THE LAW OF CONTRACT (AMENDMENT) ACT, 2019

The Law of Contract (Amendment) Act, 2019 (the Amendment Act) was passed by Parliament on the 18th of September 2019 and is now awaiting Presidential assent. If it attains Presidential assent, it will be published in the Kenya Gazette and come into effect.

The Amendment Act amends the Law of Contract Act by requiring creditors to realise the assets of the principal debtor before bringing a suit against a surety (including a guarantor). A surety is a person who has given a special promise to answer for the debts, defaults or miscarriages of another person.

The Amendment Act will not apply retroactively.

If assented to, the Amendment Act will significantly prejudice the utility of guarantees in Kenyan financing transactions. It is also drafted in a wide manner and could affect the enforceability of the following:

• security agreements provided by third parties;
• unilateral guarantees and other financial instruments issued by banks and others for trade or to support project obligations or public tenders such as demand guarantees and letters of credit; and
• structures that may be recharacterised as guarantees, such as put options, in respect of underlying loans granted to creditors of primary debtors which are exercisable upon default of the loans. In line with the practice of the English courts, Kenyan courts will tend to interpret transactions based on their substance more than their form.

The Amendment Act conflicts with the freedom of contract by limiting the flexibility of parties to agree that a surety assumes the principal debtor’s obligations. It also departs from international practice and norms and is likely to have a negative impact on the Kenyan financial market.

The Amendment Act may pose a number of practical challenges, such as:

• It may be impractical to realise certain assets of the principal debtor. For instance, a third party may have a security or preferential interest in that asset, the asset may be geographically out of reach, or it may be uneconomical to realise the asset. Seemingly, the right to sue a guarantor in such a case would not arise. Similarly, a guarantee in respect of a debt obligation for which the creditor’s recourse is contractually limited would be at odds with the essentials of the law because the creditor would not have recourse to all the assets of the principal obligor.
• Creditors rely on guarantees to lend to debtors who would otherwise pose unacceptable credit risks. Commercially, it is important for such creditors to retain the option to call upon the guarantee as a first or last resort depending upon the structure of the financing. The Amendment Act takes away this right.
• By requiring a creditor to realise all assets, the Amendment Act presupposes that the creditor has security over the assets or can cause a liquidation of the assets. In light of this, the Amendment Act will not promote a rescue culture for financial distress that the Insolvency Act is meant to achieve.
• Although each transaction should be looked at specifically, foreign law governed guarantees issued by Kenyan guarantors are also likely to be affected by the Amendment Act.

In view of the above, it will be important to carefully structure financial transactions to ensure that they are not affected by the Amendment Act. For instance, the parties may adopt co-debtor structures. As noted above, the Kenyan courts may recharacterise these as a guarantee. It will therefore be imperative to ensure that such structures are well thought-through and that the transaction documents are meticulously drafted with appropriate protective provisions. 

Bowmans is well placed to assist in structuring financial transactions and advising creditors to mitigate the impact of the Amendment Act on financial transactions.