How Insolvency Affects Business Contracts in Kenya: A Guide for Business Professionals
When a business faces insolvency—meaning it can’t pay its debts—this can have a big impact on any contracts the company is part of. Contracts with suppliers, customers, and lenders might change or even be canceled due to insolvency proceedings. In Kenya, the Insolvency Act, 2015 lays out how this process works, providing guidelines for protecting both the struggling business and its creditors. Here’s a simplified look at what happens when insolvency affects commercial contracts, and what business owners should know.
What Happens to Business Contracts in Insolvency?
When a business becomes insolvent, a court-appointed person, known as an administrator or liquidator, may be assigned to handle its assets. An administrator manages the company in the hope of keeping it running or selling parts of it to pay off debts, while a liquidator’s job is to sell the company’s assets to pay creditors if the business must close.
When a company goes into administration, creditors – people or businesses it owes money to – are typically restricted from taking any action to enforce their rights or collect debts. This is done to give the business a chance to reorganize or find new financing without pressure from creditors. If the business goes into liquidation (the process of selling assets to pay off debts), contracts may either end or be renegotiated to fit the liquidation process, sometimes affecting both suppliers and customers of the business (elibrary.acbfpact.org).
The Pre-Insolvency Moratorium: What It Means for Creditors
In Kenya, recent updates to the Insolvency Act introduced a “pre-insolvency moratorium,” which gives a struggling business a temporary break from debt collection efforts while it tries to sort out its finances. This moratorium lasts 30 days but can be extended. During this period, creditors—like suppliers, landlords, or banks—cannot demand payment or seize assets unless the court or an appointed “monitor” allows it (DLA Piper Africa).
This breathing space gives the company time to negotiate with creditors for things like extended payment terms or other ways to reorganize its finances. For creditors, it means a delay in receiving payments, but it also gives the business a chance to recover and avoid full liquidation, which might otherwise reduce the amount creditors can collect.
How Different Creditors are Protected
The Insolvency Act sets up protections for two types of creditors:-
Secured creditors: These are lenders who have rights to specific assets of the business, like a property or machinery, as collateral. Secured creditors are usually paid first in the event of insolvency. However, they may be temporarily restricted from enforcing their rights while the company is in administration or under a moratorium. This pause is to see if keeping the business running could yield a better outcome than an immediate sale of assets.
Unsecured creditors: These are individuals or companies without a specific claim on the business’s assets. While unsecured creditors are lower on the priority list for repayment, the law requires a part of the company’s assets to be set aside specifically for them. This ensures they get some compensation even if the business’s funds are limited.
Termination of Contracts and “Voidable Transactions”
Sometimes, a contract with a company facing insolvency might include an “insolvency clause,” which allows one party to end the contract if the other becomes insolvent. However, Kenyan courts may review these clauses to see if they unfairly harm other creditors. Contracts that are deemed to give an unfair advantage to one party, especially just before insolvency, can be canceled or reversed by the courts.
Additionally, any transactions made by the insolvent company just before going into administration could be seen as “preferential” if they prioritize one creditor over others. Such transactions might be voided to make sure all creditors have a fair chance to get repaid.
Options for Saving the Business and Its Contracts
In Kenya, the Insolvency Act No. 18 of 2015 includes options that can help a business in distress negotiate its way out of trouble without going straight to liquidation :-
Company Voluntary Arrangements (CVAs): A CVA is an agreement between the business and its creditors to alter payment terms and manage debt more flexibly. With approval from the court, CVAs can help businesses settle debts over time while continuing to operate.
Schemes of Arrangement: This is another court-approved method where a business can restructure its finances with the cooperation of creditors, allowing it to continue operations without immediately liquidating assets. This can be particularly useful for businesses with complex debts that need time to reorganize.
These options can be vital for preserving ongoing contracts, which might otherwise be terminated if the business were liquidated. By choosing a CVA or Scheme of Arrangement, companies can negotiate with creditors to keep the business going and maintain supplier or customer relationships.
Final Thoughts
For any business professional, understanding the implications of insolvency on contracts is essential. Insolvency doesn’t just mean a company is out of money—it can also disrupt agreements, delay payments, and affect business relationships. The Kenyan Insolvency Act aims to balance protecting creditors’ rights with giving distressed businesses a chance to recover. Knowing the basics of how insolvency impacts contracts can help business owners and partners navigate the process more effectively and make informed decisions when dealing with a financially troubled business.
Written by Elizabeth Museo, AMMLAW Communication
REFERENCES:
https://www.oraro.co.ke/the-insolvency-act-2015-the-impact-on-creditors-and-their-right-to-realise-securities/
https://www.dlapiperafrica.com/en/kenya/insights/2021/why-new-changes-to-the-insolvency-laws-matter.html
https://elibrary.acbfpact.org/acbf/collect/acbf/index/assoc/HASH9afe/ea5084cd/de43375c/e3.dir/AfCoPCaseStudy023.pdf
Insolvency Act No. 18 of 2015 https://brs.go.ke/download/insolvency-act-18-of-2015/