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Why new changes to the insolvency laws matter

By Beatrice Nyabira, Judy Muigai and Christine Murangi

The Business Laws (Amendment) (No.2) Act, 2021 received Presidential assent on 30 March 2021 and brought amendments to several statutes into effect, many of which are geared towards improving the ease of doing business in Kenya.  One of the affected statutes is the Insolvency Act, 2015 and this article explores the impact of some of the changes on businesses and creditors.

One important amendment relates to the funds which are safeguarded for unsecured creditors.  Generally, secured creditors are entitled to proceeds realized from the sale of charged assets.  The Insolvency Act created an exception to this rule by requiring that 20% of the net proceeds realized from the sale of assets subject to a floating charge be set aside exclusively for the benefit of unsecured creditors.  This portion is commonly known as the ‘prescribed part’ and is designed to improve the returns to unsecured creditors from a corporate insolvency process.  This is crucial because under the prescribed waterfall of payments, unsecured creditors rank second last as they are only ahead of shareholders in terms of priority.  As such, without the protection afforded by the prescribed part the unsecured creditors may receive minimal returns, if any, as the assets are usually insufficient to cover the full liabilities in an insolvency.

Previously, the only instances when the prescribed part did not apply were where the net assets of the insolvent company were less than Kshs 500,000 or where the court disapplied the prescribed part on application by an insolvency practitioner, if the practitioner considered that the cost of distributing it would be disproportionate to the benefit of doing so.  The Business Laws (Amendment) Act has now amended section 474 of the Insolvency Act to include an additional ground for disapplying the prescribed part.  Now, the prescribed part will not apply in a case where a floating charge holder applies to the court to disapply it on the grounds that it unfairly harms its interests.  The court can then make orders to apply or disapply the prescribed part entirely or place conditions on its application.  This is a welcome amendment as it allows for a balancing of the interests of different classes of creditors.

Given that floating charges are usually held by asset finance lenders and commercial lenders, it appears that the amendment seeks to serve two main purposes: one, it reinforces the special position held by secured lenders in insolvency proceedings and, two, it protects the interests of lenders who play a critical role in enabling the acquisition of much-needed assets/ infrastructure and servicing of critical company contracts.

A second significant amendment to the Insolvency Act is the introduction of a pre-insolvency moratorium.  The moratorium is initially granted for a period of 30 days (but can be extended for an additional 30 days’ period) and applies to cases of ‘financially distressed’ companies.  During the moratorium period, the directors of the company remain in control of the company except for certain actions which require the approval of a licensed insolvency practitioner, known as the monitor, who oversees the implementation of the pre-insolvency moratorium. 

While a pre-insolvency moratorium is in effect, creditors including suppliers and landlords are prevented from taking any enforcement action against the company and its assets, without the consent of the monitor or the court.  At the same time, security granted by the company during the moratorium period can only be enforced if reasonable grounds existed for believing that such security would benefit the company at the time it was issued. 

The pre-insolvency moratorium appears to be an emergency ‘out-of-court’ mechanism intended to offer debtor companies some breathing space to agree on informal restructurings or other formal insolvency procedures with creditors. The ultimate objective is to afford management an opportunity to rescue a company, which is very timely given the lingering adverse impact of COVID-19 pandemic on businesses.

Fortunately for creditors, they are not left without a right of remedy during the moratorium period.  For example, if a property to be disposed is subject to a security, the holder of the security must consent or the court must give its approval and the holder of the security retains priority upon distribution of the proceeds. Furthermore, any creditor, director or member of the company who is dissatisfied with the monitor’s conduct during the moratorium period may apply to the court for appropriate remedial orders. The court may, on such application, end the moratorium period. 

The moratorium is not available in certain instances. Companies already in administration, liquidation (including provisional liquidation) or in which an administrative receiver has been appointed are ineligible. Similarly, companies which have had a moratorium in effect or been subject to a company voluntary arrangement (CVA) during the twelve months prior to the application date are also ineligible.  Notably, companies for which a liquidation application has been made in court but a liquidation order has not been issued would qualify for the pre-insolvency moratorium.  A moratorium has the advantage of pulling all creditors into restructuring discussions, including small, expensive or uncooperative secured or unsecured creditors who may otherwise shun the efforts of larger commercial lenders to give the debtor some breathing space.

To apply for a pre-insolvency moratorium, directors of an eligible company are required to file a document in court setting out why a moratorium is desirable.  The directors also need to attach a statement from the proposed monitor confirming that the moratorium has a reasonable prospect of achieving its goal and that the company is likely to have sufficient funds available to it during the proposed moratorium period to carry on its business.  On the latter requirement, the directors and proposed monitor can engage creditors regarding the credit facilities that can be made available over the moratorium period.  Oftentimes, such facilities enjoy super-priority in terms of repayment.

The pre-insolvency moratorium automatically takes effect when the requisite documents are filed in court and the monitor is required to publicise the commencement of the moratorium through the Kenya Gazette, one or more newspapers with wide circulation in Kenya and on the company’s website.  

The two amendments to the Insolvency Act described above provide useful measures in the journey towards a more effective insolvency regime.

The article was featured in the Business Daily on 22 September 2021 and can be accessed here.