DERIVATIVES – ENFORCEABILITY OF CLOSE OUT NETTING IN NIGERIA.


Introduction

The Companies and Allied Matters Act (CAMA 2020) is a game changer for derivative transactions in Nigeria. It introduces innovative provisions that will impact financial collateral arrangements typically used by parties involved in derivative trading. This article will examine the novel provisions introduced by CAMA 2020 as it relates to financial collateral arrangements.

An examination of financial collateral arrangements under the CAMA 2020

Until recently, the enforceability of derivative transactions in Nigeria had lingering questions. This was mainly due to the uncertainty over enforcement of the close out netting provisions. To mitigate this, counterparties were typically advised to pursue the Automatic Early Termination route.

Netting is a reconciliation and payment mechanism which involves the aggregation and conversion of mutual payment obligations into a single claim, so that the party owing the greater aggregate amount makes a net payment to the party owing the lesser aggregate amount. Forms of netting include contractual/settlement, insolvency and close-out netting.

Prior to CAMA 2020, Nigerian laws supported contractual netting and insolvency netting. Insolvency netting is a mandatory right of set-off that arises when a company goes into liquidation. It is automatic and applies at the date on which the liquidation commences.

Insolvency netting is recognised under the provisions on mutual credit and set-off in section 33 of the Bankruptcy Act[1] and implied by reference in the previous CAMA[2]. Section 33 of the Bankruptcy Act provides that where there has been mutual credits, mutual debts or other mutual dealings between a debtor and any other person claiming to prove a debt in the debtor’s liquidation, an account of what is due from one party to the other in respect of such mutual dealing and the sum due shall be set off against any sum due from the other party and the balance of the account and no more shall be claimed or paid on either side respectively. Thus, it required the claim and cross claims to be between the same parties in the same right.

Contractual or settlement netting is the netting of reciprocal deliveries or payments which are due on the same date. It provides for mutual payment obligations of contracting parties to be discharged by a single net payment obligation from one party to the other. This form of netting addresses the risk presented when parties’ obligations are not performed simultaneously, particularly where payment obligations are in the same currency to be performed on the same date. It assesses the parties’ mutual payment obligations and requires physical payment only from one of the parties, usually the one with the larger debt.

Close-out netting on the other hand, is typically employed to minimise the risk of exposure to an insolvent counterparty. It applies to contracts having different settlement dates and results in dealings between the counterparties coming to a close.

Prior to CAMA 2020, insolvency netting was mandatory and it was not possible to enforce certain provisions under such agreements after the commencement of winding up without a court order. This was because under Nigerian law, any disposition of the property of the company made after the commencement of the winding up shall, unless the court otherwise orders, be void[3]. Furthermore, in line with the provisions of section 499 of the erstwhile CAMA, where the termination of obligations under netting agreements do not occur prior to commencement of winding up, the liquidator may have been able to “cherry-pick” and require the performance of contracts that he deemed beneficial while disclaiming the onerous contracts.

However, CAMA 2020 now recognises and provides a legal framework for termination and close-out netting.

Close out netting is defined under CAMA 2020 as including the occurrence of “the 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[4]. Netting agreements are recognised to include a ‘master netting agreement’, a ‘master-master netting agreement’, and a ‘collateral arrangement’.

Section 721 of CAMA 2020 further provides that:

  • “The provisions of a netting agreement 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-
  • Any action of the liquidator;
  • 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
  • Any other provision of law that may be applicable to an insolvent party, subject to the conditions contained in the applicable netting agreement.”

With this provision the perennial issue with derivative transactions in Nigeria, which was to the effect that only insolvency netting was possible, has been addressed.

In terms of obligations of the parties to a netting agreement surviving the commencement of insolvency proceedings, the only obligation/right, if any, of either party is to make/receive payment or delivery under a netting agreement which shall be equal to its net obligation/entitlement with respect to the other party as determined in the netting agreement[5].

Furthermore, the provisions under CAMA 2020 limit the liquidator’s powers to disclaim netting agreements as onerous contracts. It provides that:

Any power of the liquidator to repudiate individual contracts or transactions will not prevent the termination, liquidation or acceleration of all payment or delivery obligations or enforcements 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 of such qualified financial contracts in accordance with the terms of such netting agreement[6].

Section 721(6) of CAMA 2020 also provides protection for netting agreements in that a liquidator is prohibited from avoiding the terms of such agreement unless there is clear evidence that the enforcing party made such transfer or incurred such obligation with actual intent to “hinder, delay or defraud any entity to which the insolvent party was indebted or became indebted”. The relevant time period is the period on or after the date that such transfer was made or such obligation was incurred.

These new provisions mitigate the risks hitherto inherent in “qualified financial contracts” which includes a whole range of derivatives and will go a long way to enhance financial stability and investor confidence in the Nigerian financial sector.

Conclusion

There is no doubt that with the improved regulatory landscape, the CAMA 2020 has commendably set the tone for the actualisation of key innovations in the market, providing enabling legal backing for netting, bankruptcy remoteness and attendant regulatory frameworks for the smooth functioning of financial markets in Nigeria which would ultimately impact positively on transactions between counterparties and other participants in the market.  


The information and opinions in this publication are provided for general information only. They are not intended to constitute legal or other professional advice. If you would like additional information, please contact the author at [email protected]

© All Rights Reserved. Sefton Fross is a leading full-service law firm in Nigeria internationally recognised for its expertise in corporate, commercial and mergers and acquisitions.


Leave a Comment

Your email address will not be published. Required fields are marked *