Since its declaration by the World Health Organization as a
global pandemic, Covid-19 has had devastating effects on businesses all
over the world. Courts in many jurisdictions including the US have
recognised the pandemic as a natural disaster with far reaching effects.
By GODWIN WANGONG'U, SYLVIA KANG'ETHE & PETER MAKAU
Summary
- Since its declaration by the World Health Organization as a global pandemic, Covid-19 has had devastating effects on businesses all over the world.
- Courts in many jurisdictions including the US have recognised the pandemic as a natural disaster with far reaching effects.
- Parties to contracts have had to establish whether the Covid-19 pandemic falls within the scope of the force majeure clause; as well as whether the doctrine of frustration can be relied on for one to be relieved of their contractual obligations.
Parties
to contracts have had to establish whether the Covid-19 pandemic falls
within the scope of the force majeure clause; as well as whether the
doctrine of frustration can be relied on for one to be relieved of their
contractual obligations.
Locally, the government has
put in place various legislative and policy measures to cushion both
citizens and businesses from the ensuing economic hardships. Such
include reduction of the Central Bank Rate to 7 percent to enable
commercial banks lend to consumers at affordable interest rates,
reduction of VAT rate from 16 to 14 percent leading to reduction on the
price of vatable goods and services and reduction of Cash Revenue Ratio
to 4.25percent. The reduction by the Central Bank is intended to
increase liquidity among commercial banks. This will in turn avail more
cash to the banks to continue advancing credit facilities to businesses
and other consumers.
Despite the various measures, many
businesses continue to experience reduced turnover. This has hampered
many businesses’ ability to service their credit facilities timeously.
This may in turn result in drastic measures by creditors such as
commencement of insolvency proceedings which would negatively impact the
ability of businesses to operate as going concerns in the long-term.
In
this publication, we explore the various options available to both
businesses and creditors for purposes of increasing capital flow so that
the businesses can remain afloat while at the same time meeting their
financial obligations to their creditors.
Insolvency is a financial position where a company is unable to
meet its financial obligations as and when they become due. More likely
than not, an insolvent company’s liabilities are more than its assets.
Under the Insolvency Act, 2015, a business is insolvent if a demand to
pay its debts has been issued and the notice period has lapsed without
the company honouring the same. At this point, a creditor has the
statutory right to lodge an insolvency petition in court for the assets
of the company to be liquidated as a way of recovering its money.
It
is important to note that Kenyan courts have ruled that insolvency is
not a measure of last resort in debt recovery. Courts have also
determined that where the debtor has made proposals to liquidate the
debt, such proposals should not be taken as inability to pay the debt
and therefore an insolvency petition presented where such proposals
exist will be declined. Similarly, courts frown upon creditors who
present insolvency petitions for the sole purpose of coercing debtors to
pay. Consequently, it is important for both creditors and debtors to
consider arrangements that provide for adequate capital to run the
business while at the same time servicing the debts.
That
notwithstanding, many companies may find themselves dealing with
insolvency petitions during this pandemic. However, as discussed below,
there are various options in law which both the debtor and the creditor
may explore to achieve a win-win situation in the long-term instead of
liquidation. A snippet of each of these options is outlined below.
Company voluntary arrangements (CVAs)
A
Company CVA is a statutory insolvency procedure which sees a company
and its creditors agree on repayment of the debts over a specified
period of time. Usually, a CVA is proposed by the company in distress,
through its directors. It may also be made by a company’s creditors or
administrators. The objective of a CVA is to rescue a viable company in
financial distress from liquidation.
A CVA has
provisions on what happens in case of default. It is implemented in much
the same way as a commercial contract between the parties and is
binding upon the company and its creditors. During the negotiation and
pendency of a CVA, the directors of the company may apply to court for a
moratorium on payment of its debt(s). It is important for companies to
review the terms of their loan agreements with various lenders to
confirm whether entering into a CVA is one of the default events which
may trigger liquidation proceedings. A company should also consider its
existing contracts with third parties to avoid triggering termination as
a result of such arrangements.
Schemes of arrangement and compromise
A
scheme of arrangement is used by companies to give effect to a debt
restructuring as it enables a company to agree with its creditors or a
class of them in respect of its debts owed to creditors. It can also be
used to effect a solvent reorganisation of a company in order to avoid
insolvency.
A scheme of arrangement presents an
opportunity to reach a compromise or arrangement with creditors, whether
through a conversion of debt to equity or through any other genuine
structure that will allow the company to focus on a return to
profitability. As noted under CVAs, a company with multiple loan
agreements should review the terms of such agreements to ensure that
entering into a scheme of arrangement and compromise would not amount to
a default event and therefore trigger liquidation proceedings.
Administration
The
objectives of administration, as provided for under the Insolvency Act,
are to maintain the company as a going concern, to achieve a better
outcome for the company’s creditors as a whole than would likely to be
if the company were liquidated without first being placed under
administration and to realise the property of the company in order to
make a distribution to one or more secured creditors.
The
company or its creditors may apply to court for the company to be
placed under administration so that it continues doing business while at
the same time be protected from creditors through a statutory
moratorium. Administration is undertaken under the supervision of an
administrator and the High Court. The end goal is for the business to
increase its turnover over a specified period, normally 12 months, upon
whose completion a report is filed in court by the administrator as to
the company’s ability to settle its debts in the long-term while
remaining afloat.
Balance sheet reorganisation
Balance
sheet reorganisation entails modifying the debt, operations or
structure of a company as an attempt at eliminating financial harm,
maintaining the business as a going concern and potentially improving
its financial and business prospects. It is intended to assist companies
in financial difficulties (or in danger of getting into financial
difficulties) to re-organise their affairs. Indeed, the various modes of
balance sheet restructuring may be utilized as part of a
compromise/arrangement, a CVA, or, in case of a company under
administration, the administrator’s proposals.
In the
context of debt restructuring and corporate recovery, the various modes
of balance sheet reorganisation may be in the form of:
Modification/renegotiation of borrowing/lending terms; consolidation/
further lending; refinancing; equity injection;strategic divestures; job
mergers or right sizing; and redundancies.
Equity
injection would entail the company raising additional capital and
issuing shares to investors in the company. The Companies Act, 2015
allows a company to alter its share capital by, inter alia, increasing
its share capital by allotting new shares.
A company in
financial distress may invite equity investors who will provide it with
capital and in return allot new shares to them. Both private and public
companies are at liberty to consider this when debts and losses
increase depleting the company’s capital. Capital may be raised
privately from specific investors or on the capital markets. Whenever a
company is financially challenged the shareholders should always
consider the option to re-organize its balance sheet and avoid possible
demise through liquidation. However, the incoming investors may want to
influence the management of the company through board representation.
Consequently, equity investment is often accompanied by corporate
governance restructuring of the investee company.
The writers are Nairobi-based advocates of the High Court of Kenya practising as such at Mboya Wangong’u & Waiyaki Advocates
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