Corporate Insolvency and Winding Up
Insolvency
Corporate Insolvency and Winding Up
Syllabus tag: KASNEB CPA | Intermediate Level | CA21 Company Law | Topic 10 Corporate Insolvency and Winding Up
Lesson objectives
By the end of this topic, you will be able to:
- Distinguish the rescue procedures from liquidation
- Distinguish compulsory from voluntary winding up
- State the grounds for a compulsory winding-up order
- Set out the order in which creditors are paid
- Explain fraudulent and wrongful trading
Why this matters
The Insolvency Act 2015 reoriented Kenyan law towards rescuing viable businesses rather than simply liquidating them. Knowing which procedure fits which situation is the substance of this topic.
Rescue or liquidate
Administration places the company under an administrator with a statutory purpose: first to rescue the company as a going concern, failing that to achieve a better result for creditors than liquidation would, and failing that to realise property for secured or preferential creditors.
A moratorium applies during administration, so creditors cannot enforce without consent. That breathing space is the point of the procedure.
Company voluntary arrangement is a binding compromise with creditors, approved by the required majorities. It suits a company that is fundamentally viable but cannot meet its debts as they fall due.
Liquidation ends the company. It is the last resort, not the first.
The ordering matters and is examinable: rescue is attempted before realisation, and an examiner will expect that reasoning rather than a reflexive answer of winding up.
Types of winding up
Compulsory — by order of the court on a petition.
Voluntary — by resolution of the members, and of two kinds:
| Members' voluntary | Creditors' voluntary | |
|---|---|---|
| Company is | Solvent | Insolvent |
| Requires | A declaration of solvency by the directors | No declaration |
| Liquidator appointed by | The members | Effectively the creditors |
| Control | Members | Creditors |
The declaration of solvency is the dividing line. Directors declare that the company can pay its debts in full within a stated period. A director who makes that declaration without reasonable grounds commits an offence — which is what stops it being a formality.
Grounds for compulsory winding up
- The company is unable to pay its debts
- The company has resolved by special resolution to be wound up by the court
- The company has not commenced business within a year, or has suspended it
- It is just and equitable to wind up
Inability to pay debts is established by a statutory demand left unsatisfied for the prescribed period, by an unsatisfied execution of judgment, or by proof that the company cannot pay as debts fall due.
The just and equitable ground is the flexible one. It has been applied to deadlock between equal shareholders, to the failure of the substratum — the main purpose for which the company was formed — and to the exclusion of a member from management in a quasi-partnership company.
Order of distribution
Assets are applied in this order:
- Fixed charge holders, out of the asset charged
- Liquidation expenses, including the liquidator's remuneration
- Preferential debts — certain employee claims and taxes
- Floating charge holders
- Unsecured creditors, sharing rateably
- Members, according to their rights
Two points to hold onto.
A fixed charge holder ranks ahead of the expenses in respect of the asset charged, because the asset was never freely available to the company. A floating charge holder ranks behind preferential creditors — which is the practical difference between the two charges and the reason lenders prefer a fixed charge.
Members come last. That is the corollary of limited liability: they take the residue if there is one, having risked only their investment.
:::checkpoint A bank holds a floating charge over a company's stock. On liquidation the realisations cover the liquidator's expenses and the preferential creditors, leaving a small surplus. Explain the bank's position and why a fixed charge would have been better. :::
Fraudulent and wrongful trading
Fraudulent trading requires intent to defraud creditors. It carries personal liability to contribute to the assets, and criminal liability. Intent is hard to prove, which limits its practical use.
Wrongful trading requires no dishonesty. It applies where a director knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation and did not take every step to minimise creditors' losses.
That lower threshold is the point. Wrongful trading catches the far commoner case of directors who trade on hopefully, believing something will turn up, while creditors' position worsens.
The standard applied is the same dual test as in directors' duties: what a reasonably diligent person with the general knowledge expected of that role would have concluded, and what this director actually knew.
The defence is that the director took every step to minimise loss to creditors. Continuing to trade is not automatically wrongful; failing to act once the position is hopeless is.
:::checkpoint Two directors continue trading for eight months after their finance director warns that insolvency is unavoidable. One resigns immediately; the other stays and negotiates a partial repayment plan with the major creditors. Discuss their respective positions on wrongful trading. :::