SEPLAT and Its Access Bank Nemesis - Plugging the Governance Gap

Sunday, December 06, 2020 / 02.57PM / By Proshare Governance Unit / HeaderImage Credit: Scientific American Blogs

On Wednesday, December 02, 2020, the head office of SeplatPetroleum Development Company Plc,whose ordinary shares are listed on the Nigerian Stock Exchange (NSE) and theLondon Stock Exchange (LSE) was closed to business based on a court order whichpermitted a receiver/manager, Messrs Kunle Ogunba & Co to enforce an exparte motion requesting that Access BankPlc take over SEPLAT's head office premises.

The problem appears to be related to a dispute between Access Bank andCardinal Drilling Nigeria Ltd over a loan taken from Diamond Bank Plc (sinceacquired by Access Bank Plc) for which the latter has been unable to fullydischarge/could not repay in line with the original terms of the facility. Theloan is a legacy debt that the drilling company owed the now-defunct DiamondBank which entered into a merger with Access Bank Plc to form the larger bankinginstitution (acquiring the assets andliabilities of Diamond Bank Plc in 2019).

In its letter to the Nigerian Stock Exchange (NSE) on the matter, theupstream Oil and Gas (O&G) company indicated that SEPLAT was not ashareholder in Cardinal Drilling Company and therefore was not liable forits debt obligations.

The unfolding development however represents a material event that couldadversely affect the company's declared earnings and dividend payouts toshareholders (beyond the debt issue as it concerns a key operatingasset/related party - Cardinal Drilling Nigeria) and thus becomes an issue inneed of better clarity and understanding.

As a follow up to the commentary on the PressRelease by SEPLAT Plc (SEPLAT Plc Refutes Being Party to Cardinal DrillingServices Loan with Access Bank) some material observations central to the unfoldingactions between parties become important.

The Eye of The Storm

CentralObservations

1. In the light of the claims and counter claims byparties, and the information available from financial returns/reports; weidentified two separate strands for necessary market learning, viz:

a) The obvious Debt Issue; and

b) The corporate governance matters arising arounddisclosures made by SEPLAT Plc.

2. While we believe that the matter(s) related to thedebt issue are already in court and it would be subjudice to comment on same;we do however feel obliged to draw attention to two (2) correlated points forwhich attention must not be lost:

a) The issue of recalcitrant debtors and the mediacottage industry that always ensues, drowning the substantive practice andgovernance issues and lessons important for market and regulatory growth. Thisimportant dimension to risk management and debt collection efforts was asubject of the 2020 DebtorsAfrica report on the challenge of collectionof non-performing loans (NPL's) of Nigerian banks. This current case offers yetanother opportunity to interrogate the processes in place for a fair resolutionof NPLs in order to improve credit administration and debt recovery practicesin Nigeria; and

b) The need to interrogate if and whether SEPLAT Plc mayhave solely enjoyed all the benefits of the facilities granted CardinalDrilling (indirectly as a related party); to its advantage and wholly for thepromotion and advancement of its businesses.

3. Deriving from point 2b above, there is oftentimes thecase that playing smart delivers unintended consequences and, in this case, acul de sac. The argument upon which SEPLAT's public release is premised is thatit has no relationship with Cardinal Drilling Nigeria, yet a cursorylook at publicly available information and listed entity disclosures, withoutan attempt to lift the legal corporate viel, reveals the following:

a) Cardinal Drilling indicated on its website the factthat it was mid-wifed by SEPLAT Plc viz: "The above innovative commercialarrangement of SEPLAT mid-wifing CARDINAL DRILLING Nigeria Limited enabledCARDINAL DRILLING Nigeria funding to be realized as Maurel & Prom throughCARDINAL DRILLING SAS will contribute 40%." (see screenshot below)

b) SEPLAT Plc has consistently disclosed in both itsinterim and annual reports that Cardinal Drilling is a related party.

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4. It thus begs the question - "Which of the twostatements is true - between the press release and the published reports? Bothstatements cannot be true at the same time. The guidance from IAS24 offers aguide here.

5. It is this latter point that the market must addressits minds to in the interim, as it goes to the heart of governance practices expectedfrom listed entities; especially the credibility of representations made byquoted firms on public trading floors to the investing public.

We believe a clarification will be helpful here, but we must firstaddress the debt recovery conundrum and how actions should be perceived.

Thinking Through A New Debt Recovery Paradigm

The contemporary problem in uncluttering the debt recovery processbetween Cardinal Drilling Nigeria, SEPLAT Plc and Access Bank Plc highlight thenew recovery approach that DebtorsAfrica noted in their 2020 Report onthe nature and outlook of debt recovery in Nigeria.

On page 9 of the introduction to the report, the reportwriters noted the need for a new debt recovery approach.

According to the report authors:

"In walking through theissues of resolution of delinquent assets of lenders, both banks and theircustomers are going to have to enter a new era of loan initiation,disbursement, and recovery/repayment. The old paradigm is stunted and suffersfrom the following asset creation and management shortcomings:
Pre-approval assessment can takepainfully long
Customer character assessment has beenlargely a hit-or-miss affair
Loan monitoring has been fragile andunengaged
Loan recovery/remediation has beenadversarial rather than collaborative
Customers have had narrow leeway towork through loan repayment by way of restructuring and workouts"

To pursue a revitalized and forward-facing creditadministration process the report writers advocated for a new approach notingthat:

"The new paradigm,however, assumes greater bank customer engagement and better pre-approvalassessment and monitoring. The new loan framework follows a different algorithmas represented below:

Credit Bureau rating review as baserate customer assessment criteria;
Project operating cash flow forecastthat rests on base rate industry values for cost components and revenues;
Monte Carlo analysis of revenue risk/project cost value at risk (VaR);
Industry/project SWOT analysis withdetailed risk modelling of revenues and costs;
Milestone-based credit disbursementschedules based on scaled completion deadlines against agreed project executionplans. At this stage, the lender builds-in repayment lags and affirms criticalpath options and costs;
Loan monitoring and control involvesone-on-one guidance of customer loan utilization and costs. The potential forloan diversion is reduced to a minimum as disbursements are choreographed inline with agreed repayment programmes which loan officers monitor and superviseclosely;
Loan payback follows agreed anniversarydates but, in the event, that unexpected or unpredictable events take place(such as COVID-19), a loan resolution process is triggered immediately and apre-agreed repayment framework is initiated at either the instance of the bankor the customer or both;
Rather than lenders and customersfinding themselves locked in interminable arguments over repayment plans anddefault on repayment pledges, the pre-agreed resolution mechanism kicks-in andpulls the loan repayment process into a remedial default mode designed torestructure the Facility in a way that averts delinquency;
A digital library of publicly available delinquent bank debtors provideslenders insight into the character and managerial capacity of borrowers. Thedigital library places both a moral and business burden on delinquent borrowersas prospective lenders would use the library to fact-check the borrowinghistory of a loan applicant and use the history to set up a character ratingindex that would guide credit appraisal memorandums (CAMs) and informacceptance or decline of credit requests; and
The pressure of having lenders able to review the nature of past loanfacilities and repayment records of a prospective borrower creates a borrowingenvironment quickly and effortlessly that is sensitive to historical loanperformance data and past loan resolution difficulties. The register profilesthe corporate boards of borrowing entities and helps lenders assess the fitnessof the company's leadership to the borrower. Leveraging the psychology of 'social proofing', the failure of a borrower to abide by the terms of a loanagreement with one lender would put other lenders on notice to decline the loanrequest of a previously delinquent borrower until such a time the borrowerredeems the earlier facility. The soundness of the psychology has beenvindicated by the numerous requests from delinquent borrowers for media housesto bring down digital stories posted online or references to earlierdelinquencies associated with the companies."

Illustration 1: Lending Decision Matrix-BalancingManagerial Competence and Corporate Status

Source: (PDF) NPLs & Bad Debtors: - The Case for a New Industry Approach - Debtors Africa, May 13, 2020

The Bank as Nemesis

The Seplat Plc, Cardinal DrillingNigeria and Access Bank debt squabble is a case study in how banks become thenemesis of borrowers where proper housekeeping had not been done by the borrowerand the borrower's corporate governance oversight may have been lax.

For example, a review of the sequence of events shows that in 2012,Cardinal Drilling Services Limited applied for and obtained a credit facilityfrom Diamond Bank Plc (now merged with the larger current Access Bank)to buy CDS Rigs 101, 201, 202 and 203. The loan was secured by a fixedand floating Debenture over Cardinal's assets (the "Debenture"). The CardinalRigs were used to provide drilling services to SEPLAT.

CDS 101 and 201 were used to execute SEPLAT's 2019 work programme andall four (4) Rigs were critical to Seplat'sfuture drilling plans and to shareholder returns by way of improved revenuesand possible dividends.

Nevertheless, Cardinal Drilling was unable to service the outstandingpart of the loan facility, prompting Access BankPlc, which absorbed all the assets and liabilities of theold Diamond Bank Plc, to pursue recovery of the loan amount outstanding andaccrued interests which is estimated at approx. US$86m.

Access BankPlc has since gone to court to enforce its rights and itwould appear that the entangled relationship between Seplat Plc and Cardinal Drilling, suggestingstrong ties between both entities makes the separation of the entities a difficulttask; and it would be up to the courts to establish same or otherwise.

This will also be helpful to the credit practice; as envisaged in thedebtors report.

From an investors perspective however; and indeed from a best practicegovernance standpoint, the findings throws up issues that the regulators andmarket operators must use to clarify how related party relationships andtransactions are communicated andunderstood.

Without prejudice, allowing companies to acknowledge withoutresponsibility or hide behind nebulous links with related corporate andindividual third parties becomes a major hazard to good corporate governanceand could adversely affect share values and independent shareholder interests.

The Access BankPlc and Seplat Plc/Cardinal Drilling Nigeriacase thus offers the market such an opportunity to review, monitor and guidenew regulations surrounding the links between listed entities and theirnon-listed associates.

Time for a Paradigm Shift

Banks have been peppered by recalcitrant debtors and as established, oldrecovery models appear insufficient especially in periods where recessionarypressures or unpredictable events like the COVID-19 pandemic result indisruptions to corporate cash flows (see illustration 2 below).

Illustration 2: Debt Recovery/Management - The Old Paradigm

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Source: (PDF) NPLs & Bad Debtors: - The Case for a New Industry Approach - Debtors Africa, May 13, 2020

The new debt management model depends on openness concerning the statusof the borrower (for example, creating clarity around corporaterelationships such as Seplat Plc/Cardinal DrillingNigeria) and ensuring that a repository of credit standing isavailable for institutions to do pre-lending forensics on the borrowing entity.This could help in shaping the terms of the loans and define the appropriateloan structure.

The "C" of character in the five (5) Cs of credit bankers aretraditionally tutored needs a framework for a proper assessment of how toderisk credits and reduce the probability of loan default (seeillustration 3 below).

Illustration 3: Debt Recovery/Management - The New Indicative Paradigm

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Source: (PDF) NPLs & Bad Debtors: - The Case for a New Industry Approach - Debtors Africa, May 13, 2020

A digital repository of debtor action as a reference for creditinitiation would be a needed addition to the arsenal of banks in combattingdelinquent loans. For companies listed on equity Exchanges, this would helpensure that equity prices of listed entities reflect contingent liabilitiesthat may be off-balance sheets, and in the case of listed banks, it would helpbring clarity to the character of assets on its annual statement of financialposition. See debtorsafrica.com

Conclusion - Devils at Heaven's Gate

The issue of clarity and transparency in corporate governance has beenhighlighted by the ongoing case between Access Bank Plc and Cardinal DrillingNigeria in which Seplat Plc has become an interestedparty by default in the case of a loan delinquency owed by a 'related party'.

The clarification of the nature of the relation between SEPLAT Plc andCardinal Drilling Nigeria is considered important to establish the structureand cash flow patterns of SEPLAT's Oil & Gas business and the contingentliabilities that the company could be carrying that may adversely affect itsfuture earnings. The letter sent by SEPLAT to the Nigerian Stock Exchange (NSE)and the London Stock Exchange (LSE), with due respect, will appear inadequateunder the circumstance.

To calm investor nerves, the management of Seplat Plc may consider doing thefollowing:

Clarify the precise 'related party' relationshipbetween SEPLAT Plc and Cardinal Drilling Nigeria for its investors on both theNigerian Stock Exchange (NSE) and the London Stock Exchange (LSE);
State which interested parties are common to bothentities and at what levels this begins and stops (IAS 24 will be a usefulguide here);
Consider unveiling the ownership No. 16A Temple Road,Ikoyi, Lagos and nature of occupancy (helpful to its cause in avoding thecollateral damage by location as represented in the release/disclosure);
Propose a corporate governance covenant that createsan arms length relationship between SEPLAT Plc and Cardinal Drilling Nigeriarecusing SEPLAT from transactional obligations involving Cardinal DrillingNigeria (as currently available evidence suggest that SEPLAT Plc is a 'key' client of Cardinal Drilling Nigeria; andaccording to the drilling company's website; responsible for the midwife of theoil service company (see also the interim and audited financial statementsof the SEPLAT Plc provided here below under illustrations)
SEPLAT Plc must work out a means of managing the operationalrisk posed by the debt situation Cardinal Drilling has found itself; toprotect shareholders interest; especially at a challenging time like this.

Though the road to hell was paved with good intentions; corporatechincanery should not be one of the building blocks.

Illustrations - Related Party Disclosures:

1. pg 226 The list ofSeplat's related party transactions is outlined in Note 42 tothe financial statements of the 2019 Annual Reportand Accounts

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page 226; Note 42. Related party relationships andtransactions

TheGroup is controlled by Seplat Petroleum Development Company Plc (the parentCompany). The parent Company is owned 6.43% either directly or by entitiescontrolled by A.B.C. Orjiako (SPDCL(BVI)) and members of his family and 12.19%either directly or by entities controlled by Austin Avuru (Professional SupportLimited and Platform Petroleum Limited). The remaining shares in the parentCompany are widely held. The goods and services provided by the related partiesare disclosed below. The outstanding balances payable to/receivable fromrelated parties are unsecured and are payable/receivable in cash.

ii) Entities controlledby key management personnel (Contracts >$1million in 2019)

CardinalDrilling Services Limited (formerly Caroil Drilling Nigeria Limited): Is ownedby common shareholders with the parent Company. The Company provides drillingrigs and drilling services to Seplat. Transactions with this related partyamounted to N2.89billion, $9.44 million (N621 million, $2.03 million). Receivables and payableswere nil in the current period (receivables in 2018: N1.49 billion, $4.87million).

2. pg 35, Note 24 The 2019 Interim management statement and consolidated interim financial results For the three months ended 31 March 2019 (expressed in US Dollars and Naira) - 30 April 2019

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page 35. Related party relationships andtransactions

The Group is controlled by Seplat Petroleum Development Company Plc (the 'parent Company'). The shares in the parent Company are widely held.

24a. Related party relationships

Theservices provided by the related parties:

"Cardinal Drilling Services Limited(formerly Caroil Drilling Nigeria Limited): Is owned by common shareholderswith the parent Company. The company provides drilling rigs and drillingservices to Seplat."

3. pg 46, Note 19 The Interimmanagement statement and consolidated interim financial results For the ninemonths ended 30 September 2016 (expressed in US Dollars and Naira) - 27 October 2016

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page 46. Related party relationships andtransactions

The Group is controlled by Seplat Petroleum Development Company Plc (theparent company). The parent company is owned 21.37% by Maurel & Prom (MPI),15.19% either directly or by entities controlled by A.B.C Orjiako (Shebah PetroleumDevelopment Company Limited) and members of his family and 13.15% eitherdirectly or by entities controlled by Austin Avuru (Professional SupportLimited, Abtrust Integrated Services and Platform Petroleum Limited). Theremaining shares in the parent company are widely held.

19a. Transactions

TheService provided by related parties are:

"Cardinal Drilling Services Limited(formerly Caroil Drilling Nigeria Limited): is owned by common shareholderswith the parent company. The company provides drilling rigs and drillingservices to Seplat."