ANJARWALLA & SEJPAL: Making insolvency laws in Kenya more

In Summary

The economic downturn resulting from the Covid-19 pandemic has caused unprecedented challenges to businesses and brought into sharp focus the difficulties businesses are facing. It is no longer ‘business as usual’.

To cushion their economies from the effects of the pandemic, countries around the world, Kenya included, are taking measures aimed at resuscitating businesses. These have included tax cuts, changes in law and key stakeholder support such as banks to ensure loan markets stabilisation. The extent of the issue is reflected in the massive bailouts that many governments in the West have offered their citizens and businesses to maintain some sort of equilibrium in the economic turmoil.

Nevertheless, a lot of businesses are struggling and face the risk of insolvency, with corporate insolvencies in Kenya expected to accelerate as a consequence in 2020 and the coming years.

DIRECTORS’ PERSONAL LIABILITY

So how does this affect the duties and responsibilities of directors of such companies?

Ordinarily, directors have a legal duty to act in the best interests of their company.

However, when the company is facing a solvency crisis, this duty changes. In the event of financial difficulties the Kenyan Insolvency Act imposes penalties on directors if they do not consider the position of the company’s creditors.

To allow a company to continue trading whilst directors know or ought to know that there is no reasonable prospect for the company to pay its debts can lead to personal liability for those directors under the concept of “wrongful trading”. If the company were to go into liquidation or administration, the insolvency practitioner (or indeed any creditor) can seek an order from the court to make the directors personally responsible to pay them.

Unlike the related concept of “fraudulent trading” which sets a higher bar for the complainant to prove fraudulent intent on the part of directors in continuing to trade, wrongful trading is easier to prove. The complainant would only need to show that a director actually knew or ought to have known that the debts being incurred will not be paid when they fall due.

We therefore propose that the provisions in the Insolvency Act dealing with wrongful trading are suspended for the duration of the pandemic. Directors may not be able to fully assess their companies in this crisis to determine the possibility of avoiding liquidation and the prospect of personal liability. For fear of being found liable for wrongful trading, directors may cease trading, causing harm to the company. As a result, the provision would foreseeably have disproportionate negative effects and should be suspended.

In the meantime, directors of companies would be well advised to evaluate the financial condition of their companies with their advisers and ask themselves pertinent questions in order not to expose themselves to this kind of liability. During this time, it is essential that all decisions taken and the reasons for them are recorded in board minutes. Liability cannot be extinguished simply by a director resigning if the company subsequently goes into insolvency.

ALTERNATIVE PROCESSES

The law in Kenya currently requires businesses that are unable to pay their debts when due, to cease operations and file for administration or liquidation or commence voluntary arrangements with creditors. Given the massive number of businesses that have had to shut their doors completely (including hotels and lodges, cinemas and gyms to name but a few) or substantially reduce their operations (restaurants, shops and manufacturers of non-essential products), it is necessary for the law to provide some other mechanism to allow businesses to survive this period without having to close their doors for good because they have no other option.

In our opinion, the law should allow for a special type of procedure that companies can initiate which will give them the breathing room to survive. In this article we call this procedure a Covid-19 Stay Application.

COVID-19 STAY APPLICATION

The procedure, if introduced, would allow a company that is in financial distress to make an application to court for a stay on all applications seeking to liquidate it during the pandemic period – a Covid-19 Stay Application.

In law, an application to stay is an application to suspend or postpone judicial proceedings. In this case, the Covid-19 Stay Application is one that would suspend liquidation proceedings for the duration of the pandemic, for companies experiencing financial distress, and those which can demonstrate that without the stay, insolvency will be inevitable.

The application should not be interpreted to mean that a company is insolvent and, therefore, demonstrating that it is only because of the pandemic that the business is suffering is fundamental. The application cannot be used by a business that was in difficulty before Covid-19 or reasons unconnected to the virus.

CREDITORS

In order to ensure that creditors are not unfairly disadvantaged by the stay if granted, the creditors of the business can challenge the process on the grounds that the conditions for stay have not been met, or the grant of a stay is likely to cause harm or injury in an unfair manner.

Following success in lodging the application, we propose a two-month period within which, the company will be required to come up with solutions, structures or proposals that can be adopted to shield the company from the negative effects of the pandemic.

If the company is unable to devise a strategy to save itself from cataclysm within the 2-month period, we would propose that the period can be extended, but only with the consent of 50% of the company’s creditors or with court approval.

Companies that are completely unable to survive the pandemic should be allowed to pursue the existing liquidation procedure in the Insolvency Act. If there is a chance that a company might survive the pandemic, then it should be allowed to pursue a Covid-19 Administration.

COVID-19 ADMINISTRATION PROCESS

The new Covid-19 Administration process we propose is in many ways similar to the existing administration procedure under the Insolvency Act. However, the special procedure is necessary because the impact to the business has been caused by a pandemic that by all things considered is of a temporary nature. So unlike conventional business failures, when the pandemic is contained the business should eventually be capable of resuming as before. The Covid 19 Administration like the moratorium that applies in the case of administrations under the existing legal regime, would involve the automatic suspension of claims made against the company.

We propose that the Covid-19 Administration process would run for a 12-month period with the possibility of an extension. For the duration of this period, the company must appoint an Insolvency Act licensed insolvency practitioner to act as a Supervising Administrator (SA) who has a vital role to play in the Covid-19 Administration.

FILING REPORT

For instance, the Supervising Administrator will be responsible for filing a report in court within 14 days following the expiry of the 2-month grace period confirming the company’s prospects for success in surviving the pandemic. In addition, the directors, while continuing in office, will be legally obliged to report to the Supervising Administrator for the purpose of maintaining the business as a going concern.

This is unlike the current administration regime where the administrator takes control of the business and the directors would typically step down. That would not be realistic in this situation given the significant number of companies facing difficulty yet there are only thirty odd licensed insolvency practitioners, making it therefore necessary for the directors to remain running the business.

We further propose that the Supervising Administrator is granted the powers of an administrator under the Insolvency Act, plus other powers to ensure efficiency in the performance of their duties. They should have the power to pursue errant directors that are liable for misconduct. Further provision should also be made that prior to disposing of capital assets of the company other than in the ordinary course of business, consent of the Supervising Administrator must be obtained.

In addition, it is only with the consent of the Supervising Administrator, or the consent of 50% of the creditors or the court’s approval that a company should be able to make payments to creditors. The Supervising Administrator should also be given power to borrow money on behalf of the company where necessary.

INDIVIDUAL BANKRUPTCY

The Covid-19 pandemic has resulted in individuals facing daunting health and economic prospects.

There is every likelihood that a great number of individuals will be rendered bankrupt by the pandemic. To the extent possible, we believe they should be cushioned against bankruptcy processes in order to allow them an opportunity to recover.

Akin to companies, we would propose a stay on filing bankruptcy suits for individuals for the duration of the pandemic. A person at risk of bankruptcy should be allowed to make an application for protection from bankruptcy proceedings against them or a stay in the event of already instituted bankruptcy proceedings.

The bankruptcy filing would trigger an automatic stay that will bar further action against the bankruptcy estate absent court permission to the contrary. Such actions as foreclosures, collection proceedings and attachment orders would be suspended. The stay should be for a limited period to allow the individual and the creditors to enter into arrangements for the repayment of debts. Where there are no reasonable prospects of debts being repaid then creditors should be allowed to pursue the existing bankruptcy remedies under the Insolvency Act.

In the face of the unprecedented challenges caused by the novel coronavirus which may collectively sound the death knell for many in Kenya’s business community, our proposals aim to balance the need to protect both individuals and companies from the spiralling effects of the virus while protecting the interests of their creditors.

It is therefore incumbent upon the government and all relevant stakeholders to collaboratively take bold, proactive and urgent steps to steer businesses to the other side of this crisis.

Mr Anjarwalla and Ms Sejpal are Advocates of the High Court of Kenya and Partners at Anjarwalla & Khanna LLP