INSOLVENCY: Legal protection for directors

The downfall of big Kenyan retail chain Uchumi Supermarkets, which painfully exited the Tanzanian and Ugandan markets amid financial woes, might see some previous Uchumi directors being held personally liable for Uchumi’s huge losses to investors, financiers, suppliers and employees.

Recently, Kenya’s Capital Markets Authority (CMA) revived the fraud case it filed against ex-Uchumi directors in 2017, but which the High Court in Nairobi dismissed on account of defective charges.

The downfall is also set to cast light on legal, business, public policy and other aspects of transactions which require carefulness and soundness of judgment on the part of directors and senior managers.

The supermarket giant last year survived insolvency and has been banking on a Ksh1.8 billion ($18 million) bailout package from the Kenya government of which Ksh700 million ($7 million) was been released in December.

Recent media reports indicate that the government declined to release the full amount promised after Uchumi failed to meet certain conditions of the bailout, with some analysts casting a bleak outlook on recovery efforts for the ailing retail chain.

Uchumi’s downfall brings to the fore a lot of issues about corporate governance and how things fell apart in general and the importance of directors’ protection against personal liability when a company goes under.

Auditor’s role under microscope

Because of the collapse of Uchumi, there have been calls for “Big Four” audit firm Ernst & Young (EY) in Kenya to be put under closer scrutiny.

The capital markets regulator, CMA, issued a Notice To Show Cause (NTSC) to EY on August 31, 2016 as part of a probe that wants to establish the audit firm’s role in accounting malpractices at Uchumi.

However, EY filed a case against the regulator in the High Court of Kenya seeking for an order to stop the NTSC process. High Court judge John Mativo’s judgment delivered just last month dismissed the audit firm’s case, paving the way for the prob.

Possible enforcement actions that EY could face include a censure, monetary penalties and being required to compensate investors who purchased Uchumi shares during the 2014 rights issue.

Liability of directors

A key principle of company law and modern commerce is that a limited company is separate and distinct from its shareholders and directors. Though it requires individuals (generally, directors) to enter into arrangements, a company will usually be treated as solely responsible for its debts and obligations. But this principle is not applied without exception.

For Uchumi, the High Court in Nairobi has already given the capital markets regulator the green light to examine the conduct of ex-Uchumi directors. Wrongful trading and fraudulent trading charges are being considered by the regulator.

In Tanzania, both wrongful trading and fraudulent trading are offenses under the Companies Act, Cap 212, and the Capital Markets and Securities Act, Cap 79. Wrongful trading is a civil offence, while fraudulent trading is a criminal offense.

Directors who know, or should have realised, that the company was going into liquidation but choose to close their eyes to the company’s condition, bury their head in the sand and continue trading as normal could be liable for wrongful trading.

Fraudulent trading, considered to be a more serious offense than wrongful trading, is when a director knows or should have realised that the company was going into liquidation but continues trading with the intention of defrauding creditors.

Section 269 of the Companies Act allows a court to declare a director of a company that has gone into liquidation to be personally responsible, without limitation of liability, for the debts or liabilities of the company if the director is found guilty of fraudulent trading, which can carry up to five years imprisonment.

The court may also order that person not to be a director of or in any way, be concerned in or take part in the management of a company for a period of up to five years.

The crucial point to note is that a lot will depend on how much the director knew about the company’s condition at the time of committing the alleged wrongful trading or fraudulent trading.

Directors facing the likelihood of regulatory investigations for possibly incriminating evidence need to be proactive by gathering pertinent evidence to establish the facts. Bringing in a lawyer early can help defend you against charges arising from a company’s collapse and protect your interests. ____________________________

The author is the managing partner of Isidora & Company Advocates.