What Happens to Employees and Creditors When a Kenyan Company Is Wound Up?

When a Kenyan company goes into liquidation, what happens to the people it owes money to, and the people it employs, follows a fixed order under the Insolvency Act, 2015. Understanding where employee claims sit in that order matters whether you are a director planning an orderly wind-down, an employee wondering if you will see your last pay, or a supplier deciding whether to keep extending credit.

Two Routes Into Liquidation

Voluntary liquidation comes in two forms, distinguished by section 382. A members’ voluntary liquidation is one where the directors have made a statutory declaration of solvency under section 398. A creditors’ voluntary liquidation is one where no such declaration has been made, usually because the company cannot pay its debts. A company can also be liquidated by the Court on the grounds listed in section 424, including inability to pay debts. Which route applies changes who controls the process, but the priority rules for paying claims, set out below, apply to a company in liquidation.

The Order in Which Creditors Are Paid

Under section 471, the liquidator distributes the assets available to creditors in accordance with the Second Schedule to the Act. Paragraph 1 of the Schedule says the debts of a company in liquidation are payable in the order of priority listed in paragraphs 2, 3 and 4, and paragraph 5 provides that claims of the same priority rank equally and, if the assets are insufficient, abate in equal proportions.

• First priority: the expenses of the liquidation, including the liquidator’s remuneration and properly incurred fees and expenses, and certain costs of the person who applied for the liquidation order (paragraph 2).
• Second priority: employee claims, described below (paragraph 3).
• Third priority: PAYE deductions, non-resident and resident withholding tax deducted by the company, and customs and excise duty (paragraph 4).

Ordinary unsecured creditors, such as most suppliers and trade creditors, are paid after these categories, in proportion to their claims if there is not enough to go round. Members receive nothing until all creditors have been paid in full.

Where Employee Claims Sit

Employees are not paid first, but they are not ordinary unsecured creditors either. Paragraph 3 of the Second Schedule gives second priority to several employee claims, namely:

• wages or salaries for services provided during the four months before the commencement of the liquidation;
• holiday pay payable on termination of employment before, or because of, the liquidation;
• compensation for redundancy that accrues before, or because of, the liquidation;
• amounts deducted from wages to satisfy an employee’s obligations to other persons, including amounts payable to the Kenya Revenue Authority; and
• certain payments ordered by the Industrial Court under the Labour Institutions Act.

“Wages or salaries” includes commission and remuneration for piece work, as well as holiday or sickness pay and pay for absence from work for any other good reason.

The Cap on Employee Claims

The preferential treatment has a ceiling. Under paragraph 3(2), the total amount given priority under the wage, holiday pay, redundancy, deduction and Industrial Court items may not exceed KES 200,000 for any one employee, as at the commencement of the liquidation. Paragraph 3(3) requires the Cabinet Secretary to adjust that figure by Gazette order for each three-year period, so check whether an adjustment order is in force for the date your liquidation commenced.

The practical effect is that an employee owed more than the capped amount, for example because pay has been withheld for many months, has the excess treated as an ordinary unsecured claim, competing pro rata with every other unsecured creditor. Employee claims within the cap are paid ahead of the tax deductions in the third priority, which is a deliberate ordering reflecting that employees are less able to absorb a total loss than a revenue authority. The definition of “employee” excludes, in a company liquidation, a nominee or relative of, or a trustee for, a director of the company.

Secured Creditors and Floating Charges

Secured creditors are not simply placed at the top of the queue, and the type of security matters. Under section 473, if the assets available for payment of general creditors are insufficient to meet the expenses of liquidating a company, those expenses have priority over claims to property subject to a floating charge created by the company, and are paid out of that property. Section 474 goes further and makes a share of the assets available to unsecured creditors where a floating charge relates to a company’s property in liquidation or administration. A lender’s security documents will specify which kind of charge it holds, and that distinction, not just the label “secured”, determines how early it sits in the queue.

The Act also stops a floating charge holder from appointing an administrative receiver: section 690(2) provides that the holder of a floating charge may not appoint one, and an appointment in contravention is void, subject to the exception in section 690(4) for floating charges created before the section commenced.

What Happens to Employment When Liquidation Starts

In a liquidation, as opposed to an administration or a voluntary arrangement, the business is being wound down rather than rescued, so employment does not generally continue as normal. Employees become creditors for what they are owed, subject to the priority and cap described above. This is one of the real practical differences between liquidation and rescue procedures, which are designed to preserve the business and with it the jobs. Our article on the options before liquidation explains those procedures, and our article on director liability on insolvency covers what directors risk by delaying.