General frameworkJurisdictional pros and cons
What are the primary advantages and disadvantages in your jurisdiction of incurring indebtedness in the form of bank loans versus debt securities?
In our jurisdiction, the most common form of debt is bank loans. There are a handful of large corporates that have issued debt securities. The advantage of debt securities over bank loans is primarily pricing. However, debt securities involve longer processes, as the Capital Markets Authority would be involved.
The securities market is generally considered to be relevant to a much smaller market of sophisticated investors, whereas bank finance is available to all. Bank credit tends to be more expensive, and generally over-collateralised. However, while debt securities may be priced lower than bank credit, the associated disclosure and due diligence requirements, and resulting delays, lead many enterprises to shy away from seeking debt securities. The recent failure of three institutions (two banks and the country’s largest supermarket), each of which had issued commercial paper in the past few years and that are unlikely to yield any returns to the investors, has further dented the market.Forms
What are the most common forms of bank loan facilities? Discuss any other types of facilities commonly made available to the debtor in addition to, or as part of, the bank loan facilities.
The common types of facilities are term loans and overdraft facilities. We also see trade finance (eg, letters of credit and invoice discount facilities) and commodity finance. Development finance and project finance (in areas such as energy and infrastructure) have become more prevalent given the country’s push for its vision 2030 blueprint for development. Mobile loans (small unsecured loans) offered by banks through tie-ups with mobile telecommunications operators have also become very popular. Banks such as KCB Bank offer lending services through Safaricom Limited service MPESA. The minimum loan issued by KCB Bank is 100 shillings with the maximum being 100,000 shillings at an interest rate of 3.66 per cent per month and payable within one to three months.
Recently there has been a proliferation of digital loan platforms. According to Business Daily, a study conducted by FSD-Kenya, Central Bank of Kenya, Kenya National Bureau of Statistics and Consultative Group to Assist the Poor shows that ‘about 6.5 million Kenyans are digital borrowers, borrowing from banks, mobile network operators such as Safaricom and Airtel, and even savings and credit cooperative organisations’. The report provides that ‘digital loans are easy to obtain, short-term, carry a high interest rate and are available from numerous bank and non-banking institutions’. M-Shwari, which is offered by Safaricom through MPESA, has the highest prevalence. MPESA loans are repaid in 30 days at an interest rate of 7.5 per cent per month. Failure to repay your loan leads to cancellation of use and a negative credit listing at a credit reference bureau. M-Shwari gives a minimum credit of 50 shillings and a maximum of 1 million shillings. Just like in the KCB service, one only needs to be an active MPESA user to use these mobile phone loans.Investors
Describe the types of investors that participate in bank loan financings and the overlap with the investors that participate in debt securities financings.
Development Finance Institutions (DFIs) and private equity funds have been particularly active investors in banks. Investors in debt securities include pension funds and insurance companies.
The government’s launch of an infrastructure bond through a mobile phone offering (M-Akiba) was aimed at attracting the public to invest. The Treasury marketed this bond to the general public. Through the issuance of this bond, the government aimed to broaden its investor base and reduce its borrowing cost. Prior to M-Akiba, the minimum investment amount for a bond was 50,000 Kenyan shillings. Whereas with M-Akiba, investors could buy in denominations of 3,000 shillings and since M-Akiba was sold through mobile phones, the government was looking to tap into an investment pool of approximately 30 million registered mobile money account holders. Although there was a lot of interest in M-Akiba prior to its launch, less than 25 per cent of the 1 billion shillings on offer was purchased. A study conducted after the launch revealed that poor timing (the change in deposit regulations which forced banks to increase interest rates paid on savings and upcoming national elections took centre stage) and a poor understanding of the product were cited as the top two reasons for the launch not being as successful as expected. Nevertheless, M-Akiba stands to be the first mobile bond to be sold in Africa and proves that, given the right marketing, Kenya is primed for such opportunities.
The Central Depository and Settlement Corporation and the Nairobi Securities Exchange jointly re-opened the M-Akiba Retail Infrastructure Bond Issue to offer Kenyans a fresh opportunity to invest in the government infrastructure bond. M-Akiba was scheduled to run from 27 May 2019 to 7 June 2019. The value date is 10 June 2019 and will start trading at the Nairobi Securities Exchange on 11 June 2019. The tenure for this bond will be one year and three months.
How are the terms of a bank loan facility affected by the type of investors participating in such facility?
DFI investment in banks has required banks using the money capital provided by the DFIs to comply with and adhere to DFI’s stricter rules on environmental, health and safety and sanctions.Bridge facilities
Are bank loan facilities used as ‘bridges’ to permanent debt security financings? How do the structure and terms of bridge facilities deviate from those of a typical bank loan facility?
Kenya does not have specialist mezzanine debt providers and therefore bank facilities are sometimes used for bridge financing. The problem with this is that the time and cost involved in securing such short-term financing often makes it impractical or feasible.Role of agents and trustees
What role do agents or trustees play in administering bank loan facilities with multiple investors?
The terms of the agents or trustees are typically set out in the finance documents. Loan Market Association (LMA) type loan documentation is often used when multiple lenders lend in syndicated transactions. Alternatively, common terms agreements are used where they have individual arrangements with the borrower. The agent acts as a facility agent to all of the banks in a syndicate and the security trustee would hold the security documents in its name, on behalf of the lenders, under the terms of an intercreditor agreement.Role of lenders
Describe the primary roles and typical fees of the financial institutions that arrange and syndicate bank loan facilities.
Typically, the primary roles of financial institutions are as facility agent and mandated lead arranger, with the security trustee role being given to a security trustee company. Fees vary from transaction to transaction depending on the size of the financing and the relationship with the borrower (typical fees include arranger fee, facility agent fee, security trustee fee and commitment fees). The arranger to a financing would typically also be the lead lender and would take on the responsibility of being the transaction coordinator.
The fee arrangements are usually set out in fee letters and are not disclosed in the main loan agreement.Governing law
In cross-border transactions or secured transactions involving guarantees or collateral from entities organised in multiple jurisdictions, which jurisdiction’s laws govern the bank loan documentation?
With respect to cross-border transactions, we often see parties agreeing to English law as the governing law, since reciprocal arrangements exist between Kenya and England concerning enforcement of English court judgments. The law governing security documents is usually local law, as enforcement locally would usually be more practical and convenient.
RegulationCapital and liquidity requirements
Describe how capital and liquidity requirements impact the structure of bank loan facilities, including the availability of related facilities.
Guideline 4.1.3 of the Central Bank of Kenya’s (CBK) Guideline on Capital Adequacy CBK/PG/03 sets the minimum absolute core capital requirement for banks, mortgage finance companies and financial institutions as follows:
- banks and mortgage finance companies: 1 billion shillings; and
- financial institutions: 200 million shillings.
While there was a proposal in the 2016/2017 fiscal budget to raise the core capital for financial institutions to 5 billion shillings, the proposal was rejected by the Kenyan parliament and the requisite amendments to the Banking Act were therefore not effected. This is the second time this proposal has been rejected before parliament, the first being in 2015.
The CBK notably objected to the proposals for increasing of core capital, which were seen as locking out smaller lenders. On 16 November 2016, the CBK issued a Guidance Note on the Internal Capital Adequacy Assessment Process, which, rather than prescribing fixed capital thresholds, requires institutions ‘[ensure] that total capital levels are adequate and consistent with their strategies, business plans, risk profiles and operating environment on a going-concern basis’.
Further, the CBK issued Banking Circular Number 3 of 2018 on 6th April, 2018 being the Guidance Note on Implementation of International Financial Reporting Standard (IFRS) 9 on Financial Instruments. Kenya adopted IFRS 9 to meet the mandatory global compliance deadline of 1 January 2018. IFRS 9 replaces the Accounting Standard (IAS) 39 for organisations dealing with accounting treatment of financial assets. The pivotal shift introduced by IFRS 9 is in the concept of provisioning for expected losses, which requires banks to set aside funds in anticipation of losses. Under IAS 39, such provisions would only be made after default had occurred and the loan was classified as non-performing. The CBK has noted that this new model of provisioning will greatly impact capital and might lead to a decline in compliance with the capital adequacy requirements. It has given banks a five-year window within which to recapitalise. A similar circular has been issued for microfinance institutions.
The requirement for provisioning of expected losses under IFRS 9, coupled with the continuing restriction on interest that can be charged on loans by licensed institutions will mean that the strain on credit availability in the market will remain.
The lending capabilities of local lenders, especially in the form of loans for bigger projects, are therefore limited. This has led to loans being offered through loan syndications, a practice that is gaining popularity in Kenya. In addition, foreign banks with higher core capitals have improved lending capabilities by lending directly to local borrowers or through their subsidiary institutions in the country.Disclosure requirements
For public company debtors, are there disclosure requirements applicable to bank loan facilities?
Typically, there are no disclosure requirements applicable. A debtor may be required to disclose its existing loans under statutory reporting requirements, such as in its annual returns filed by companies under the Companies Act and under the Capital Markets Act if they are listed on the securities exchange. However, where the facility is for a substantial amount, the public company debtor may be required by the lender to disclose, among other things, details of the management (directors), shareholders, audited accounts and pre-existing debts etc.Use of loan proceeds
How is the use of bank loan proceeds by the debtor regulated? What liability could investors be exposed to if the debtor uses the proceeds contrary to regulations? Can investors mitigate their liability?
The bank typically stipulates in the loan agreement what the loan proceeds must be used for, as law does not otherwise regulate this.
The Proceeds of Crime and Anti-Money Laundering Act, the Prevention of Fraud (Investments) Act, the Prevention of Terrorism Act No. 30 of 2012, the Prevention of Organised Crimes Act, the Anti-Corruption and Economic Crimes Act and the Banking Act are also relevant, to the extent that these laws make it an offence for any individual or organisation to open, operate, finance, recruit or assist any person or organisation engaged in terrorist activities. Section 6 of the Prevention of Organised Crime Act No. 6 of 2010 (the POC Act) criminalises attempting, aiding, abetting, counselling, procuring or conspiring with another to commit an offence under the Act. The maximum penalty upon conviction is a fine of 1 million shillings, imprisonment for a term not exceeding 14 years, or both. A lender could therefore be held directly liable for facilitating the offences under section 6 of the POC Act. The Proceeds of Crime and Anti-Money Laundering Act accords immunity and protection to institutions and officers in respect of obligations carried out under the Act in good faith, such as reporting of suspicious transactions.
Under section 15(1) of the POC Act a lender could be required to produce all information and to deliver documents and records regarding any business transaction conducted by or on behalf of any person where the Attorney General of Kenya has reasonable ground to suspect that person of committing an offence under the POC Act. A lender’s premises can also be searched and any documents or records removed for this purpose.
The use of loan proceeds by a debtor is also regulated through the provisions of the loan documentation, for instance making it an event of default if the borrower acts in contravention of the law or provisions of the documentation.
Guideline 10.3.4 of the Risk Management Guidelines 2013 on lending principles requires, among other things, that where funds are being used for a project, institutions should satisfy themselves that funds are not used for purposes other than financing the project.
Prudential Guideline CBK/PG/08 on Anti-Money Laundering and Combating the Financing of Terrorism requires that the board of directors of a financial institution:
- establish adequate internal control measures to address potential money laundering and terrorist financing risks;
- obtain, verify and maintain proper identification of customers wishing to open accounts or make transactions whether directly or through proxy;
- obtain and maintain adequate records, enable the identification of unusual or suspicious transactions;
- train staff on a regular basis in the prevention, detection and control of money laundering and the identification of suspicious transactions; and
- monitor and report any suspicious transactions or activities to the CBK that may indicate money laundering or other attempts to conceal the true identity of customers or ownership of assets.
The fulfilment of these requirements is a way of negating liability on the part of the bank.
The CBK also published the Banking Circular Number 12 of 2015 of 11th December, 2015 being the Guidance Note on compliance with Anti-Money Laundering and Countering the Financing of Terrorism. Laws, Regulations and Prudential Guidelines introduced template quarterly questionnaires to capture data on the exposure of institutions to these risks and an annual self-assessment questionnaire to evaluate system controls of an institution. Another CBK circular on the subject is Banking Circular Number 3 of 2018 dated 23rd March, 2018 being a Guidance Note on Conducting Money Laundering/Terrorism Financing Risk Assessments, which is intended to set clear standards and parameters that inform resource allocation into risk areas and policies. The Banking Circular No. 2 of 2019, which was issued by the CBK on 18 May 2019, directed banks, microfinance institutions and mortgage finance institutions to nominate an independent external third party to undertake review of the institution’s anti-money laundering measures and combating the financing of terrorism compliance. The CBK directed a contracted third party to independently submit the report of the review to the CBK by 31 May 2019. It is likely that the review may be an annual requirement by the CBK.Cross-border lending
Are there regulations that limit an investor’s ability to extend credit to debtors organised or operating in particular jurisdictions? What liability are investors exposed to if they lend to such debtors? Can the investors mitigate their liability?
There are no regulations limiting an investor’s ability to extend credit to debtors organised or operating in particular jurisdictions. Our responses in question 11 apply to this section also. Because of the shift to risk-based supervision in bank operations, certain edicts or public policy statements from time to time may affect an investor’s ability to lend to persons in certain jurisdictions. An example would be the Kenyan government’s 2015 closure of money remittance or transfer firms in response to the threat of Al-Shabaab (an Al-Qaeda affiliate based in East Africa) which affected investments in Somalia (this ban was subsequently lifted). Compliance with the aforementioned laws, regulations and Prudential Guidelines is a way of mitigating liability.Debtor’s leverage profile
Are there limitations on an investor’s ability to extend credit to a debtor based on the debtor’s leverage profile?
Yes. Banks, financial institutions and mortgage finance companies in Kenya are prohibited from granting to any person, or permitting to be outstanding, any advance or credit facility or give any financial guarantee, or incur any other liability on behalf of any person, such that the total value of the advances, credit facilities, financial guarantees and other liabilities in respect of that person at any time exceeds 25 per cent of its core capital, unless authorised by the CBK.Interest rates
Do regulations limit the rate of interest that can be charged on bank loans?
Since September 2016, banks are required to limit the rate that can be charged on a Kenyan shilling loan to no more than 4 per cent above the base rate set and published by the CBK. The CBK rate is set pursuant to section 36(4) of the Central Bank Act, which requires the CBK to publish the lowest rate of interest it charges on loans to banks and microfinance institutions. Until recently, the penalty for banks or financial institutions acting in contravention of section 33B was a fine of 1 million shillings. In default, the chief executive was liable to a one-year prison term. The CBK rate is currently at 9.5 per cent. In March 2019, section 33B that introduced the interest cap was declared ‘unconstitutional, null and void’ by the High Court ‘for being vague, ambiguous, imprecise and indefinite’. The court has however delayed the nullification for a period of 12 months for parliament to reconsider the provisions. Section 33B (3) that meted punishment on banks and bank officers was declared unconstitutional for being discriminatory contrary to articles 27 and 29 of the Constitution and an infringement of fair hearing under article 50 of the Constitution.
The CBK through Banking Circular No. 1 of 2019 recently issued the Kenya Banking Sector Charter (KBSC) to banking, microfinance and mortgage finance institutions. KBSC has been introduced as a measure to correct market failures that led to the introduction of section 33B. KBSC compliance is expected to improve credit pricing of loans by allowing banks to implement risk-based credit scoring techniques which will mean customers receive differential credit pricing based on credit information.
Section 44A (1) and (2) of the Banking Act limits the maximum amount that a bank can recover from a debtor. The maximum amount is the sum of the following:
- the principal owing when the loan becomes non-performing;
- interest as agreed contractually between the debtor and bank, not exceeding the principal owing when the loan becomes non-performing; and
- expenses incurred in the recovery of any amounts owed by the debtor.
This section does not, however, apply to limit any interest under a court order accruing after the order is made.
The Consumer Protection Act also contains provisions relating to certain types of credit agreements requiring lenders to disclose whether or not interest would accrue on the unpaid amounts and if such interest is accruing the lender must disclose the interest rate, in the absence of which the lender is treated as having waived the interest.Currency restrictions
What limitations are there on investors funding bank loans in a currency other than the local currency?
There is no formal exchange control regime in force in Kenya after the repeal of the Exchange Control Act in 1995. However, there are certain limited conditions and procedural requirements that apply in connection with the repatriation of foreign currency from Kenya that should be noted. In 2016 the CBK introduced guidelines for large cash transactions. Under the CBK’s additional guidelines, for any cash transaction above the equivalent of US$10,000, commercial banks are required to obtain documentary evidence to support the transaction such as the source of funds, details of the beneficiary, why a large deposit is necessary and the purpose of the funds. Further, section 7 of the Foreign Investments Protection Act allows for the transfer of profits out of Kenya by a holder of a certificate, in respect of the approved enterprise to which such certificate relates. This includes the principal and interest of any loan specified in the certificate. The transfer should, however, be in an approved foreign currency and at the prevailing rate of exchange.Other regulations
Describe any other regulatory requirements that have an impact on the structuring or the availability of bank loan facilities.
Imposition of prepayment premiums or penalties by lenders on a borrower in respect of loans is prohibited under section 62(1) of the Consumer Protection Act.
Sections 441 to 443 of the Companies Act 2015 prohibit a public company from giving financial assistance to a person or entity for the purchase of the company’s shares.
Withholding tax is charged at a current rate of 15 per cent with respect to interest on loans. However, exemptions apply to loans from financial instructions licensed by the CBK, as such structuring of the loan facility will be affected by withholding tax requirements and may influence the pricing of the loan.
Under section 516 of the Companies Act, 2015, a company that is a public company is not permitted to, among other things, exercise a borrowing power unless the Registrar has issued it with a trading certificate under the section.
The Banking Act prohibits a banking institution from granting or permitting to be outstanding:
- any advance or credit facility to any company against the security of the company’s own shares;
- any advance, credit facility or financial guarantee to or in favour of any company in which the banking institution holds, directly or indirectly or has a beneficial interest in more than 25 per cent of the share capital of that company;
- any unsecured advances in respect of any of its employees or their associates (however, facilities granted to staff members within schemes approved by the board and serviced by salary through a check-off system are allowed); and
- any advances, loan or credit facilities, which are unsecured, or which are not fully secured to any of its officers or their associates; where facilities to insiders are secured by guarantees, these guarantees should be supported by tangible or other securities with proven market value that are duly charged and registered in favour of the institution.
In compliance with constitutional requirements on consumer protection requiring provision of information necessary for the consumers to gain the full benefits of goods and services, the Kenya Bankers Association, in conjunction with the CBK, introduced the annual percentage rate (APR) pricing mechanism, which requires banks to disclose the total costs associated with a loan in a loan-repayment schedule (Guideline 3.4.4 of the Prudential Guidelines). The APR takes into account the interest rate component, bank charges and fees, and third-party costs, including legal fees, insurance costs, valuation fees and government levies.
Following the introduction of the interest rate cap law, lenders in the market attempted to raise arrangement fees, tariffs, commissions and other costs as a way of recovering additional returns on loans. However, under Banking Circular No. 6 of 2016 the CBK clarified that any arbitrary increment of charges is illegal pursuant to:
- section 44 of the Banking Act, which provides that no institution shall increase its rate of banking or other charges except with the prior approval of the Cabinet Secretary of Finance; and
- Regulation 2 of the Banking (Increase of Rate of Banking and Other Charges) Regulations, 2006, which provides that an application for approval of increase in the rate of banking or other charges under section 44 of the Act ought to be submitted to the Cabinet Secretary through the Governor of the CBK.
Security interests and guaranteesCollateral and guarantee support
Which entities in the organisational structure typically provide collateral and guarantee support for bank loan financings? Are there limitations on which entities in the organisational structure are permitted to provide such support?
Typically parent and holding companies provide collateral and guarantee support for loan financing to their subsidiaries, while sister companies provide the same to each other as there are no legal restrictions on issuing guarantees subject to the entity providing the collateral support derives some commercial benefit or so doing.
For public companies, board members’ approval is required for a company to issue a guarantee or provide security to secure the obligations of a director of the company, a director of a holding company, or to a person connected with a director of the company or of a holding company. For private companies, the shareholders’ approval is required for a company to issue a guarantee or provide security to secure the obligations of a director of the company or a director of a holding company.
What types of obligations typically share with the bank loan obligations in the collateral and guarantee support? If so, are all such obligations equally and ratably covered by the collateral and guarantee support?
Unsecured obligations would rank after secured obligations. The priority of secured obligations is (in the absence of any security sharing agreements) by reference to the date of creation and registration. Fixed charge securities enjoy the highest ranking. Floating charge security ranks above unsecured obligations except for preferential creditors (which include employees’ salaries and certain government taxes up to certain limits).Commonly pledged assets
Which categories of assets are commonly pledged to secure bank loan financings? Describe any limitations on the pledge of assets.
Assets of all types may be the subject of security in Kenya including future and contingent rights, cash in accounts, interests under contracts and receivables. The assets that are commonly pledged are land and company assets. Securities over land and company assets are registered at the Lands Registry and the Registry of Companies, respectively. More recently securities over movable property (which includes receivables) are also registered at the Collateral Registry. The limitation in respect of a charge over land is that the secured interest is subject to any overriding interests that need not be registered and as such a creditor may be unaware of the overriding interest at the time of taking the security.
The Movable Property Security Rights Act was passed in 2017, and it provides a legal framework for dealing with security rights in movable assets including:
- transactions that secure payment or performance of obligations, without regard to its form and irrespective of the person who owns the collateral;
- collateral (defined in the Act as a movable asset that is subject to a security right or a receivable that is subject to an outright transfer) by way of:
- a chattels mortgage;
- a credit purchase transaction;
- a credit sale agreement;
- a floating and fixed charge;
- a pledge;
- a trust indenture;
- a trust receipt;
- a financial lease or any other transaction that secures payment or performance of an obligation; or
- an outright transfer of a receivable.
Describe the method of creating or attaching a security interest on the main categories of assets.Charge over land
Under the Land Laws enacted in May 2012, namely the Land Act (Act No. 6 of 2012) (the Land Act) and the Land Registration Act (Act No. 3 of 2012), there are currently only two types of securities that are capable of being created over immovable property, namely: an informal charge; or a formal charge.
A formal charge is created where a chargor creates security over land in favour of a lender and the security is registered at the Lands Registry and the Companies Registry (if created by a company). The Land Registration Regulations, 2017 introduced standard forms for registration of charges and other land transactions.
An informal charge is created where a chargor deposits a written undertaking with the chargee to charge the property or deposits a document of title with the chargee.Charge over company assets
A specific debenture is a charge created over a specific asset of a company whereas an all-assets debenture is a charge created over the whole or substantially the whole of a company’s assets both present and future.
Failure to register a charge at the Companies Registry will render it void against a liquidator, administrator or other creditors of the company.
Security can be created over ships and aircraft in the form of a mortgage and is registrable at the relevant registry. A ship mortgage is registrable with the Companies Registry and the Kenya Maritime Authority, whereas an aircraft mortgage is registrable at the Companies Registry and notified to the Kenya Civil Aviation Authority.Security rights over movable assets
A security right over movable assets is created by way of a security agreement where the security right provider has rights in the assets or the power to create the security right over the asset. Please note that a charge over a company’s movable assets would be subject to registration at both the Companies Registry and the Collateral Registry.Perfecting a security interest
What steps are necessary to perfect a security interest on the main categories of assets? What are the consequences of failing to perfect a security interest?
The perfection of a security in relation to a company’s assets involves the payment of stamp duty and registration of the security at the relevant registry. Failure to register a security at the relevant registry will render the security void against a liquidator, administrator or other creditors of the company. Pursuant to section 885 of the Companies Act, a security created by a company must be registered within 30 days from the day on which it is created.
Security documents that need to be stamped must be stamped within 30 days of the date of the security document. If the security document is executed outside Kenya, then it must be stamped within 30 days of execution or after the date the security document is first received in Kenya.
In relation to a security right over movable assets created pursuant to the Movable Property Security Rights Act, in order to achieve effectiveness over third-party rights, the secured creditor should register a notice on the Collateral Registry. Priority of a security right over movable assets is determined by the time of registration - the first secured creditor to register a notice in respect of a security rights over a grantor’s assets ranks in priority to a subsequent secured creditor who has registered the notice. An instrument creating a security right under the Movable Property Security Rights Act is exempt from stamp duty.Future-acquired assets
Can security interests extend to future-acquired assets? Can security interests secure future-incurred obligations?
Yes, security interests can extend to future-acquired assets and obligations.Maintenance
Describe any maintenance requirements to avoid the automatic termination or expiration of security interests.
Charges over a company’s assets are usually created as continuing securities and are usually only discharged once all obligations are fulfilled. To the extent that the security is a security right over movable assets, an initial notice in respect of the security right will be effective for the period of time indicated by the registrant in the notice, but shall not exceed 10 years in any event. If the security right is created for a period of more than 10 years, the secured creditor has to register an amendment notice within six months before expiry of the first initial notice to extend the registration of the security right for a further period of 10 years.Release
Are security interests on an asset automatically released following its sale by the debtor? If so, are the releases mandated by law or contract?
There is no automatic release. Release of security interest over an asset involves the holder of the security signing, stamping and registering a document of discharge at the relevant registry. Release of security rights created over movable assets requires the secured creditor to register a cancellation notice at the Collateral Registry. The security interest in movablemoveable property extends to the proceeds of the collateral.Non-fulfilment of guarantee obligations
What defences does a guarantor have against claims for non-fulfilment of guarantee obligations? Can such defences be waived?
A guarantor has the following defences against claims for non-fulfilment of guarantee obligations:
- extension of time: the court reaffirmed the principle that where a creditor affords more time to the debtor without the consent of the guarantor then the guarantor stands discharged from liability (Rouse v Bradford Banking Co Limited  AC 586, HL);
- variation to the contract: the court stated that where the agreement between the principals is amended in a way that is not obviously unsubstantial or for the benefit of the guarantor without his or her consent then the guarantor is discharged. Similarly, if the loan amount is increased without the guarantor’s consent the guarantor would be released from obligation (Bolton v Salmon  2 Ch 48);
- release of the debtor: the court affirmed that where a creditor releases a security, the guarantor would have a defence for non-fulfilment of guarantee obligations (Re Walker, Sheffield Banking Co v Clayton  1 Ch 621); and
- lack of consideration: a company that gives a guarantee and does not receive a commercial benefit from the issuance of the guarantee will have a defence of lack of consideration.
There are a number of other defences, including duress, undue influence, misrepresentation and non est factum, that are available to guarantors. Waiver of a defence is dependent on the defence (eg, it is not possible to waive the defence of lack of consideration).Parallel debt requirements
Describe any parallel debt or similar requirements applicable in a secured bank loan financing where an agent acts for multiple investors.
In circumstances where an agent acts for multiple investors in a secured loan financing, the investors may structure the financing in a way that involves security trustee and syndicated loan arrangements.Enforcement
What are the most common methods of enforcing security interests? What are the limitations on enforcement?
The common methods of enforcing security interests are:
- suing the debtor for the money due and owing under the security interest;
- appointment of a receiver of the income (if any) under the security and, more recently, the appointment of an administrator;
- taking possession of the security by the receiver/administrator; and
- sale of the security.
The limitations on the enforcement mechanism may be contractual, as provided for in an intercreditor agreement. The Land Act also limits a chargee’s action for money on a security secured by a charge, and provides that a court may order the postponement of any proceedings, until a chargee has exhausted all other remedies relating to the charged land.Inside insolvency
Under the relatively new Insolvency Act 2015, a holder of a qualifying floating charge is entitled to appoint an administrator in respect of a company that has created the security. A qualifying floating charge is a charge over the whole (or substantially the whole) of the assets of a company. The document creating the qualifying floating charge must expressly state that section 534 of the Insolvency Act applies to the floating charge. The administrator’s major role is to rescue the business of the company and it has various powers including, but not limited to, the power to dispose of the assets of the company.
On liquidation of a company, all claims against the company shall be admissible as proof against the company. The liquidator has the power to deal with all the assets of the company, save for those assets that have been charged to secured creditors by way of a fixed charge. For floating charge security, the security holder is paid out of the proceeds of the liquidation after the preferential creditors as listed in the Insolvency Act have been paid.Fraudulent conveyance and similar doctrines
Describe the impact of fraudulent conveyance, financial assistance, thin capitalisation, corporate benefit and similar doctrines on the structure of bank loan financings.Fraudulent conveyance
The structure of bank loan financing in the context of acquisition financing counters the effects of fraudulent conveyancing by ensuring that attempts to challenge, terminate, impair, suspend or forfeit a borrower’s title or interest to the security would be an event of default. A fraudulent conveyance of property that is taken as security would render the security unenforceable.Financial assistance
For private companies financial assistance is not prohibited under the Companies Act 2015. There are exceptions set out in section 446 of the Act as to when financial assistance can be given by a public company.Thin capitalisation
If foreigners control 25 per cent of a company, thin capitalisation rules apply. The rules would not directly affect financing but preclude the company from deducting interest on loans to reduce taxable profits if it is thinly capitalised (ie, where the debt to equity ratio is more than 3:1).Corporate benefit
A company must derive a corporate benefit before guaranteeing the obligations of another company. Where corporate benefit is not apparent, the structure of the bank loan financing may include a corporate benefit agreement.
Intercreditor mattersPayment and lien subordination arrangements
What types of payment or lien subordination arrangements, or both, are common where the debtor has obligations owing to more than one class of creditors?
Subordination agreements can be of different types. A distinction can be made between contingent subordination and absolute subordination. A contingent subordination agreement is where a creditor will have its rights or entitlements subordinated only in the event of specified circumstances, usually insolvency or bankruptcy. An absolute or complete subordination agreement is one that is not contingent on any event other than the validity and enforceability of the agreement itself.
Another distinction in subordination agreements is between security subordination and payment or debt subordination. The security subordination involves the secured debt of, at least, the subordinated creditor. With this type of subordination, the subordinated creditor loses the priority to collateral it otherwise would have against the senior creditor. The second type of subordination alters the order in which payment will be made to the creditors and might or might not involve secured debt.
The challenge in enforceability of subordination arrangements is the rule of interpretation of contracts under contract law. It is possible that the court will be called upon to interpret the provisions of the subordination agreement. Some subordination agreements will contain a specific reference to the rights purportedly granted, assigned, or waived, making the court’s job simple, at least on the question of contract interpretation. Other subordination agreements rely upon general language forcing the court to determine exactly what the parties contemplated. Where the drafting is clear, the courts have generally been willing to enforce the agreement as written. Where the drafting is not clear, the result is much harder to predict and senior creditors bear the risk of ambiguity in intercreditor agreements.Creditor groups
What creditor groups are typically included as parties to the intercreditor agreement? Are all creditor groups treated the same under the intercreditor agreement?
Intercreditor agreements can be between just the creditors or alternatively, the debtor may also be a party. The rights of each creditor will be set out in the agreement and are typically the same for each creditor group.Rights of junior creditors
Are junior creditors typically stayed from enforcing remedies until senior creditors have been repaid? What enforcement rights do junior creditors have prior to the repayment of senior debt?
Typically, first-lien lenders will require that they maintain the exclusive right to realise on the collateral package for a specified period following a borrower default and that the second-lien lenders waive numerous rights that otherwise would be granted to them as secured lenders. The rights granted in favour of the first-lien lenders, are generally counterbalanced by certain protections afforded to the second-lien lenders. The second-lien lenders may have a right to be consulted before action is taken. The second-lien lenders may also have the right to limit the amount of debt that the borrower can incur. Further, the second-lien lenders may have the right to restrict amendments to first-lien credit documentation, for example, extending maturities or increasing interest rates.
Junior secured creditors may take enforcement action without consent or having to wait for senior creditors. Intercreditor agreements may, however, provide differently.
The Insolvency Act 2015 provides a list of preferential creditors and prioritises the remuneration of the bankruptcy trustee, liquidator, any person who applied to the court for an order adjudging a person bankrupt or placing a company in liquidation, persons involved in the preservation of the company’s assets, then wages and salaries to employees, then finally certain taxes.
The Movable Property Security Rights Act requires security rights such as debenture instruments and charges over movable properties to be registered at the Collateral Registry to achieve third-party effectiveness. Such registration determines priority.
What rights do junior creditors have during a bankruptcy or insolvency proceeding involving the debtor?
The rights of a junior creditor in bankruptcy proceedings will depend on whether the junior creditor is a secured or an unsecured creditor. As discussed in question 31, a secured creditor takes priority over an unsecured creditor if there are competing claims to the property or to the proceeds from the sale of the property. A junior creditor who is a secured creditor is guaranteed certain rights, regardless of subordination. These rights include the right to assert and prove its claim, the right to seek court-ordered protection for its security, the right to have a stay lifted under proper circumstances, the right to participate in the voting for confirmation or rejection of any plan of reorganisation, the right to object to confirmation and the right to file a plan where applicable.
For an unsecured junior creditor, after all expenses have been paid in full in a winding up, the company’s unsecured debts are paid in priority to all other debts. These debts rank equally among themselves after the payment of the liquidation expenses and are required to be paid in full, unless the assets are insufficient to meet them, in which case they share the assets between themselves in proportion to their debts.
The event of administration, as mentioned above, is a procedure allowing for the reorganisation of a company or the realisation of its assets under the protection of a statutory moratorium. During the moratorium all creditors are prevented from taking action to enforce their claims against the company, where the company is the debtor. Specifically, once a statutory moratorium is in place creditors cannot commence insolvency proceedings against the debtor, secured creditors cannot enforce security over the assets of the debtor and a creditor cannot exercise the right to distrain or repossess assets in the debtor’s possession.Pari passu creditors
How do the terms of the intercreditor arrangement change if creditor groups will be secured on a pari passu basis?
Where creditors are secured on a pari passu basis, the intercreditor agreement should contain an express provision stating that the creditors rank pari passu with each other regardless of when the securities were created.
Loan document termsStandard forms and documentation
What forms or standardised terms are commonly used to prepare the bank loan documentation?
In Kenya, most lenders have their own standardised terms, which are incorporated in their facility letters, loan agreements or offer letters that set out the terms of the loan and which are produced by the banks in-house. They instruct external lawyers to prepare the security documents. In syndicated, complex or higher-value loans, most banks instruct external lawyers to prepare the loan documentation and typically the loan agreement would be based on LMA-style documentation.Pricing and interest rate structures
What are the customary pricing or interest rate structures for bank loans? Do the pricing or interest rate structures change if the bank loan is denominated in a currency other than the domestic currency?
There are two main types of loan interest rate structures in Kenya: fixed rate and variable rate.
The pricing on the interest rate on local currency loans is determined by reference to the CBK rate (which is currently 9.5 per cent) and by adding the agreed margin (which is currently capped at four percentage points above the CBK’s benchmark rate).
For loans denominated in foreign currencies (eg, US dollars) banks normally apply a margin over LIBOR.
Have any procedures been adopted in bank loan documentation in your jurisdiction to replace LIBOR as a benchmark interest rate for loans?
We are not aware of any procedures being adopted. LIBOR is still in use as a benchmark rate.Other loan yield determinants
What other bank loan yield determinants are commonly used?
Banks typically only specify the cost of borrowing as a margin over a base-lending rate (currently the CBK rate for local currency loans and usually LIBOR for hard currency loans). There are moves for banks to specify actual costs and a draft bill that is currently being debated (Financial Markets Conduct Bill) may make that a legal requirement if it is passed.Yield protection provisions
Describe any yield protection provisions typically included in the bank loan documentation.
Increased costs, default interest rates and withholding tax gross-up provisions are commonplace. Change in circumstances clauses are not typical but would be included in high-value borrowings by sophisticated borrowers. For more complex arrangements (eg, syndication) there are likely to be provisions relating to the Foreign Account Tax Compliance Act of 2009 (FATCA), which seeks to penetrate bank secrecy rules to address tax evasion and impact loan documentation where non-US entities receive US-source interest and other payments. Prepayment penalties are no longer used, due to restrictions introduced under the Consumer Protection Act.Accordion provisions and side-car financings
Do bank loan agreements typically allow additional debt that is secured on a pari passu basis with the senior secured bank loans?
No, additional debt would not usually be referred to in typical loan agreements. Security documents usually provide that the borrower must not have or incur any other financial indebtedness nor grant security interests to third parties without the consent of the lender.Financial maintenance covenants
What types of financial maintenance covenants are commonly included in bank loan documentation, and how are such covenants calculated?
Financial maintenance covenants are negotiated specifically for different transactions and are unlikely to appear other than in arrangements for more sophisticated borrowers that may have multiple lenders and in complex financings. The types of financial maintenance covenants include:
- maintenance of minimum working capital and debt service coverage ratios;
- maintenance of minimum net worth;
- restrictions on other borrowings, shareholder salaries, distributions, or dividends;
- restrictions on the use of borrowed funds;
- restrictions on compensation packages for officers;
- limits on borrowing bases; and
- financial covenant ratios including debt to equity, value of net assets, financial indebtedness over earnings before interest and tax, and current ratio (current assets to current liabilities).
Describe any other covenants restricting the operation of the debtor’s business commonly included in the bank loan documentation.
Covenants are negotiated on a transaction-specific basis. These covenants include positive covenants, negative covenants and information covenants. Negative covenants include a negative pledge, restrictions on change of control and changes to the group structure or a change of business, and restrictions on financial indebtedness and payment of dividends.Mandatory prepayment
What types of events typically trigger mandatory prepayment requirements? May the debtor reinvest asset sale or casualty event proceeds in its business in lieu of prepaying the bank loans? Describe other common exceptions to the mandatory prepayment requirements.
Types of events triggering mandatory prepayment often include:
- change of control of the borrower unless the lender approves the change;
- illegality (eg, if it becomes illegal to maintain the loan on the same terms); and
- receipt of insurance proceeds unless they are used to replace a lost or damaged asset.
Describe generally the debtor’s indemnification and expense reimbursement obligations, referencing any common exceptions to these obligations.
It is a typical standard term to have the debtor covenant to indemnify the bank on a full and unqualified basis for the following:
- all costs, charges, taxes, liabilities, damages and expenses suffered by the bank in relation or incidental to the negotiation preparation and completion of the security and enforcement of the security;
- in connection with costs incurred in any proposed transaction concerning the secured assets for which the borrower needs the bank’s consent;
- costs incurred in effecting any registration that the bank may deem necessary or expedient or for the proper protection of its security;
- in connection with the expenses incurred by the bank in the maintenance, repair or insurance of the charged assets;
- all losses, actions, claims, expenses, demands and liabilities for anything done or omitted in the exercise of the powers conferred or implied by the security document; and
- in relation to legal fees owing to the advocates or other professional or technical advisers of the bank in respect of their work done.
The common exception is where any expenses or obligations are expressly imposed on the bank by law, and the transfer of such expense or obligation to the account of the borrower is prohibited.
Update & trendsKey developments
Are there any other current developments or emerging trends that should be noted?Key developments44 Are there any other current developments or emerging trends that should be noted?Amendment to the interest rate capping
The High Court has declared section 33B (1) and (2) of the Banking (Amendment) Act 2016 unconstitutional, null and void thereby halting the interest rate capping that was introduced in 2016. The said section was declared unconstitutional ‘for being vague, ambiguous, imprecise and indefinite’. The Court has delayed the nullification of section 33B for 12 months to allow the National Assembly an opportunity to tackle the ambiguities and in so doing has minimised any possible disruption on existing contracts. The penalty that was imposed for breaching the provisions has been nullified, which means that there is currently no consequence for breaching the said provision. The court also held that section 33B of the Banking Act did not limit or appropriate the CBK’s powers to formulate monetary policy. In fact, parliament only needs to rectify the ambiguities in the sections to reinstate it to its full effect. As at 19 March 2019, the Consumers Federation of Kenya has filed a notice of appeal against the ruling.
Following the continued application of the interest rate capping law which is contrary to the CBK’s recommendations to parliament, CBK introduced the KBSCKenya in September 2018 in order to correct the existing market failures in the banking businesses. The KBSC is binding on all financial businesses, banking, mortgage and microfinance institutions. It introduces risk-based credit pricing which allows persons with better credit rating to access credit more easily as the credit scoring index will be used to determine the credit pricing. This will be enhanced by the credit information sharing which the CBK noted that institutions had flagrantly ignored or used negatively to blacklist borrowers. Whether parliament will give the CBK time to implement the KBSC and groom the banking industry or not, and what the consequences, arising from the implementation of the KBSC is unclear at this stage.Introduction of Lands Registry prescribed forms
The Cabinet Secretary for the Ministry of Lands and Physical Planning issued a notice on 27 April 2018 bringing into effect the Land Registration (General) Regulations, 2017 (the Regulations). The Regulations brought into force new standard forms to be used at the Lands Registry for the registration of land transactions.
In 2019 the standard forms for registration of interest in land under the Land Registration Regulations came into force. Any person who wishes to deviate from the standard forms must apply to the Lands Registrar for approval.Mobile and internet-based lending
Mobile and internet-based lending continues to develop thereby enhancing financial lending to individuals and small and medium enterprises. Recently, Safaricom Limited, through the M-Pesa platform, introduced M-1, a concept that was introduced in M-Fuliza that is akin to bank overdrafts, which allows consumers to complete transactions on the mobile platform where they have insufficient funds in their M-Pesa accounts. The lack of regulation in respect of mobile lending platforms has favoured the significant growth of internet and mobile-based lending business, as they are not within the regulatory control of the CBK. There are proposals to regulate such businesses to level the competition with the institutions that are regulated under the banking laws, and also to protect consumers from exploitative interest rates.Capital Markets Authority Regulatory Sandbox
The Capital Markets Authority (CMA) launched a regulatory sandbox in April, 2019. This is a regulated testing environment where innovators who have new business models and developing technologies that have the potential to broaden capital markets in Kenya can check the feasibility of their products and services. The CMA issued the Policy Guidelines in March, 2019 to allow for testing of these models.
The sandbox is only applicable to products, services or business models that are not already regulated under existing laws and it is up to the person making the application to be included in the sandbox to prove that their product is not already regulated. Participation is based on application and approval by the CMA and is open to:
- companies incorporated in Kenya;
- companies that are licensed by a securities regulator in an equivalent jurisdiction; and
- applicants who intend to offer innovative products, solutions or services in Kenya.
The sandbox is also only open to applicants who have products that are fully developed; the sandbox is not a testing hub for ideas or non-developed products. An applicant can apply at any time upon payment of an application fee and the CMA can either reject the application or issue a letter of approval, which letter can be revoked by the CMA at any time within the testing period. The applicant is then allowed to offer their product or services in Kenya for 12 months before receiving full approval to operate. Once the testing period is over, the CMA will either:
- grant a licence to the applicant;
- grant the applicant permission to operate in Kenya;
- implement new regulations based on the insights gained from the test; or
- deny the applicant permission to operate in Kenya.
The sandbox is not open to cryptocurrency based innovations owing to potential risks that may be involved.Proposed regulation of mobile money services
Members of parliament are advocating for mobile money services to be delinked from telecommunication firms and for mobile money services such as M-Pesa by Safaricom, T-Kash by Telkom and Airtel Money to be licensedlicenced as banks by the CBK. If the members of parliament are successful, the telecommunication firms will only be allowed to issue SMS services, voice and data services. The Kenya Information and Communications (Amendment) Bill, 2019 has been gazetted but has not gone before the National Assembly for debate. The timeframe for its passing is uncertain.The Law of Contract Amendment Bill 2019
Members of parliament have proposed the Law of Contract Amendment Bill, 2019, which provides that in the event of default by a borrower or debtor, the creditor or lender will first have to realise the assets of the borrower before pursuing the borrower’s guarantors. The bill has been gazetted and has gone through the first reading. The timeframe for its passing is uncertain at present.