In times of liquidity constraints, with the insolvency conundrum already claiming some of Tanzania’s corporate debtors, a lending bank must be fully aware of the situations in which the validity of security over assets given to secure loans can be challenged.
As businesses navigate in a tough economic landscape, it is pertinent now to consider the special provisions of the Tanzanian Companies Act, 2002 (‘CA 2002’) that empower the court to set aside transactions entered into by a corporate debtor that has gone into administration or liquidation.
The underlying rationale of these provisions is to ensure that the value of a corporate debtor’s assets is maximized and the pari passu distribution principle in insolvency (equitable treatment of all creditors) is properly applied.
The main provisions, transactions at an undervalue (Section 368), preferences (Section 369) and invalid floating charges (Section 372) are weapons that an administrator or liquidator can use to challenge the validity of security and they strike a reign of fear into the hearts of banks and other creditors.
Due to space limitation, this article discusses the salient aspects; readers are encouraged to read the detailed provisions of the CA 2002 before applying the provisions to specific factual scenarios, to avoid upsetting valid secured credit transactions undertaken in the ordinary course of business.
For an administrator or a liquidator to move the court for orders that are necessary for restoring the position of the corporate debtor with regard to transactions at an undervalue and preferences, there is a ‘relevant time’ which is statutorily prescribed in the CA 2002.
‘Relevant time’ is variously defined by Section 370(1); for instance, in the case of a transaction at an undervalue or of a preference which is given to a person who is connected with the corporate debtor, at a time in the period of 2 years ending with the onset of insolvency.
From the foregoing, is the ‘relevant time’ the date of the decision or is it the date of entering into the transaction/giving the preference?
While the CA 2002 is silent on this question, the former timeframe is obvious in practical sound judgment. After all, the question of when the decision is made is a factual question to be determined on a case-by-case basis.
The CA 2002 is also silent on how to address problems that may emanate from the distinction of the two timeframes where there is a long time interval between making the decision and entering into the transaction/giving the preference.
A time is not a ‘relevant time’ unless the corporate debtor was at that time unable to pay its debts or became so as a result of the transaction or preference. These requirements are presumed to be satisfied unless the transaction at undervalue was entered into by, or the preference was given to, a person connected with the corporate debtor (except by reason of only being its employee).
Persons ‘connected’ with a corporate debtor are defined under the provisions of Section 369(5) to mean a director or a person connected to a director and includes a person in accordance with whose instructions the directors of a company are accustomed to act.
If fruitlessly rebutted, the ‘connected persons’ presumption would show that, in deciding to enter into the transaction at an undervalue or to give the preference, the corporate debtor was influenced by a desire to put the creditor in a better position than it would otherwise have been as a consequence of insolvency.
Consequently, in terms of Section 371(1), the court may, inter alia, order that any asset transferred be vested in the corporate debtor or that any security given by the corporate debtor be released or discharged.
However, if a person received a benefit from an undervalue transaction or preference in good faith and for value, it would not be required to pay any money to the administrator or the liquidator except as specified under Section 371(2)(a) and (b) of the CA 2002.
In light of the prevailing economic conditions, it would seem likely that court applications around the issue of challenging the validity of security provided by a corporate debtor that has gone into administration or liquidation, are in the cards. Rulings on these applications would offer a valuable insight into the current thinking and attitude of the Tanzanian judiciary on the issue.