A Company is considered insolvent if it cannot pay debts as they fall due or in the usual course of business. In Kenya, the Law regulating Insolvent Companies’ affairs is the Insolvency Act, No. 18 of 2015 [hereinafter “the Act”]. Section 384 of the Act provides the test for insolvency and describes the instances where a Company will be deemed as unable to pay its debts.

Under Section 384 [1] of the Act, a Company shall be deemed unable to pay its debts if: –

  1. A creditor to whom the company is indebted for 100,000.00 or more has served on the company a written demand requiring the company to pay the debt within 21 days, and the company has failed to meet the demand to the reasonable satisfaction of the creditor; or
  2. A monetary decree or order has been passed against the company, and the company has failed to satisfy such decree or order in whole or in part; or
  3. It is proved to the satisfaction of the Insolvency Court that the company is unable to pay its debts as they fall due.

The situation described in section 384 [1] [c] above is often described as equity insolvency or cash-flow insolvency.

Further, in section 384 [2], a company is also regarded as unable to pay its debts if it is proved to the Court that the value of the company’s assets is less than the number of its liabilities. This includes contingent and prospective liabilities.

According to the English Supreme Court in BNY Corporate Trustees Services Ltd v Eurosail-UK 2007-3BL Plc [2013] UKSC 28, a company in the situation described in section 384 [2] is often said to be “balance-sheet” insolvent. Still, that expression is not to be taken literally because a company’s statutory balance sheet, prepared following company law requirements, may omit some contingent assets or liabilities.

There are so many instances where creditors and members of the Company resort to insolvency proceedings to recover a debt, yet the test under section 384 has not been met. While creditors are at liberty to use insolvency proceedings as a means of debt recovery, insolvency proceedings cannot be used to arm-twist a party into complying with their obligations to satisfy a debt. Similarly, the Insolvency Court cannot be used by debtors as a means to shield themselves from their obligation to pay debts.

Case in point: – a debtor may file an application praying for an administration order to enjoy the interim moratorium provided for under Section 561 of the Insolvency Act. The interim moratorium will typically operate as a temporary halt on specific transactions and adverse actions against the company, such as execution.

In such an instance, the insolvency proceedings would amount to a sham and can be deemed contrived.

At all times, it is upon the debtor who invokes the jurisdiction of the Insolvency Court to prove that, indeed, the company is unable to pay the debts owed. This was the position of the Court in the matter of Ali Jillo Fallan (Insolvency Cause 6 of 2018) [2021] KEHC 8 (KLR) (Commercial and Tax) (10 September 2021) (Ruling), where the Court held that to establish insolvency; it must be shown that the debtor’s liabilities as a fact exceed his assets and not merely that they might do so, and clear proof of this must be adduced. For this reason, the debtor must furnish the Court and the creditors with a statement of financial position.

Where the debtor proves inability to pay debts, the burden then shifts on the creditor opposing the insolvency proceedings to verify that the debtor is indeed able to pay its debts, the proceedings are a sham, or irregularities exist in the financial reports. This can be determined from an inspection of the statement of financial position, which is a right granted to all creditors.

In such an instance, the creditors can seek an order from Court for an independent forensic audit of the company’s financials to be carried out to determine whether the company is in financial distress. This will provide an independent and accurate analysis of the company’s financials and guide the Insolvency Court on the next steps.

At Riskhouse International, we have a multidisciplinary team that consists of insolvency lawyers, forensic auditors and accountants who can help detect any financial irregularities through a thorough financial audit. We investigate matters relating to fraudulent financial statements and other accounting frauds; potentially fraudulent payments; revenue-related irregularities such as revenue overstatement or understatement; matters involving fraudulent disbursements, cash larceny and skimming; and inventory frauds with the aim inter alia to provide support in Personal Bankruptcy and Corporate Insolvency Litigation.