For context, the number of companies that have faced liquidation has been on the rise, even long before the pandemic and geopolitical tensions hit, in your opinion what is the cause behind the rising cases?
The global economic climate has presented significant challenges to business generally, and these factors have had an impact on the Kenyan economy. The influence of escalating interest rates and other prevailing macroeconomic factors on business and investment operations has been substantial and cannot be understated. Foreign currency scarcities and fluctuations in exchange rates consistently present a formidable challenge for debt and equity investments and this predicament is exacerbated by recent tax hikes as the government aims to secure additional income.
In addition, most businesses do not take prompt action to use the mechanisms set out under the Insolvency Act to mitigate the risks of liquidation early enough. This laxity is a key contributor as to why liquidation is the most common insolvency procedure in use in our market.
What’s your reaction to investors’ assertion that the current regime is killing businesses with over taxation? What should businesses and investors, especially those in the SME sector do differently to keep up?
The concern about over-taxation is a valid one, especially for Small and Medium Enterprises (SMEs) in Kenya. High taxes can indeed be a burden on businesses, making it challenging for them to operate effectively in the current economic environment. The current fiscal environment is unlikely to change given the need for the government to increase tax revenue to meet its financial requirements. However, there are proposals that may offer reprieve for SMEs. For instance, the draft Medium-Term Revenue Strategy published the National Treasury in September 2023 indicates that the government is considering reducing the corporate rate of income tax from the current 30% to 25%.
2,030 firms were struck from the registrar of companies according to Business Registration Service. Has some of your clients been affected by the current economic unpredictability to an extent of shutting down?
The current economic unpredictability has indeed posed challenges in the Kenyan market, and it has been a difficult environment for many companies to operate in.
Are there any policy reforms you would recommend? What is the way forward in your view?
The Insolvency Act would evolve to allow for faster resolution and implementation of insolvency mechanism so as to ensure the effectiveness of restructuring proposals by distressed companies.
Notably, there is a Bill presently under consideration by the Senate that seeks to expedite the insolvency resolution process for corporate entities by introducing a fast track administration procedure. This fast-track process aims to help these businesses swiftly address their financial challenges, settle outstanding debts to creditors, and prevent further losses. The process enables entities to maximize the value of their distressed assets through prompt sales or reorganization, ultimately benefiting both creditors and shareholders by optimizing the returns on their investments. Furthermore, the fast-track procedure is cost-effective due to the imposition of statutory time limits for resolutions, making it an affordable option for SMEs.
How long does it take to liquidate a struggling company? What’s the process like? As witnessed in the case of Nakumatt, insolvency in Kenya is a protracted process, how long should insolvency proceedings normally take? What does the process entail?
There are two types of liquidation outlined in the Insolvency Act: voluntary liquidation and liquidation by the High Court.
In voluntary liquidation, a company can be liquidated if it passes a resolution for voluntary liquidation in a general meeting or if the company’s articles specify conditions for liquidation. Before this resolution is passed, notice must be given to holders of qualifying floating charges, and within 14 days of passing of the resolution, a notice setting out the resolution must be published in the Kenya Gazette, newspapers, and on the company’s website is required.
Voluntary liquidation can be further divided into members’ voluntary liquidation and creditors’ voluntary liquidation. In members’ voluntary liquidation, authorized insolvency practitioners are appointed as liquidators by the members, whereas, in a creditors’ voluntary liquidation, the liquidator is appointed by the creditors.
The timeline for a voluntary liquidation can take between 3 months and 1 year as the process is influenced by various factors such as the size of the company, the number of creditors, and the complexity of the company’s financial affairs.
Liquidation by the High Court can occur under various circumstances outlined in the Insolvency Act, such as inability to pay debts, public interest, or a special resolution by the company. Any person, including the company, creditors, or the Attorney General, can initiate liquidation by the High Court. The High Court has the authority to appoint a provisional liquidator if necessary and rectify the company’s membership register. The Court may also delegate certain powers to the liquidator.
The Official Receiver plays a significant role in Court-ordered liquidation, acting as the liquidator until another person is appointed. Creditors and contributories have the opportunity to choose the liquidator, and the Court can confirm the choice. The liquidator must realize the company’s assets and distribute them to creditors or beneficiaries. Various powers of the High Court are available, including issuing arrest warrants for absconding contributories.
The timeline for liquidation by the High Court would be influenced by the court calendar and given the backlog of cases in Kenyan courts, it is often difficult to predict how long the process would take.
In your view, do you think liquidation law is ineffective going by the big number of businesses which are closing down? Which challenges has the liquidation law posed on businesses? How should companies align to it?
Despite the increase in corporate insolvencies in Kenya, the Insolvency Act is still an effective law that adopts a pro-rescue culture and creates a possibility for a fresh start for businesses in Kenya. The Insolvency Act provides for various restructuring options such as company voluntary arrangements, through which the directors of a company can make a proposal to the company with its creditors for the satisfaction of their claims otherwise than by payment in full.
In addition, the effectiveness of the Insolvency Act would be greatly improved by the early adoption of insolvency tools by distressed companies. Inactivity by distressed companies and the social stigma associated by adopting insolvency procedures results in the limited use of insolvency procedures and leaves liquidation of the companies as the only result.
Since the Insolvency Act came into effect the number of Kenyan companies facing liquidation has greatly increased, with many companies such as Nakumatt and ARM Cement having faced long processes. Even though since then, the government has made amendments to the Act, what challenges still remain when it comes to insolvency proceedings?
Insolvency proceedings are greatly impacted by the backlog in our judicial system. The Insolvency Act envisions administration as a process that should take between 12 and 18 months, however, constrains in the number of judges available to determine insolvency proceedings and the ease at which parties can obtain injunctions to halt such proceedings have watered down the effectiveness of the Insolvency Act and limited the window in which financially distressed companies can implement restructuring plans, leaving liquidation as the only option left to such companies.
In addition, the fact that judges and lawyers often do not have the necessary expertise and knowledge about the Insolvency Act poses a significant challenge. This can result in long delays and inconsistent legal decisions, which can be tough for debt-ridden businesses and might cause them to fail.
Furthermore, liquidation processes are affected by limited prospects for recovery in the Kenyan market, primarily due to the absence of a robust market capable of absorbing distressed assets. This deficiency hampers the efficient disposal of assets and the realization of their full value, making it harder for creditors to recoup their dues. As a result, the slow and often cumbersome insolvency proceedings continue to pose a considerable challenge, necessitating further reforms and interventions to streamline the process and enhance recovery prospects for all stakeholders involved.
Currently a number of companies in Kenya are in financial distress, what conditions are necessary to determine one as insolvent? Is there any obligation to initiate restructuring or insolvency proceedings in Kenya?
The Insolvency Act sets out various tests to determine if a company is unable to pay its debts. The predominant tests are the balance sheet test and the cash flow test.
Under the balance sheet test, a company would be considered unable to pay its debts if the value of the company’s assets is less than the amount of its liabilities (including its contingent and prospective liabilities). Under cash flow test, on the other hand, a company would be considered unable to pay its debts if it that the company is unable to pay its debts as they fall due.
A company would also be considered unable to pay its debts if:
A creditor (by assignment or otherwise) to whom the company is indebted for Sh100,000 or more has served on the company, a written demand requiring the company to pay the debt and the company has for 21 days afterwards failed to pay the debt or to secure or compound for it to the reasonable satisfaction of the creditor; or
if execution or other process issued on a judgment, decree or order of any court in favour of a creditor of the company is returned unsatisfied in whole or in part.
There is no mandatory obligation for a company to initiate restructuring or insolvency proceedings in the event that the company meets any of the tests set out in the Insolvency Act.
In the case of a violation (when insolvency proceedings are not commenced), what consequences can the director and the company, as whole, face? Have there been any such circumstances within Kenya and how were they handled in accordance with the Act?
The directors of a company have a duty to promote the success of the company for the benefit of the members of the company and act in good faith. In the event of insolvency, this obligation changes to a duty to act in the best interests of the company’s creditors. Consequently, directors need to be cautious in actively safeguarding the company’s assets and minimizing any potential harm to creditors to the greatest extent possible.
Directors should also be aware that if the company goes into insolvency, they may be held liable for a variety of offenses. These offences include:
Fraudulent trading:
This arises when a director is knowingly a party to carrying on the business of a company with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose.
Such an intent may be inferred if a director allows a company to incur credit at a time when the business is being carried on in such circumstances that it is clear the company will never be able to satisfy its creditors.
If the court finds that there was fraudulent trading, a director can be personally liable and be required to contribute to the company’s assets. The director may also be liable on conviction to a fine or imprisonment or both.
Wrongful trading:
Once a director or directors of a company conclude (or ought to have concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation or insolvent administration, they have a duty to take every step which a reasonably diligent person would take to minimize potential loss to the company’s creditors.
The court can order a director to make such contribution to the company’s assets as it thinks proper if after the company has gone into insolvent administration or liquidation it is determined that the director has failed to comply with this duty.
