Schemes of arrangement to the rescue of Kenyan companies in financial distress
Kenyan companies in financial distress now have more options than before. Previously, going into bankruptcy was not an uncommon fate for failing firms.
New possibilities for the rescue of ailing companies have opened up as a result of the successful corporate restructuring of Kenya Airways plc and a related court ruling that schemes of arrangement are binding on all creditors if 75% are in agreement.
The Kenya Airways restructuring has shown that schemes of arrangement have significant potential as a method of conducting debt restructuring. Where previously some large corporate entities have gone into bankruptcy under their debt obligations, schemes of arrangement have emerged as a viable option for obtaining relief from creditors and gaining some much-needed breathing space.
An important lesson learnt in this restructuring is that banks in Kenya are not excluded from the binding effect of schemes of arrangement where a creditor successfully rallies 75% of creditors to accept the scheme.
In the Kenya Airways case, some local banks had argued that they were not the same type of creditor as the Government of Kenya. However, both the Court of Appeal and the High Court of Kenya ruled that the banks were in fact in the same class (i.e. financial creditors) and so were bound by the scheme of arrangement.
Schemes of arrangement are provided for in the Companies Act, 2015, and are a legal mechanism to effect structural change within a company or to significantly affect the rights and obligations between a company and its shareholders. Although schemes were provided for under the previous Companies Act, they were not commonly used.
As it is likely that other Kenyan companies may in future be interested in exploring the possibilities that schemes of arrangement offer, it is useful to have a working understanding of their legal standing and how they function.
The primary advantages of using a scheme of arrangement are to:
Avoid the need to conclude the many individual agreements that would otherwise be unavoidable;
Provide greater certainty around the timing and outcome of the proposal; and
Make the scheme binding on any creditors or members who voted against it, provided it has the approval of 75% of the relevant creditors or members and is sanctioned by the court.
Any scheme of arrangement may be proposed by either the company or any creditor or member (or the liquidator or administrator, if that is the situation). To start the process, the company (or other proposer of the scheme) defines the creditors or members that the scheme will affect. Thereafter, an application is made to court to convene a meeting with the affected creditors or members.
Once the court has directed where and how the meeting will be convened, the company gives notice of the meeting either directly to each creditor or member or by way of an advertisement.
If sent directly to each creditor or member, the notice must be accompanied by a statement that explains the effect of the proposed arrangement or compromise and specifies any material interests of the directors. If the material effect on the directors is different from the effect of the arrangement on others, then this must be explained.
Similarly, if the arrangement affects the rights of debenture holders of the company, the statement must also explain how they are affected.
Companies should note that it is mandatory to provide enough information to allow the creditors or members to make an informed decision about the scheme.
The creditors or members must be given at least 14 days’ notice of the meeting.
For a scheme to be considered as passed at the meeting, it needs the approval of a simple majority in number, representing 75% of the creditors or members in value.
After the scheme meeting, any creditor or member of the same class is entitled to apply to court to sanction the scheme of arrangement. By the same token, any creditor or member may challenge the outcome of a scheme meeting in court, but this challenge must be supported by convincing evidence that there has been a failure to comply with the statutory requirements.
There are a number of English cases, which state that a court must consider a host of factors before sanctioning a scheme. For instance, the members or creditors of the relevant class must have been fairly represented at the meeting, and the statutory majority must have acted in good faith and in the best interest of the class to which they belong
While English cases are not binding on Kenyan courts, they do have persuasive value when a case is being argued.
Once the court sanctions a scheme, however, it is binding on all the affected members or creditors, whether they voted for the scheme or not. The final step that would be required to make the scheme effective is to immediately lodge the court sanction order for registration with the Registrar of Companies, otherwise it will have no effect.
Companies contemplating a scheme of arrangement should be aware of the hurdles that can be encountered. For example:
There may be objections to the way creditors or members are classified (as happened in the Kenya Airways case);
Publicity around the court proceedings may attract non-affected parties to try and join the proceedings.;
Other court proceedings might also be launched in an attempt to hold up the process and ensure the applying parties’ views are heard;
A creditor may successfully file a petition for the winding up of the company before the court issues an order sanctioning the scheme of arrangement;
A creditor may apply to the court for conservatory orders based on alleged breach of the right to property under Article 40 of the Constitution of Kenya. The petitioner is likely to allege that section 926(3) of the Companies Act, which provides for the scheme as binding, is unconstitutional. The potential argument here would be that the scheme denies the creditor the right to property (being the debt owed);
Court availability, especially if judges have heavy caseloads and time is of the essence for the company concerned.
All in all, the road to a successful scheme of arrangement is not necessarily smooth but may be well worth the effort if it saves the company.