Reasons ranging from macro-economic conditions to poor management may result in placing a business in financial distress. This article provides general options available for companies in financial distress under the laws of Ethiopia.

From an Ethiopian law perspective, a limited liability company will be legally considered to be in financial distress if it has lost three quarters of its capital or is in cessation of payment. The difference between these two incidents is as follows:

  1. Loss of Capital- If a company has lost three quarters of its capital, the management of the company is required to inform shareholders of the financial status of the company and request for their decision on the future of the company .1 If the shareholders and management of the company do not decide on the fate of the company within 90 consecutive days from the date on which the loss of three-quarters of the capital is known, any interested person may apply to court for the dissolution of the company.2
  2. Cessation of Payments - Cessation of payments occurs when the debtor is unable to pay its debts which are due and payable with its liquid assets.3 Credit reserves, overdraft and similar facilities that are available to the debtor will be considered as liquid assets of the debtor.4 Debts will be considered due and payable only after a creditor has issued a default notice to the company.5 At the point of cessation of payments, the management of the company has an option to consider reorganization proceedings or bankruptcy proceeding.

As a result of either of the above stated events, the management of a company will be faced with two options: rescue the company with a view to ensuring its survival or if this is not possible, opt for a liquidation of the company.

In the context of the first option, the management of the company should consider the following possibilities for the survival of the company within the existing shareholding:

  1. Equity injection – If a company is in distress and the management decides to save the company, the shareholders will be required to raise the capital of the company to at least more than 1/4th as a pre-requirement to renew its business license.6 Although the law is clear that there is a need for capital injection, it lacks clarity on the exact amount to be injected. It is not clear whether the shareholders are required to compensate the loss prior to injecting 1/4th of the existing capital or if only injecting 1/4th of its existing registered capital is sufficient.
  2. Reduction of capital – This is one of the options to be implemented if a company is facing a loss.7 The reduction of capital can either take the form of reducing the par value of shares or by exchanging old shares for lesser number of shares.8 Shareholders are required to approve the reduction of capital through an extraordinary shareholders' meeting.9 However, creditors who are not given adequate guarantees for the payment of their claim may block the decision of the shareholders to reduce the capital of the company until the capital is restored to the amount existing at the time when the claim originated.10
  3. Debt Restructure – If a company is on the verge of cessation of payment or it has been less than 45 days since its cessation of payment, a reorganization proceeding can be opened.11 The reorganization proceeding will permit the company to have an observation period of at least 4 months to come up with a plan for reorganizing its debts. During the observation period, the management of the company are provided with the opportunity to explore multiple options to revive the finance of the company including rescheduling of claims, sale of assets/business units, debt to equity conversion, or issuance of debt instruments. Thereafter, the plan will have to be approved by the creditors and the court before being implemented.12

If for various reasons, survival of the entity within the existing shareholding is not possible, the management of a company will have to consider the following options that will result in the transfer or winding up of the business:

  1. Sale of Business as a Going Concern – the sale of the business may be implemented in the context of preventive restructuring, reorganization proceedings or bankruptcy.13 The objective of the sale will be to maximizing the value of the business as a going-concern for the benefit of the creditors.14 The sale of the business will be conducted either in a public auction or a private sale.15 As a result of the sale, the contracts of the company will be transferred to the buyer. Consequently, contractual provisions restraining the assignability of the contracts, (including intuitu personae contracts) will not be enforceable provided that such contracts are necessary for the continuation of the business.16
  2. Dissolution – Among the grounds of dissolution that cause the liquidation of a company are the voluntary decision of shareholders or a bankruptcy declaration.17

Voluntary Liquidation: When a company has lost three quarters of its capital, but not in cessation of payments, the management of the company is required to decide on the dissolution of the company and appoint a liquidator if other options for ensuring the survival of the company are not being considered.18 This decision will be published in a newspaper having wide circulation and posted on the company`s website within 21 days from the date of the decision to dissolve.19 Until winding-up of the company is completed, the company will retain its legal personality and name, to which the words "in liquidation" will be added.20 Furthermore, the powers of the management of the company during this period will be limited to actions only necessary to the winding-up of the company that do not fall within the scope of powers of the liquidator.21 It is important to note that the management of a company should opt for liquidation route only if the management is certain that the company is able to settle its outstanding debts from its assets or through other means, including debt remission or capital injection from shareholders.

Bankruptcy: A company that has been in cessation of payments and has not applied for reorganization is subject of bankruptcy proceedings. For companies that are undergoing bankruptcy proceedings, there will be an automatic divestment of the company with respect to all its assets.22 Moreover, the capacity to sue or to be sued will only be vested in the trustee.23 Consequently, the business activities of the company will cease, and the management responsibilities of the company will be vested on the trustee.24 To proceed with the winding-up of a bankruptcy estate, the court will order the trustee to wind-up the company and issue payment to creditors as per the order of priority provided in the law.25 Thereafter, the trustee will sell the assets of the company by a public auction or private sale depending on which option is to maximize the purchase price of the assets.26 Where the total amount to be paid is not sufficient to fully satisfy the claims of creditors belonging to the same class of rank, such creditors shall be paid on a pro rate basis based on the admitted claims.

In conclusion, if a company registered in Ethiopia incurs financial difficulties, identifying the financial standing of the company and swiftly planning the next steps is crucial. As a first step, distinguishing if the company is facing a capital loss or cessation of payment is necessary to map the course of actions. Thereafter, it is important to take note of the relevant period of limitations that will apply on the company. If the company has incurred a loss of capital, the management of the company will have 90 days from the date on which the loss is known to decide on equity injection or voluntary liquidation.27 In the context of cessation of payments, if the company faces actual or foreseeable economic or financial difficulties but not yet in cessation of payments or has been in cessation of payment for less than 45 days it is important for the management of the company to consider opening proceedings for preventive restructuring, reorganization or bankruptcy, as the case may be.28

Furthermore, if the management of the company does not take the required action in time, there will be liabilities that will result from what will be considered as the negligence of the management. Such liabilities in the context of loss of capital include joint and several liability of shareholders for any debts assumed by the company after the loss of capital.29 In the context of bankruptcy, the managers of the company will be liable to bear all or part of the debts of the entity where the manager is at fault and has contributed to the insufficiency of assets of the company, resulting in the decrease of value of the assets and the increase of value of the liabilities, including for failure to file for bankruptcy at the right time.30 Shareholders will also be held liable to creditors if they have , acting in their own interest, given instructions to the management that resulted in the cessation of payments of the debtor.31

Footnotes

1. Article 473 (c) and 532 (1) of the Commercial Code.

2. Article 532 (3) of the Commercial Code.

3. Article 590 (1) of the Commercial Code.

4. Article 590 (2) ) of the Commercial Code.

5. Article 590 (4) of the Commercial Code.

6. Article 19 (6 & 8) of the Commercial registration, Licensing and Post Licensing Inspection Directive No. 935/2022.

7. Article 646 of the Commercial Code.

8. Article 465 of the Commercial Code

9. Article 466 of the Commercial Code

10. Article 467 of the Commercial Code.

11. Article 635 (2) of the Commercial Code.

12. Article 685 of the Commercial Code.

13. Article 689 & 747 of the Commercial Code.

14. Article 689 (3) of the Commercial Code.

15. Article 689 (2) of

16. Article 691 of the Commercial Code.

17. Article 181 (3 & 5) of the Commercial Code.

18. Article 473 (1c) and 532 of the Commercial Code.

19. Article 474 (1) of the Commercial Code.

20. Article 479 (1) of the Commercial Code.

21. Article 479 (2) of the Commercial Code.

22. Article 725 (1) of the Commercial Code.

23. Article 725 (2) of the Commercial Code.

24. Article 744 of the Commercial Code.

25. Article 775 of the Commercial Code.

26. Article 779 of the Commercial Code.

27. Article 532 (3) of the Commercial Code.

28. Article 617, 635 and 705 (2) of the Commercial Code.

29. Article 473 (5) of the Commercial Code.

30. Article 803 of the Commercial Code.

31. Article 805 of the Commercial Code.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.