The President of the Federal Republic of Nigeria signed the Companies and Allied Matters Act, 2020 (the “Act”) into law on the 7th of August 2020. The Act repeals and replaces the Companies and Allied Matters Act, 1990. The effective date of the Act is yet to be confirmed as the Act will only become effective after it has been gazetted.
The Act is a welcome development and has been unanimously described as Nigeria’s most revolutionary piece of business legislation in decades. One of the innovations of the Act is the inclusion of provisions on Netting.
The concept of netting
“Netting” is a reconciliation and payment mechanism under which amounts owed between contracting parties are consolidated into a single, smaller payment from one party to another. Netting is used to denote contractual arrangements by which claims of different parties against each other are reduced to a single balance. Bilateral netting enables two counterparties in a financial contract to offset claims against each other to determine a single net payment obligation that is due from one counterparty to the other, meaning that the payables and receivables are netted off. On the other hand, multilateral netting typically involves netting among more than two parties, using a clearing-house or central exchange.
Netting is very common in advanced economies where settlement is based on net positions in bilateral or multilateral financial arrangements rather than by gross positions. A strong netting system generally gives rise to a thriving derivatives market, as it provides the most accurate picture of a company’s financial position, solvency and liquidity risk. Generally, the benefits of netting are:
(a) Reduction of credit risk;
(b) Reduction of settlement risk;
(c) Reduction of liquidity risk; and
(d) Reduction of systemic risk.
The introduction of a netting regime under the Act is, therefore, welcome and required to build a thriving derivatives market. This Article examines the provisions of the Act as it relates to netting and examines the scope of its application.
Netting in Nigeria prior to the Act
Prior to the Act, Nigerian law did not make any specific provision for netting and there were no Nigerian judicial authorities on the netting concept in the context of structured finance transactions. However, as a general principle, outside of an insolvency, parties were free and are still free to agree to almost any kind of netting arrangement they choose — insofar as it is neither illegal nor contrary to public policy.
The challenges with respect to enforcement of close-out netting provisions prior to the Act arose in the context of insolvency of a Nigerian party. The close-out netting provisions in that instance would be subject to the mandatory provisions under the Bankruptcy Act, the rules on fraudulent preference, the rules on “cherry picking” and pari passu distribution.
However, when opining on the enforceability of such close-out netting provisions in structured finance transactions, Nigerian lawyers would opine that as a general principle, Nigerian courts would, in adjudicating on the enforceability of such netting provisions, consider the decision of English courts in the absence of Nigerian judicial precedent. The premise for this advice was that English case law is of persuasive authority before the Nigerian courts. In the absence of a legislative framework for netting, relying on this opinion was not enough comfort for bankers, primary dealers and other financial institutions in the derivatives market and thus stalled the growth of the derivatives market in Nigeria.
The intervention of the Act
Netting provisions are now included in Sections 718 to 721 of the Act. Section 721 of the Act is particularly relevant. It provides that “the provisions of a netting agreement is [sic] enforceable in accordance with their terms, including against an insolvent party, and, where applicable, against a guarantor or other person providing security for a party and shall not be stayed, avoided or otherwise limited by;
(a) any action of the liquidator;
(b) any other provision of law relating to bankruptcy, reorganisation, composition with creditors, receivership or any other insolvency proceeding an insolvent party may be subject to; or
(c) any other provision of law that may be applicable to an insolvent party, subject to the conditions contained in the applicable netting agreement.”
The netting provisions in the Act, therefore, eliminate the limitations imposed by the mandatory provisions under the Bankruptcy Act on insolvency set-off, the rules on fraudulent preference, the rules on “cherry picking” and pari passu distribution. As highlighted earlier, the provisions will have the effect of reducing credit risk. Besides reducing credit risk and regulatory capital burden for banks, the legislation would free up capital, reduce hedging costs and liquidity needs for banks, primary dealers and other market makers.
There is no doubt that the netting provisions are a welcome development and a step in the right direction.
Ofili is an associate partner with DETAIL Commercial Solicitors
chukwudi@detailsolicitors.com
