This week’s focus note is on restructuring, given the ongoing restructuring of Nakumatt Holdings.
Business restructuring refers to a process of re-organizing a company’s ownership, operational and capital structure in order to make a company more profitable or come out of insolvency. The need for corporate restructuring arises because of the change in a company’s ownership structure due to a merger or takeover, adverse economic conditions, or adverse changes in the business such as bankruptcy or buyouts. Corporate restructuring may include changes in the asset structure, liability structure or both of them, thus simultaneously reducing tensions between debt and equity holders to facilitate a prompt resolution in case the company is in a distressed situation.
A business is insolvent when its liabilities exceed its assets. However, in practice, insolvency comes about when a business cannot raise enough funds to meet its obligations, or pay debts as and when they fall due. Properly called technical insolvency, it may occur even when the value of a business’ total assets exceeds its total liabilities. Mere insolvency does not afford enough ground for lenders to petition for involuntary bankruptcy of the borrower, or force liquidation of the business.
In Kenya, before the enactment of the Insolvency Act, 2015, there existed no corporate rescue mechanisms and insolvent companies capable of being turned around would inevitably be forced into liquidation, with losses to the creditors and shareholders. The two main rescue mechanisms introduced under the Insolvency Act, 2015 include;
- Administration, and
- Company Voluntary Arrangements
- Administration of Insolvent Companies
Administration is a fairly new development in Kenyan Law, it was introduced by the Insolvency Act, No. 18 of 2015 as an alternative to liquidation with the following key objectives;
- to maintain the company as a going concern,
- to achieve a better outcome for the company’s creditors than liquidation would offer, and
- to realize the property of the company in order to make distributions to secured or preferential creditors.
The process of administration is headed by an Administrator, who may be appointed by an administration order of the court, unsecured creditors, or a company or its directors. An administrator of a company is required to perform the administrator’s functions in the interests of the company’s creditors as a whole.
Once the Administrator is appointed, they are entitled to all the records of the company and are required to present a proposal to the creditors on their plan to salvage the company. The Administrator must therefore set a date for the creditors meeting and invite all the creditors that it knows of, having had access to the books of the company. Only creditors who have filed proof of debt before 4 pm of the day before the Creditors meeting are entitled to vote at the said meeting.
At the Creditors’ meeting, the Administrator must present their proposal to the Creditors who shall vote on it. The percentage of an individual vote shall be determined by the amount of debt owed to the creditor. The creditor may opt to either vote for the proposal without amendments, vote for the proposal with amendments, or reject the proposal altogether. The decision of the creditors meeting shall be final.
- Company Voluntary Arrangements
Company Voluntary Arrangements were also introduced in Kenyan law by the Insolvency Act, No. 18 of 2015. This arrangement is entered into when a company is insolvent and the directors, administrator or liquidator as the case may be, make a proposal to the company’s shareholders and its creditors on the best way to save the company from liquidation. However, there are restrictions placed on Company Voluntary Arrangements, with the arrangement not being an option in the case of the following:
- banking and insurance companies,
- companies under administration or liquidation,
- a company in respect of which a voluntary arrangement has been carried out,
- companies in public-private partnerships, and
- companies with liabilities of over Kshs 1 bn.
The Directors must appoint a person, who must be a licensed insolvency practitioner, to supervise the company for the process of implementing the voluntary arrangement. The Supervisor must within thirty days of the proposal or a longer period allowed by court, submit a report to the court detailing their opinion on the viability of the proposal and whether a meeting of the creditors should be called to vote on it and the date and time of such a meeting.
On the date of the creditors’ meeting, the creditors shall appoint a chairperson who shall divide the creditors into groups of secured creditors, unsecured creditors and preferential creditors. The Creditors shall then vote either to approve the proposal as is, approve it with modifications or reject it altogether. The proposal is approved if voted for by a majority of the members and a majority of each group present at the meeting. The proposal if approved shall be binding on the company and the creditors.
Case Study of Nakumatt Holdings
Nakumatt Holdings is a Kenyan supermarket chain. Until February 2017, Nakumatt was regarded as the largest Kenyan retailer, with 62 branches across the region, (45 in Kenya, 9 in Uganda, 5 in Tanzania and 3 in Rwanda) and a gross turnover of Kshs 52.2 bn. However, what was fueling Nakumatt’s rapid expansion was funding through debt. This included short-term borrowings, bank loans and letters of credit to its numerous suppliers. However, due to a number of reasons, Nakumatt started experiencing serious cash-flow difficulties in 2016. The retailer was therefore unable to meet its financial obligations to landlords, its suppliers and employees. It was for these reasons that the administrator was appointed by an order of the court pursuant to an application filed by unsecured creditors, and Nakumatt Holdings was placed under administration in January 2018.
PKF Consulting Limited (PKF) was appointed as Nakumatt Holdings’ administrator. This was in order to assess the possibility that the company could be revived after a full assessment of the company, and for all creditors of Nakumatt to come forward and register their claims with the retailer.
Having assessed Nakumatt’s last audited accounts as at February 2016, and management accounts as at 31 December 2017, Nakumatt’s current creditor structure was as highlighted below:
|
Current Nakumatt Creditor Structure |
||
|
Nature of Creditor |
Credit Amount (Kshs) |
% |
|
Banks |
6,904,420,252 |
19.3% |
|
Commercial Paper & Short Term Note Holders |
4,796,185,517 |
13.4% |
|
Private Placement Loans |
1,141,228,071 |
3.2% |
|
Kenya Revenue Authority |
1,817,510,671 |
5.1% |
|
Staff Related Liabilities |
1,368,081,380 |
3.8% |
|
Trade Creditors |
18,583,535,586 |
51.9% |
|
Other Creditors |
1,215,011,579 |
3.4% |
|
Total |
35,825,973,058 |
100.0% |
From the table, we find that Trade creditors had the biggest claim against Nakumatt, this includes mainly the suppliers of tradable goods on credit. Their claim accounted for 51.9% of total creditor claims, amounting to Kshs 18.6 bn. The amount of assets securing all of Nakumatt’s debts amount to Kshs 5.2 bn. Nakumatt’s liabilities thus surpass the available assets by Kshs 30.6 bn.
Following the assessment of Nakumatt’s financial position, the administrator determined that if a liquidation route was used, then out of the total creditors of Kshs 35.8 bn, Kshs 30.6 bn are unlikely to be paid. This represents a significant 85% potential loss to the creditors. In essence, all unsecured creditors, namely Trade Creditors, Commercial Paper Holders and Short Term Note holders, and private placement loan providers will suffer the maximum 100% loss of their debt amounts, as the available assets would first pay off secured creditors. Since the business model of Nakumatt can support a better outcome for all the creditors as compared to a liquidation scenario, the Administrator set out to come up with a restructuring proposal to achieve this outcome based on the company remaining a going concern.
Nakumatt’s administrator came back to creditors with a proposal that the creditors were supposed to take a vote on and if deemed fit, the company shall adopt as the way forward. The proposal highlighted the following scenarios as prerequisites in order for the proposal to be viable:
- The suppliers continue supporting Nakumatt so that the company can start generating sales,
- The landlords support the company so that the branches are available for business,
- The management agreement and financial support from Tusky’s supermarket continues to remain in place until the company can stand on its own feet.
The administrator thus proposed a debt waiver and restructuring into equity in order to ease the debt burden for the company and turn the business around, as highlighted in the tables below:
|
Creditors’ Debt Waiver and Equity Conversion |
||
|
Debt Waivers |
Debt to Equity Conversion |
|
|
Banks |
0% |
0% |
|
Staff Related Liabilities |
0% |
0% |
|
Kenya Revenue Authority |
0% |
0% |
|
Commercial Paper Debt & Private Placement |
Kshs 1,484 mn (25%) |
Kshs 4,453 mn (75%) |
|
Trade & Other Creditors |
Kshs 4,704 mn (25%) |
Kshs 14,113 mn (75%) |
|
Total |
Kshs 6,188 mn |
Kshs 18,567 mn |
|
Current Nakumatt Firm Value As Per the Administrator |
||
|
Current Firm Value |
100.0% |
Kshs 7,993 mn |
|
Nakumatt Shareholding after Debt Conversion |
||
|
Existing Shareholders |
30.1% |
Kshs 7,993 mn |
|
Creditors |
69.9% |
Kshs 18,567 mn |
|
Total Value of Company Post Conversion |
100% |
Kshs 26,559 mn |
Looking at the proposal, we find that Bank debt, Kenya Revenue Authority and Employee liabilities were treated as preferential creditors; thus exempting them from the 25.0% waiver that non-preferential creditors took on their debt, as well as the 75.0% debt to equity mandatory conversion. The current shareholder value was estimated at Kshs 7.99 bn, with the value of the creditors’ equity stake post conversion being Kshs 18.6 bn. The converted shareholders were then to assume a majority stake in the company, oversee its turn around, and finally take it to an Initial Public Offering (IPO) in the year 2024.
The administrator thus presented the proposal at the Creditors meeting for the Administration of Nakumatt Holdings Limited, which was held on 14th March 2018. The administrator had hoped to use the meeting in order to get the creditors to buy in to support the turnaround efforts of the retailer. However, a number of creditors rejected the proposal as is, citing the following issues:
- The debt waiver of 25% for the various non-preferential creditors, without a guaranteed upfront payment to cushion the waiver effect. Namely, Corporate paper and private placement loans, trade and other creditors will all lose 25% of their debts, while preferential creditors were not subjected to the same, namely the banks, employees and tax obligations to Kenya Revenue Authority (KRA). This is despite the continuous support that the company will still require from suppliers of trade goods in order to turn around the business,
- The Debt to equity conversion was also restricted to the non-preferential creditors; with banks, employees and the KRA not required to convert their debts, while the rest of the creditors were required to convert 75% of their debt obligations. In addition, the banks will still earn some interest on their debt, albeit at lower than market interest rates,
- The value assigned to current shareholders of Kshs 8.0 bn is deemed unrealistic and cannot be validated using the proposed structuring methods that will be applied. The company is worthless without the support of creditors. Thus the administrator erred in assigning the business value on this premise,
- The fact that the administrator proposed in its governance and management proposals to have 2 Board members from the existing shareholders in the New Board to run the company, citing their industry expertise. This is despite the current shareholders having put the company into the dire situation it is in currently; the attempt to assign value to current shareholders and then bring them into governance calls into question the independence of the administrator. In recent situations where some form of administration has come in, such as Chase Bank, the current shareholders have ended up with nothing
- The agreement with Tusky’s supermarket that is currently supporting the operations of the company. This raised a number of concerns with creditors as the details of the support and business intentions of Tusky’s was not made clear,
- The numerous accounts of mismanagement at the retailer, with the recent significant exceptional loss adjustment of Kshs 18.0 bn in respect to pilferage, stock shrinkage and losses due to stock obsolescence,
- Administration to be extended for a longer period beyond one year, and thereafter play the role of Monitoring Agent. This is despite the fact that the administrator chose to absolve himself from all claims and liabilities that pertains to the business restructuring and performance of the business post restructuring, and if the company does not follow out the recovery strategy and achieve the laid out milestones,
The Creditors meeting for the Administration of Nakumatt Holdings Limited held on 14th March 2018, was adjourned due to the view of the creditors that the Administrator did not fully disclose the affairs of the company. The meeting was adjourned for two weeks to enable the Administrator to amend the proposal. In addition, a section of the creditors called for the second meeting to have a vote for liquidation of the company, as they had questions about the viability of the recovery strategy. The matter is going before the High Court on the 26th of March 2018 in order for the Administrator to give an update on the process.
In our view, the proposal brought forth was not equitable and fair to all creditors. In addition, it failed to inspire confidence especially with the major stakeholders required to turn around the business, especially suppliers, landlords, and employees. We thus concur with the creditors who rejected the deal in the current format.
However, we also are aware that the best-case scenario for all creditors is a debt to equity conversion of their creditor claims, as liquidation is not in the best interest of anyone. This should include even the banks who had taken preferential debt. Case in point being the recent restructuring of Kenya Airways. In the case of Kenya Airways’ restructuring, the Government and a number of banks converted their debt into equity to the tune of Kshs 59 bn. The Government’s stake in Kenya Airways rose to 46.5% from 29.8% before the debt to equity conversion, while the bank’s consortium (KQ Lenders Co.) ended up owning 35.7% of the company. Ordinary shareholders who did not inject additional equity were diluted by 95.0%. Kenya Airways recently reported 2017 results for the first 9 months, registering a Kshs 470 mn equity position, up from a negative equity position of Kshs 44.9 bn in 2016, which can be attributed to the positive effects of the debt to equity conversion. This highlights that the company is finally in a positive equity position and can pay off its liabilities when due. We thus strongly recommend that creditors adopt the debt to equity conversion.
We would suggest the following amendments and / or considerations:
- Creditors, especially trade creditors to realize that an outright liquidation is not in anyone’s interest and consider a conversion. It may be useful for all creditors to collectively retain an investment adviser,
- The administrator to demonstrate independence from current shareholders and ascribe no value to their stake, consistent with the current realities of the business. Administrator conclusions and recommendations that are not grounded on analysis can be challenged in court hence delaying the resolution of the current situation. Attempting to ascribe 30% stake to current shareholders raises significant questions,
- Better disclosures and transparency around the numbers reported by Nakumatt and presented in the proposal, and
- All debt holders should be subject to conversion of debt to equity just as was the case in Kenya Airways.
This is the first significant private sector insolvency restructuring in Kenya under the new Act, it is important that it is done professionally and with due care since it sets a precedent to future cases.
Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted. This publication, which is in compliance with Section 2 of the Capital Markets Authority Act Cap 485A, is meant for general information only, and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.
