Tuesday, January 17, 2023
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Interview"We are still not benefiting from the dividends of the reform,"

“We are still not benefiting from the dividends of the reform,”

Tadesse Lencho (PhD)

“People fear that if Ethiopia floats its exchange regime, everything will fall down,”

Tadesse Lencho (PhD) is TBeST Law LLP’s managing partner. He has primarily taught tax and bankruptcy law at Addis Ababa University and has practiced law as an advisor to several organizations.

He was also one of the drafters of the long-overdue Commercial Code, which was ratified in 2021. Tadesse earned his first law degree from the AAU. He received his master’s degree from Michigan University and also received his PhD from the University of Alabama in interdisciplinary studies, but in tax law.

Despite recent changes and rapprochements, Tadesse feels Ethiopia is yet to reap the benefits of the reforms. Ashenafi Endale of The Reporter was granted audience. EXCERPTS:

The Reporter: You have been engaged with the academic, private, and public sectors. How do you evaluate the relationship between these three pillars?

Tadesse Lencho (PhD): I have knowledge about how the three operate. Historically, the relationship between academia, the private sector, and the government was strained. Most of us in academia are disengaged. We were not involved in advising the government. Except for a very few, most of us were completely disengaged from advising the government.

But in the last two or three years, there has been a sort of rapprochement among the three.

I was involved in the revision of the current commercial code. I was one of the drafters of the bankruptcy law, one of the three books included in the commercial code. The bankruptcy law is also known as the insolvency law. I was involved in advising the government and drafting the law. I found the government really open to new ideas and reform. In fact, work on the 60-year-old commercial code began 30 years ago.

Under the new government, we were able to successfully amend the commercial code, along with other colleagues and foreign juries. We presented the bill to the Council of Ministers, and then it was approved in Parliament. I am not saying there are no problems, but we see openness.

If you take legislative openness as a measure of openness, Ethiopia saw the biggest legislative reforms in the past four years since the 1960s. The emperor introduced many of the codes we have today, including the civil code, penal code, and commercial code.

There have also been major revisions to the charity and CSO laws, the anti-terrorism law, the media law, and the administrative procedure law, which Ethiopia has never had before. So we can say there is a great deal of openness in the government and that it is receptive to new ideas.

But still, there are problems of implementation and misunderstanding. We are still not benefiting from the dividends of the reform in Ethiopia. So the software has to be reformed, as well as the bureaucracy, the civil service, and the institutions; without them, we are going nowhere.

Legislative reform is a good place to start. But the implementation of the new legislation is determined by institutional reform.

Why did the commercial code amendment take over 30 years? Why did the current government rush into approval in the past four years? Is it related to the government’s deregulation, liberalization, and privatization moves?

There are many reasons for the dalliance, but it is mainly attributable to a lack of political and institutional commitment to revise the commercial code when it is needed. There was no political willingness prior to 2018. It was not because of a lack of technical assistance.

I was actually involved in the revision of the commercial code back in 2008. The Addis Ababa chamber of commerce launched an initiative and organized a national committee of experts, including lawyers, financial experts, and accounting experts. We forwarded recommendations to the government but did not succeed.

The lack of attention was the result of a lack of political willingness. If the government has the will, there is always a way to revise a law.

The revised commercial code finally became law in 2021. But it was not the whole commercial code that was revised. The commercial code of 1960 is comprised of five books. When we took up the revision of the commercial code in 2018, we had a challenge. Can we undertake the revisions of all five books at the same time?

We realized book three needed additional study and additional expertise. So we decided we were not going to wait until studies were done for books three and four. Hence, for the sake of time, books one, two, and five, which are the natural contents of the commercial code, came out first.

These three books are the ones needed for any business organization, from birth to death. Books one and two talk about the birth and death of business entities and the expansion of businesses. Book five is about the decline, the old age, and the “death” of business organizations. Books three and four are about sectoral organizations, such as banking and insurance. You cannot have separate books for agriculture, mining, or other sectors. But you can have banking and insurance.

Books three and four are still undergoing another revision, which will be separate from the commercial code. They will be introduced as the “Financial Services Code.” Nothing is lost as a result of this. The commercial code is missing nothing. From the beginning, books three and four were included in the commercial code, simply because the drafters in the 1960s thought they had to include them. It was not a necessity. The three books demonstrate the importance of a commercial code

What are the changes and alterations occurring in the commerce landscape in Ethiopia since the revision of the code? And how do you evaluate the implementation of the new commercial code?

The first major change in the new commercial code is the concept and scope of redefining what is meant by “trade.” In the old commercial code, the concept of trade was limited. Trade is dynamic. What used to be sacred in the old days could be traded today. What used to constitute religious activity could be a trade.

So what we did in the new code is create an open-ended list of what constitutes trade. Anything that can be done professionally and for profit can become a trade. There is no limit. Of course, there are some limits regarding morality and legality. If people organize themselves for contract killing, that cannot become a trade because killing is a crime. People cannot also organize to steal. Apart from these prohibitions of morality and legality, anything can be traded.

The other major reform was to take out certain parts of the old commercial code that are ephemeral in nature. What kind of accounting should traders maintain? That should be left for other areas of the law. Only things that are relatively permanent and long lasting should be addressed by the commercial code.

The other thing is that we have transformed the landscape of business organizations. There were six business organization formation modalities in the repealed commercial code. Now we have seven. We took out one of those business organizations, which was very mysterious in nature. It was never actually put into effect. It is the “Ordinary Partnership.” Even among the lawyers, nobody knows what it really stands for. This was an irrelevant organization. So we took that out.

Instead, we introduced two new business organization formations. One is the LLP, which helped our law firm to form. LLP is designed primarily for professionals; lawyers, auditors, valuators, architects, and even physicians can now form LLP organizations. They can seize the opportunity of economies of scale without losing sight of the fact that they are professionals.

This is a personal organization in the sense that the partners are as important as the business organization itself. The partners provide the same services as the organization itself. It combines professional and business aspects.

The second is that we introduced the “one-person company.” OPC is an offshoot of PLC. PLC needs individuals to form. It takes two to form a company. So you cannot form a company unless there are two people. We have removed the second person and introduced OPC. OPC is pretty similar to PLC.

We knew from experience that the majority of PLCs in Ethiopia are one-person businesses. Why do we need the other person? The other person is usually not even effectively a member. The second person is usually not a significant contributor of capital. He is not involved in running the business. So why do we need two people when one person can establish a company?

It is in the nature of LLP, SC, PLC, and OPC that third parties are not protected by the number of people. They are protected by the capital that they contribute. Capital is the main guarantor of the business organization. So we established OPC as an important and new kind of business organization.

The fourth major change we introduced in the code is the recognition of groups of companies. Previously, we did not have laws regarding groups of companies. Holding companies are one type of company group. We know that a group of companies operate in this country and are very successful.

Many of the multinational companies are groups of companies. So we wanted to have rules about parent companies and subsidiaries, and we wanted to regulate their relationship. How does a parent company abroad control its subsidiaries in Ethiopia? How does the subsidiary respond? We have detailed rules now about groups of companies. This gave recognition to the fact that groups of companies exist in Ethiopia. It’s as if you’re acknowledged as family but not as extended family. Now we have both the nuclear family and an extended family. Now groups of companies have consolidated accounting systems and that sort of thing.

The fifth change is about my area of expertise, which is bankruptcy law. We have made various changes here. One is changing the attitude towards the insolvency of companies. In the old code, the focus was on liquidation in bankruptcy. We’ve shifted our mindset from liquidation to rehabilitation to business revival. How can we save the business entity, even though it is in financial distress?

So we have new ways of saving a business in the context of insolvency, such as rehabilitation schemes. For instance, the preventive structuring scheme, which is prevention, is better than cure. It is similar to the approach to patients in hospitals.

Preventing a company from going into liquidation is better than going into liquidation itself. Whenever the company faces imminent financial distress, it takes it upon itself to reschedule its debt with its major creditors, tax authorities, and other significant stakeholders.

So it takes action before it becomes irreversible to prevent its own insolvency. So the preventive structure scheme prevents the closure of a company upon its inability to pay its debt.

The other one is reorganization. It is similar to preventive structuring but covers all kinds of creditors. Businesses can now apply to the court to reorganize their debt. You can ask for a rescheduling of the due debt, ask for a reduction of debt, or ask for reorganization. To save itself, a company can merge, split, or be transferred to a third party. If the management is bad, we can sell the company to a better third-party manager. It is not about selling it, but saving it.

We save a business for the sake of serving the society it serves. A business is a very important institution in modern society. It is a great disservice to lose a business entity because of poor management or a lack of cooperation from creditors or other stakeholders, so we introduced new schemes to avoid liquidation.

Are all businesses able to get their debts rescheduled, reorganized, or rescheduled by going to court?

In theory, any company can apply for such rights, but they are determined by the diagnostics. It is just like diagnosing a patient.

The businesses have to be audited before they can benefit from the schemes. If the problem with the company is very serious, it has to be liquidated. So the business has to get a financial health check, just like people go to the hospital for checkups. An early check means there is a chance for rehabilitation.

Much of the reason why businesses in this country are in financial distress is that they do not intervene until the company’s financial situation has deteriorated, at which point it is too late to rehabilitate. Proactive measures are crucial.

But to your question, the answer is no. There are certain businesses that cannot be saved. There are also certain factors that lead to insolvency, including financial and technological distress. If there is obsolescence in your area of business, if you do not change your technology and transform, you cannot save your business. There are so many companies that have disappeared because of technological changes. There are also international economic factors that may account for the insolvency of businesses. If their line of business is already obsolete and disappearing, there is no way you can save it.

Only after auditors, accountants, and experts have evaluated the company can a decision be made about whether or not it can be saved.

Many businesses complain that the tax authorities have a firm grip on them, forcing many out of business.

Basically, tax is not part of the commercial code.

The tax law was revised in 2016. Since then, there have not been any major revisions, except for the introduction of the new excise tax in 2019. Currently, the government is revising the VAT. They may also be revising the income tax law.

Taxpayers have lots of complaints, particularly in the area of auditing. Large businesses, in particular, have serious complaints about the tax assessment system. The mechanism for calculating estimated taxes is at the heart of the complaints.

The tax issue is a very important and broad subject that needs a separate interview session.

One of the problems we have in Ethiopia is that the auditing system is not properly regulated. For instance, what is the regulation for “estimated tax income?” Aside from the books of account and external auditors, how do tax officers estimate taxes? How do they estimate your income, expenses, or reject your expenses? These are legitimate and ongoing questions.

There is also another problem. On the government side, there is a theory that says the government is not collecting tax in proportion to what the economy produces. So they say the tax-to-GDP ratio is low. It has always been very low. It is much lower than even the sub-Saharan countries, and there are a number of factors for that.

One of those factors is the tax laws themselves. The tax base is not as broad as it should be. For instance, the government does not collect tax revenues from the agriculture sector in Ethiopia. There is a conscious policy to incentivize agriculture, so the tax from agriculture is disproportional to what agriculture contributes to Ethiopia’s GDP.

Ethiopia is an agrarian country. But that was the conscious policy the government took. As a result, the government can’t complain about the low tax-to-GDP ratio.

There are also several types of tax incentives given to investors. Tax breaks can last anywhere from six to fifteen years. There is a lot of tax revenue loss from the provision of tax incentives, including duty-free privileges and other packages. These are structural problems that the government must address them.

Apart from the legislative problems, there are also administrative problems. For instance, the tax on the rental income system is not productive. The movement must look at the administrative side of tax loopholes. There are a lot of tax avoidance activities that the government has to address.

The government has to work to stop the over taxation of certain sectors.

Large taxpayers complain that they are paying lots of taxes, regardless of what their books of accounts say. They are asked to pay more taxes. This is basically because of the estimated tax assessment system in the auditing process.

Uncertainty, unpredictability, and many other factors are among the problems. The government has to work hard to improve the investment environment. Then the tax authority can ask for more taxes. Over-taxation of certain sectors discourages investors.

There are many investors I know who prefer predictable, effective tax administration to tax incentives. They would rather be without the tax incentives than have this unpredictable tax assessment system. The government has to consider this.

The major source of the problem is both administrative and structural.

Recently, the tax-to-GDP ratio has fallen considerably. COVID-19 played an important role in economic declines and exacerbated inflation. Lower revenue means lower taxes. It is a global challenge. Inflation reduces tax revenue and reduces business activity. There are also political factors in Ethiopia.

The tax morale, or willingness of the business community to pay tax, is also another issue. The country’s security situation also has an impact on tax revenue. The government has to look at the structural, administrative, as well as political and security problems.

The government also drafted a new property tax for the first time since the Derg regime. But there is an argument at the House of Federation regarding who should collect property tax.

A property tax is a tax on movable property. Because Ethiopian property owners do not pay enough tax, the government considered instituting a property tax. So we can generate some income for the government. The property legislation introduced during the Derg still exists, and its revenue contribution is very small. So they decided to raise property taxes as an alternative revenue source for the government.

But there are practical and constitutional challenges. The first issue is that the constitution does not specifically address property taxes. It is not mentioned. Some people argue the constitution mentions property tax indirectly, but the general consensus is that property tax is not mentioned in the constitution.

When the constitution does not specify an issue, it is referred to the joint houses: the House of Federation and the House of Peoples’ Representatives. The two Houses have to pass a resolution on the collection of property taxes by either the federal government or the regional states, or both.

There was a proposal to designate it as shared revenue between the federal government and the regions.

But by its very nature, property tax is universally considered a local tax, not even a regional tax. “Local tax” means it is an urban tax. It is a municipal tax. My view is that we should not share property taxes. Let it be collected at the municipal level.

The municipality then uses it directly.

Yes. It is directly voted for. Property tax is also linked to direct democracy. People who are paying property tax can also demand certain kinds of services from the municipality itself. Schools, health centers, side streets, lights, and all kinds of services demanded can be addressed with the money.

To my knowledge, the issue is still not solved. But my position is consistent with what the literature says. We have to make it local. Of course, the Ethiopian constitution does not talk about local government. It only makes a plea to the state to establish local government.

So the municipalities do not exist under the constitution, except for Addis Ababa. Other municipalities are under the jurisdiction of the regional states.

As a result, the property tax should be assigned to urban areas for their own growth as well as for the direct participation of the people in the design of the rate and amount of property tax. Of course, there are also questions about whether property taxation is a good idea. Some economists say it is not a good idea because it involves a lot of contacts that lead to corruption.

Involvement of the assessors, the valuators, tax collectors, and taxpayers can lead to dangerous corruption. Some people also say it does not generate as much revenue as the government thinks. As a result, they advise the government to raise taxes through other means, such as VAT, income tax, and corporate tax.

If Ethiopia joins the WTO and other trade blocs like the African Continental Free Trade Area (AfCFTA), will Ethiopia have to amend the commercial code, or will the recent revision suffice?

I do not think there is a need to revise the current commercial code. While preparing the revised commercial code, we have taken account of the reforms underway elsewhere in Africa and globally. But if there is a need, we might do it again.

The main areas where the WTO and other trade blocs touch are tariffs, customs duties, import duties, and that sort of thing. These organizations intend to promote the free movement of goods and services. The idea is to remove barriers to trade.

So that is where I expect a lot of changes, instead of the commercial code. Tariffs on goods and services originating in AfCFTA members, for example, could be reduced or eliminated entirely. The same is true with the WTO. The WTO is concerned with the removal of tariffs.

In terms of business, I do not expect a lot of changes. The commercial code already recognizes the number of business organizations that exist. Some differences might occur in the nature of entities that exist in different countries. But the treaties address such kinds of changes in the names.

We addressed everything in the commercial code, and we do not anticipate changes soon. The tax law and related issues might be revised because the tax rate has to be somewhat comparable. If some countries try to attract investors and traders by reducing taxes at the expense of other countries, it will be problematic.

So the main change will be in the customs duties, customs procedures, and related areas. Visa laws and employment laws will also change. Many countries are changing their visa policies to ease the movement of people, goods, and services.

If you have restrictive employment and work permit procedures, that hinders trade integrations. That is where I expect a lot of changes.

What is the latest update regarding the Financial Service Code, which is being compiled by the Ministry of Justice (MoJ)?

A few people from the Ministry and the International Financial Corporation (IFC) are working on the new code. Banking industry experts are also taking part, specifically to revise Book Four. I am not directly involved in this.

Currently, the government is working on a new legislation to open up the banking sector for foreigners. There are a lot of arguments regarding the entry modalities. What is your take on this?

I’m not overjoyed about the financial sector’s opening. I do not know how much forex the open-up will generate. That will depend on how many foreign bankers are willing to come to Ethiopia. We have to wait and see.

People realize the open-up isn’t all that it’s cracked up to be after much fanfare and optimism. So it is going to be a problem.

But in terms of competition, the financial sector is a protected sector. Regulation has protected the domestic financial sector. But they protected only the interests of a few shareholders. Are the consumers getting better financial service as a result of this protection? I doubt it. The number and types of financial services you get in Ethiopia are very limited.

As a result of the opening and coming of foreign banks, I anticipate increased competition. Competition is usually good. Just look at how ethio telecom has been reformed following the opening up of the sector. Its services have improved quite considerably. Safaricom joined the sector. So consumers will start getting better services. This will incentivize businesses.

The opening up of the financial sector will also bring technology to facilitate the depositing and raising of money. Access to credit is the most difficult thing in Ethiopia’s business activities. The liberalization may improve access to finance, but we have to wait and see if it will be realized.

I see some level of protectionism going on. The central bank needs to protect local banks from the shocks of foreign banks’ entry. Otherwise, the small fish in Ethiopia will not survive.

Banks should only be protected for the healthy operation of the monetary system in this country. The banks should not be protected just to protect certain stakeholders, like shareholders or even some borrowers. It is important to liberalize the financial sector so that consumers get what they deserve.

But the financial sector’s liberalization is going to take time because of the level of caution.

But foreign banks have reservations because account liberalization and the forex regime remain restricted. Do you think the Ethiopian government can go in this direction too?

It is going to take a major change in attitude. Many people are concerned that if Ethiopia abandons its exchange regime, everything will fall apart. There is nothing to control. Proverbially, “the aircraft will crash to the ground” and everything will be out of control. That is a very apocalyptic attitude. Many African countries have achieved success by allowing their currencies to float. So it requires a lot of courage.

Ethiopia is accustomed to this controlled foreign exchange regime. I do not know if they are overcoming that. Of course there are going to be turbulence and problems in the aftermath of forex regime liberalization. Inflation can soar. The turbulence remains only until demand and supply settle down in the forex market.

Unless the forex regime is liberalized, it does not make sense to liberalize the financial sector. One of the greatest barriers to accessing credit is the forex regime. So we need to liberalize many things at the same time. We need to get out of this control mentality.

Yes, control gives you some degree of certainty. But it also limits you to this small economy.

It is not only the financial sector that has to be opened. It is the nature of the service. It is not only about the banks and insurance. It is also about the capital market, which is in the pipeline. Hopefully, access to credit will improve in Ethiopia once the consumer begins accessing finance from the banks, the capital market, and also equity investors.

The amended Payment System Proclamation has recently been debated in Parliament. The bill states that foreign companies in Ethiopia cannot establish subsidiaries. Safaricom Ethiopia complained to the Parliament because they were unable to establish MPesa as a business unit of Safaricom Ethiopia or their subsidiary. This means it is Safaricom Kenya that will have to establish MPesa as its subsidiary in Ethiopia. Do you think such legislation is compatible with the commercial code?

We need to know the rationale behind the proclamation. We have to know why they are proposing a new entity. Why do they have to establish a new entity separate from Safaricom’s core operations? So I cannot comment without knowing the rationale.

You established a new law firm last month. Can you tell us about it?

The Ethiopian Ministry of Justice has registered TBeST Law LLP as a limited liability partnership (LLP). This is the eighth law firm that has been registered by the ministry so far. (TBeST stands for Tadesse, Beniam, Sisay, and Tibebe.) We do not want the name to be just a coincidence, but a reality. We intend to be the best law firm in this country in the next five years. We want to address the most complex transactional issues in this country.

The Ethiopian legal services sector has lagged far behind its counterparts in nearby nations like Kenya, where law firms can employ hundreds of specialized lawyers and paralegals in a single firm.

Before, there was no legislation in Ethiopia enabling lawyers to form law firms. But since 2019, the legislation has changed. The “advocacy law” is introduced, giving rise to law firms for the first time. The amended commercial law also allowed LLP to be one of the seven business organizations recognized under the new commercial code. A number of law firms are forming to take advantage of these new laws.

There are more law firms in formation currently. But TBeST wants to be on the front line, given the expertise and specialization we are bringing on board and our long years of experience in academia and practice.

I hope the establishment of a large number of law firms in Ethiopia will transform the narrow perception of lawyers from that of court-bound dispute handlers to professional partners and assistants to their clients’ legal needs in transactional matters, negotiations, and the prevention of disputes.

What are the requirements to establish a law firm in Ethiopia now?

You have to be a professional, have degrees in law, and practice it. The second requirement is that you need an advocacy license. You also need a partnership agreement, which is an agreement among the partners, to regulate the relationship. The fourth, which is optional, is that you need a memorandum of association.

There is also a capital requirement. After examining all these documents, the advocacy department at the MoJ qualifies you to establish a law firm. But it is not an OPC since it requires two people.

So it is both business and advocacy.

When the partner is more important, it has to be either a general partnership or an LLP. It cannot be a PLC or OPC. PLCs and SCs are intended for non-person-related services and goods. For instance, banking requires professionals, but the professional is not more important than the bank for the customer. The individual can be any employee.

A partnership is not an association of capital. It is an association of the partners. Under LLP, the individual is just as important as the company. That is because the client relies on the professionals’ opinions.

In which areas is your law firm currently practicing?

Investment, corporate matters, tax, employment, immigration issues, intellectual property, technology, and the NGO sector, among others. Our partners have specialized expertise in all these areas and provide service to all sectors, including agriculture, manufacturing, finance, real estate, mining, NGO, and telecom, among others.

The lawyers we have here have at least 10 years of experience working in government, the private sector, and academia.

So far, eight law firms have been established. Are they sufficient for Ethiopia?

Obviously, it is not enough. Even in Kenya, there are large numbers of law firms operating. They are much older. A single Kenyan law firm has up to 150 lawyers. In Ethiopia, the largest law firm has 10 lawyers.

Ethiopia did not have the legislation before, but now the number will increase soon because of the huge demand.

The kind of lawyers Ethiopia used to have were litigators. Lawyers always go to court. But at law firms, we provide transactional laws, contractual laws, negotiations, and deals. We do not necessarily go to court. We need more law firms that work on corporate issues.

There has been serious investment uncertainty since the war in northern Ethiopia. Do you think the investment climate is improving now?

The investment climate has been down for the past two to three years, partly because of the war, COVID-19, and the international situation. A number of factors depressed the investment situation.

The conflict and the transitional process Ethiopia has been through are very unique. The political and security challenges were not good, and investors’ confidence is down quite considerably. But we are seeing some signs of resurgence. An agreement has been signed between the Ethiopian government and the Tigray People’s Liberation Front. As a result, Ethiopia is getting positive reviews from the international community.

Ethiopian officials went to the US-Africa summit recently. This was unthinkable a year ago, even six months ago, for the PM to go to the US. We need to capitalize on this. The international economic situation is improving. So the investment inflow to Ethiopia will also improve. But we have to improve government services and reduce corruption.

Under such circumstances, investment will not come. It is going to take some time to recover from the impact of the conflict. But Ethiopia has a lot of work to do to rebuild investor confidence.

What are your plans for your new law firm?

We are very serious. We did not just come together out of passion. We came together to establish the kind of law firm we have been dreaming of for many years. This is a dream come true for all of us. Our service quality standards, as well as our growth and expansion plans, are all intertwined.

We want investors, whether they are in London or Johannesburg, not to feel they are in a country where the corporate legal service is poor. So we want to be efficient, competitive, and expand. We have the plans in place.

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