Security interests and guarantees

Collateral 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 that provides the collateral support deriving some commercial benefit for doing so.

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; and
  • 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.
Creating a security interest

Describe the method of creating or attaching a security interest on the main categories of assets.

Charge over land

Under the Land Laws that were passed 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: 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. A charge over a company’s assets is registrable at the Companies Registry and can also be registered at 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, 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 right 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 registered at the Collateral Registry, 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 must 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 movable 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 [1894] 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 [1891] 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 [1892] 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 that are available to guarantors, including duress, undue influence, misrepresentation and non est factum. 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 or 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 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, except for the 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.

Law stated date

Correct on

Give the date on which the above content is accurate.

13 June 2020.