By Daniel Benson Kaaya
A modern credit-based economy requires predictable, transparent and affordable enforcement of both unsecured and secured credit claims by efficient mechanisms outside of insolvency, as well as a sound insolvency system – World Bank Principles and Guidelines for Effective Insolvency and Creditor Rights System [April 2001]
One of the key characteristics of insolvency law is ensuring the honouring of a creditor’s claim by the debtor. A creditor’s claim ought to be honoured pari passu. The pari passu principle ensures the rateable and equitable distribution of the assets of the insolvent company among its creditors.
In ensuring this equitable and rateable distribution of assets, after realising the assets, the creditors have to be ranked as per the law. One of the factors mostly considered in ranking is security. Joanna Benjamin, professor of law, argues that creditors take security in order to manage credit risk. Security may be personal or proprietary. In proprietary security, the creditor takes proprietary interests or rights in identified assets while with personal security, the recourse of the creditor is not to the assets but to a person—personal rights is against a third party for example a guarantor.
It is from this background of ensuring creditors’ claims are honoured pari passu, among other grounds, that, the Insolvency Act 2015 was enacted. It is not in doubt that it has immensely modernised the insolvency law regime in Kenya. This is because among other purposes, insolvency law aims at promoting the honouring of the obligations of a debtor in financial difficulties and, where possible, the renewal of solvency, applying the principles and lawful solutions specified therein.
One of the commonest ways of ensuring that creditor’s right are protected is by formulating a definitive procedure of distributing the bankrupt’s assets to the claiming creditors. The UNCITRAL Legislative Guide on Insolvency Law, provides that recognition of existing creditor rights and establishment of clear rules for ranking of priority claims is important, because it creates certainty in the market and facilitate the provision of credit, in particular with respect to the rights and priorities of secured creditors. Apart from ensuring certainty and predictability to lenders, these rules that ensure ranking of priorities of creditor claims ensures that all participants are able to adopt appropriate measures to manage risk.
Competent legal regime that actively considers the interest of the creditors is immensely important. The deficiency of orderly and effective insolvency procedures can exacerbate economic and financial crises. Francois Gianviti, the General Counsel IMF, moots that without effective procedures that are applied in a predictable manner, creditors may be unable to collect on their claims, which will adversely affect the future availability of credit. Without orderly procedures, the rights of debtors (and their employees) may not be adequately protected and different creditors may not be treated equitably.
In reverence to the Model Law, the Insolvency Act, 2015, provides for clear-cut priority of claims. Priority claims refers to those claims that will be paid before payment of general unsecured creditors—a creditor without a security interest. A secured claim refers to a claim assisted by a security interest taken as a guarantee for a debt enforceable in case of the debtor’s default.
An establishment of priority of claims is important in ensuring that creditor’s claims are honoured in the right order. Second Schedule to the Insolvency Act, 2015, discusses preferential debts. Preferential claims or debts are divided into three: first priority claims, second priority claims and third priority claims. Priority debts include, among others, remuneration of the insolvency practitioner, employee wages and unpaid contributions to employee benefit plans and tax deductions.
Further, the Act has entrenched the principle of creditor participation in insolvency proceedings. Ron Harmer, Asian Development Bank, argues that creditor participation is increasingly regarded as an important element of an insolvency law, especially as a counter-balance to the roles assigned to other participants under the law and as an important means of safeguarding creditor interests. The entrenchment of this principle, therefore, is supremely important since is an essential feature of any well-developed insolvency administration system.
Evidence of this entrenchment is manifest in the provisions of creditors meetings and their participation in alternatives to bankruptcy procedures for both natural companies and companies. ^