Options for Companies in Distress on Account of the COVID-19 Pandemic or Similar Events

Posted on May 6th, 2020

Options for Companies in Distress on Account of the COVID-19 Pandemic or Similar Events

 

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The COVID-19 pandemic has impacted numerous companies and businesses globally with the result that many are currently facing financial difficulties including possible insolvency, closure and/or an uncertain future. In these difficult circumstances, it is important that directors and business owners understand the options available to them with a view to either rescue and revive their business or dissolve them in an organised and legal manner.

Directors and owners of businesses in distress ought to take care not to attract liability for wrongful trading. Liability for this might arise if they knew or ought to have known that there was no reasonable prospect that the company would avoid being placed in insolvent liquidation. It should be noted however that trading whilst insolvent does not, in itself, constitute wrongful trading. Liability only arises if it can be shown that the company is worse off as a result of the continued trading.

Corporate insolvency in Kenya is governed by the Insolvency Act, 2015 (the Act). Under the Act, a company is deemed insolvent if:

  1. it has failed to pay a debt exceeding KES 100,000 after the lapse of 21 days from service of a written demand for payment;
  2. a decree, order or judgment entered against the company is returned unsatisfied in whole or in part;
  3. if the court is satisfied that the company is unable to pay its debt; or
  4. if the court is satisfied that the value of the company’s assets are less than its liabilities.

The main options available to insolvent companies or companies in distress under Kenyan law are administration, company voluntary arrangements and liquidation. Each of these processes have various advantages and disadvantages and it is necessary that directors and business owners clearly define the objectives they wish to achieve and carefully weigh which option is best suited to achieve these objectives.

Administration

Administration is a procedure used to reorganize a company or to realise its assets under the protection of a statutory 12 month moratorium which prevents creditors from taking action to enforce their claims against the company which may prevent the implementation of a strategy for the company’s rescue or asset realization.

The objectives of an administration are twofold, namely to allow an insolvent company to continue trading with protection from creditors through a moratorium and to achieve a better result for creditors than is likely if the company was to be liquidated.

An administration order will be issued if court is satisfied that the company is or is likely to become unable to pay its debts (upon satisfaction of the cash flow, balance sheet and net asset position tests), and that the administration order is reasonably likely to achieve the objective of administration.

An administrator is appointed by way of an administration order. He may, among other things, sell the company’s property, borrow or institute proceedings on behalf of the company. He must however seek the creditors approval for his proposals and has a duty to perform his functions as quickly and reasonably as is practicable. He is an authorized insolvency practitioner and considered an officer of the court, whether or not appointed by court.

An administration may be terminated on:

  1. the lapse of the statutory 12 months’ period if there was no prior application for the extension for the same;
  2. when its objectives have been achieved;
  3. when it moves from being an administration to either a creditors’ voluntary liquidation or a liquidation on an application by the administrator; or
  4. on an application by an administrator who reasonable believes that the objective of an administration will not be achieved or believes that the company should not have entered into an administration in the first place.

The advantages of an administration are numerous, for instance, an administrator owes his or duty to all the creditors and not to a single creditor. Administration also has the prime advantage of a statutory moratorium which prevents all creditors from bringing forward legal claims against the company while it undergoes administration. This may afford the company time and space to recover while ensuring that the goodwill and value of the business is preserved.

An administration process does not ordinarily interfere with the company’s employment or commercial contracts. Also, although administration may lead to liquidation of the company, the business itself may well be saved, in whole or in part, by sale to a third party.

The downside of an administration is that it very often leads to the eventual liquidation of the company and it may not be possible to secure the sale of the business. It also has the potential of being lengthy and costly. Further, it comes with negative publicity and exposes directors to claims in for misfeasance, fraudulent trading, wrongful trading, preferences, liability for transactions undertaken at an undervalue among others.

Company Voluntary Arrangement

A company voluntary arrangement (CVA) is a voluntary arrangement, compromise or scheme of arrangement between a company and its creditors that is lodged in court as a proposal to take effect as voluntary arrangement.  The CVA takes effect upon its approval by court and binds every creditor and member of the company.

A CVA is implemented under the supervision of an insolvency practitioner who assumes the role of a “supervisor” and becomes responsible for implementing the arrangement in the interests of the company and its creditors and monitoring compliance by the company with the terms of the CVA.

During the period during which the CVA is being considered, small eligible companies have the option of applying for and obtaining a moratorium which commences at the time when the application for the moratorium is lodged in court and ceases at the end of the day in which a meeting has been held to consider the implementation of a CVA, provided that the duration does not exceed 30 days.

CVAs can take many forms including but not limited to mergers and acquisition, share capital restructuring, debt for equity swaps, compromises, among others.

Some of the key advantages of CVAs include the fact that directors remain in control of the company. CVAs also tend to be more affordable than other formal insolvency procedures such as liquidation and administration. Further, a short-term moratorium is available to small companies while the CVA proposal is being considered. An administration may also be combined with a CVA which may avail the advantage of a statutory moratorium.

On the other hand, some of the disadvantages of CVAs are that unlike an administration process, they have no automatic statutory moratorium. Further, in the event that a CVA is combined with an administration, the insolvency costs increase thereby defeating the purpose of opting for the CVA in the first place. Secured creditors are also not bound by CVAs and may still appoint an administrator or liquidator. Finally, if a CVA fails and the company cannot meet its terms, it may be sued by creditors. It is therefore important to ensure that the terms of the CVA are feasible.

Liquidation

Liquidation is the legal process by which a company’s control is removed from directors and placed under a liquidator for purposes of collecting and realising its assets and distributing the same to the creditors in order of priority ranking and thereafter, in the event of any surplus, distributing it to the members. When such process takes places, the company is deemed to be dissolved.

A company may file for liquidation in order to avoid incurring liability for wrongful trading. The intention is to bring the company to an end. Once the liquidation order has been made, legal proceedings against the company may be instituted or continued only with the approval of the court.

There are two types of liquidation namely, a compulsory liquidation and a voluntary liquidation where compulsory liquidation is supervised by the High Court of Kenya while a voluntary liquidation is instigated by the members or creditors of the company. A compulsory liquidation will normally be initiated on the basis that the company is insolvent while a voluntary liquidation is normally initiated when the company is not insolvent.

A members’ voluntary liquidation is undertaken when a company is solvent. It is deemed to have commenced after the passing of the special resolution by the members of the company after which the company ceases to carry on its business, except in so far as may be necessary for its beneficial liquidation.

The directors of the company are required to produce a declaration of solvency which declares that the company will be able to pay all its debts within 12 months. Creditors play no part in members’ voluntary liquidation since the assumption is that their debts will be paid in full. The Registrar of Companies dissolves the company after 3 months from the date of receipt of the final accounts of the company by removing its name from the register of companies.

A creditors' voluntary liquidation is commenced by the directors convening a general meeting of members to pass a special resolution to wind-up the insolvent company (private companies may pass a written resolution with a 75% majority), appoint a liquidator and nominate up to 5 representatives in a liquidation committee. Thereafter, the directors must also convene a meeting of creditors, within 14 days.

The advantage of a liquidation is that it brings matters to an end for a struggling business in a legal and organised manner. It also removes the responsibility from the company’s directors and transfers it to a qualified insolvency practitioner who makes decisions for the directors. It has the effect of permitting employees to claim terminal or redundancy dues from the relevant government fund and lifts the pressure of court judgement and debt recovery claims.

On the other hand, some of the major disadvantages of liquidation include the fact that on the appointment of a liquidator, all the powers of the directors cease. Further, the business can no longer trade, employees lose their jobs and creditors and suppliers may lose money which might make is difficult for the directors to start a similar business. In addition, the business’ reputation, licenses and assets may be lost on liquidation.

This alert is for informational purposes only and should not be taken as or construed to be legal advice. If you have any queries or need clarifications, please do not hesitate to contact Noella Lubano (noella@oraro.co.ke), Eva Mukami (eva@oraro.co.ke), Jessica Detho (jessica@oraro.co.ke)  or your usual contact at our firm, for legal advice relating to the COVID-19 pandemic and how the same might affect your business.

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