PAPER SERIES VIII - NETTING

04/29/2021

I. Introduction

With the increasing sophistication of the global financial markets, comes the need for domestic financial markets to develop their architecture and infrastructures to support requisite advancement as well as align with international standards, thus the enactment of new companies' legislation and other financial legislation[1] that will position Nigeria and its capital markets at par with its international counterparts.[2]

Of the several impactful provisions in the Companies and Allied Matters Act, 2020 ("the Act") with implications for corporate finance and securities transactions, one of the most innovative, is the inclusion of netting and bankruptcy remoteness provisions aimed at making the financial market in Nigeria more competitive. Unlike under the Companies and Allied Matters Act, Cap C20, Laws of the Federation of Nigeria, 2004 (Repealed), counterparties will no longer place reliance on the sanctity of contracts and the believe that Nigerian courts, where faced with the construction of a netting arrangement pursuant to a financial derivative contract, will uphold the terms of the contracts as agreed by the parties;[3] the Act now provides further statutory premises for the enforcement of netting provisions in financial derivatives contracts in addition to the already existing common law contract principles.[4]

This paper examines the provisions of the Act on Netting and the enforceability of netting agreements and other qualified financial contracts.

II. Definition of Basic Concepts and Powers of Financial Regulatory Authority

For purposes of its provisions on netting as contained in chapter 28 and section 718 to 721, Section 718 of the Act provides the definition of several concepts amongst others:

Netting means the occurrence of the following - (a) termination, liquidation or acceleration of any payment or delivery obligation or entitlement under one or more qualified financial contracts entered into under a netting agreement; (b) calculation or estimation of a close-out value, market value, liquidation value or replacement value in respect of each obligation or entitlement or group of obligations or entitlements terminated, liquidated or accelerated under paragraph (a); (c) conversion of any values calculated or estimated under paragraph (b) into a single currency; and (d) determination of the net balance of the values calculated under paragraph (b), as converted under paragraph (c) whether by operation of set-off or otherwise.

Netting Agreement means any - (a) agreement between two parties that provides for netting of present or future payment or delivery obligations or entitlements arising under or in connection with one or more qualified financial contracts entered into under the agreement by the parties to the agreement (a "master netting agreement"); (b) master agreement between two parties that provides for netting of the amounts due under two or more master netting agreement (a "master-master netting agreement"); and (c) collateral arrangement related to or forming part of one or more of the foregoing;

Qualified financial contract means any financial agreement, contract, or transaction, including any terms and conditions incorporated by reference in any financial agreement, contract, or transaction, pursuant to which payment or delivery obligations are due to be performed at a certain time or within a certain period of time and whether or not subject to any condition or contingency.[5]

Party means a person constituting one of the parties to a netting agreement; while Person includes partnerships, companies, regulated entities such as banks, insurance companies and pension fund administrators, or any other body corporate (including statutory corporations or statutory bodies) whether organised under the laws of Nigeria or under the laws of any other jurisdiction and any international or regional development bank or other international or regional organisation.

The Act further provides its own definition for terms or concepts such as financial regulatory authority, cash, collateral, collateral, collateral arrangement, insolvent party, liquidator, non-insolvent party, security interest collateral arrangement, title transfer collateral arrangement.[6]

Pursuant to Section 719 of the Act, a financial regulatory authority may in relation to the relevant sector it regulates, by a notice issued under this section, designate as "qualified financial contracts" any agreement, contract or transaction, or type of agreement, contract, or transaction, in addition to those listed in section 718 of the Act. This simple connotation of this provision is that the list of qualified financial contracts in Section 718 of the Act is only a base, statutorily define financial regulatory authority can designate any agreement, contract, or transaction as a qualified financial contract.

III. Enforceability of Netting Agreement and a Qualified Financial Contract

A. Enforceability of a Qualified Financial Contract

A qualified financial contract shall not be and shall be deemed never to have been void or unenforceable by reason of the Gaming Machines (Prohibition) Act or any other laws relating to games, gaming, gambling, wagering or lotteries.[7]

B. Enforceability of Netting Agreements

The provisions of a netting agreement[8] are 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.[9]

After commencement of insolvency proceedings in relation to a party, the obligation, if any, of either party to make payment or delivery under a netting agreement shall be equal to its net obligation to the other party as determined in accordance with the terms of the applicable netting agreement.[10]

Section 712(3) of the Act states that after commencement of insolvency proceedings in relation to a party, the only right if any of either party to receive payment or delivery under a netting agreement shall be equal to its net entitlement with respect to the other party as determined in accordance with the terms of the applicable netting agreement.

Any power of the liquidator to assume or repudiate individual contracts or transactions will not prevent the termination, liquidation or acceleration of all payment or delivery obligations or entitlements under one or more qualified financial contracts entered into under or in connection with a netting agreement, and applies, if at all, only to the net amount due in respect of all such qualified financial contract in accordance with the terms of such netting agreement.[11]

Section 721(5) specifies that the provisions of a netting agreement which provide for the determination of a net balance of the close-out values, market values, liquidation values or replacement values calculated in respect of an accelerated or terminated payment or delivery obligations or entitlements under one or more qualified financial contracts entered into are not affected by any applicable insolvency law limiting the right to set off, offset or net out obligations, payment amounts or termination values owed between an insolvent party and another party.

The liquidator of an insolvent party may not avoid- (a) any transfer, substitution or exchange of cash, collateral or any other interests under or in connection with a netting agreement from the insolvent party to the non-insolvent party; or (b) any payment or delivery obligation incurred by the insolvent party and owing to the non-insolvent party under or in connection with a netting agreement on the grounds of it constituting a preference by the insolvent party to the non-insolvent party, unless there is clear and convincing evidence that the non-insolvent party- (i) made such transfer, (ii) incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the insolvent party was indebted or became indebted, on or after the date that such transfer was made or such obligation was incurred.[12]

Reasonable notice to interested parties, individuals, persons, or entities shall be required for the realisation, appropriation, or liquidation of collateral under a collateral arrangement unless otherwise agreed by the parties: Provided that this subsection is without prejudice to any applicable provision of law requiring that realisation, appropriation, or liquidation of collateral be conducted in a commercially reasonable manner.[13]

IVĀ· Conclusion

The financial derivatives market has over the years become very sophisticated. In Nigeria, the initial protections afforded to counterparties under the International Swaps and Derivatives Association ("ISDA") transactional document or contract framework are subject to the mandatory provisions of Nigeria law prior to the enactment of the Act.

Statutorily, the provisions on Netting now give a netting agreement or qualified financial contract primacy over other provisions of the Act or laws, especially those relating to bankruptcy, insolvency, restructuring, the rules on fraudulent preference or transfers, the rules on cherry-picking and pari passu distribution which previously may have prevented the enforcement of a netting agreement or any other qualified financial contract.

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Epilogue

With a large population, its commendable landmass and appurtenance to the Gulf of Guinea in the Atlantic Ocean, Nigeria as a developing country holds a lot of potentials for economic growth and development. The enactment of the Companies and Allied Matters Act, 2020 by the National Assembly and its assent by the President of the Federal Republic of Nigeria on 7 August 2020 is aimed at creating an enabling corporate environment for corporate investment and ease of doing business.

The Act now permits single shareholding and directorship and a streamlined process for the incorporation of companies. This is complemented by provisions on the incorporation, management and regulation of limited liability partnership, limited partnership, registration of business names, together with the trustees of certain communities and associations. It is important to state that given the level of Nigeria's corporate and company law development from English Company Law consisting of common law principles, the doctrine of equity and statutes of general application to the Companies and Allied Matters Act, Cap C20, Laws of the Federation of Nigeria, 2004 (now Repealed), the provisions on repeal, saving and transition from CAMA 2004 to the Act, 2020 are significant, as they saved every acts, actions, obligations or liabilities and entities done, owed or created under prior company laws.

This Paper Series does not attempt to exhaustively discuss all the provisions of the Act that are innovative and that have implications for corporate finance and securities transactions. At best, the various articles in the Paper Series are simply the writer's attempt to capture the essential corporate requirements and procedures, compare new provisions with prior existing provisions and provide practical instances i.e., transactions implemented pursuant to these provisions. It essentially emphasizes sections of the Act that businessmen, investors, legal and financial advisors, and other users of the Act would regularly utilize in their bid to implement their corporate finance and securities transactions.

Given its newness, these provisions are yet to receive judicial evaluation and interpretations by Nigerian courts, however, they have the full force of the law and has been enforced or implemented by regulators, especially the Corporate Affairs Commission. It is believed that time, practice, regulatory directives, and ultimately case laws will give a better understanding of the various innovations in the Act. In the meantime, users of the Act can find guidance from practices and applicable decisions of Nigeria and those of courts in a jurisdiction with similar legislation.

Author:Ikemefuna Stephen Nwoye, LL.B (ESUST, Ebeano City) 2010, B.L (NLS, Lagos) 2011, LL.M in International Business Regulation, Litigation and Arbitration (NYU, New York) 2014. A Barrister and Solicitor of the Supreme Court of Federal Republic of Nigeria with expertise in the areas of banking & finance, mergers & acquisitions, international law & trade policies, and dispute resolution. This paper should not in anyway serve as a substitute for legal advice or opinion. The views expressed are personal to the author and do not necessarily reflect the views of any organisation or person that the author is or might have been affiliated to.

[1] In December 2019, the Nigerian Securities and Exchange Commission issued an amendment to its Rules and Regulations to provide for new rules on the regulation of derivatives trading. In February 2020, the Central Bank of Nigeria (CBN) offered its first long-term Naira settled OTC FX Futures Contracts to hedge against foreign exchange (FX) risk, with a tenor of 5 years and to be traded on the FMDQ OTC Securities Exchange.

[2] See FMDQ Insights, CAMA 2020 Netting Provisions: Game Changer for FMDQ Derivatives and Central Counterparty Agenda, Positions Nigerian Financial Market for Radical Transformation available at https://fmdqgroup.com/cama-2020-netting-provisions-game-changer-fmdq-derivatives-central-counterparty-agenda-positions-nigerian-financial-market-radical-transformation/

[3] See Chukwudi Ofili, Enforceability of Netting Provisions and the Intervention of the CAMA, 2020 published in Businessday Newspaper 27 August 2020 available at https://businessday.ng/opinion/article/enforceability-of-netting-provisions-and-the-intervention-of-the-cama-2020/. The writer highlighted the challenges with respect to enforcement of close-out netting provisions prior to the Act. The close-out netting provisions in that instance would be subject to the mandatory provisions under the Bankruptcy and Insolvency laws, the rules on fraudulent preference, the rules on "cherry picking" and pari passu distribution.

[4] Olaniwun Ajayi Newsletter October 2020, An Appraisal of Netting Provisions Under The Companies And Allied Matters Act, 2020 available at https://www.olaniwunajayi.net/wp-content/uploads/2020/10/An-Appraisal-of-Netting-Provisions-Under-the-Companies-and-Allied-Matters-ACT-2020.pdf

[5] Pursuant to Section 718 of the Act Qualified Financial Contract includes (a) a currency, cross-currency or interest rate swap; (b) a basic swap; (c) a spot, future, forward or other foreign exchange transaction; (d) a cap, collar or floor transaction; (e)a commodity swap; (f) a forward rate agreement; (g) a currency or interest rate future; (h) a currency or interest rate option; (i) an equity derivative, such as an equity or equity index swap, equity forward, equity option or equity index option; (j) a derivative relating to bond or other debt securities or to a bond or debt security index, such as a total return swap, index swap, forward , option or index option; (k) a credit derivative, such as a credit default swap, credit default basket swap, total return swap or credit default option; (l) an energy derivative, such as an electricity derivative, oil derivative, coal derivative or gas derivative; (m) a weather derivative, such as a weather swap or weather option; (n) a bandwidth derivative; (o) a freight derivative; (p) an emission derivative, such as an emission allowance or emission reduction transaction; (q) an economic statistic derivative, such as an inflation derivative (r) a property index derivative; (s) a spot, future, forward or other securities or commodities transaction; (t) a securities contract, including a margin loan and an agreement to buy, sell, borrow or lend securities, such as a securities repurchase or reverse repurchase agreement, a securities lending agreement or a security buy or sell back agreement including any such contract or agreement relating to mortgage loans, interests in mortgage loans or mortgage-related securities ; (u) a commodities contract, including an agreement to buy, sell, borrow or lend commodities, such as a commodities repurchase or reverse repurchase agreement, a commodities lending agreement or a commodities buy or sell back agreement ; (v) a collateral arrangement ; (w) an agreement to clear or settle securities transactions or to act as a depository for securities ; (x) any other agreement, contract or transaction similar to any agreement, contract or transaction referred to in paragraphs (a) - (w) with respect to one or more reference items or indices relating to interest rates, currencies, commodities, energy products, electricity, equities, weather, bonds and other debt instruments, precious metals, quantitative measures associated with an occurrence, extent of an occurrence, or contingency associated with a financial, commercial or economic consequence, or economic or financial indices or measures of economic or financial risk or value ; (y) any swap, forward, option, contract for differences or other derivative in respect of, or combination of, one or more agreements or contracts referred to in paragraphs (a-x) ; and (z) any agreement, contract or transaction designated as such by the financial regulatory authority under this Act ;

[6] Section 718 of the Act.

[7] Section 720 of the Act.

[8] Pursuant to Section 721 (8) of the Act, For the purposes of Section 721 - (a) a netting agreement is deemed to be a netting agreement notwithstanding the fact that the netting agreement may contain provisions relating to agreements, contracts or transactions that are not qualified financial contracts defined in section 718, provided, however, that, for the purposes of this section, such netting agreement shall be deemed to be a netting agreement only with respect to those agreements , contracts or transactions that fall within the definition of "qualified financial contract" in this Chapter ; (b) a collateral arrangement is deemed to be a collateral arrangement notwithstanding the fact that such collateral arrangement may contain provisions relating to agreements, contracts or transactions that are not a netting agreement or qualified financial contracts as defined in section 718 of this Act, provided, however, that, for the purposes of this section, such collateral arrangement shall be deemed to be a collateral arrangement only with respect to those agreements, contracts or transactions that fall within the definition of "netting agreement" or "qualified financial contract" as defined in section 718 of this Act ; and (c) a netting agreement and all qualified financial contracts entered into shall constitute a single agreement.

[9] Section 721 of the Act.

[10] Section 721 (2) of the Act.

[11] Section 721 (4) of the Act.

[12] Section 721 (6) of the Act.

[13] Section 721 (7) of the Act.