Troubled companies should consider reorganisations such as standstill arrangements and debt conversion into equity to help them stay afloat in a tough business environment, a top commercial law expert says.
More than 10 publicly traded companies have issued profit warnings in the last one year including the self-listed Nairobi Securities Exchange (NSE) highlighting a tough business environment that risks pushing most companies into liquidation.
According to MMC Africa Law’s Bernard Musyoka, players in the financial, agricultural, manufacturing and fast moving consumer goods sectors are the hardest hit with a huge reduction in profits as recorded in their balance sheets published recently.
“Most businesses are sinking deeper into debt and face a risk of imminent shop closure every day. This is unless a working turn-around strategy can be implemented immediately. Nakumatt, Uchumi and Kenya Airways fall into this category, and are currently rolling out measures aimed at driving them back to profitability” said Musyoka.
Lifestyle clothing retailer Deacons East Africa, underwriter Sanlam Kenya, Sameer Africa, Sasini, Family Bank, CIC Insurance, Williamson Tea, Unga Group Limited, Shelter Afrique, Limuru Tea are among the listed companies that have already issued profit warnings in the last one year. Listed companies are required by law to issue profit warnings if their profit for the current year is going to be least 25 per cent lower than the profit for the previous year.
Private companies have not been spared either. Giant retail outlet, Nakumatt, is currently struggling to stay afloat amid claims of unpaid rent, salaries and suppliers.
Mr Musyoka warned that these companies risk falling in the jaws of creditors who often result into using harsh methods that lead into liquidation and push shareholders into losses and the employees into unemployment.
“This is because such liquidation will not be straight forward, it will likely face resistance from the companies and it will take time for all the creditors to agree how to share the pie,” argued Musyoka.
The expert has advised creditors of companies facing turbulent times to consider deployment of administration – a corporate insolvency procedure by which a company can be re-organised or have its assets realized for the benefit of its creditors.
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Administration allows for the re-organisation of a company or the realization of its assets under the protection of a statutory moratorium, which prevents creditors from taking action to enforce their claims against the company during the administration process and so hamper the implementation of a strategy for the company’s rescue or asset realisation.
Other key options at the disposal of businesses caught up in such economic hardships include standstill arrangements with creditors or debts conversion into equity.
Under a standstill arrangement, the debtor company gets a new leaf of life by allowing it to trade and pay a nominated supervisor of such scheme an agreed amount at agreed intervals, which can be distributed to the on-hold creditors as agreed.
“This offers the company protection during the still period and a second chance to rectify the financial mistakes that led it into the red in the first case,” added Musyoka.
Debt into equity swaps on the other end is a capital re-organisation of a company in which a creditor converts indebtedness owed to it by a company into one or more classes of that company’s share capital which may not be equity share capital in the strict sense. This lowers the level of the debt of the debtor company, hence improving cash flows.
Mr Musyoka concludes that “unless the existing shareholders are willing to pump more capital, such conversion of debt into equity in favor of the creditor often results into a dilution of existing shareholders”.