Netting arises when several contracts between the same two parties are settled concurrently. The amount due from the several contracts is collated and the obligations to pay or be paid are combined into a single obligation of the net amount. The process of collating these several off-setting claims into a single claim is generally called “netting’’.
An example is: Where Company A enters into a contract with Company B (first contract) amounting to about N10 million in favour of Company A on the 1 January 2020; and a second contract on the 2 February 2020 amount to N20 million between the same parties now in favour of Company B and a third transaction on the 3 March 2020 amounting to N30 million in favour of company A; these three different agreements are individually valid and enforceable, however they may be combined by the process of netting so that eventually Company A is settled by a single payment of N20 million from Company B.
In a swap transaction for example, assume two parties enter into a swap agreement on a particular security whereby they both owe money to each other. At the end of the swap period, the following is due:
- If Investor X is due to receive N100,000,000 from Investor Y
- And Investor Y is due to receive N25,000,000 from Investor X
- Then, instead of Investor Y paying Investor X N100,000,000 and Investor X giving Investor Y N25,000,000, the payments would be netted
- Consequently, Investor X would give Investor Y N0, while Investor Y would give Investor X N75,000,000
Netting, as it relates to insolvency, dates back to the beginning of commercial relations. The early history of insolvency law provides some fundamental perspective for understanding the efficiency implications of netting.
In Nigeria, the concept of netting was codified in the recent Companies and Allied Matters Act signed into law by President Muhammadu Buhari on the 7 August 2020 to provide explicitly for circumstances where multiple transactions/contracts relating to insolvency may be combined and settled. The amounts due for the contract may involve obligations to pay under one contract and a right to receive under another, are summed together and the several obligations to pay or be paid are combined into a single obligation for the net amount.
By Section 718 of the CAMA 2020, netting means the occurrence of the following:
- 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;
- Calculation or estimation of a cl0se-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)
- Conversion of any value calculated or estimated under paragraph (b) into a single currency; and
- Determination of the net balance of the values calculated whether by operation of set-off or otherwise;
Netting is a reconciliation, settlement and payment mechanism under which competing rights or interests are terminated and valued, resulting in amounts payable between contracting parties being consolidated into single, smaller payment from one party to another. That is, the party’s gross obligations are offset against each other and treated (for payment purposes, but not for regulatory capital purposes) as a single obligation such that there is, effectively, only one claim in existence at any given time.
Netting is also used when a company is in bankruptcy and the parties wish to settle or offset the balances owed to each other. It is similar to set-off clause or set-off law. A company carrying on business with another company ‘defaulting company’ may ‘net’ any money owed the defaulting company with money that’s owed them. The final balance is the amount owed by them or to them, which can be used in bankruptcy proceedings.
In high transactions, companies may enter into ‘Qualified financial contracts’. Qualified financial contracts mean financial agreements, contract or transaction, including any terms and conditions incorporated by reference in any financial agreements, contract or transactions, 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.
While a netting agreement means any:
- Agreement between two parties that provide for netting of present or future payment or delivery obligations or entitlements arising under or in conjunction with one or more qualified financial contracts entered into under the agreement by the parties to the agreement called the master netting agreement.
- Master agreement between two parties that provides for netting of the amounts due under two or more master netting agreements known as master-master netting agreement; and
- Collateral arrangement related to or forming part of one or more of the foregoing.
Benefits of Netting and Netting agreements
Netting saves companies unnecessary waste of time and costs by reducing several deals entered into by corporations into a single transaction by narrowing the transaction and deal.
In the foreign exchange market, companies or banks can consolidate the number of currencies and foreign exchange deals into larger trades, reaping the benefits of improved pricing. In situations where companies have more organized time frames and predictability in settlements, they can more accurately forecast their cash flows.
Netting is a method of reducing risks in financial contracts by combining or aggregating multiple financial obligations to arrive at a net obligation amount. Netting is used to reduce settlement, credit, and other financial risks between two or more parties.
Precious Okoh is a legal practitioner called to the Nigerian bar in 2019. He is currently a member of the Nigerian Bar Association and passionate about commercial litigation, Arbitration and Dispute Resolution and very curious about digging into novel fields of law like technology, artificial intelligence and Energy law.
