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Financial distress not a sufficient reason for grant of an Administration Order; an exposition of Section 531 of the Insolvency Act, 2015

CM Advocates > Legal News  > Financial distress not a sufficient reason for grant of an Administration Order; an exposition of Section 531 of the Insolvency Act, 2015

Financial distress not a sufficient reason for grant of an Administration Order; an exposition of Section 531 of the Insolvency Act, 2015

The Insolvency Act, 2015 (hereinafter referred to as “the Act) introduced the option of placement of a company under administration as opposed to the making of a liquidation order as soon as a company presents signs of insolvency.

The objectives of administration are listed under Section 522 of the Act as: maintaining the company as a going concern, achieving a better outcome for the company’s creditors than would likely to be the case if the company were liquidated (without first being under administration) and/or realizing the property of the company in order to make a distribution to one or more secured or preferential creditors. From the foregoing provision, it is clear that the focus under Section 522 of the Act is on striving to maintain a Company as “a going concern” if there is potential of the same; and thereby avoidance of liquidation process, for the sake of all persons affected especially the creditors.

The common belief is that all that is required to be proved for an administration order to be granted is that the company is unable to pay its debts. However, this is not the position; Section 531 sets out the threshold to be met for grant of an administration order. First, that the company is or is likely to become unable to pay its debts; and secondly, that the administration order is reasonably likely to achieve an objective of administration.

In analyzing the First condition, Courts have held that a company is unable to pay its debts if it is commercially insolvent. In that regard, the applicant has to adduce evidence to the effect that the company is in financial distress. Interestingly, Courts have further established that it is not sufficient for an Applicant to only show that a company has been served with various demand letters by its creditors, as though the same is proof of the company’s indebtedness. Case in point In re Naomi Muthoni Mwangi [2019] eKLR the Court held as follows:

The application is scanty in details of the Company’s inability to meet its debt. Naomi attached three letters from Co-operative Bank demanding immediate payment of outstanding amounts. One such letter dated 27th July 2018 demanded settlement of Kshs. 5,951,089 by the Company. Another letter dated 27th July 2018 demanded settlement of Kshs. 635,832.23. The third letter is dated 30th July 2018 and it made a demand for Kshs. 368.50.

Even though Naomi presented these documents as evidence of the Company’s indebtedness she failed to prove that the Company is unable to pay its debt, which is a precondition of ordering administration under Section 531.

It would therefore seem that the threshold for proving the inability of a company to pay its debts is high as there has to be sufficient proof of inability to pay the debts.

In analyzing the Second condition, Courts have held that they need to be satisfied that an administration order is ‘reasonably likely’ to achieve an objective of administration. In that regard, Courts have established that the term ‘reasonably likely’ equates, in the context of the statute a reasonable but not real prospect. Indeed, the emphasis is on ‘reasonable’ which means that the prospect must be based on reasonable grounds and as such speculative suggestion is not enough and neither is a statement simpliciter that the company or the proposed administrator believes that an objective of administration will be achieved. It is the applicant who seeks to and must satisfy the court of the prospect and must thus by way of affidavit in support of the motion establish the reasonable grounds, including an indication of how long the turnaround is expected to take.

Further, the evidence in support of this second condition must be beyond a prima facie case but not to the level of real prospect. In this regard, the Applicant must provide a substantial measure of detail about the proposed plans to maintain the company as a going concern.

On the flip side, Courts have dismissed applications for administration that have failed to satisfy the conditions under Section 531 of the Act. In re Nakumatt Holdings Limited [2017] eKLR, the Learned Judge in dismissing an application seeking to place the company under administration held as follows:

“In this regard, I am concerned that the level of the Company’s indebtedness has not been clearly revealed and neither can it be easily discerned from the documents availed by the company. I am also concerned that I have been unable to ascertain with ease the likely costs of rendering the company able to resume full scale trading as before.

The Company is evidently unable to pay its debts. For all the reasons stated in this ruling, the Company, in my judgment, has however not shown to the required standard that an administration order is reasonably likely to achieve an objective of administration. I am not satisfied that this is a case for administration for the following additional reasons. The level of indebtedness may be beyond salvage and neither the company nor the administrator has taken the time to address this. By way of disposal; I reiterate that taking the totality of the evidence properly placed before the court and considering the circumstance and litigation history of this matter, I am not convinced and satisfied that that an order for administration if made as requested is reasonably likely to achieve an objective of administration as detailed under the Act.”

In conclusion, it is without doubt that placing a company under administration is a viable option if there is hope of the company being revived. It is however important to note that for the Court to grant an administration order, the applicant must satisfy the conditions imposed under Section 531 of the Act. In that regard, financial distress in itself is not a sufficient reason for grant of an administration order in the absence of proof that the administration order is reasonably likely to achieve an objective of administration under section 522 of the Act.

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