The material terms and conditions of an USD$100million amortising term loan facility being advanced by ABC Limited, a New-York based lender, to JAC Limited, a Nigerian corporate borrower, have been thoroughly negotiated, the transaction documents and fees have been agreed except that the perfection of the documents requires an aggregate payment of $1,375,000 as both stamp duty tax and registration fees; an amount which (could be higher depending on the nature of the document and the underlying security) the borrower is adamantly reluctant to pay.
The above scenario is a common thread true of most finance transactions in Nigeria where given the high perfection costs, transaction parties agree to either perfect the documents for a mutually agreed notional amount or postpone payments until the occurrence of an event of default. Whilst neither option represents a perfect panacea, they are both viewed through the prisms of pragmatism rather than the ideal.
Whilst this article examines the legal implication of perfection and the probable options of circumventing these hefty payments, its ultimate goal is to instigate a nationwide discourse on the propriety of these payments and spur an ideological shift away from redundant practices to a more liberal ambience capable of catalysing investment.
Perfection: A Formality or Necessity?
The Black’s Law Dictionary defines Perfection as ë… the validation of a security interest as against other creditors usually by filling a statement with some public office or by taking possession of the collateral. There are three principal modes by which a security interest may be perfected (which method of perfection is applicable depends upon the nature of the security interest) and these are: (a) possession of the collateral; (b) statutory registration or filing; and (c) notice to debtor’s relevant counterparties. Under Nigerian law, the type of security documents that would typically fall within category (b) are mortgages, charges and security assignments. This perfection mode involves stamping and registration of the documents (also alternatively referred to as instruments in this article) at the appropriate government agencies.
Based on Sec 22(4) of the Stamp Duties Act (Cap S8, LFN 2004) (SDA), any document executed in Nigeria, or relating, wheresoever executed, to any property situate or to any matter or thing done or to be done in Nigeria must be duly stamped. This position further resonates in the provisions of Sec.1 102(1)and(2)of the SDA which makes payment of Stamp Duty compulsory on both loan capital and share capital. The SDA also specifies the applicable duty payable on the relevant document depending on the nature of the instrument (which could be on a flat or ad valorem basis) and also the time frame within which such instrument should be stamped. Generally, all instruments are required to be stamped within 40 days of their execution, however, in the case of instruments chargeable with ad valorem duty, within 30 days from the date of execution or after it was first received in Nigeria.
It is widely acknowledged that based on the SDA, the consequence of not stamping an instrument goes to the admissibility of such instrument in civil proceedings. It would therefore seem that the only real exposure in not stamping an instrument is its inadmissibility in court. While this is certainly true in most cases, it is not true in all cases especially if the instrument is one that requires registration at a registry (e.g. the Corporate Affairs Commission). The consequential effects of not stamping or insufficiently stamping a document is compounded by the provisions of Sec 202 of the Companies and Allied Matters Act (Cap C20, LFN 2004) (CAMA) which provides that where a charge is expressed to secure all sums due or to become due the particulars required shall state the maximum amount deemed to be secured by such charge (being the maximum sum covered by the stamp duty paid thereon) and such charge shall be void, so far as any security on the company’s property is thereby conferred as respects any excess over the stated maximum. Sec 202 of CAMA therefore suggests that a registerable document is void for any amount above which it is not stamped hence a security holder cannot make a claim over and above the amount to which the instrument is stamped.
Generally speaking, the cadre of documents that require registration in a financing deal are the security documents. However, as earlier indicated, not all security documents require registration e.g. pledges, lien and some documents may require registration at more than one registry e.g. security over a vessel would need to be registered at both the Corporate Affairs Commission and the Nigerian Maritime Administration and Safety Agency (NIMASA). Nonetheless, the essence of registration is to ensure the effectiveness of the security interest created under the document and also guarantee the priority of the security holder against any other secured creditor.
The obvious deduction from the above therefore is that perfection is critical in ensuring the protection and priority of security interests. However, that process involves stamping and registration of the security possibly at different registries with payment of significant fees to both the stamp duty office and the appropriate registry or registries (depending on the nature of the underlying asset) e.g. a debenture creating security interests over varied assets including a vessel would require the payment of; ad valorem stamp duty at a chargeable rate of N0.75 for every N200 worth of the facility, registration fees of 1% of the facility and payment of consent and registration fees at NIMASA. Going by the test case scenario above, the borrower would pay about N230million as perfection costs. This is without prejudice to the numerous bank fees, legal fees, grossed-up withholding tax and other taxes to be paid.
Are there any Workarounds?
The significant payments to be borne as perfection costs if aggregated with other taxes to be paid to the Government (whether local, municipal or federal) makes the cost of debt capital to the borrower even more astronomical. It is this reality that has largely driven some of the options to be examined below. Having said this, a number of the methods in this article do not introduce “new devices” but simply highlight saving opportunities as it is trite law that tax avoidance strategies involving legal acceptable arrangements designed to reduce the tax burden on taxable persons are permitted by law to minimize tax exposure.
a. Notional Stamping
Notional stamping is a practice whereby transaction parties agree that the document should be assessed based on an agreed sum that is less than the value of the facility advanced and duty is paid on this notional amount. Under this arrangement, the agreed notional amount on which duty is paid and which serves as the basis for the calculation of registration fees, becomes the maximum sum deemed to be secured under the security. In order to mitigate the exposure created by virtue of Sec 202 CAMA, there is an embedded mechanism to up-stamp the document i.e. to pay the outstanding difference as duty, in the event of a default.
However, even though significant costs savings can be achieved through notional stamping, the reality is that there are also significant drawbacks. The first being the impact of notional stamping on the priority of the creditor over other secured creditors. Given that the priority ranking system in respect of competing security interests is determined by the order of their registration (by virtue of the trite legal maxim that where the equities are equal, the first in time prevails), security interests of a secured creditor would rank in priority over any subsequent third party security interests only to the extent of the maximum sum covered by the stamp duty paid by that secured creditor. Therefore where a subsequent creditor has perfected its security document for full value over and above the initial creditor’s, the latter runs the risk of ranking lower in priority to the former for that outstanding difference which he is yet to pay duty.
The second drawback is as a result of hardening period given under insolvency proceedings in Nigeria. Based on the combined reading of Sections 495, 496 of CAMA and Section 46 of Bankruptcy Act (Cap B2, LFN 2004), there is an inherent risk that in the event of an insolvency of the borrower, payment of the unpaid stamp duty by a creditor within 3 (three) months of a winding-up petition may be deemed a fraudulent preference against other creditors and declared void.
b. Execution Abroad
The SDA recognizes that the execution of documents can take place offshore and therefore requires that any document executed abroad must be stamped within 30 days after the document has been first received in Nigeria. Therefore payment of duty can be deferred and penalties avoided by executing the document outside Nigeria and then stamping it within 30 days if it ever needs to be produced in Nigeria.
Given that stamping is a pre-requisite to registration at the appropriate registry, the obvious drawback is that perfection of the document will not be completed hence the protection and priority of the creditor’s security interest is significantly exposed.
c. Taking alternative forms of security interests
Rather than obtain security interests, that would statutorily require registration and thus stamping, an informed creditor can take other forms of security interests over a borrower assets that do not require any registration. These non-registrable securities include instruments such as Hypothecation Letters, Pledges, Liens, Memorandum of Goods Pledged, Account Charge (over amounts that are not book debts), Quasi Securities (e.g. finance leases, factoring and block discounting agreements, retention of title clauses, conditional sale agreements), Charge Backs, Charge on Rent, Charge on Insurance Policy etc.
Since these forms of security do not require any registration, then the need to stamp this type of documents becomes less relevant especially as the effect of not stamping only impacts on their admissibility in court. Therefore, to avoid penalties for late stamping, the documents could be executed abroad.
The need for a comprehensive review and reform of both the SDA and CAMA could not be more true today than ever particularly considering that neither has undergone any significant amendments since 1956 (in the case of the SDA) and 1990 (in the case of CAMA). The option of maintaining status-quo is counter-productive and places a hefty burden on parties consummating financial transactions.
It is this writer’s view that radical ideas such as (a) abolishing ad valorem tax; (b) significantly reducing registration fees to flat rates; (c) having notice-filing and associated priority rules extend to all forms of security and quasi-security whether granted by companies or unincorporated businesses; (d) allowing registration even where there is no instrument; or (e) setting up collateral registries that different states hence de-centralising the registration process; need to be championed and debated by all and sundry.
In conclusion, it is imperative to have a perfection process that is less bureaucratic, more efficient and more cost-sensitive as this will reduce the cost of capital for borrowers, engender more confidence for lenders, and could potentially lead to increase in revenue for government as parties actively adhere to these process rather than looking for alternative means of avoiding payment.
Abayomi Adebanjo is seasoned legal analyst and heads the Banking, Finance & Infrastruce Unit of Jackson Etti & Edu.