Directors’ duties in insolvency in Kenya are a real and often overlooked exposure. This guide explains how the duties shift and how to protect yourself.
Who this guide is for
This guide is for directors of companies in or near financial difficulty, and for the shareholders and advisers around them. It sits alongside our guides to company administration and business rescue and to liquidation and winding up, as well as personal bankruptcy and insolvency for individual directors and striking off a dormant company, which set out the options for the company itself.
The duty shifts towards creditors
In normal times, directors run the company for the benefit of its members. But once the company is insolvent, or heading there, the people with the real economic stake are the creditors, because it is their money that will be lost if the company fails. Kenyan law recognises this, and the practical effect is that directors of a company in the zone of insolvency must have regard to the interests of creditors and must not worsen their position. Continuing to run the business as if nothing has changed is where directors get into trouble.
Insolvent trading
The central risk is insolvent trading. Broadly, if a director knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding an insolvent liquidation, and the company kept trading and incurring debts anyway, the Insolvency Act, 2015 allows the court to order that director to contribute personally to the company’s assets. In our view this is the exposure directors most often miss: the debts are the company’s, but the personal contribution order lands on the director who traded on when they should have stopped.
Fraudulent trading
Worse than insolvent trading is fraudulent trading: carrying on the company’s business with intent to defraud creditors or for any fraudulent purpose. A person knowingly party to that can be ordered to contribute to the company’s assets, and fraudulent trading can also be a criminal offence. The line between pressing on in good faith and trading fraudulently is one directors should never test without advice.
| Conduct | What it is | Consequence |
|---|---|---|
| Insolvent trading | Trading on with no reasonable prospect of avoiding insolvent liquidation | Personal contribution order |
| Fraudulent trading | Trading with intent to defraud creditors | Personal contribution; possible offence |
| Misfeasance / breach of duty | Misapplying company property or breaching duties | Repayment or compensation |
| Disqualification | Unfitness shown in an insolvent company’s failure | Ban from acting as a director |
Disqualification
Beyond money, a director can lose the right to act as a director at all. Where a director’s conduct in connection with an insolvent company shows them to be unfit, the court can disqualify them from being a director or taking part in the management of a company for a period. Disqualification protects the public from directors who have shown they cannot be trusted with limited liability.
How to protect yourself
The good news is that the protection is largely in the directors’ own hands. Directors who watch the numbers, take professional advice as soon as solvency is in doubt, document their decisions and the basis for them, and stop trading when there is no realistic prospect of recovery are very unlikely to face a contribution order. It is the directors who bury their heads, keep ordering supplies they cannot pay for, and hope for a miracle who are exposed.
Common questions
Can a director be personally liable for company debts? Yes. A director who trades on with no reasonable prospect of avoiding insolvent liquidation can be ordered to contribute personally.
What is insolvent trading? Continuing to trade and incur debts when the director knew, or should have known, there was no reasonable prospect of avoiding insolvent liquidation.
What is fraudulent trading? Carrying on business with intent to defraud creditors, which carries personal liability and can be a crime.
Can a director be banned? Yes. A director shown to be unfit in an insolvent company’s failure can be disqualified.
How do I protect myself? Take advice early, keep records of your decisions, and stop trading when recovery is no longer realistic.
Common pitfalls
For example, the recurring failures are not recognising when duties shift to creditors; continuing to trade and take credit in the hope that things turn around; failing to document the board’s reasoning for pressing on; and taking money out of a failing company. Each of these is exactly what a liquidator later examines.
What you should do now
- First, monitor solvency closely, and treat doubt about paying debts as a trigger to act.
- Next, take professional advice as soon as insolvency is a real risk.
- In addition, record the board’s decisions and the reasons for them.
- Meanwhile, stop trading and incurring credit when there is no realistic prospect of recovery.
- Finally, avoid paying yourself or favoured creditors ahead of the general body of creditors.
How OLM Law can help
Our insolvency and corporate teams advise directors of distressed companies on their duties and personal exposure, on when and how to act, and on defending insolvent-trading, fraudulent-trading, misfeasance and disqualification claims. We also guide boards through rescue and liquidation so that decisions are made and recorded correctly. To protect your position as a director, contact John Maina or Kenneth Likoko, Partners, at OLM Law Advocates LLP.
This article is a general guide only and is not legal advice. Please seek advice on your specific circumstances.
Authors
Further reading
- Insolvency and Restructuring in KenyaCorporate Law
- Bankruptcy and personal insolvency in KenyaCorporate Law
- Director Duties Under Kenya’s Companies Act 2015: What Boards Get WrongCorporate Law
- How to strike off a company in KenyaCorporate Law