A New Insolvency Law for Ethiopia

After so many years of trials and setbacks during revisions, the Commercial Code has finally crossed the last legislative milestone, an approval by the Parliament on March 25, 2021, repealing the old Commercial Code of Ethiopia, which was in service for the last six decades. The revision started three decades ago, but partly because of the lack of institutional will and political instability, it has taken decades to get past the Parliament. The last two years of Ethiopia’s political transition have seen a flurry of major legislative reforms, and it is perhaps no coincidence that the revision of the Commercial Code has been successful during this period. Now, Ethiopia has a new insolvency law.Last promulgated in 1960 (its actual drafting was much earlier), the Commercial Code is nearly 70 years old. The countries from which the Code was derived, most notably France and Italy, have revised their commercial codes several times during this period. Measured in terms of only time, it is fair to say that the Commercial Code has long outlived its normal shelf life.

The Commercial Code, as its name implies, is a systematic collection of multiple laws. The Commercial Code of the 1960 (just repealed and replaced) consisted of five books: General Law of Traders (Book I), Law of Business Organizations (Book II), Law of Carriage and Insurance (Book III), Law of Negotiable Instruments and Banking (Book IV), and Law of Bankruptcy and Schemes of Arrangement (Book V). If it were not for the device of a “Code,” which organizes multiple laws into one coherent law book, each of these laws could stand on its own and be revised and promulgated in isolation. It is important to remember that the just-approved Commercial Code is short of the two sector-related commercial laws of Books III and Book IV. The Commercial Code, in its current organization, mirrors the life cycle of a business from birth (Books I and II), to growth (Books I and II), to its decline, and resuscitation and/ or death (Book III). Books III and IV from 1960 will be revised and issued in a separate package as “Financial Code”.

Forming the last leg of the Commercial Code, insolvency law is the least known in commercial practice and courts so much that the number of insolvency cases litigated before courts can be counted on the fingers of two hands.

Factual insolvencies occur every day but few of these insolvencies ever make it to formal bankruptcy proceedings in courts. The reasons for these are many, the most plausible being an unfamiliarity with the advantages of collective bankruptcy proceedings and the dread with which bankruptcy is generally viewed by insolvent businesses. Even members of the legal profession are often reluctant to contemplate bankruptcy proceedings when their clients are faced with the problem of a cessation of payment of debts and instead prefer the messy procedures of individual civil litigations in seeking an enforcement of debts against defaulting debtors. The result has been multiple civil proceedings against a single defaulting debtor and lengthy drawn-out court litigations involving multiple court orders and injunctions against execution of judgments. Orders for executions and injunctions against executions, opening of individual proceedings, and stay of executions are familiar incidents in many of the individual civil and/ or commercial court proceedings involving debt.

Other rival debt enforcement proceedings have also overshadowed collective bankruptcy proceedings. The creditors which deal professionally with debt default, the banks, have generally been able to avoid collective bankruptcy proceedings and instead have relied upon foreclosure laws that gives banks the power to unilaterally foreclose on the collateral of defaulting borrowers. This contributed to a state of affairs in which banks use foreclosure laws to deal with insolvencies, in many instances to the detriment of all other creditors of an insolvent business. When they could go at it alone, there was no reason for banks to opt for collective proceedings like bankruptcy in which they compete with multiple creditors of an insolvent business.

The few formal bankruptcy proceedings in courts are themselves fraught with problems discouraging both insolvent businesses and creditors from viewing bankruptcy proceedings as a viable option to other debt enforcement and settlement procedures. Formal bankruptcy procedures are notoriously litigious and slow, and contrary to the real intention of these proceedings, are flanked by multiple proceedings which undermine the very purpose of bankruptcy proceedings as collective proceedings. Formal bankruptcy proceedings are therefore preferred neither for the time they take, cost they save, rate of recovery or for the outcome. One of the most famous bankruptcies in Ethiopian history, the Holland Car saga, has taken more than nine years and its finality is not yet in sight.

Drafted in the context of all these problems of debt enforcement, the new insolvency law, placed as Book III of the new Commercial Code, is set to overcome these problems and more. The biggest reform in insolvency law is the introduction of pre-bankruptcy proceedings whose primary aim is the rescue of struggling businesses. It encourages businesses (managers, directors, and owners) to initiate business rescue proceedings as early as possible to enhance the chances of the business’s rescue and prevent liquidation. In the past, only businesses with the most serious problems of financial default were involuntarily dragged through the bankruptcy process, by which time the chances of business rescue are so slim and liquidation and business closure all but inevitable. With the new friendly business rescue proceedings in the Code, it is hoped that more and more businesses will opt for such procedures and thereby forestall liquidation and closure.

The new insolvency law affords debtor businesses the opportunity to enter into court-supervised debt-restructuring negotiations and settlements with their major creditors without having to interrupt their normal course of business. This proceeding—called preventive restructuring—is entirely new in the Ethiopian insolvency regime and enables businesses to initiate rescue measures early and provides them with the best opportunity to negotiate and enter into a settlement for debt-restructuring. Preventive restructuring is the least intrusive proceeding as the ordinary business of the debtor continues unaffected and the restructuring plan is approved by the court only if all affected creditors have agreed to the plan. In other words, it is a court-supervised contractual debt-restructuring procedure.

Businesses facing financial difficulties can now also propose a reorganization plan which will, if voted favorably by a qualified majority of creditors and approved by a bankruptcy court, provide the businesses with the opportunity to clear their debts and return to a healthy bill of business life. In cases where it is unlikely for the reorganization plan to receive a qualified majority of creditors’ approval, the new insolvency law provides for an alternative scheme of selling the business as a going concern in which the struggling business will have a new lease of life in the hands of third-party purchasers.

Successive doing business reports of the World Bank’s Ease of Doing Business have given Ethiopia a low mark partly because of the wrong conclusion that Ethiopian law does not have provisions for “reorganization.” The Commercial Code of 1960 has two insolvency plans which are akin to reorganization (simple debt adjustment schemes) known as “schemes of arrangements” and “composition.” But since these procedures are rarely (if ever) used or invoked in practice, it is as good as if they never existed. The new insolvency law aims to correct this misunderstanding by calling the proceeding “reorganization” and providing for new rules which make these proceedings attractive, both for the struggling debtor businesses as well as creditors.

Modeled after the US Chapter 11 Reorganization rules, the “reorganization” proceedings of the new insolvency law of Ethiopia provide for more detailed procedures for the preparation and negotiation of a “reorganization plan,” creation of “classes of creditors” for discussing, and voting on the “reorganization plan, and alternatives to a reorganization in cases where a reorganization plan is unlikely to be approved, called ‘sale of business as a going concern.’” It is expected that with all these rules in place for the assurance of struggling debtor businesses and protection of all classes of creditors, businesses facing financial difficulties will opt for reorganization to prevent total liquidation of their businesses through straight bankruptcy proceedings.

Liquidation and closure of a business is not desirable but is unavoidable sometimes. Placed as the last option for businesses facing financial difficulty, the bankruptcy provisions of the new Commercial Code are procedurally similar in many respects to the bankruptcy provisions of the 1960 Commercial Code with only necessary changes in the organization of the rules and filling of the gaps in existing proceedings along with new rules which run with the times. The most important reform in the straight bankruptcy proceedings is the revamping of the rules on simplified bankruptcy proceedings for small and medium enterprises.

Called “summary bankruptcy proceedings” in the 1960 Commercial Code, the simplified bankruptcy proceedings are aimed at providing for less costly and time-bound proceedings and are intended to incentivize small and medium enterprises to follow formal bankruptcy proceedings when liquidating and closing their businesses. One of the most attractive features of simplified bankruptcy proceedings is that owners of small and medium enterprises will obtain a “discharge” if they meet certain conditions. In terms of numbers and perhaps even of cumulative volumes, the overwhelming majority of businesses in Ethiopia belong to the “small and medium enterprise” category, and if that is the case, it is expected that simplified bankruptcy proceedings will serve as a primary liquidation and clearing proceedings for an overwhelming number of businesses struggling with debt and unable to survive in a competitive market.

The new insolvency regime has also removed features of the old insolvency regime which made bankruptcy proceedings unattractive, particularly to debtors. One of these features is the absence of a “discharge” for innocent but hapless debtors. Innocent or not, the bankruptcy law of the old Commercial Code lacks provisions for a “discharge” of debtors. Not only do bankrupt debtors lose control of their businesses to third party independent administrators (trustees), the debtors do not have any prospect of ever freeing themselves from the deadweight of having once been declared bankrupt in their business lives.

In keeping with the times, the new insolvency law of the Commercial Code has a separate title for “discharge,” under which debtors who have been declared bankrupt might apply to the court of bankruptcy and receive a “discharge” not only from the debt that remains unpaid after a formal bankruptcy but also from the unflattering status of “bankrupt.” Bankrupt debtors can now apply to court for a “discharge” within three years from the date of the declaration of bankruptcy, and this is a fairly short period of time for debtors anxious to rejoin the business community, cleared from the heavy burden of having been declared bankrupt. “Discharge” is available for innocent debtors only, and only after a court proceeding in which creditors and trustees are afforded the opportunity to demonstrate to the court that the debtor was engaged in activities which precluded discharge.

As innocent debtors are protected from the permanent burden of bankruptcy, debtors and managers of debtors’ businesses, as well as creditors found to be responsible for the bankruptcy of a business, are made liable both civilly and criminally for their actions. The Commercial Code of 1960, operating on the strict wall of separation between commercial and criminal matters left criminal offenses to the Criminal Code of the time. The new insolvency law removes this wall of separation and provides for civil and criminal liabilities for offences directly connected to bankruptcy. This was done to ensure that the civil and criminal liabilities associated with bankruptcy proceedings are not overlooked by the parties responsible for the conduct of bankruptcy proceedings.

Insolvency Reform and Ease of Doing Business

Successive indices of the WB’s Ease of Doing Business (DB) Index have given Ethiopia a low ranking in the world, partly due to the nation’s inability to revise its Commercial Code of 1960. Ethiopia’s DB ranking has suffered in all areas where old laws haven’t been revised. One category in which Ethiopia consistently scored low points is in the category of “Resolving Insolvency,” which ranks countries on the basis of time, cost, outcome, and recovery rate of insolvency proceedings as well as the strength of the insolvency framework. Ethiopia’s overall DB ranking for 2020 was 159th out of 190 countries, and its ranking in the area of “Resolving Insolvency” was 149th. In this regard, Ethiopia ranks quite unfavorably with some high-performing countries of Africa, like neighboring Kenya (50th) and Rwanda (62nd).

Ethiopia is expected to score high in such areas like a strong reorganization regime, robust creditor participation in insolvency proceedings, recognition of the principle of “best-interest-creditors’ interest” and discharge of innocent debtors, not to speak of the greater confidence foreign investors and international financial institutions will have on the Ethiopian insolvency regime. It is hoped that with the passing of a new and modern insolvency law, Ethiopia’s doing business ranking in the area of “strength of insolvency framework” will improve considerably and with the implementation of the new insolvency law, Ethiopia will also see a substantial improvement in its ranking in the areas of the time, cost, and recovery rate of insolvency proceedings.

Legislative Reform is good news, but…

If the more than 60 years of the Commercial Code have shown us anything, it is that legislative reform by itself is not enough in bringing about desired reforms on the ground. So much of the Commercial Code, particularly the insolvency law, remained virtually untested in practice for reasons unable to recount here due to time and space limitations. Legislative reforms are often greeted with euphoria at the time of passing. But if these reforms are not followed by robust implementation, apathy and frustration are likely to replace the euphoria .

Legislative reforms must be accompanied by institutional and cultural improvements to complete the circle of effective and immersive reform. This triumvirate of reforms—legislative reforms accompanied by institutional and deeper cultural reforms—is particularly critical in insolvency reform, as the involvement and knowledge of so many actors is necessary for the machinery of insolvency to work as desired. Institutions like commercial courts, members of legal and accounting professions, banks and other financial institutions, and many regulatory agencies need to have a clear and common understanding on the workings of insolvency proceedings.

Owners, managers, and directors of business organizations or proprietorships will need to properly understand their obligations towards their businesses and creditors in order to fully utilize the machinery of insolvency proceedings and initiate business rescue measures as early as possible, and in serious cases, pave the way for the smooth and proper liquidation of their businesses. Financial institutions need to be brought on board and be made to play by proactive rules in business rescue measures, if need be, by providing critical financial injections to struggling businesses as their absolute priority of payments from collateral is assured in the draft insolvency law.

In short, so much hangs now on the two prongs—institutional and cultural reforms. Legislative reform is a great step forward, no question about it, but it is one small step forward in the grand scheme of things, and those tasked with the implementation of the new laws must walk the giant steps.

And finally, a note on the pace of the revision of the Commercial Code. The revision was late at most by three and at least by two decades. Though long overdue, it is better late than never. The revision of the Commercial Code should not take this long again. Since it is a composite of several books, individual books should be revised as situations dictate, not as it has been done in the past, where the whole is revised at once. Just as individual proclamations are revised and issued “as amended,” the Commercial Code should be revised from time to time and in real economic or commercial time and issued every so often “as amended” instead of “the Commercial Code of 1960 or 2021.” If the long and delayed revision of the Commercial Code can teach us anything, it is this: we need a focused and institutionalized system of legislative reforms to undertake and complete legislative reforms in the time these reforms are needed.

9th Year • Apr 16 – May 15 2021 • No. 97

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