The Daily Nation published a newspaper article on 21st March 2023 which has elicited much concern, especially from lenders on the issue of guarantees as security for a debt, with financiers worrying that guarantors, who are supposed to be a fallback when a loan goes bad, may not be such a useful option after all. The High Court held that a lender is barred from pursuing a guarantor after selling by auction the assets of the principal borrower provided as security and failing to recover the outstanding debt.
Banks and other lenders normally require adequate security before they advance any loan. Ordinarily, banks secure their interest by registering a charge on the debtor’s property. In addition to charges, lenders may require additional security which may take the form of Guarantees and Indemnities by either directors and owners of the lender, or by related companies.
Where there is default and the security held is in the form of land, the lender has several remedies allowed both under the Charge and under the Land Act, No. 6 of 2012 (the Act). Under Section 90(3) of the Act, if a borrower fails to pay the loan together with any interest, or defaults in any of the obligations, the lender (read Chargee) may either sue the debtor, appoint a receiver to collect the income of the charged land, lease it, enter possession or to sell it.
Section 97 of the Act provides that where the lender opts to sell the charged land, it has a duty of care to the debtor and other guarantors of the facility to obtain the best price reasonably obtainable at the time of sale. This means that the charged property should be sold at the best price, considering the market and the forced sale value.
The High Court applied the above provisions, in the ruling delivered on 10th March 2023 in Insolvency Notice Cause E010 of 2021- Home Africa Limited and Eco Bank Kenya Limited.
Eco Bank had advanced a facility of KES 483,545,885 to Moru Ridge Ltd. The loan was secured by a Charge on land owned by Moru Ridge and a Letter of Guarantee and Indemnity issued by Home Africa Ltd.- the debtor’s affiliate. The borrower defaulted in repaying the loan; the Bank sued Moru Ridge and obtained an order allowing it to sell the land whose forced sale value was KES 525,000,000. The amount the Bank sought to recover was KES 938,592,262.44. The Bank then sought and was granted leave by the court to purchase the charged property (Ecobank Kenya Limited -v- Moru Ridge Limited.
In addition to this, the Bank sought to liquidate the guarantor- Home Africa Limited and issued statutory demands against it, the guarantor then filed an application to set aside the Statutory Demand on the basis that their obligations as guarantors had been wholly extinguished on account of the acts of the bank in realizing its security and that the Bank’s decision to purchase the property estopped them from claiming against the guarantor.
The Bank relied on various court decisions which held that a Lender has liberty to realise securities without any direction by a debtor, surety, or the court unless expressly agreed on in the loan agreement.
Ordinarily, the matter would have been determined with reference to Section 91 (1) (b) of the Land Act, No. 6 of 2012 Laws of Kenya, which provides that a Chargor is at liberty to sue for excess sums should the security given turn out to be insufficient to cover the full debt owed by the Chargor.
However, the Judge seemed to have based her judgement on Section 97 of the Act, which provides for an exception to the privilege under section 91 in cases where a bank sells the security at a price lower than twenty-five per cent of its market price. In essence, Section 97 provides that in cases where a chargee sells property at twenty-five per cent or below of its market price, there is a presumption that they have breached the duty of care owed to the Chargor and guarantor to obtain the best price reasonably obtainable at the time of sale. It is on this basis that the Honorable Judge held that Ecobank had breached this duty of care and, consequently, were not entitled to further recovery from the guarantor.
This decision puts in sharp focus the place of guarantees and indemnities. Whereas Banks may argue that they are allowed by contract and the law to realize any securities they hold in any order that they wish, this judgement seems to have pegged the ability to recover against guarantors not only to the outcome of an exercise of the statutory power of sale but also to the degree of care taken in the process of realizing the prior securities.
If the ruling is not successfully challenged on appeal, then Banks and other lenders need to be wary as to the nature of securities that they accept before providing financial accommodation. Such guarantees and indemnities must be carefully worded to enable Banks to recover notwithstanding botched land sales. The banks should also ensure that they comply with the law while exercising the remedies provided for under the law.
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Read the original publication at TripleOKlaw.
