The COVID 19 pandemic and the resulting government directives to limit the spread have severely impacted multiple sectors in Kenya. Uncertainty about the duration of the crisis has caused individuals and businesses to implement defensive cash management strategies and cancel or postpone non-essential spend, disrupting revenue streams for suppliers and service providers and leaving many unable meet their financial obligations. Unfortunately for some companies, this may result in insolvency, possibly followed by liquidation. It is therefore critical that individual directors of companies facing financial difficulty are aware of their potential individual liability in an insolvency situation, and immediately begin to act in a manner to avoid or mitigate such risk.
1. What constitutes insolvency?
Insolvency is the inability of a company to pay its debts. The Insolvency Act 2015 provides that a company is unable to pay its debts if:
- a creditor to whom the company is indebted for KShs 100,000/- or more has served a written demand on the company requiring it to pay the debt and the company has failed to pay the debt for at least 21 days or to secure or compound it to the creditor’s satisfaction;
- if an attempted execution of a judgment, decree or order of any court is returned unsatisfied, in whole or in part;
- if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due or that the value of the company’s assets is less than the amount of its liabilities (including contingent and prospective liabilities).
2. What risks does a director of an insolvent company face?
Under the Companies Act 2015 and the Insolvency Act 2015, a director can potentially be held personally liable for certain actions relating to the period prior to a liquidation with penalties that include (i) disqualification from being a director for up to 15 years (ii) disqualification from being otherwise involved in the promotion, formation or management of another company or (ii) an order to personally contribute to a company’s assets in compensation.
3. What actions might lead to a directors’ personal liability?
- Engaging in wrongful trading – which may arise if a liquidator forms the view that a director knew or ought to have known that there was no reasonable prospect that the company would avoid being placed in insolvent liquidation. A company is in insolvent liquidation if at the time the liquidation commences, its assets are insufficient for the payment of its debts and other liabilities and the expenses of the liquidation. When considering an allegation of wrongful trading, the court will consider the manner in which a director undertook their duties with the director’s liability being mitigated if they can prove that they took steps to avoid potential loss to the company’s creditors;
- Participating in fraudulent trading – which may arise where a liquidator forms the view that the business of the company was carried out with the intent to defraud the company’s creditors or for fraudulent purposes;
- Mishandling of company property – which occurs (within the twelve months immediately preceding the commencement of the liquidation) in anticipation of liquidation, such as fraudulent removal of property or falsification of company documents. If found guilty, a director on conviction is liable to pay a maximum fine of two million shillings (approx. USD 20,000.00) or to imprisonment for a term of up to 5 years or both.
Matters that a court will take into consideration when determining liability and the appropriate penalty include:
- the extent of the responsibility of the director for the causes of the company becoming insolvent;
- the extent of the responsibility of the director for any failure by the company to supply any goods or services which have been paid for;
- the extent of responsibility of the director for the company entering into any transaction or giving any preference, being a transaction or preference that is liable to be set aside under the laws relating to insolvency;
- the extent of the responsibility of the director for any failure by the directors of the company to comply with a duty under the laws relating to insolvency to call a creditors’ meeting in a creditors’ voluntary liquidation;
- any failure by the director to comply with any obligation by or under a provision of the law relating to insolvency.
4. What other risks might a director of an insolvent company face?
If a director has given a guarantee to a creditor in respect of the liabilities of the company, the creditor may choose to call on the guarantee to satisfy the debt.
5. Given that directors are not responsible for the impact of COVID 19, what defences are available e.g. in claim for wrongful trading?
In jurisdictions such as the United Kingdom and Germany, emergency legislation has been passed to suspend certain statutory provisions relating to directors’ liability, including for wrongful trading. These actions have been taken to protect directors’ who may ordinarily face liability for continuing to trade while in insolvent liquidation, but which would now be unjust due to the impact of COVID 19 on consumer and other business activity, as well government directives to cease certain business activities. Suspension of wrongful trading provisions has not occurred in Kenya and there has been no official indication that it will occur.