In recent years, the media has been smattered with reports of companies in deep financial distress. Prominent among them are major leaguers such as Nakumatt Holdings, ARM Cement and more recently, Mumias Sugar Company. As observers collectively ponder what went wrong with these companies, market players are keenly watching to see if the provisions of the Insolvency Act, 2015 can help to put the situation right, keeping in mind that there may be many more casualties in the pipeline as a result of the COVID-19 pandemic.
The Insolvency Act has been lauded for its relevance in the modern Kenyan economy and it undeniably brings a number of advantages such as consolidating insolvency regimes into a single piece of legislation and enabling distressed companies whose financial position is salvageable to be restored to ‘going concern’ status.
One issue which remains the subject of ongoing debate is the impact of the Insolvency Act on the options available to the secured creditors of a company in extreme financial straits. In contemplating this issue, one cannot avoid looking at administration and receivership which are two common approaches to corporate insolvency out of the larger menu of options available under the Insolvency Act. These two terms tend to be conflated but there are crucial differences between them, as we shall see below.
Administration allows a company some ‘breathing space’ so as to be rescued or restructured by an administrator. The first priority of administration is to restore the company to viability but should that prove infeasible, the second objective is to achieve a better result for the creditors than would be the case under liquidation.
Where an administrator cannot reasonably achieve either of these two objectives, then their role is to dispose the company's property and distribute the proceeds to the company's creditors, in order of their prescribed ranking. In fulfilling this last duty, an administrator is legally mandated to act in the interests of all creditors.
It is difficult to assess whether administration in Kenya is successfully rehabilitating companies in distress because many a time, the administrators’ efforts are hindered by claims from myriad parties which even if they do not succeed, take up the administrator’s time and resources. Furthermore, it seems that administrators are often appointed when it is far too late in the day to give the recovery strategy a real chance of success. No one wants to run the risk of extending trade credit to a company that is already under administration. Insolvent companies are also often dogged by the belief that the ‘rot’ inside the company is so widespread that it requires new ownership and new management to bring the company back to life. Where such an attitude prevails, the administrators’ main task tends to default to a search for a buyer for the whole company or its valuable parts.
As regards the option of receivership, secured creditors may sometimes opt to appoint a receiver when a corporate debtor falls into financial troubles. Receivers are responsible for disposing the assets upon which the loan facilities were secured, in such a manner as to maximize the value of the debts discharged. Unsurprisingly, lenders may prefer to appoint a receiver because he/she is deemed to be an agent of the company and thus the company is ultimately held liable for the receiver’s acts or omissions.
One notable merit of receiverships is that they enable the secured assets to be disposed of swiftly, which means that they could possibly fetch a better price due to their newer/ better condition than if they first have to wait for an attempt to save the company.
Starting January 2016, when the relevant section of the Insolvency Act commenced, restrictions apply to the ability of secured creditors to appoint receivers over substantially the whole of the company. As such, their primary remaining remedy is to appoint an administrator instead. It appears that the reasoning behind the prohibition was to tip the balance in favor of collective insolvency proceedings in which all creditors participate and in which a duty is owed to all creditors.
Getting into a comparison of the two options, although secured creditors may initially view administration as an inferior remedy, it arguably is not as prejudicial to them as they fear, for a number of reasons, some of which are mentioned below.
Firstly, unlike administration, receivership does not trigger an automatic statutory moratorium. Creditors can therefore commence or continue legal action against the company, including petitioning for winding up orders. Such action by creditors may jeopardize the attempts to turn the company’s fortunes around. The protection offered by the statutory moratorium in the case of administration is therefore beneficial.
Secondly, secured creditors benefit from the perception that administration is geared towards rescuing the business which attracts greater stakeholder support e.g. from trade and unsecured creditors and licensing authorities etc. Consequently, a company in administration typically enjoys more goodwill and faces less resistance from a wider range of stakeholders.
Thirdly, administrators have the flexibility to explore a number of options as they develop their proposals for approval. This means that they can employ an optimal mix of techniques to inject capital, generate cash, revive operations and pare down some of the debt. Such a hybridised approach should yield better financial returns over time than a wholesale sell-off.
In the final analysis, the optimal option for recovery of debts owed by a distressed entity will depend on numerous considerations including the legal rights of the stakeholders to initiate administration, receivership, liquidation etc., and the expected outcome of the selected insolvency procedure from a financial and reputational perspective. In any event, where a company’s future prospects are promising, it is probable that the stakeholders will agree to cooperatively pursue a course which enables the company to survive, repay its debts and garner returns for its other investors, those along its value chain and the wider economy.
The article was also published in the Business Daily on 1 December 2020 and can be accessed here.