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The evolution of insolvency laws across the world has been aptly described as the “redefinition of insolvency from sin to risk, from moral failure to economic failure”. In the United Kingdom, for example, the treatment of debtors has significantly improved since medieval times, when failure to co-operate with bankruptcy commissioners would earn convicted bankrupts the death penalty. Kenya is no exception.
Until the enactment of the Insolvency Act, 2015 (the Insolvency Act), corporate insolvency in Kenya was instinctively regarded as the “kiss of death” for struggling businesses. With the ‘once in a generation’ overhaul of the insolvency landscape in 2015, Kenya has now adopted a pro-rescue culture, which embraces the possibility of a fresh start for businesses.
Despite the business rescue culture embedded in Kenya’s current insolvency regime, the coronavirus pandemic has brought about profound economic challenges that have left many businesses teetering on the edge of failure. So far, this economic upheaval has not been reflected in the number of corporate insolvencies, which remain implausibly low across many jurisdictions, including Kenya. Regulators and other economic experts attribute this state of play to relief packages introduced by countries across the world to prevent mass business failure. It is feared that as the packages continue to be phased out, the artificially low corporate insolvencies may pave the way to a “tsunami of bankruptcies”.
Considering the potential spate of insolvencies and the typical economic downturn expected from the approaching electioneering season, private equity (PE) and venture capital (VC) funds with Kenyan investments should have a second look at their investee companies from an insolvency perspective. One of the main areas of concern for investors, especially regarding portfolio companies, is the issue of parent entity liability. There are also macro opportunities in relation to distressed debt or distressed assets, given the continuing economic weakness in the region that is likely to trigger insolvencies across companies and sectors.
PE and VC firms are often concerned about potential exposure to any financial o r n on-financial li ability arising from investee insolvency. In general, Kenyan corporate insolvency is grounded in the concept of limited liability, a fundamental principle of corporate law that a company has separate and distinct legal personality from its directors and shareholders. Save for certain exceptions, shareholder liability in investee insolvency situations is remote, and creditors generally have no recourse to a company’s shareholders or owners because of the concept of limited liability, which would also apply to directors in the parent entity.
Nevertheless, directors in the insolvent portfolio company itself should be concerned about potential liability under Kenyan insolvency and company laws. In an insolvency situation, the duty to promote the success of the company shifts to a duty to act in the best interests of the company’s creditors. Therefore, directors must be cognizant of their fiduciary and statutory duties, including the duty to protect the investee’s assets and minimise potential losses to creditors. Directors should also be aware that there are several offences that a director may potentially be liable for if the company goes into liquidation. These offences, which include wrongful and fraudulent trading, may attach significant liability on directors, including a court order making a director personally responsible to pay the company’s debts or the possibility of criminal sanction.
Moving away from issues facing portfolio companies and their directors but keeping with the rescue culture at the core of the revamped insolvency regime, we have noted increased interest in the viability of pre-pack sales/ administrations in Kenya. The term ‘pre-packaged sale’ refers to an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator, and the administrator effects the sale immediately on, or shortly after, appointment.
Pre-pack sales are not regulated under the Kenyan insolvency regime, and as far as we know, none have been successfully attempted in Kenya. The lack of defined guidance on the practice means that insolvency practitioners are unwilling to assume the risk that comes with a pre-pack sale. In addition, Kenya is a highly litigious jurisdiction, meaning that any disgruntled party (e.g., a single unsecured creditor) would be likely to initiate a potentially protracted legal dispute in respect of such a transaction. This would defeat the purpose of the entire process given that cases in Kenya can take up to three years to determine at first instance, with appeals taking much longer.
Another area getting increased attention in light of the COVID19 economic crisis is distressed debt investing. The economic fallout from the COVID19 pandemic has also presented a “generational opportunity in distressed debt investing” outside of Africa, with investors in developed markets saying that this is “one of the great environments, possibly, to buy distressed debts that may have ever been in existence”.4 Distressed debt, also referred to as “impaired debt”, “sub-performing debt” or “non-performing loans” (NPLs), is debt that “a borrower is unlikely to be able to repay in full to the lender on its maturity date because the borrower is in financial difficulty or in an insolvency process”. Distressed debt investing typically involves market participants buying debt for different reasons, including:
Participants in distressed debt markets are diverse and include PE funds, hedge funds and special situation funds. However, distressed assets continue to be largely overlooked as an asset class by investors in the African space. We believe that the limited investor appetite in distressed debt investments is due to a variety of reasons, including the lack of a developed legal and regulatory framework, political risks prevalent in many African countries and investor reluctance to deal with state- and familyowned businesses without strong collateral mitigants. This has perhaps left the distressed market in Africa at a much more nascent stage compared to other regions.
That said, there is evidence of increased interest from various market participants looking to trade in distressed assets, particularly for businesses that have good business models but are facing significant financial difficulties for various reasons, including the COVID19 cash crunch. On the continental scene, the International Finance Corporation (through its Distressed Asset Recovery Program (DARP)), partnered with Nimble Group, a South African distressed debt investor, to buy USD 90 million of unsecured retail NPL portfolios in South Africa, Namibia, Botswana, Lesotho and Eswatini (former Swaziland). There is also real opportunity for blended investment vehicles combining aspects of angel or VC investments with debt investments over a longer period of time than the typical five-year life cycle of investments in a conventional market environment. Hybrid investment vehicles would need a different investment funding structure and more customised time frames, depending on a sector or asset focus that addresses distressed opportunities.
This analysis of the market trends in the distress and recovery space ends on a hopeful note. Kenya’s evolving insolvency regulatory framework continues to search for ways to support corporate rescue. For example, Parliament recently passed an amendment to the Insolvency Act to provide for a pre-insolvency moratorium that prevents creditors from taking enforcement actions while a company in financial distress considers its options for rescue. A wider effort to amend the existing Insolvency Act to address gaps and inconsistencies fell victim to the effects of the pandemic, but it is expected that the process to kick into high gear soon.
This article was first published by AVCA Legal & Regulatory Bulletin March Edition.