Month: September 2024

Whether we like it or not, there will be leadership changes in government. Whether the current ruling party breaks the eight or the opposition wins power come 2024, there will be changes in the various government entities. A change of minister, board members, managing directors, head of agencies, etc., often leads to a review of previously entered contracts as the new head seeks to undertake a value-for-money analysis and/or legal compliance. As such, it is essential that private sector entities entering into various contracts with the government ensure they comply with the applicable laws to avoid termination of such contracts because the contract was procured or entered into unlawfully. In this article, we look at some loopholes that private sector entities and government officials must avoid in entering into a contract to avoid future termination because the contract was entered into contrary to law.

Government Contracting

The government remains the number one spender in Ghana’s economy. The government includes ministries, departments and agencies, local government entities – metropolitan, municipal and district assemblies, and state-owned entities. The government procures goods, works and services from private sector entities and enters into partnership arrangements with private sector entities to provide infrastructure and services that the government is responsible for. The government also enters into finance arrangements with banks, financial institutions and individuals to obtain funds for its development activities. These are all done through contracts between the government and the private sector entities.

Every contract that the government intends to enter into is regulated by law. Generally, a contract entered into in contravention of the applicable laws will make the contract unenforceable on the grounds that the contract is unlawful. Whilst it is the government’s responsibility to ensure that the laws are complied with when entering into such contracts, the declaration of such contracts as unlawful also adversely affects the private parties who are counterparties to the contracts. The private parties, therefore, have a vested interest in ensuring that the contracts are entered into in accordance with the applicable law. The declaration of the contract as unlawful, therefore unenforceable, bites the private party harder than the government in many cases.

Regulatory Framework

Several laws regulate the capacity of a government entity to enter into a contract. The laws prescribe the capacity of the entity to enter into the contract, the procedure to follow in entering into the contract, and the approval to obtain to enter into the contract. The first thing to note is that government entities are created by law. The contracts entered into by a government entity must be permitted within its establishment instrument. Capacity is crucial for the validity of a contract. A private party entering into a contract with a government entity must satisfy itself that the government entity has the capacity to enter into the contract.

Secondly, the procurement of goods, works and services of a government entity must be conducted in accordance with the Public Procurement Act. The Public Procurement Act prescribes various procurement methods to be adopted by a procuring entity. It also indicates approvals required for the various methods, which approvals depend on contract sum thresholds. Even where a competitive procurement process is adopted by the procuring entity, there are processes specified under the Act to govern the various stages of the process. For restricted tender processes or noncompetitive processes, there are conditions that are prescribed, and that must be satisfied for the use of such processes. Failing to use the right procurement method, not following the prescribed procedure, or not obtaining the required approval will lead to procurement challenges. Therefore, whilst the government entity is to ensure compliance, it is in the interest of the private party to understand the process and ensure it is followed.

There are notable exceptions to the application of the Public Procurement Act. These include awarding contracts for extracting natural resources; including petroleum and mining activities, and partnership arrangements. Agreements, where government entities borrow money or enter into financing arrangements, do not also come under the Public Procurement Act. Specific legislation is in place to deal with contracting arrangements for these activities.

One common mistake observed is the implementation of partnership arrangements under the Public Procurement Act rather than the Public Private Partnership (PPP) Act. The Public Procurement Act governs the procurement of goods, works and services financed wholly or partly through public funds and the disposal of public stores. The PPP Act governs all partnership arrangements between a public entity and a private sector party where the private sector party provides public infrastructure and services under a long-term contract. The private sector party assumes significant risk and obligation for the financing, designing, construction, and operation and maintenance of the infrastructure. The private sector party will perform the service that the government entity ordinarily performs and, in return, receives payment from the end-users or direct payment from the public entity. The PPP Act provides the legal framework that governs the project preparation, procurement, contracting and post-closing management of the project. PPP arrangements come in many forms, including; concessions, build operate transfer, build own operate transfer, rehabilitate operate transfer, operation and maintenance arrangement, etc. Where a project that is a PPP project is procured under the Public Procurement Act, the process and resulting contract are unlawful. The public entity must, therefore, clearly define the project and choose the right framework under which to implement the project. Generally, PPP projects require substantial investment from the private partner. The private partner must protect its interest by ensuring the partnership arrangement is undertaken under the right legal framework and that the process is followed with the relevant approval obtained.

The PPP Act also has some exceptions. These include the award of petroleum agreements, mining contracts, outsourcing of government services without significant transfer of financial and operation risk, and procurement of goods, works and services under the Public Procurement Act.

Financing arrangements come under the law establishing the relevant government entity, the Public Finance Management Act (PFMA), and the Constitution. These are not exhaustive. Where the entity has the capacity to borrow, such borrowing must be approved in the annual budget for the entity, or the entity must seek approval from the Minister of Finance. This is subject to the internal approval requirements of the entity. Parliamentary approval may be required in some instances.

Approval requirements

A critical factor in ensuring that contracts entered into with the government are not declared void because the contracts are unlawful is to obtain approvals required by law. The courts have held that failure to obtain such approval will render the contract void, and no action can be based on such contracts.[i] As discussed above, the procurement processes under the Public Procurement Act or the PPP Act require a number of approvals at the various stages of the procurement process. Similarly, finance arrangements require approval from the Minister of Finance under the PFMA and, for companies, from the government as a shareholder for state-owned companies where such transactions amount to major transactions.

The Constitution also requires parliamentary approval in several instances. These include instances where the government enters into:

• a loan agreement
• arrangements where the government provides or issues guarantees for repayment obligations or performance of any other obligations by any public or private entity
• international business or economic transaction to which the government is a party;
• agreements that provide for exemptions from, or variation or deferment of applicable taxes and
• agreements for the exploitation of natural resources.

Where the contract relates to any of the above, it is crucial for the validity of the contract to obtain parliamentary approval. As indicated, the courts have held that such contracts are invalid where parliamentary approval has not been obtained. In some of these cases, it was the government that requested for the declaration of the contract as invalid, even though it was the duty of the government to obtain the approval.

Private sector entities entering into contracts with the government must, therefore, ensure that the internal approvals required under the establishing instrument of the public entity or company are obtained, in addition to approvals required under other laws.

Conclusion

All contracts entered into by or with the government are regulated by law. Generally, the failure to comply with applicable law will adversely affect the validity of the contract. The government remains the largest spender and will continue contracting with private sector companies. Since political change is inevitable, it is essential to ensure that the process of entering into such contracts and the contract terms comply with the relevant laws. Required approvals must be obtained. While the government entity is responsible for ensuring compliance, the private sector counterparties mostly bear the risk of non-compliance. Private sector companies seeking to enter into such contracts must seek legal advice on the applicable laws, compliance with the required processes and that the required approvals have been obtained. As an added safeguard, a formal opinion should be obtained from a reputable law firm advising on the transaction on the validity and enforceability of the resulting contracts prior to execution of the contract by the private sector party.

A company may distribute its assets to its shareholders for an array of reasons, including as a return on investments, to support its ongoing operations, or when it ceases operations. In Kenya, the distribution of a company’s assets is mainly regulated by the Companies Act, 2015 (the Companies Act) and the Insolvency Act, 2015 (the Insolvency Act) together with the regulations made thereunder. There are also sector-specific laws governing the distribution of assets in regulated industries like banking, insurance, capital markets, retirement benefits and telecommunications. The existing regulatory framework seeks to protect creditors and minority shareholders and to guarantee the equal treatment of shareholders.

There are various ways of distributing the assets of a company, including via liquidation, dividend in specie, distribution in specie and share buyback. We discuss these options below.

Distribution upon Liquidation

Liquidation or “winding up” is a procedure under which the assets of a company are realised and distributed to creditors in a statutory order of priority pursuant to procedures under the Insolvency Act. In the event of any surplus, distribution is made to the company’s shareholders.

Section 381 of the Insolvency Act contemplates two types of liquidation, being voluntary liquidation and liquidation by the Court. Voluntary liquidation may be initiated by the members or creditors of the company in accordance with the provisions of the Insolvency Act.

A members’ voluntary liquidation is deemed to have commenced after the passing of the special resolution by the members of the company after which the company ceases to carry on its business, except in so far as may be necessary for its beneficial liquidation.

Where a company is to be liquidated through a members’ voluntary liquidation, the directors are required to convene a directors’ meeting and make a statutory declaration (commonly known as a declaration of solvency), in the standard form prescribed under the Insolvency Act, to the effect that they have made a full inquiry into the company’s affairs, and that having done so, they have formed the opinion that the company will be able to pay its debts in full, together with interest at the official rate, within such period (not exceeding twelve (12) months from the commencement of the liquidation) as may be specified in the declaration.

It is important to note that the statutory declaration by directors has to be made within five (5) weeks before the date of passing the resolution or on the date of the resolution but before the passing of the resolution. The declaration must include the latest statement of the company’s assets and liabilities, in the standard form prescribed under the Insolvency Act, at the latest practicable date before the declaration is made. The declaration is also to be lodged with the Registrar of Companies within fourteen (14) days after the date of the resolution.

Creditors play no part in a member’s voluntary liquidation since the assumption is that their debts will be paid in full. The Registrar of Companies dissolves the company after three (3) months from the date of receipt of the final accounts of the company by removing the company’s name from the Register of Companies.

Section 406 of the Insolvency Act outlines the process of initiating a creditors’ voluntary liquidation. A creditors’ voluntary liquidation is commenced by the directors convening a general meeting of members to pass a special resolution to wind up an insolvent company and appoint a liquidator. Thereafter, the directors must also convene a meeting of creditors within fourteen (14) days of members passing the resolution to wind up the company.

The Second Schedule to the Insolvency Act sets out the priority of claims in an insolvency as first, second or third priority claims. The claims which take first priority are the expenses of administration or liquidation. Second are the company debts, as listed in the Second Schedule, to the extent that they remain unpaid. The third priority claims relate to the tax obligations incurred by the company under the Income Tax Act (Cap. 470) Laws of Kenya as well as the Excise Duty Act, 2015.

Once priority claims have been settled, secured creditors holding fixed and floating charges will rank ahead of unsecured creditors. Shareholders are the last to be paid to the extent of the capital they contributed to the company.

Dividend in specie

A dividend in specie, is a dividend which is to be satisfied otherwise than in cash. The dividend can be a transfer of company shares, physical assets, assignment of a debt or the transfer of the benefit of convertible debentures. A company will typically declare a dividend of a specified amount which it will satisfy by transferring a non-cash asset of equivalent value to its shareholders.

A company is generally permitted to undertake a dividend in specie, as provided under section 485 (3) of the Companies Act, unless explicitly prohibited by its articles. A company’s articles will more often than not authorise a company, subject to approval by its shareholders, to declare a dividend of a specified amount and for such amount to be satisfied by the transfer of non-cash assets of equivalent value to its shareholders.

It is important to note that distributions can only be made out of profits or capital available for this purpose as stipulated in section 486 of the Companies Act.

Distribution in specie

Also known as distribution in kind, this involves circumstances where a company identifies a non-cash asset that it wishes to transfer to a shareholder or sister company (for example, as part of an intra-group reorganisation). The transfer is known as a distribution in specie but there is no requirement to declare a dividend.

Whereas a dividend is typically described in a company’s articles as a “distribution payable in respect of a share”, a distribution in specie is a “distribution consisting of or including, or treated as arising in consequence of, the sale, transfer or other disposition by a company of a non-cash asset”. Therefore, since the provisions in a company’s articles only apply to dividends, shareholder approval is not generally required for a distribution in specie.

Although a distribution in specie is flexible for the directors of a company since it does not involve shareholder approval, this method of distribution has certain limitations. Specifically, a company may not distribute assets in specie if the value of the proposed assets exceeds what it can distribute to its shareholders. Where a company distributes assets of a higher value than it should, this may result in legal issues for the company and the recipient of the asset. It may be viewed as an unlawful return of capital, as the distribution exceeded the distributable value. Where a shareholder knowingly receives assets categorized as an unlawful distribution, they may be expected to either return the asset back to the company or pay the value of the asset.

It is important to note that section 486 of the Companies Act provides that distributions can only be made out of profits of a company available for distribution or capital. Therefore, before opting for distribution in specie as a mode of asset distribution, the company should ensure that it has sufficient distributable profits.

Share Buyback

A share buyback is a purchase by a company of its own shares from a shareholder. Companies typically repurchase their own shares from the market in instances where they want to consolidate ownership of the company, increase share prices or reduce the cost of capital. Share buybacks by private limited companies are governed by Part XVI of the Companies Act.

A limited company undertaking a share buyback must comply with the provisions of the Companies Act, failing which the transaction would be declared void. Further, the failure constitutes an offence by the company and every officer in default. The officer in default is liable to fines as prescribed in the Companies Act.

A company is permitted to repurchase its own shares, provided that it is not restricted or prohibited from doing so in its articles and subject to complying with the procedural requirements set out in the Companies Act. Under the Companies Act, a limited company may not purchase its own shares unless they are fully paid.

Further, section 449 (2) provides that a limited company may purchase its own shares only out of distributable profits of the company or the proceeds of a fresh issue of shares made for the purpose of financing the purchase. A private limited company may however purchase its own shares out of capital as provided under section 449 (1) of the Companies Act. Under section 484 of the Companies Act, a company that agrees to purchase its own shares is not liable in damages for failing to redeem or purchase any of the shares.

A share buyback is a viable option only where the company’s capital or distributable reserves are sufficient to cover the cost of the shares. Payment of the shares may be made through a non-cash asset.

Conclusion

The foregoing is a synopsis of the various ways a company may distribute its assets in order to achieve its desired objective considering the structure, unique needs of the company, prevailing laws and other considerations.

It is important to note that each method of distribution is subject to legal and tax implications, such as payment of income tax, stamp duty and capital gains tax. Therefore, a company should obtain legal and tax advice before embarking on the distribution of its assets.