There has been a rise in mergers and acquisitions transactions (M&A Transactions) in Kenya even as business entities grapple with tough economic times and the ability to stay afl oat in the evolving business market. Th e recent acquisition of National Bank of Kenya Limited by KCB Bank PLC, the merger of NIC Group PLC and Commercial Bank of Africa Limited, the acquisition of Quick Mart and Tumaini Self Service Supermarkets by Sokoni Retail Kenya to form a single retail operation and the proposed acquisition of one hundred percent (100%) of the issued share capital of De La Rue Kenya Limited (a subsidiary of De La Rue PLC) by American firm HID Corporation Limited are some of the notable M&A Transactions that have taken place in Kenya in 2019. All these recent M&A Transactions have brought to the fore, among other issues, the fate of employees in the merging entities. In most instances, a high number of employees are declared redundant and thereaft er, have to wait for fresh advertisements of positions by the merged or acquiring entity and apply to be recruited.
Employment and labour law considerations feature highly during M&A Transactions. More often than not, such transactions lead to loss of employment due to the restructuring of the target company, or the change in character and identity of the transferring entity. Unlike other contracts involving assets and liabilities of the transferor, contracts of employment are currently not assignable to the acquiring entity under Kenyan law.
Other than setting out the basic conditions of employment and addressing the legal requirements for engagement and termination of employees, both the Employment Act, 2007 and the Labor Relations Act, 2007 are silent on the effect of M&A Transactions on employees. In practice, the contracts of employment are terminated on account of redundancy subject to compliance with the conditions as set out under section 40 of the Employment Act.
In some instances, the Competition Authority of Kenya (the Authority) established under the Competition Act, 2010 undertakes a public interest assessment to ascertain the extent to which the M&A Transaction will cause a substantial loss of employment and impose conditions to mitigate such as has been in case of the acquisition of National Bank of Kenya Limited by KCB Bank PLC where the Authority approved the merger on condition that KCB Bank PLC retains ninety percent (90%) of the employees from National Bank of Kenya Limited for a period of at least eighteen (18) months. This was also seen in the merger between NIC Group PLC and Commercial Bank of Africa Limited where the Authority approved the merger on condition that both entities retain all the employees for a period of at least one (1) year.
The Kenya Law Reform Commission, a statutory body established under the Kenya Law Reform Commission Act, 2013 with the mandate to review all the laws of Kenya to ensure that they are modernised, relevant and harmonised with the Constitution of Kenya, 2010, recently prepared a draft Employment (Amendment) Bill, 2019 (the Bill) which amongst other provisions, proposes to amend the principal Act (being the Employment Act, 2007) by introducing a new section 15A which provides for the transfer of employees during M&A Transactions.
The proposed section 15A provides that such transfer of employees shall not operate to terminate or alter the terms and conditions of service as stipulated in the original contracts of the employees. It also creates an obligation on the transferor to notify and consult with the affected employees or their representatives regarding the anticipated transfer, the implications of such transfer and the measures that the transferor envisages will be taken to mitigate such implications. Further, the Bill provides that any dismissal taking place prior or subsequent to the transfer shall amount to summary dismissal if such dismissal is premised on the transfer.
Essentially, the Bill seeks to eliminate the difficulties occasioned during M&A Transactions by ensuring that the employees are not left out in the cold when their employer is bought out. It also creates an obligation for the transferor to inform and consult with the employees who shall be affected in an M&A Transaction. This has been the practice in other jurisdictions such as the United Kingdom and even closer home, in neighbouring Uganda.
The Bill borrows heavily from the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE Regulations) as amended by the Collective Redundancies and Transfer of Undertakings (Protection of Employment) (Amendment) Regulations 2014 applicable in England and Wales. TUPE Regulations are aimed at protecting the rights of employees in M&A Transactions in England and Wales by imposing obligations on employers to inform and, in other cases, consult with representatives of affected employees. Failure to comply with these obligations attracts penalties and sanctions to the employer.
While the proposed law could be seen as a relief for employees who are mostly losers in M&A Transactions, it brings with it several challenges and may potentially make M&A Transactions even more complex and strenuous, particularly on the part of the transferee.
Firstly, all the transferor’s rights, powers, duties and liabilities in connection with any employment contract shall be transferred to the transferee. Further, the transferee shall be liable for all the employees’ dues dating back to the commencement of the employment contract. This also means that the transferee shall shoulder all the liabilities that arose from the transferor’s engagements with its employees, including but not limited to cases initiated by and against the transferor.
Secondly, the proposed amendment as currently drafted may subject the parties in M&A Transactions to unnecessary costs and restrictions. It may not be practical to place the transferee under an obligation to automatically retain all the employees of the transferor without any loss of benefits or contractual dues. Such a provision shall defeat the purpose of M&A Transactions, as most of them are geared towards restructuring the business for purposes of reducing operational costs.
With respect to the dismissal of employees immediately prior or subsequent to an M&A Transaction, the proposed amendment as currently framed might open a pandora’s box as it may operate as a blanket protection to all employees including those whose contracts may be terminated for valid reasons during the transition period. The proposed amendment as drafted protects employees against redundancy processes while creating a higher standard of proof against the transacting parties with regards to any termination disputes arising in the course of an M&A Transaction.
Further, the proposed amendment fails to appreciate the contractual rights and obligations of parties with respect to employment and M&A Transactions. There should be provision to allow the transferee to freely negotiate alternative arrangements and contractual obligations with the transferor’s employees and maybe set the standards that should guide this process. By doing so, the parties would have a better chance to make agreements that are favourable to all.
While the issue of how to deal with employees and employment contracts remains a challenge in M&A Transactions in Kenya, the proposed amendments to the Employment Act will no doubt come as a sigh of relief for many employees who have long viewed themselves as collateral damage in M&A Transactions. However, the proposed amendment is likely to increase the cost of undertaking M&A Transactions in Kenya which may well end up being counterproductive as regards the rationale for which the M&A Transaction was carried out in the first place.
On the 20th of April, 2018, the Cabinet Secretary for Interior and Coordination of National Government, Dr. Fred Matiangi, issued directives requiring all foreigners to regularise their work permits within sixty (60) days. The directives were issued during a Parliamentary Security Committee meeting in Mombasa.
The directives require foreigners to obtain electronic work permits and the Government to set up a digital register where one can search to confirm whether a foreigner is legally in Kenya. Regularisation of the permits will involve surrender of the present permits in exchange for electronic permits and updating of information on the systems at the immigration offices. Currently, there are no e-permits. By this process, the Government will confirm who is in Kenya legally or illegally.
Immigration officials will also be required to vet foreigners in strict accordance to the Kenyan laws and there will be more rigorous processes for approval of permit applications. This means that, in adherence to the laws, no permits will be issued for skills that are readily available within the country.
The effect of these directives is that upon the lapse of the sixty (60) days, the police will be mandated to arrest and deport anyone who has not regularised their permits and is in Kenya illegally. The directives will also tighten the already stringent measures the Government has imposed relating to issuance of work permits and special passes.
Employers of foreign nationals also need to familiarise themselves with the directives since upon implementation; their foreign employees may be affected forcing employers to employ skills that are locally available. Employers should therefore ensure that all foreign employees comply with the directives once implemented.
Although we understand that the immigration officials have begun implementing the directives, the directives have not (as at the date of this alert) been published as required by law and may be subject to a legal challenge.
Conventional debt and equity financing models have become largely inaccessible amidst the economic slump that has been occasioned by the global financial crisis. The ramifications of this have been felt in Kenya where there has been a slow-down on lending to the private sector. This has inadvertently resulted in a deceleration of economic growth as traditional lenders have scaled back on loan disbursements. This has also been exacerbated by the capping of interest rates chargeable by banks and financial institutions which was introduced in 2016.
The decline in credit issuance and uptake has had an effect on the recent slowdown of Kenya’s economic performance due to the general election in 2017 which greatly affected the country’s economic outlook. These are clear manifestations of a paradigm shift needed in Kenya in the manner in which capital is raised by various entities. But there is hope, with the world economy bouncing back from the global recession in 2010, reforms have been made in the traditional financing models in Kenya. Against this backdrop, companies now have the recourse to explore alternative financing models to remain competitive and profitable.
Sale and Leaseback Transactions
Sale and leaseback financing has proved to be an attractive option for some companies that seek to keep up with their growth strategies. Essentially a sale and leaseback transaction involves a sale of an interest in property with a reservation on the possessory terms. The underlying characteristic of these kind of transactions is that, the seller acts as a lessee and they raise the capital through property that they hold by transferring the property to a buyer through sale. This transaction enables the seller to dispose of the property and obtain capital injection for the business, while maintaining the use of the same property at an agreed lease premium for a specified term. This is especially beneficial to a buyer who seeks to incur the least possible maintenance costs of the property.
A sale and leaseback financing model varies from traditional financing models because it typically entails:
Classification of Leases
Whether a lease shall be classified as an operating lease or a capital lease is usually agreed upon at the inception of the transaction. It is important to classify the lease the parties intend to enter into as both have different effects on the parties.
A lease will be classified as an operating lease where the rental premiums are considered as operating expenses in the seller-lessee’s book of accounts, and the property leased does not form part of the seller-lessee’s balance sheet. On the other hand, a capital lease is considered as a loan to the seller-lessee and stated as such in the seller-lessee’s books of account. Most leases in a typical sale and leaseback transaction will be operating leases. However, a capital lease would arise where there is a buyback agreement contained in the lease; there is a buyback option with a defined price in the lease; or the lease value is greater than ninety per cent (90%) of the value of the property.
Advantages and Disadvantages Certain advantages have been identified to inure with sale and leaseback financing model. One key motivation for adopting this financing model is the tax advantages that flow from these transactions. It has been noted that in majority of these transactions, the seller is usually motivated by the need to realise immediate loss which is used to offset the seller’s operating income. The seller in essence receives proceeds from the sale of a non-liquid asset, yet retains for a term the use and possession of the asset.
The seller in a sale and leaseback transaction obtains a greater amount of capital through a leaseback than when they opt for conventional types of borrowing. Needless to say, this financing model is essential in providing working capital to the seller-lessee who will realise approximately one hundred per cent (100%) of the market value of the property unlike debt and equity forms of financing which may not result in the same returns. This is especially important in markets experiencing fluctuations in conventional lending sources.
For the buyer-lessor, this financing model allows it to have a hands-off approach to the management of the property as it incurs no responsibility for the operational or managerial aspects of the property which is left to the seller-lessee.
A sale and leaseback transaction also comes with its fair share of challenges, a notable one being a high interest rate on the lease that the rental property may attract. Tax implications may also be evident with recent changes in the International Financial Reporting Standards.
The fact that the property is no longer under the ownership of the sellerlessee also means that the seller-lessee may have no say with regards to the interest that the buyer-lessor will charge on the leased property. This may in the long run mean that the seller-lessee has to incur higher costs in using and managing the property as this responsibility does not rest with the buyer-lessor. This denotes an inherent risk that is evident in many lease arrangements.
It is clear that the sale and leaseback financing model is an option Kenyan companies could consider in their quest to raise capital to finance their growth strategies in the market. Numerous advantages can be drawn from the adoption of this model, especially in light of the drawbacks of conventional financing models.
Moreover, this model is attractive to entities that are unable to attract a wide variety of financing. This financing model may be useful for companies that may want to accrue some capital to use for their expansion initiatives. Ultimately, these entities could benefit from unlocked real estate value, reduction in a company’s investment in non-core business assets, such as buildings and land and freeing-up of the entity’s cash in exchange for executing a long-term lease.
Sheila has advised both local and international clients and was part of a team that advised in the acquisition of a 48.9% stake in a company which specializes in providing serviced office solutions by a leading real estate and investments management company.
Sheila holds a Bachelor of Laws (LLB) from the University of Nairobi and a post-graduate diploma in Law from the Kenya School of Law.
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