SEVERANCE PAY: WHAT YOU NEED TO KNOW

Introduction

For various reasons, layoffs commonly happen. Downsizing too. Mergers and acquisitions occur and whenever they do, they create overlap problems, and employees are cut. “Must we offer compensation to employees who are terminated involuntarily?” That is a question that employers frequently ask.

Kenya’s Employment Act recognizes that such situations, which lead to what in legal parlance is termed redundancy, do arise. For that reason the law seeks to cushion affected employees from the immediate loss of income. The Act does so by providing for severance pay – an amount of money to be paid to an employee whose employment has been terminated following a redundancy exercise. In this brief article, we share our thoughts about severance pay under Kenyan law.

Option or Obligation?

Under Section 40 of the Act, an employer can only terminate a contract of service on account of redundancy after having paid to the affected employee declared redundant severance pay.  

It is thus not for the employer to choose whether or not to pay severance pay; each employee declared redundant is entitled to severance pay as a matter of right.This position has been affirmed in our Courts, which have demonstrated that they frown upon employers who use their bargaining power to shortchange employees during redundancies. Simply put: the employee does not have to demand severance pay from the employer; the obligation is on the employer to pay the employee at the rate set under the Employment Act or the contract of employment.

Computation of Severance Pay

Under the Act an employee who has been declared redundant should be paid fifteen (15) days’ worth of pay for every complete year of service. To compute the severance pay due, courts divide the employee’s monthly pay by thirty (30) days to get the pay for per day. The pay per day is then multiplied first by fifteen days and finally by the total number years of service.

If, however, the contract of employment provided for higher severance pay than the one under the Act, the employer must pay that higher amount. If the contract did not provide for such pay at all or provided for a lower one, the employer must pay at the rate stipulated under the Act.

So, should the rate under the Act be applied on gross salary (i.e. basic salary and allowances) or on basic salary? Kenyan courts have been confronted with this question and have determined that it is the latter. Allowances are therefore not factored in. Where an employee has been receiving varying amounts as monthly pay during his term of employment, the amount paid as the last monthly salary is the one to be used in calculating severance pay.

Illustration

Mr. Chapa Kazi was employed as an office messenger with a basic salary of Kshs. 25,000/= per month and worked for eight years without a variation in his basic salary.  The total severance payable to him in the event of redundancy shall be as follows (15/30 x 25,000) x 8 = 100,000.

Conclusion

In sum: severance pay is not optional; it is an obligation which every employer must fulfill if they declare a redundancy. The rate to apply is fifteen days’ pay for every complete year of service unless a higher pay is provided under the contract of employment. The basic salary is the one used to calculate the pay and allowances are not included. Anything short of these may lead to legal action by the employee resulting in additional costs for the employer.

Article by CG Mbugua & Makau Kithuka

Disclaimer

This article is intended for general knowledge only. For substantive legal advice on this, please contact the authors through cgmbugua@lexgroupafrica.com or pmakau@lexgroupafrica.com

The Data Protection Bill, 2018: A Move towards Tangible Regulation

Introduction

On nearly a daily basis, you often are required to provide information about yourself that is personal. You walk into an office of a service provider, or download a form from their website which you then fill and submit so that can you receive certain services. You give this information without really knowing whether that information will be used for purposes other than those you gave it for or who else will see or receive it.

Privacy International, a UK-based charity that promotes the right to privacy across the world notes that despite increasing recognition and awareness of data protection and the right to privacy across, there is still a lack of legal and institutional frameworks, processes, and infrastructure to support the protection of data and privacy rights. At the same time, the increasing volume and use of personal data, together with the emergence of technologies enabling new ways of processing and using it, mean that an effective data protection framework is more important than ever.

Cognizant of this need, the Kenyan Parliament is considering a bill called the Data Protection Bill which when passed, will regulate how your personal data can be collected, stored, used or processed by another person while observing your right to privacy. You may also be the person on the other side of the scale – the one receiving other people’s personal information most likely because you need it as part of your due diligence for a commercial deal, or to enable you provide the services you do to clients or customers. The Bill is relevant to you too because if passed, it will regulate how you should collect, store, use or process the information.

In this article, we highlight salient features of the Bill, which if when passed, may apply to you.

What Kind of Personal Information is covered?

  • Race, gender, sex, pregnancy, marital status, national, ethnic or social origin, colour, age
  • Physical/mental health, disability, religion, conscience, belief, culture, language and birth
  • Education, medical, criminal or employment history of the person
  • Identifying number, symbol assigned to the person
  • Fingerprints or blood type
  • Contact details
  • Correspondence to or from the person that is of a private or confidential nature
  • Information given for a grant, award or prize proposed to be made to the person

What Principles Would Apply When Handling the Information and/or Data?

  • Its collection, storage, use or processing must be necessary for a lawful, explicitly defined purpose
  • It must be collected directly from and with the consent of the person
  • It may only be released to another person and put to a different use with the consent of the person
  • Steps must be taken to ensure it is accurate, up-to date, complete and that it is safeguarded against the risk of loss, damage, destruction, or unauthorized access
  • The person has a right to access to the personal information

What Specific Steps are required to be taken by the Data Recipient?

  • Notify the person of the use to which the information will be put to;
  • Notify the person that if they waive their rights they will have permitted you to collect it
  • Take necessary steps to ensure the integrity of personal data you have or control
  • Take steps to correct or delete false or misleading data
  • If you reject the person’s request, inform them in writing the reasons for the rejection.
  • Do not keep data for a longer period than necessary or as provided under any law.
  • Do not transfer the data outside Kenya unless under specific outlined circumstances.
  • No profiling: making a decision based on automated processing of the data which has a legal implication on or significantly affects them without any human intervention. Notably however, profiling is legal where necessary for maintenance of law and order by any public entity.
  • Notify the person and the Kenya National Commission on Human Rights and take steps to ensure the restoration of the integrity of the information system as soon as possible after you discover unauthorized access or processing of the data.

Conclusion

As of January 2018, statistics showed that over 100 countries around the world had enacted comprehensive data protection legislation, and around 40 countries were in the process of enacting such laws. Kenya is in the latter category. Once the Bill is passed into law, businesses will need to be aware of what their rights and obligations will be in order to handle personal data in compliance with the law. That said, the Bill – as is – does point you and I in the direction that regulation of personal data in Kenya is taking. Are you ready for it?

 

By Miriam Maina and Pauline Njau

All You Need to Know About the Housing Levy

Introduction

Decent and affordable housing in Kenya is important as it affords dignity, security and privacy to Kenyans. The Constitution of Kenya, 2010 mandates the State to take legislative, policy and other measures to achieve the progressive realization of among others, the right to adequate and accessible housing. Kenya has made considerable strides in addressing decent housing but more is required to be done, as has been recommended by recent studies.

Among the aspirations in the President’s Big Four Agenda is a goal of delivering Five Hundred Thousand affordable homes before the year 2022. On a broad scale, the President seeks to pursue partnerships with private developers to unlock land for development, reduce construction cost and grow the mortgage finance market. 

However, more relevant for this discussion is the proposal to introduce payments to the National Housing Development Fund (the “Fund”), which is the subject of this article. The Fund, which is proposed to be under the control of the National Housing Corporation (NHC), is established under the Housing Act.

Contributions and Returns

Contributions to the Fund were introduced by way of amendments to the Employment Act, 2007 (in the Finance Act of 2018). Employers and employees are required to each make a contribution of 1.5% of the employee’s monthly basic salary to the Fund provided that the combined contribution does not exceed Kshs. 5,000/ per month. Persons who are not in formal employment or who are non-citizens may contribute a minimum of Kshs. 200 per month. Gazetted Housing Regulations (the “Regulations”) allow for contributions above the statutory minimum. NHC is required to specify on a yearly basis the return applicable on members’ contributions.

Benefits to Employees

According to the Finance Act, 2018, the Employees who contribute to the Fund shall benefit through several ways that include:

  1. Obtaining financing for purchase of a home under the affordable housing scheme, at an interest rate of up to 7%per annum on a reducing balance basis (or other rate gazetted by NHC from time to time). The financing is available on application and satisfaction of the set criteria.
  2. For employees who cannot qualify for affordable housing, transferring their benefits to a pension scheme or to a person registered in the affordable housing scheme or their spouse or children.
  3. Through cash distributions.

 Affordable Housing Relief

Under the Income Tax Act, any Kenyan resident making the said contribution and who  has applied for  a house under the affordable housing scheme is entitled to a tax relief equal to 15% of the gross salary up to Kshs. 108,000 per annum. Therefore, when computing the tax payable by the contributor, the said relief is deducted from the gross tax computed hence lowering the tax liability of the contributor. However, a contributor who has been allocated a house under the affordable housing scheme and who has enjoyed the affordable housing relief is not be eligible for a similar relief in any subsequent purchase of a house under the affordable housing scheme.

Offences and Penalties for Contravention

The Regulations further prescribe various offences and penalties for non-compliance. For instance, it is an offense under the Regulations for an employer to fail to register with the Fund, to make contributions and/or to keep proper records.

Challenge to the Implementation of the Levy

Notably, in September 2018, the Central Organization of Trade Unions (COTU) filed a suit challenging the implementation of the housing levy which was to take effect on January 1, 2019. The court issued orders stopping the implementation until the case is determined. The matter is scheduled to be heard in court on 26th February 2019. However, as at the date of this publication, reports in the media indicated that the Government had reached an agreement with COTU and parties had agreed that the case would be withdrawn to pave way for the implementation of the levy.

Article by Judy Marindany & Audrey Seur

The Law on Venture Capital in Kenya

Introduction

Venture capital may be defined as long-term risk capital typically provided by professional investors to new and expanding businesses which are usually high risk, but offer the potential for above-average returns. Venture capitalists pool their resources including managerial abilities to assist new entrepreneur in the early years of the project. Once the project reaches the stage of profitability, they sell their equity holdings at high premium. The concept has its roots in the US. The common projects in which such capital is invested are usually in Information Technology (IT), Biotechnology or Clean Technology.

Governing Law

In Kenya, this type of investment is governed by the Capital Markets Act (“the Act”) and Regulations made under it. The Act contemplates registration of venture capital companies (VCCs) and defines a registered venture capital company as a company approved by the Capital Markets Authority (CMA) and incorporated for purposes of providing risk capital to small and medium sized businesses in Kenya with high growth potential, whereby not less than 75% of the funds so invested consist of equity or quasi-equity investment in eligible enterprises.

The Act empowers the CMA to grant approval to entities to operate as registered VCCs. In addition, it bestows upon the CMA the power to issue guidelines and rules governing VCCs. Pursuant to this power, the CMA issued the Capital Markets (Registered Venture Capital Companies) Regulations in 2007.

Approval of Venture Capital Companies

In order to operate as a registered VCC, one has to obtain approval to the CMA. When one applies to be registered, they are required to provide details in respect of such matters as the capital structure, shareholding, subsidiaries and affiliated companies, the nature of venture capital financing to be undertaken, particulars of directors, shareholders, auditors and company secretary, amongst others.

Additionally, so as to be considered for approval, the applicant must meet the eligibility criteria set out in the Regulations. For instance, the applicant must be duly incorporated under the Companies Act as a company limited by shares, have as its principal object the provision of risk capital to SMEs, have a minimum paid up share capital of Kshs. 100M, have a minimum fund of Kshs. 100M and have a demonstrable track record as a VCC.

To enable CMA make a decision on the application, the law requires one to furnish the CMA with certain information and documents, which include details of the investment policy in respect of each fund to be operated, prescribed evidence of appointment of a licensed fund manager and details of the corporate governance structures of the applicant.

It is imperative to note that under the Act, without the approval of the CMA, it is unlawful to carry on business as a registered VCC or to hold oneself out as a registered VCC and carry on business as such.

Benefits of Registration

Once registered, VCCs enjoy certain tax incentives under the Income Tax Act. For instance, there are exemptions in respect of dividends received by registered VCCs. In addition, there are exemptions on gains arising from trade in shares of a venture company enterprise earned by a registered venture capital company within the first ten years of the date of first investment in that venture capital enterprise. This is subject to meeting the criteria that the venture company enterprise in which the investment is made has not been listed for a period of more than two years at the date of the trade.

Limitations imposed on Registered VCCs

The flipside is that the Regulations limit investment that can be made by registered venture capital companies. They require that investment may only include investment in a company or person associated with a venture capital enterprise.
The enterprises that they may invest in (venture capital enterprises) are limited to companies that do not trade in real property, banking and financial services, and retail and wholesale trading services.
In addition, registered VCCs are only allowed to raise money through private placements and are prohibited from making offers to the public.

Conclusion

Statistics indicate that the in 2018, annual venture capital invested surpassed $100 billion. Approximately $130.9 billion was invested across 8,948 deals recorded in 2018. These statistics suggest that venture capitalists will have capital to fund innovation for years to come. Venture capital has great potential to spur growth of SMEs in Kenya. With an enabling legal framework, we hope that the relevant players can tap into the potential which we believe will have a lasting social and economic impact in the country.

If you wish to know more about venture capital, please contact us:

 

By Peter Waiyaki and Pauline Njau
pwaiyaki@lexgroupafrica.com and pnjau@lexgroupafrica.com

Management Companies in Residential Properties in Kenya: An Overview

Concept of Management Companies

The term “Management Companies” can be used to describe companies that are used in managing housing units, such as apartments, located in multi-unit developments. They are common in situations where residential housing units comprise the entirety of the development, or a substantial component of it. The developments are usually constructed with the intention that the developer would retain the reversionary interest in the land, but upon registration of all subleases over the units, he/she will hand over management of the estate and ownership of the reversionary interest to an entity owned by the purchasers of the various units constructed (“Unit Holders”). Thus, when one purchases a unit in the development, they purchase also a share in the entity and enjoy two legal interests; as the owner of the individual unit, and as a part owner of the entity. It is that entity that takes over management of the estate and ownership of the reversionary interest that is called the Management Company.

Why Management Companies?

Save for developments done pursuant to the Sectional Properties Act, incorporating Management Companies in multi-unit developments is not a requirement of the law. Indeed, there are developments in which, upon a developer selling the units, they retain the role of maintaining the estate and retain ownership of the reversionary interest (duties ordinarily carried out by Management Companies). Management Companies are therefore largely a creation of industry practice. The idea behind their establishment is that where a group of persons individually own all the apartments in a multi-unit development, they ought also (at least after the multi-unit development has been fully completed by its developer) to be the members of a company which owns the common areas associated with their individual units, and which ultimately controls the extent, quality and cost of the shared services from which individual units benefit.

Several advantages flow from establishment of Management Companies, both for the developer and for the Unit Holders. For the Unit Holders, they are able to maintain an input into decision-making as regards their development and controlling the costs of having common services provided for their collective benefit. This they do by periodically electing the persons to serve as the management company’s directors. In addition, as an advantage to both to the developer and the Unit Holders, it is a convenient way of dealing with management of the estate once the units are sold out. Unless the multi-unit development is very small, it would normally be impractical for the common areas to be co-owned by all the unit-owners in their personal capacities, and for arrangements in relation to the provision of common services to be dealt with by contracts under which each of the owners was jointly and severally liable in their personal capacities.

Ownership and Control of Management Companies

The ownership and control of Management Companies varies depending on the phase of the development and the registration of the units. At the point of incorporation, the developer has only just begun to build the property and therefore they (directly or through their nominees) own and control the company. At this stage, the company is inactive, and the developer is responsible for all the operations of the residential property. During letting out of units in the development, the management company may be owned by the developer and Unit Holders whose units have already been registered. After registration of all sub-leases in the development and upon transfer of the reversionary interest in the underlying land to the management company, the developer finally hands over the ownership and control of all operations to the management company. From amongst them, the members appoint a board of directors who run the company and contract the services and persons needed such as a management agent.

Role of Management Companies

Generally, the duties of a management company include maintaining the common areas and associated facilities, contracting third parties to provide services or advice, procuring insurance to cover risks in the development determining the amounts of service charge payable by members and applying for renewal of the reversionary interest from the Government upon expiry of the term of the main lease from the government.

Where a Management Company fails, refuses or neglects to perform its duties or does so in a way that leaves Unit Holders aggrieved, the members of the company can seek appropriate means of redress available in the documents governing the subleases and in law. For instance, as shareholders, the Unit Holders have recourse to various remedies available under company law.

Conclusion

In sum, the benefits that accrue from use of Management Companies are numerous and perhaps this explains why developers have embraced them. It is however important for developers to seek appropriate legal advice on structuring of the Management Companies as circumstances vary from each development to the other. It is important for purchasers to understand the role of Management Companies, right from the point they sign agreements for sale, as these end up being the entities that determine the quality of services in the estate as well as other fundamental issues governing the estate.

Article by: Enock Mulongo and Pauline Njau

Please note that this publication is meant for general information only and does not create an advocate-client relationship between any reader and Mboya Wangong’u & Waiyaki Advocates. Readers are advised in all circumstances to seek particular advice on any issue dealt with herein.

 

 

Court Rules on Payment of CGT in Forced Sale of Land by Lenders

Just as we had predicted in our article ‘Payment of Capital Gains Tax in Bank Forced Sale Transactions in Kenya’, the High Court has recently held that KRA’s requirement for Capital Gains Tax (“CGT”) to be paid simultaneously with stamp duty on a sale of land by a Lender pursuant to its statutory power of sale is unreasonable, unfair and influenced by an error of law. For purposes of this article and for ease of understanding, we have used the terms ‘Lender’ and ‘Borrower’ instead of ‘Chargee’ and ‘Chargor’ respectively.

In Miscellaneous Civil Case Number 510 of 2017 (unreported), the Kenya Bankers Association (“KBA”) challenged the administrative action by KRA compelling Lenders to pay CGT on the sale of land pursuant to the Lenders’ statutory power of sale. It observed that the KRA’s i-Tax system does not permit the payment of stamp duty on a transfer unless an acknowledgment number for the payment of CGT on that sale is entered into the i-Tax system.

While agreeing with KRA that, to expect a Borrower to pay CGT in respect of a transaction which he has no control is unreasonable, the High Court held that it was equally unreasonable and unfair to demand a Lender to pay CGT upfront without first making a determination, based on the relevant factors, whether there is in actual fact a capital gain or loss. The Court was of the view that, although the Lender is a nominee of the Borrower for the purposes of payment of CGT (where, after the sale of the property the same is found to be lawfully due and payable), such a decision must be determined on a case to case basis. It stated that it was irrational to direct that CGT be paid in respect of all transactions entered into pursuant to the Lender’s exercise of its statutory power of sale before such a sale can be completed.

In addition, the Court held that, on the sale of land by a Lender in a forced sale, CGT is payable by the Borrower (owner of the land) upon registration of the transfer and not by the Lender or purchaser, unless there is a surplus from the proceeds of sale as to constitute the Lender a trustee for the Borrower.

Consequently, KRA was ordered to allow payment of stamp duty on instruments of transfer following sale of Land by Lenders pursuant to their statutory power of sale, without requiring the payment of CGT or an acknowledgement number for payment of CGT.

 

Considering that payment of stamp duty is done online, KRA should, following the High Court’s decision, change its i-Tax system to allow for payment of stamp duty without requiring an acknowledgement number for the payment of CGT, in respect of all transactions entered into pursuant to the Lender’s exercise of its statutory power of sale. We wait to see whether this will be done.

Article by: Patience Laki

Please note that this publication is meant for general information only and does not create an advocate-client relationship between any reader and Mboya Wangong’u & Waiyaki Advocates. Readers are advised in all circumstances to seek particular advice on any issue dealt with herein.

 

Alternative Public Procurement Methods in Kenya

Article by: <a title="The Associates" href="http://www.lexgroupafrica.com/team/associates/">George Kinyua</a>
Article by: George Kinyua

Public procurement law regulates the purchasing by public entities of goods, works or services. Its aim is to open up supply of goods and services in the public sector to competition, primarily to guarantee quality of supplies. In Kenya, this law is enacted in the Public Procurement and Asset Disposal Act, No. 33 of 2015 (“the Act”).

Under the Act, open (competitive) tendering is the preferred and default procurement method for public entities. However, situations may arise (typically owing to urgency, the type of goods or services sought to be procured or the supplier’s circumstances) which warrant the use of alternative procurement methods and procedures. In this article, we look at the most distinct of these methods, which, under the Act, include two-stage tendering, restricted tendering, direct procurement, electronic reverse auction, framework agreements, and specially permitted procurement procedures.

Two-stage tendering is used when, due to complexity of the goods or services sought to be procured and inadequate knowledge on the part of the entity, it is not feasible for the procuring entity to formulate detailed technical specifications for the goods or services. The procuring entity therefore invites tenderers to submit initial tenders containing proposals with technical specifications but without financial quotes. The entity evaluates the initial tenders and invites the tenderers whose tenders are retained to submit a second round of tenders with respect to a single set of technical specifications (generated by the procuring entity from tenders received in the first round) and with financial quotations. It is from this second round of tenders that the entity selects a supplier.

Restricted/limited tendering is tendering restricted to certain potential suppliers and may be used only where (i) the complexity or specialized nature of the goods or services requires that tendering be limited to pre-qualified suppliers, (ii) the time required to conduct open tendering would be disproportionate to the value obtained in the long run, or (iii) there are only a few known suppliers of the relevant goods or services.

Direct procurement occurs when the procuring entity issues a tender document directly to a particular supplier inviting the supplier to make a proposal to the procuring entity for negotiation. This method can only be used where (i) the goods or services are available only from a particular supplier and no reasonable alternative or substitute exists, (ii) there is urgent need for the goods or services due to an unforeseeable event beyond the control of the procuring entity which makes it impractical to use the other procurement methods, (iii) it is necessary to purchase from that supplier for reasons of standardization or because of the need for compatibility with existing goods, technology or services, (iv) the supplier is a public entity supplying on terms that are fair and comparable to those obtainable in the open market.

An electronic reverse auction (also known as e-action, procurement auction or e-sourcing) is a relatively new trend in public procurement. In a reverse auction, unlike a traditional (forward) auction that involves a single seller and many buyers, there is a single buyer (the procuring entity) and many suppliers. The buyer indicates its requirements and tenders compete on technical proposals and price quotations. An electronic reverse auction is a reverse action that is conducted through electronic media, either remotely or on site. For a procuring entity to utilize this method, the Act requires that it must possess a procurement portal and suitable software.

A framework agreement is an agreement between a procuring entity and various suppliers that sets out terms upon which the procuring entity will procure specified goods and services from the suppliers who are party to the agreement. During the term of the agreement, the procuring entity may make specific purchases through call-offs or inviting mini-competitive bids from among suppliers that have entered into the agreement in the respective category. Framework agreements are typically used when the required quantity of goods or services cannot be determined at the time of entering into the agreement. Under the Act, such an agreement must include at least 7 alternative vendors for each category of goods or services.

Specially permitted procurement, a concept introduced in the Act in 2017 following the IEBC Kiems procurement debacle, is not a specific procurement method but a rule under the Act empowering the National Treasury to allow any public body to use a specially permitted procedure (essentially allowing that body to not comply with the Act) where (i) exceptional requirements make it impossible, impracticable or uneconomical to comply with the Act, (ii) market conditions or behaviour do not allow the effective application of the Act, (iii) procurement of the goods or services is regulated or governed by harmonized international standards or practices, (iv) strategic partnership with the supplier is applied, or (v) credit financing procurement is applied. In addition, the Cabinet Secretary for the National Treasury is given power to determine the procedure to be followed in carrying out procurement using this method, which procedure will vary with prevailing circumstances.

Availability of the above and other alternative procurement methods enables suppliers and contractors seeking to do business with public sector players to engage with the latter while avoiding the tedious processes involved in open tendering and public private partnerships.

Please note that this publication is meant for general information only and does not create an advocate-client relationship between any reader and Mboya Wangong’u & Waiyaki Advocates. For particular expert advice on any matter dealt with above, please contact us.

 

Securities Lending and Borrowing: An Overview

INTRODUCTION

Studies on the state of liquidity in Kenya, including a Services Volunteer Corps report on the same have recommended several measures to improve liquidity, volume and pace of trading within the Kenyan capital markets. Key among the recommendations has been the introduction of Securities Lending and Borrowing (SLB) as well as Short Selling. In line with this recommendation, the National Treasury published the Capital Markets (Securities Lending, Borrowing and Short Selling) Regulations, 2017 (“Regulations”) in November 2017,

The Regulations, define securities lending as the temporary transfer of securities from a lender to a borrower with the concurrent written agreement to return the securities either on demand or at a future date.  Full legal title to the securities is transferred from the lender to the borrower so that the securities can be used entirely as the borrower desires, including selling them onward to others. As consideration for the lending, the borrower pays the lender a fee over the duration of the loan.

THE PARTIES TO AN SLB TRANSACTION

The International Securities Lending Association (ISLA) categorizes participants in an Securities Lending and Borrowing transaction into three broad groups. The first group comprises Lenders who supply securities into the market mainly from the portfolios of beneficial owners, such as pension & mutual funds and insurance companies since they hold large, relatively stable asset portfolios. Other common lenders include collective investment schemes, sovereign wealth funds and high net worth individual investors whose interest is to grow the value of their portfolios over the medium to long term. The second group comprises borrowers who identify trading opportunities that will more than make up for the lending fee costs. Borrowers are typically regulated firms such as investment banks, market makers, broker dealers, arbitragers, directional short sellers and players in the derivatives and Exchange Traded Funds markets.  The last group comprises intermediaries/lending agents who undertake the securities lending activity on each of the parties’ behalves since securities lending is a secondary activity for many of the beneficial owners and underlying borrowers. The Regulations define a lending agent as a third party who is not a party to a securities lending agreement but who provides support services to securities lenders including the monitoring of loans, the negotiation of lending fees or rebate rates, and the management of collateral.

BENEFITS OF SECURITIES LENDING AND BORROWING

The key benefit of Securities Lending and Borrowing to the market is that it provides liquidity to the broader market, which has been wanting in the Kenyan market. Securities Lending and Borrowing also helps in supporting a number of trading strategies, timely settlement of transactions in the market and hence improvement of market efficiency.

According to ISLA, to the lenders, Securities Lending and Borrowing provides a low risk incremental income for long term investors, such as pension funds, collective investment schemes and insurance companies. These returns (both in the form of loan fee and any return from cash collateral reinvestment) help to reduce the costs of managing their investments & to provide pensions and long term savings to investors.  On the other hand, Borrowers may want to own securities for a certain period for a variety of reasons, chief among them being covering a short position (this is the net investment position in a security in which the security has been borrowed and sold but not yet replaced). Borrowers are able to use the borrowed securities to settle an outright sale. Borrowers also use Securities Lending and Borrowing in enhancing settlement efficiency, having the securities to support a trading strategy, or in merely fulfilling a settlement obligation at the Securities Exchange.

RISKS AND OPPORTUNITIES

At the market level, financial experts warn that Securities Lending and Borrowing, if not strongly regulated, carry the risk of opening the danger of stock manipulation by investors keen to benefit from a price fall and aggressive speculation which was partly blamed for aggravating the 2008 global financial crisis.  The Capital Markets Authority has however assured the market that the Regulations, which borrow from international best practice, will check this risk through, inter alia, the requirement of collateral to cover the lender’s exposure.

For market participants, J.P Morgan in a recent publication  observe that the three primary risks in SLB are borrower /counterparty default risk, operational risk and cash collateral reinvestment risk. The main risk for a lender in SLB is the counterparty default. To mitigate the risk, Deloitte advises that the securities or cash held as collateral must be used to restore loaned securities to the portfolio.  Borrowers of securities are exposed to similar risks as the lender and the main risk for them is default by the Lender in returning the borrower’s collateral. In such event, the borrower can exercise their rights under the lending agreement and can seize the borrowed securities to cover amounts due. As such, the risks can be prevented by parties.

CONCLUSION

In sum, securities lending has potential to offer a countless benefits not only to the broader market in Kenya but also to long term investors and firms that may want to participate in SLBs. The enactment of the Regulations and subsequent commitment by NSE to upgrade their systems to allow the Security Lending and Borrowing framework to work by the second quarter of 2018 are notable milestones towards introduction of this product into the market. A future article will include an exposition of mechanics of the Regulations and the Securities Lending and Borrowing transaction.

Article by: C.G Mbugua

 

Payment of Capital Gains Tax in Bank Forced Sale Transactions in Kenya

The statutory power of sale (granted to lenders under Section 96 of the Land Act) allows a lender/charge (usually a bank) to, where the charger (borrower) is in default, sell charged property. This is referred to as a forced-sale. At the time of sale, the lender (who at that time becomes a seller) is required to obtain the best price reasonably possible in the circumstances.

Payment of Capital Gains Tax

Like any other transfer of property in Kenya, sale of charged property is subject to payment of capital gains tax (‘CGT’), unless the particular property or the transfer in question is exempted from taxation generally or Capital Gains Tax in particular.

The current rate of Capital Gains Tax is 5% and it is charged on the capital gain – the amount by which the sale value of the property exceeds the adjusted cost of acquisition of the property. Adjusted costs include the cost of purchasing and/or constructing the property, enhancing or preserving its value at the time of the transfer, incidental costs to the transferor of acquiring the property, and any post-acquisition costs of establishing, preserving or defending the title to, or a right over, the property.  The incidental costs used in computation are limited to those directly related to acquisition of the property by the borrower and its sale by the lender. Additionally, the adjusted cost is reduced by any amounts that have been previously allowed as deductions under section 15(2) of ITA. Banks are advised to obtain further advice from tax experts on the issue of computation.

Borrower’s non-cooperation

It is worth noting that most of the information that would assist the lender in computing the net gain for purposes of Capital Gains Tax is usually in the possession of the borrower.  While it is in the borrower’s interest to disclose information relating to adjusted cost (since it is an allowable deduction which would lower its tax liability) this being a forced sale the borrower’s co-operation is likely to nonetheless be at its minimum. From our enquiries at the KRA offices, we understand that where the borrower fails to cooperate, the bank is allowed to write to KRA requesting for their assistance in obtaining information. KRA will in turn get in touch with the relevant government agencies such as the Ministry of Lands to obtain relevant information.

However, to avoid delays and unnecessary costs, it is recommended that banks need to pre-empt the borrower’s potential non-cooperation by enhancing their KYC due diligence during loan approval to account for additional information needed in the event there is need for enforcement. We would be happy to advice further on this.

Information on the costs incidental to the sale can be provided by the auctioneer charged with the sale.

Where the value of acquisition is not ascertainable, the ITA (under Paragraph 9 of the 8th Schedule) provides that, the transfer value of the property shall be the market value of the property at the time of the acquisition or equal to the amount of consideration used in computing stamp duty payable at the point of acquisition, whichever is the lesser.

Who is liable to pay Capital Gains Tax in a forced sale?

Capital Gains Tax is payable on or before presenting an application for registration of the transfer at the Lands office. Parties to a transfer in a forced sale are the bank and a purchaser (who may, subject to certain conditions, be the bank itself).

Paragraph 5 of the 8th Schedule to the Income Tax Act (‘ITA’) provides that where a person sells property for the purpose of enforcing or giving effect to a charge or other security on the property, that person’s dealings shall be treated as if they were the acts of the owner of the property, for purposes of Capital Gains Tax. The bank therefore bears the responsibility to pay CGT.

Besides, KRA requires that, from an administration perspective, stamp duty must be paid either at the same time with or before Capital Gains Tax. This means that, since the Lands registry will not register a transfer before stamp duty has been paid before, the bank will need to source for funds to pay Capital Gains Tax.

This is problematic, given that the bank does not make a gain from the sale, since the bank must recover only those amounts that are actually owed by the borrower and pass any surplus to the borrower.

KRA recently acknowledged in our enquiry that administration of Capital Gains Tax in a forced sale is still a grey area and that they are still looking into the matter with a view to giving guidance on the same. Further, we understand that there is currently an ongoing court case regarding this. Notably, the court has previously ruled that the requirement by KRA that Captal Gains Tax should be paid either simultaneously with or before stamp duty is in breach of the ITA. We therefore foresee that the court will, in the current case, uphold its previous ruling and provide some relief to banks by ordering that Capital Gains Tax should be paid upon successful registration of the transfer instrument and by the person making the gain (if any), namely the borrower.

Article by: Patience Laki and Judy Marindany.

 

Please note that this publication is meant for general information only and does not create an advocate-client relationship between any reader and Mboya Wangong’u & Waiyaki Advocates. Readers are advised in all circumstances to seek particular advice on any issue dealt with herein.

 

Ownership of Properties to Infinity: New Regulations on Extension of Leases in Kenya

 By a Gazette Notice No. 5734 the Cabinet Secretary for Lands and Physical Planning issued  guidelines for extension and renewal of leases (the “Guidelines”).
Five months earlier, Gazette Notice No. 1812 of 27th February 2017 had appointed a ten-  member task force to investigate the processing, renewal and extension of leases in Kenya since  2010.
The foregoing actions target the complaints on the process of extension and renewal of leases as well as delays and loss of land through irregular allocations of expired leases. The legislature therefore has seen the need to come up with clear policy guidelines on extension and renewal of leases because the issue has far reaching implications on so many a local and foreign investor.

Lease Renewal under the Land Amendment Act 2016: Loopholes sealed

Under Section 13 of the Land Act as amended by the Land Amendment Act, 2016, a Kenyan citizen holding a lease from the National or County Government over land enjoys pre-emptive rights.
This ensures that the owner of the leasehold interest gets the first right to allocation of the land in question provided that the land is not required by the National or County Government for public purposes.
It is pertinent to note that pre-emptive rights only apply to Kenyan citizens. However, this does not preclude non-citizens from applying for extension or renewal of leases held by the same provided that one is in compliance with requirements under the Guidelines.

The policy, legal and institutional framework on processing, extension and renewal of leases;

Prior to the Guidelines, the process for applying for extension and renewal of leases was initiated by the registered owner. The present guidelines however seek to streamline the process by introducing and amending procedures as follows: –

• The National Land Commission (“the Commission”) Presumptive rights: Notice on expiry

The Commission will now trigger renewal on their own motion by writing to registered owners. The guidelines require the Commission to notify the registered owner by registered mail of the imminent expiry of the lease, five years prior. The notice should inform the registered owner of his/her pre-emptive rights of extension of the lease

• Advertisement and verification.

The Guidelines now require the Commission to advertise the notice of expiry of lease in two newspapers should the registered owner fail to respond to the initial notice; this is a slight departure from Section 13 of the Land Act as amended which provides for advertisement of the notice in one newspaper only.
The Commission shall undertake a physical verification of the land with a view to establish the status of the land; and secondly, to advise the registered owner on the need to apply for extension before the expiration of the term and the consequences of not doing so which include forfeiture of the preemptive right over the land and the automatic reversion the land in question to the National or County Government.

• The Application

Application for extension or renewal is made by the registered owner or appointed administrator before expiry of the Lease.
Where the term of the lease has expired without prior notice to the registered owner, the same will have to apply for renewal of the lease.
The application for extension or renewal shall be made to the Commission either by delivery of the same to their offices or in case of renewal, through the Commissions email address.
The Commission shall within seven days from receipt of the application, forward the same to the Cabinet Secretary for lands if the land is vested in the National Government or the County Executive Committee Members for lands if the land is vested in the County Government.
In order to obtain approval for extension, Kenyan citizens are required to produce land rent and rates clearance certificates, information on prospective encumbrances on the land, proof of compliance with the terms of the lease and in the case of a company, search results from the Company Registry.
Large scale investors must also satisfy the Commission of the economic benefit and the national development impact of the extension or renewal sought. However, the Guidelines do not define who constitutes a large-scale investor.

• The Process

The application process has been systemized with regard to extension of leases. The Application once receive by the Commission Officer, will be entered into a serialized register. In order to be entered in the register, the Guidelines require the application
–  a Copy of the ID/Passport;
–  an official search obtained one month prior,
–  Passport size photograph,
–  Certificate of incorporation in case of a Company; and
–  Letters of administration and confirmation of grant where applicable.
The accompanying documents required for renewal are similar to those listed above save for the additional requirement for the original lease.

• Approvals

The National and County Government shall consult with the relevant County Executive Committee Member, County Government Surveyor, Physical Planner and the Land Administration Officer of the Commission prior to approving the application for extension.
This also applies in the renewal of lease in which case the consultations should not be mere representations by the experts but also recommendations and any objections by them should be supported by reasons.
Once approval of extension or renewal of the lease is granted, there shall be revaluation to determine the payable land rent and other requisite fees, re-survey and geo-referencing and surrender the existing title. In the case of renewal, there is an additional requirement for a new letter of allotment for the parcel before the new leases is issued.

• Notification of rejection of the application

The Government is to notify the registered owner of its intention not to extend the lease three years before the lease expires and copy to the Commission.

Notice of rejection of an application is to be supported by reasons of either compulsory acquisition or non- compliance and issued within ninety days from the date of the application. At this point, all developments on the land are prohibited, previous developments are itemized and the registered owner is entitled to compensation on account of previous developments if the land is required for public purpose.

• Appeals

Appeals from the decision of the National or County Government lie in the Appeals Committee which is established by the Commission. The Appeals shall be held in the respective Counties in the Office of the Executive Committee member in charge of Land in that County.

The points of departure

The current Guidelines are not free from the shortfalls accompanying their provisions and implementation: –

  • • The preceding conditions

The foregoing guidelines have come at a time when litigation shaded the recent Land Amendment Act of 2016 where some sections of the Act were suspended by an order of the Environmental and Land Court (ELC) in Malindi pending the hearing of Petition Number 19 of 2016. One of the amendments that was suspended by the orders pertains to Section 13 of the Land Act from which the Regulations emanate. Despite the suspension of its application, the provisions in the Section 13 have been reiterated in the new Guidelines.

  • • Shortfall in Scope of Application

The guidelines have failed to address the issuance of leases for properties undergoing subdivision, amalgamation and change of user. Application for the said procedures is similar to the one for extension of lease. It was therefore expected that the Guidelines that seeks to streamline the law on renewal and extension of leases would make provisions for subdivision, amalgamations and change of user as well. The inclusion of these procedures is also more critical in light of the suspension of issuance of titles for subdivisions.

Conclusion

The new procedures and process for obtaining extension and renewal of leases is laudable for ensuring transparency. The Guidelines have attempted to provide for specific timelines for processing applications to ensure applicants do not suffer from unnecessary delays. Further, they have put in place steps to be taken by the Commission in alerting the land owners to ensure they do not unjustifiably lose their land through government re-allocation which is a positive step towards ensuring the protection of the right to property enshrined in our Constitution.

 

Article by: June Njoroge Ngwele Assisted by Pauline Kenyatta