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The Place of Insolvency Proceedings in Debt Recovery

CM Advocates > Legal News  > The Place of Insolvency Proceedings in Debt Recovery

The Place of Insolvency Proceedings in Debt Recovery

A company is considered insolvent when it is unable to pay its debts when they fall due or when it is proved to the satisfaction of the Court that the value of the company’s assets is less than the amount of its liabilities.

According to the Insolvency Act, 2015 (the “Act”), a company is unable to pay its debts if a creditor to whom the company is indebted for a minimum of KShs. 100,000.00 has served a written demand on the company requiring it to pay the said amount but it has failed to do so; or where execution or other process issued on a judgment, decree or order of any Court in favor of a creditor of the company is returned unsatisfied in whole or in part.

Section 424 of the Act stipulates, where the foregoing is the case, an application for liquidation of the company may be lodged in Court, and if the Court is satisfied that the company is indeed insolvent, it will issue an order for liquidation. The effect of such a liquidation order is to put to an end the operation of the company and have its assets sold and the proceeds thereof used in settling its debts and/or distributed to the creditors in settlement of the debts owed by the company.

A review of the Act reveals that as long as a company is unable to pay its debts, there is nothing preventing a creditor from filing a liquidation application against the company. It therefore follows that a creditor owed at least KShs. 100,000.00 or whose judgment, decree or order is returned unsatisfied can make an application for liquidation against the company. The question that begs therefore is at what point such an application should be made – after the creditor has exhausted all other debt recovery methods or as a first recourse? This article seeks to answer this question by analysing the law and judgments of the Kenyan courts on the issue.

The Intersection between Insolvency and Debt Recovery

As noted in the Act, the failure by a company to satisfy its debts allows its creditors to file a liquidation petition against the company. This mode of recovery is however not utilised by creditors for various reasons, including the common belief that the creditor is required to exploit all other ways of recovering the debt owed to them before commencing insolvency proceedings against the debtor. A liquidation order has been likened to a “a kiss of death” due to its grave implications including the closing down of a business as well as the incapacities that come with such an order. Many people therefore view it as a drastic measure that should only be invoked as a last resort when it comes to recovering debts owed by a company.

A review of the case law on this issue reveals that the main argument of debtors who find themselves facing insolvency proceedings is that the creditor ought to have first attempted to recover their debts through other civil remedies available to them before instituting insolvency proceedings against them. It has also been constantly posited in such proceedings that reviving a company that is in financial distress is more beneficial than liquidating it in order to pay creditors.

Courts have, to some extent, agreed with this notion and noted that the liquidation of companies as a first resort may be improper and that the same ought to be pursued instead as a last resort. In Siro Brugnoli & another v Giancarlo Camerucci & another [2016] eKLR, for instance, the court declined to issue a winding up order finding that the course of justice would be in favor of not winding up the company if there is an alternative remedy. The court went ahead to hold that the petitioners ought to pursue the alternative remedy available to them as opposed to winding up the company. Similarly, in Kitmin Holding Limited v Noble Resources International Pte Limited [2018] eKLR, the court was of the opinion that where a creditor has an efficacious alternative remedy for pursuing payment of an outstanding debt, then the presentation of a liquidation application should be viewed as improper and oppressive as liquidation proceedings may turn out to be death knell of the company.

As the Act does not expressly provide that the use of insolvency proceedings should be the last resort, the Courts in the above cases must have viewed the circumstances before them through the lens of the Act’s objectives which include to enable persons, entities and troubled companies operate as a going concern so that they can ultimately be in a position to meet the financial obligations of all their creditors and/or achieve a better outcome for their creditors in comparison to that which would have been the case if the creditors were adjourned insolvent or bankrupt. The ruling of the Courts appears to balance the rights of the creditors with those of the companies by attempting to resuscitate the business and give the struggling entities a second chance to settle their obligations before making the liquidation order.

In contrast to the foregoing decisions, the court in Pride Inn Hotels & Investments Limited v Tropicana Hotels Limited (2018) eKLR held that where companies failed to pay their debts, liquidation of the company need not be resorted to as the last remedy. The appellant in this case appealed against a liquidation order made against it on various grounds, including that the judge had misdirected himself in failing to find that filing of a petition for liquidation of a company should be a last resort when recovering of a debt owed. The appellant argued that the creditor ought to have first pursued other ways of recovering the debt before seeking and enforcing a liquidation order. The Court, in its ruling, stated that no provision in the Act required this remedy of liquidation of a company to be the last resort and that so long as the conditions contemplated in the Act existed, a creditor had the right to seek a liquidation order. In dismissing the appeal, the court observed that liquidation is in fact one of the ways a creditor could secure a debt and not necessarily as the option of last resort. Justice W. Karanja however delivered a diverging opinion in the foregoing case in which she agreed with the notion that liquidation of a company is a last resort as a winding up order was similar to passing a death sentence on a company and killing any hope of its resuscitation. She was of the opinion that before filing an insolvency petition the creditor ought to present evidence that all other efforts to recover the debt had failed to yield the desired results and went further to argue that the Court ought to establish if there exists an alternative and less draconian remedy to the creditor before issuing a winding up order.

It can therefore be concluded that although there are opposing views as to the stage at which insolvency proceedings may be resorted to, the proceedings can indeed be used by creditors to recover their debts even as the first point of recourse.

Challenges

There are three main challenges that can be experienced when a party chooses insolvency proceedings as an avenue of securing or recovering a debt.

i. The debt should not be a disputed one. The courts have declined to allow insolvency proceedings against companies where the debt in question is disputed. This was held in the case of Kenindia Assurance Company Limited v Administrator Nakumatt Holdings Ltd & another [2018] eKLR in which the Court issued an injunction preventing commencement of liquidation proceedings on the ground that the debt in question was disputed.

ii. The debt owed cannot be less than KShs. 100,000.00. Creditors owed less than this amount are therefore precluded from using this avenue to secure owed amounts or enforce payment of the same.

iii. Insufficiency of assets. One can obtain a liquidation order against a company but end up finding that the company has no assets that can be sold in settlement of the debt. It is therefore advisable for unsecured creditors to first carry out an investigation and establish whether the debtor in question has assets that can be sold in satisfaction of the amount owed upon obtaining a liquidation order. Where a company has assets, seeking a liquidation order would be a prudent step to secure the assets and allow the company to realise the same.

In conclusion, it is evident from the discussion above that insolvency proceedings have a place in debt recovery. This is a remedy that creditors should therefore explore as it will save them the hassle that comes with pursuing other execution proceedings. It is also an effective method of debt recovery as a company that is faced with a liquidation application is likely to pay the amounts owed or offer a payment plan for the fear of being wound up.

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