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Don’t let your business kill you this year

BUSINESS
By Dominic Omondi | Jan 5th 2022 | 6 min read
By Dominic Omondi | January 5th 2022
BUSINESS

Man looking sad after long day's work [Courtesy]

Bankruptcy law gives to the honest but unfortunate debtor … a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt.”

High Court Judge Joel Ngugi’s was quoting a verdict of the US Supreme Court on October 8, 2020 while presiding over a case in which businessman James Maina had approached him seeking a fresh start and a much-needed break from his creditors.

Mr Maina’s transport business had suffered a double tragedy, months after getting a loan from CFC Stanbic to buy a bus and invest in the booming matatu industry.

First, the bus developed a mechanical problem and before long, his business was disrupted by the post-election violence of 2007.

These were events that were beyond his control, and if people were to be punished for acts of God, such as the outbreak of the Covid-19 pandemic, then few people would be willing to take a dive into entrepreneurship.

Why Kenyans fear bankruptcy

A lot of Kenyans cringe at the idea of walking around with the ‘bankrupt’ tag.  Yet bankruptcy, or insolvency, is an important ingredient for a vibrant entrepreneurship.

“Bankruptcy and insolvency are some of the things that make people to take risks,” says Mark Gakuru, the Official Receiver at the Office of the Attorney General, noting that with insolvency laws in place, people are not afraid of going to civil jail for taking risks.

“When you have a reasonable risk-taking appetite as an entrepreneur, you should not be taken to jail.”

The problem is that a lot of people do not want to want to accept that they are in a hole.

As a result, most businesses seek help when they are in the worst shape.

Peter Kahi, an auditor at PKF Eastern Africa with over 30 years’ experience in forensic and corporate recovery assignments, says people decide to seek help “when they are on their knees” and the company cannot be rescued.

Most businesses, Mr Kahi says, opt to just bury their heads in the sand hoping that things will improve. “So you keep digging your hole.”

“You see, if they come to us earlier, there are various options of restructuring the company before they go into liquidation,” he says.

Administration and liquidation

Liquidation is the final stage of insolvency where the properties of the business are sold so as to pay preferential creditors.

The first stage is administration - which replaced receivership under the old Act.

Under administration, the company through its directors can request a court to appoint an insolvency practitioner.

Creditors can also go to court and apply for insolvency proceedings against the company.

But the first objective of any administration is to rescue the company; to maintain it as a going concern.

If this is not achieved, then you move to the second objective, which is to maximise the return for all creditors.

And when that fails, then the company goes into the final stage of selling the properties and distributing the proceeds to creditors, starting with secured creditors, as happened recently to Imperial Bank of Kenya Limited and earlier to Nakumatt Supermarkets.  

The procedures of insolvency are two. There is administration and liquidation.

The first red flag

The first red flag is seen in the profit and loss account, with the company consistently making losses. If this is not addressed the company continues sliding up to the second stage which now manifests in the balance sheet, with liabilities exceeding assets.

“In this one, some key ratios don’t make sense,” says Kahi, giving an example where you notice the company has borrowed a lot every year.

And if this is not addressed early enough, you come to the third stage which is the cash stage, where there is no money in the company.

“And when there is no money in the company is when there is that pressure from creditors. You can’t meet any obligation, so basically you have become technically insolvent,” says Kahi.

Moving the company from the cash crisis stage to the first stage of just losses in the profit and loss account is an uphill task for any insolvency practitioner, Kahi confesses.

First of all, no one will be willing to come in and inject capital into the company. This could have been done in the first stages.

Secondly, the banks and those who gave you money cannot support you anymore because they do not want to throw good money after bad.

“But if you call for professional help when those things start happening, I can assure you 100 per cent that business will be rescued.”

Objectives of insolvency

Keeping viable businesses operating, says the World Bank, is among the most important goals of insolvency systems.

The Insolvency Act, 2015 became operational in 2016, and helped improved the country’s ease of doing businesses.

The purpose of the new Act was basically to give the businesses some breathing space, unlike before when creditors would line up for their money with auctioneers, like vultures surrounding a sickly animal, on noticing that a company was in distress.

“The new Act, therefore, was supposed to protect the company from creditors,” argues Kahi.

In March 2021, President Uhuru Kenyatta signed into law a new Act that gave shareholders of companies declared bankrupt by court 30 days to salvage their businesses.

This is after he assented to an omnibus Bill that amended, among other statutes, the Insolvency Act, 2015.

A good insolvency regime, the World Bank says, should inhibit the premature liquidation of sustainable businesses.

“A firm suffering from poor management choices or a temporary economic downturn can still be turned around. When this happens, all stakeholders benefit,” says the global lender.

Peace of mind

True, there is some indignity associated with bankruptcy - which applies to natural persons while insolvency applies to corporates.

When you are declared bankrupt as an individual, you trade the luxury of holding public office, spending lavishly or being a director in any company in Kenya. But it is for peace of mind.

In the case of Maina, whose case was heard in October 8, 2020, should the court put him into bankruptcy, and unless opposed by a creditor or bankruptcy trustee, he will automatically be freed from all the debts after three years.

The exception for such release, the law says, relates to those debts which were incurred through fraud, are owed to a spouse or children’s upkeep.

Moreover, one should not have been declared bankrupt before.

Justice Ngugi noted that besides offering a fresh start to people overburdened by debt like Maina, the other goal of the bankruptcy law is to protect creditors and ensure optimal payment to them where possible.

“There is no doubt that these twin goals run through the Insolvency Act, 2015 and the Insolvency Regulations, 2016,” he said.

Predictably, Stanbic Bank objected to Maina’s petition. After all, it is likely to be a major loser should he be declared bankrupt.

According to the bank, Maina’s statement of financial position, which he had furnished the court with, did not have crucial details required under the regulations, including an itemised statement of his expenses, a statement of his current assets, including their description, value and location, and a statement of all financial transactions by the debtor during the previous three years.

It said Maina had also not published a notice to declare bankruptcy in a newspaper of regional publication and subsequently arranged for the publication of his statement of financial position in the Kenya Gazette as is required by law.

But the judge empathised with Maina, noting that it was premature for the court to consider his bankruptcy petition.

 

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