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Business | Debtors & Recovery

The Ecobank and Airtel Story: Surviving a Contingent Liability and Equity Sale

Jan 03, 2021   •   by   •   Source: Proshare   •   eye-icon 5393 views

Sunday, January 03, 2021 / 05.57PM / By Proshare Content/Research /Header Image Credit: Ecographics


Proshare Nigeria Pvt. Ltd.

 

Ecobank Transnational Incorporated (ETI) Plc released its9month 2020 result in November 2020 with sufficient optimism about its strongshort-term outlook. Indeed, analysts have noted that the group's balancesheet-cleaning exercise involving a one-off charge for the total write-down ofits cost of goodwill incurred on the acquisition of Oceanic Bank Plc in 2011,would brighten its financial results in the year ended December 2020. Althoughthe 9 months 2020 audited accounts of the behemoth were sprinkled with largeone-off charges to its P&L from the restructuring of operations andgoodwill write-offs during the year, the group remains hopeful that it wouldpresent shareholders with a strong year 2020 performance which it believeswould be followed by a more impressive outlook in 2021.

 

Theproblem with this outlook, however, is that a recent Court of Appeal (CoA)judgment delivered on November 24, 2020, has put observers on notice on thepossibility of a contingent obligation of the Nigerian operations of thelending group which could throw a wrench in the group's business as a liabilityof N22.5bn may crystalize in forthcoming years. 

 

The Short of a Long Story 

Troublestarted when Dr. Oba Otudeko, Chairman Honeywell Group, and BroadCommunications Limited filed an action at the Federal High Court (FHC) in 2006challenging the Delta State Government's purchase of O & O Network's sharesin Airtel Nigeria.

 

Accordingto Broad Communication Limited and Dr. Otudeko, the sale of the shares wasunlawful, and a breach of a Shareholders' Agreement approved and signed byshareholders in Airtel Nigeria (warehoused in O&SO). 

 

Afterthe suit was filed, efforts were again made in 2015 to sell the disputedshares.

 

Toforestall the attempt to negate the court's final judgment on the suit, Otudekoand Broad Communications published a "Buyer Beware" notice on thedisputed shares. Despite this and the persistent attempt by O&O Networks tosell the shares, the Federal High Court on the 5th of February 2015 per JusticeTsoho gave an order restraining all parties from dealing or tampering with theshares in the custody of ETI pending the final determination of thesuit. 

 

However,in what was alleged to be a disregard of the orders of the court, O & ONetworks and ETI entered an arrangement with Bharti Airtel Nigeria Limitedfor the sale of the disputed shares to Bharti Airtel Nigeria Limited for thesum of N22.5Billion in 2018 contrary to the order of Justice Tsoho's.

 

Followingthe discovery of the sale despite the court order, Dr. Otudeko and BroadCommunication through their solicitor filed an application urging the court todirect O & O Network Limited to deposit the sum of N22.5 billion being theproceeds of the sale into an interest yielding account in the name of the ChiefRegistrar of the Federal High Court pending the determination of thesubstantive suit by the court. 

 

Indelivering her ruling on March 7, 2019, Justice Olatoregun held that the orderto maintain the status quo earlier made by the Honorable Justice Tsoho onFebruary 5, 2015, was in force and that O & O Networks ought not to haveagreed with Bharti Airtel as this amounted to the disobedience of an existingcourt order.

 

Basedon this, the judge ordered O&O Networks to pay the sum of N22.5Billion,being the proceeds of the sale of the shares of Airtel Nigeria Limited into thecustody of the Federal High Court within 7 days (seeillustration below). 

 

Illustration:  The Journey of A Judgement

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A View from The Bar 

Presumably, the restrictions on O & O Ltd. from selling the sharesit held in Airtel Nigeria Ltd. arose from an agreement made under Section 22(2) of the Companies and Allied Matters Act (CAMA) 2004 (the new CAMA 2020 commences application from January2021) which provides that private companies(which Airtel Nigeria Ltd was as at the time the suit was instituted) should,via their Articles of Association, restrict the transfer of shares. As this wasthe case, O & O Ltd. was prohibited from dealing with its shares in themanner it would appear it had done and in line with observations of the FederalHigh Court (FHC), Lagos, and the Court of Appeal (CoA).

Further, O & O Ltd's several attempts at selling the shares of Airtel Nigeria Limited after an order of a FederalHigh Court restricting any dealing on the shares would appear to be adisregard of the orders of the court and it was surprising that in addition todeclaring that the company deposits the proceeds of the share sale in anominated account, no other punitive order was made. Nevertheless, O&O Ltd.may choose to appeal against the Appeal Court's decision and escalatelitigation to the Supreme Court to vacate the order of the lower court. It ishowever unlikely, in theopinion of some lawyers, that the SupremeCourt would rule in favour of O & O Ltd considering the terms of the initial shareholder agreement relied upon by the respondent. 

Giventhe potential legal outcome of the litigation of Oba Otudeko and BroadCommunications Limited against ETI and O&O Networks Limited, the accounting principle of prudence may require that the bank discloses the contingent liability it is expected to incur ifthe Supreme Court reaffirms the decision of the lower court, compelling ETI/O&O Limited to deposit with the court registrar  N22.5bn that was the alleged proceeds of the sale of Airtel NigeriaLimited shares owned by O&O Limitedto the Delta State Government (see illustration 1 below).

 

Illustration 1 ETI's Possible ContingentLiabilities; A Cold Harmattan Ahead?

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A Tidy Bit of Arithmetic

In its 9 months, 2020 audited financial statementETI reported a gross earning of US$1.6bn, while its profit before tax over theperiod was US$90.78m. The Nigerian operations of the group posted a profitbefore tax of US$37.16m. If the ETI/O&O contingent liability of N22.5bn(US$57.84m) is charged against the PBT of the Nigerian operations, the Nigerianoperations would have recorded a loss of US$20m in 9months 2020. This wouldalso have affected the group's PBT for 9months 2020 with the group posting ahypothetical PBT of US$33.62m (as against its reported US$91m) if the bankinggiant had decided to fully provide for the contingent liability (see Table 1 below which gives ETI's P&L performance in9months 2020 region by region).

 

Butshould the bank have provided for a court judgment that had not yet beendetermined? The Appeal Court decidedin November 2020 before the 9months audited account was released that ETI place N22.5bn with the high court registrar until a final determination of thecase was taken. This, according to legalauthorities, was consistent with past orders in such cases. The amount was tobe placed in an escrow account until a final judgment is given.

 

Prudentaccounting practice, according to some analysts, suggests that ETI should haveinformed shareholders in a note to the 9 months 2020 accounts of the size andnature of the contingent liability, even if the banking group deemed itunnecessary to make provisions in its books (seeillustration 2 below).

 

Illustration 2: Making That Contingent Liability Decision

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However,group executives feel differently. A discussion with the top executives of thebank indicates the following position:

  • First, no judgment has been awarded against O&O. The bank executives said the bank does not have provisions on the case because it believes there is no present obligation under IAS 37 rules

 

  • Concerning contingent liability disclosure, IAS 37 gives guidelines for making material disclosures but also gives room not to disclose if the possibility of an outflow of economic benefits is considered remote

 

Asfar as the senior executives of the continental banking group are concerned aninternal assessment of the situation suggests that no liability will arise andthe probability of the court awarding a judgment against O&O is low/remote.

 

OnProshare's further probing the bank executives reaffirmed their positionthat there was no court judgment against O&O and that they strongly believethat when the substantive matters are heard in court, there would not be ajudgment award against the company.

 

Nevertheless,the executives said that they would regularly review their position as progressis made at the courts.

 

Table 1: Understanding ETI Zone by Zone

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Source: ETI Audited Financial Statement 9 Months 2020 

 

TheLiability Debate 

Opinions differ concerning how to treat theN22.5bn potential liability. While some accountants say that the banking groupneed not make any provision for the payment since the legal case was ongoingand was likely to proceed to a higher court (Supreme Court) for finaldetermination of the substantive matter, other accounting professionals insistthat since the liability has been identified as a potential outcome that has amaterial impact on the banking group's P&L, the bank should at leastdisclose the possibility of crystallization of the amount even if no immediateprovision need be recognized. 

 

The International Accounting Standard (IAS) thatappears to address the issue is IAS 37. 

 

Thebroad requirements of IAS 37 are summarized below:

 

The Ernst and Young generally accepted accounting principles ("GAAP")Manual for IAS 37

 

Summary of IAS 37

 

Objective

The objective of IAS 37 is to ensurethat appropriate recognition criterion and measurement bases are applied toprovisions, contingent liabilities, and contingent assets and that sufficientinformation is disclosed in the notes to the financial statements to enableusers to understand their nature, timing, and amount. The key principleestablished by the standard is that a provision should only be made when thereis a liability i.e. a present obligation resulting from past events. Thestandard, therefore, aims to ensure that only genuine obligations are dealtwith in the financial statements ?óÔé¼ÔÇ£ planned future expenditure, even whereauthorized by the board of directors or equivalent governing body, is excludedfrom recognition.

 

Recognition of a provision

An entity must recognize a provisionif, and only if [IAS 37.14]

  • a present obligation (legal or constructive) has risen as a result of a past event (the obligating event),
  • payment is probable ('more likely than not'), and
  • the amount can be estimated reliably. 

An obligating event is an event thatcreates a legal or constructive obligation and, therefore, results in an entityhaving no realistic alternative but to settle the obligation. [IAS 37.10]

A constructive obligation arises ifpast practice creates a valid expectation on the part of a third, for example,a retail store that has a long-standing policy of allowing customers to returnmerchandise within, say, a 30-day period. [IAS 37.10]

A possible obligation (a contingentliability) is disclosed but not accrued. However, disclosure is not required ifpayment is remote. [IAS 37.86]

In rare cases, for example in alawsuit, it may not be clear whether an entity has a present obligation. Inthose cases, a past event is deemed to give rise to a present obligation if,taking account of all available evidence, it is more likely than not that apresent obligation exists at the balance sheet date. A provision should berecognized for that present obligation if the other recognition criteriadescribed above are met. If it is more likely than not that no presentobligation exists, the entity should disclose a contingent liability, unlessthe possibility of an outflow of resources is remote. [IAS 37.15]

 

Measurement of provisions

The amount recognized as a provisionshould be the best estimate of the expenditure required to settle the presentobligation at the balance sheet date, that is, the amount that an entity wouldrationally pay to settle the obligation at the balance sheet date or totransfer it to a third party. [IAS 37.36] This means:

  • provisions for one-offs events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at the most likely amount. [IAS 37.40]
  • provisions for large populations of events (warranties, customer refunds) are measured at a probability-weighted expected value. [IAS 37.39]
  • both measurements are at the discounted present value using a pre-tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the liability. [IAS 37.45 and 37.47]

In measuring a provision considerfuture events as follows:

  • forecast reasonable changes in applying existing technology [IAS 37.49]
  • ignore possible gains on the sale of assets [IAS 37.51]
  • consider changes in legislation only if virtually certain to be enacted [IAS 37.50]

 

Remeasurement of provisions[IAS 37.59]

  • review and adjust provisions at each balance sheet date
  • if an outflow no longer probable, provision is reversed.

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RunningBattles

Ecobank's run-in with ObaOtudeko/Honeywell Group is not new (see Proshare's earlier 2019 reports, Court Orders Ecobank to PayN22.5b Within 7 Days Over Airtel Shares; Suit Adjourned to May 28, 2019, and Facts Behind the Ecobank vs.Otudeko Debt Debacle, Airtel/SEC Angle). But this matter has several twists centred oncorporate governance (see illustration 2 below).


Illustration3: A Transition ThroughConflict

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The struggles between ObaOtudeko and various alter egos such as Honeywell have had a long and checkeredhistory with ETI that unveils the underlying challenges in themanagement of bank debt and debtors.

 

This was highlighted in a2019 DebtorsAfrica  report on Nigeria's credit creation process and itsdifficulties.

 

According to the report onpages 10 and 11 the new paradigm for lending and borrowing would need to runalong the following tracks:


"Rather than lenders andcustomers finding themselves locked in interminable arguments over repaymentplans and default on repayment pledges, the pre-agreed resolution mechanismkicks-in and pulls the loan repayment process into a remedial default modedesigned to restructure the Facility in a way that averts delinquency".

 

The report further notedthat to support a process that breaks the bone of asymmetric information withthe attendant problems of borrowers having more knowledge than lenders on theircharacter and credit history, an online digital delinquent loans registershould be created across the African continent.

 

According to the report:


"A digital library ofpublicly available delinquent bank debtors provides lenders insight into thecharacter and managerial capacity of borrowers. The digital library places botha moral and business burden on delinquent borrowers as prospective lenderswould use the library to fact-check the borrowing history of a loan applicantand use the history to set up a character rating index that would guide creditappraisal memorandums (CAMs) and inform the acceptance or decline of creditrequests".

The pressure of havinglenders able to quickly and effortlessly review the nature of past loanfacilities and repayment records of a prospective borrower creates a borrowingenvironment that is sensitive to historical loan performance data and past loanresolution difficulties. The register profiles the corporate boards ofborrowing entities and helps lenders assess the fitness of the company'sleadership as a borrower. Leveraging the psychology of 'social proofing', thefailure of a borrower to abide by the terms of a loan agreement with one lenderwould put other lenders on notice to decline the loan request of a previouslydelinquent borrower until such a time the borrower redeems the earlierfacility. The soundness of the psychology has been vindicated by the numerousrequests from delinquent borrowers for media houses to bring down digitalstories posted online or references to earlier delinquencies associated withthe companies.

 

In respect of the ongoinglegal process between Oba Otudeko and O&O, a common denominator in thevarious legal battles is the now-defunct Oceanic Bank which was acquired byEcobank Transnational Inc. (ETI) in 2011.

 

OceanicBank acquired an equity interest in Airtel as aresult of a loan default by Adewale Tinubu who took a loan from Oceanic Bank bycollateralizing the facility with his shares in Airtel. "Tinubu" owned theAirtel shares under a special purpose vehicle called O&O Networks('O&O'). On default of his loan payment, the erstwhile Oceanic Bank took overthe Airtel shares still housed in O&O.

 

WhenETI acquired Oceanic Bank in 2011 it acquired all the Oceanic Bank's assets andliabilities including the Airtel shares owned by O&O. O&O subsequentlybecame an SPV for a broader number of shareholders including Oba Otudeko andBroad Communications. This was, however, the beginning of the O&O,Otudeko/Broad communications Jujitsu

 

TheOtudeko corner insisted that by the terms of the shareholder's agreement signedby the parties in O&O existing shareholders had the right of firstrefusal to purchase the Airtel shares before O&O could offer the sharesto third parties for purchase. The issue remains a matter for determination bycourts of the competent local jurisdiction. 

 

Theissue of greater concern from an analyst's point of view is the governanceguidance in the course of the various transactions and the oversight expectedfrom financial regulators. The sale of the shares by O&O to the Delta StateGovernment was a private arrangement that did not involve the Securities andExchange Commission (SEC) oversight but is worrisome where a state governmentbuys shares in a private company using state resources.

 

Ofparticular concern is that most of these kinds of share acquisitions arecanopied under a fog of beneficial ownership. But the concern in thisparticular case was that, according to the pronouncement of a Lagos High Court,O&O breached the terms of its own shareholder's agreement in respect ofgiving existing shareholders the right of first refusal in buying its Airtelshares.

 

Withoutgoing through long and circuitous court processes, some informed analysts haveadvocated that the domestic investment climate could be improved by anSEC-administered resolution mechanism for private equity transactions involvinga variety of parties, such as the case of O&O, Otudeko, and ETI.

 

Thejury is still out on whether this suggestion would help the system improve thequick resolution of conflict but what is clear is that the present legalframework is slow and could be jammed by clever legal contrivances. 

 

Thepossibility of speedy resolution of conflicts in matters related to equitiesand perhaps fixed income assets would help in encouraging capital importationby way of foreign portfolio investments (FPIs) and should be seen as an urgentrequirement for improving foreign and domestic investment. Some lawyers haveargued that since the Investment and Securities Tribunal (IST) can only dealwith matters related to capital market operators (CMOs), private companies indispute might find the alternative dispute resolution (ADR) channel a morepragmatic approach to commercial dispute determination.

 

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ClosingThoughts - Making Governance Count 

ETI has acted prudently by making total provision for its cost-of-carryof Oceanic Bank goodwill over the last ten years. Working-off the goodwill fromits books in 9months 2020 is a decent piece of financial spring cleaning (see illustration 4 below). Also, writing off itsrestructuring obligations in the year was equally useful in clearing up the booksto allow the organization to breathe without burden. This move by ETI'smanagement seems to comply with the expected governance standard of acontinental financial powerhouse.

 

However,a few niggling problems remain.

 

Thecontingent liability of the O&O Network share sells hangs over the ETI operations like a hawk.

 

Thefact that it has not been explicitly recognized in the bank's books, if not asa contingent liability at least as a potent business risk, is worrying.

 

Itwould have been a governance boon if the group had in its recent financialstatements reported that the business dispute was not sufficiently problematicto be classified as a contingent liability.

 

Admittedlythe judgment call belongs to the management and board, but shareholders wouldhave felt more comfortable with recognition and assurance as a stakeholderengagement strategy.

 

Illustration 4:  ETI's Goodwill Waterfall

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CorporateNigeria must increasingly tighten its stakeholder communication channels tohelp investors, for example, gain a full sense of the business's strengths andvulnerabilities.

 

WhileIAS rules such as IAS 37 allow for judgment calls, such latitude should beadopted with due care for ensuring that investors are properly apprised of theorganisations weaknesses, strengths, opportunities, and threats.

 

Forcorporations listed on official capital market exchanges such as the NigerianStock Exchange (NSE), the disclosure requirements are raised more than a fewnotches. The ETI, O&O Network, Oba Otudeko, and Broad Communicationtangle are instructive not in its simplicity but in the guidance, it offers onissues such as shareholders' rights of first refusal and the clever ways SPVscan be used to acquire and sell shares; the obligations, responsibilities, andblowbacks.

 

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 Proshare Nigeria Pvt. Ltd.


Proshare Nigeria Pvt. Ltd.


Proshare Nigeria Pvt. Ltd.

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