There is a significant legislative effort by Parliament to amend the Law of Contract Act. The impact of the amendment, if passed, will be that in the case of a default by the principal borrower, the creditor should first realise the assets of the principal borrower before proceeding to commence court proceedings against the guarantor for the recovery of the debt.
The current law contains no such express restriction and lenders would typically want to have the right to pursue a guarantor without having to pursue the borrower. Apart from the contractual freedom of enforcement that secured lenders will usually reserve for themselves in the event of a default, this amendment will affect the Land Act No. 6 of 2012, which sets out various options that a security holder has in enforcing its rights, which include the right to sell the land or sue the borrower for the non-payment of the loan.
As you may be aware, the existing law in Section 91(2) of the Land Act provides the Kenyan courts with the discretion to compel a lender to exercise all its remedies against the charged land before exercising a remedy available to it under Section 91(1)(c) of the Land Act. However, this is at the discretion of the courts.
If the proposed amendment is accepted and passed into law, secured creditors will no longer have an option to elect whether to sue or to realise the security first but will instead be bound to realise the security before they can sue.
In addition and most importantly, the proposed amendment appears to not only cover suits against the borrower but suits against guarantors and providers of third party security. The drafting of the amendment is general in nature and suggests that in respect of all suits for recovery of debts to be instituted, the security of the principal borrower would have to be realised first.
This is regardless of the fact that most well drawn guarantees and third party securities are drafted with an indemnity obligation such that the guarantor/third party agrees that he is primarily liable and can be sued regardless of the position of the principal borrower. If this amendment is passed, lenders will now run the risk of having borrowers and guarantors/third party security providers frustrate the process of security enforcement by, for instance, significantly delaying it thus allowing a guarantor to dispose of his assets or reorganise so that there is nothing to attach if and when the time comes when he may be personally sued.
It is also potentially applicable to existing arrangements as there is no statement concerning its impact on existing guarantees/third-party security.
We are not aware of any other jurisdiction where such a restriction exists and it is not clear what issue the proposer of the Bill is trying to address. Given the considerable time that enforcement can take through court proceedings in Kenya, a lender's rights against a guarantor would potentially be postponed for many years negating the value of the obligation. We understand that the Bill is in its initial legislative stages and has just been introduced in Parliament. We will keep track of the process of enacting the Bill and will engage the concerned stakeholders on the impacts of the proposed amendment on the financial sector so far as securities are concerned. In the meantime, we would urge members of the Kenya Bankers Association to meet to discuss the repercussions of the proposed amendment.
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