In Nigeria, debts are typically secured through the use of guarantees, mortgages, fixed and floating charges and pledges of real, personal, tangible and intangible property belonging to the debtor or a guarantor of the debtor. Security created in favour of a lender for providing debt financing is documented using different forms of security documents.
In order to perfect security documents, such documents must be stamped at the stamp duties office and registered at the Corporate Affairs Commission (CAC). For certain assets such as real property which require the consent of the Executive Governor of the state where the real property is situate, such consent must be obtained to perfect the security created under such document. The statutory obligation to stamp documents that transfer or create a proprietary interest in assets is provided for under the Stamp Duties Act (SDA) with specific emphasis on sections 3, 23 (1) and (4) of the SDA. In addition, a charge created by a company to provide security to a lender is void against a liquidator and such lender (as a creditor of the company) unless it is registered with the CAC within 90 days of creation.
However, in large financing transactions, the stamp duty payable in respect of a security document could be very high (and in certain cases, prohibitively so). It is not uncommon for lenders to a financing to agree that the borrower may pay stamp duty on only a portion of the secured amount rather than the whole secured amount, with a further assurance from the borrower that the full stamp duty will be paid on a future date or upon the occurrence of certain events. This practice is known as “upstamping”. Until the security document is upstamped, any such lender is only protected up to the amount expressed to be secured and a lender may lose priority to any subsequent security granted on the charged assets during the period between the initial stamping and the full upstamping of the security document.
The Implication of Upstamping on Lenders
Neither the SDA nor the Companies and Allied Matters Act (CAMA), stipulate that a security document that secures a credit facility must be stamped and registered for the exact amount extended to a company or person. However, where a security document is stamped for an amount lower than the facility amount, the lenders will only be permitted to prove for and realise the security for the secured amount i.e. the amount for which that lenders has stamped and registered his security. CAMA recognises the right of parties to commercially structure their transactions such that the security documents can be stamped for an initial amount and then subsequently up stamped for an additional amount.
Pursuant to section 202 of CAMA, any additional amount for which a security document is up stamped will be valid and effective to the extent of such increased amount. The lenders would only be permitted to prove and realize the security for the full facility amount or a higher amount only upon the security document being up stamped (i.e. payment of additional stamp duty) to cover the facility amount or the higher amount being sought to be recovered.
Potential Risk to Lenders in Enforcing Security
There is a risk that prior to the lenders up stamping the security document for the full facility amount, intervening third party interests might have arisen (i.e. under other third party security), thus raising pertinent priority issues where another creditor has acquired an intervening proprietary interest. If prior to an up stamping to secure additional amounts, another creditor advances money to the borrower, and perfects its security interest over the same assets that form the subject-matter of the lenders’ security, that creditor will rank ahead of the lenders’ interest as it relates to the subsequent up stamped additional amount to be secured but lenders will still have priority in respect of original amounts for which the security was perfected.
Another risk lenders face in an upstamping scenario is that an agreement to upstamp to secure additional amounts, might be viewed as a fraudulent preference in the event of insolvency of the borrower. See section 495 of CAMA. This “hardening period” rule, and the resultant effect is that the additional / up stamped security interest would be void against the liquidator of the borrower and enable the liquidator claw-back any such payments or cancel such acts. Arguments can be made whilst referring to decisions of English courts on the fact that a preference is not fraudulent by essentially showing that the dominant motive for such preference is not to prefer certain creditors to the detriment of others. It should however be noted that such arguments are only persuasive to Nigerian courts as Nigerian courts are not bound by the decision of English courts; they are only of persuasive authority.
On the flip side, where the dominant motive was to carry out a pre-existing obligation, or to keep on good terms with a creditor, it is likely that Nigerian courts will follow English courts in holding that in such circumstances the preference is a fraudulent preference. It is important to note that there are no Nigerian law decisions on this point, however, Nigerian courts are likely to follow English courts on this point.
Addressing the Residual Risks of Upstamping
The risks identified above, while adopting the upstamping regime, can be mitigated by:
1. Establishing an upstamping regime in the relevant loan documentation;
2. Using a negative pledge clause restricting the borrower from creating any additional security over its assets;
3. Using automatic crystallization provisions in the security documents for floating charges to crystalise into a fixed charge when there is an attempt to create security over the assets in favour of a third party; and
4. Establishing a stamp duty escrow account to hold the balance of the perfection costs to enable lenders upstamp at will.
The options highlighted in (1) to (4) above are by no means exhaustive as other options have not been discussed in this paper.
Chukwudi Ofili is a Senior Associate in the corporate and commercial, banking and corporate finance practice group of Bloomfield Law Practice; and advises on matters such as local and foreign currency syndicated lending, leases transaction/structured/project finance, structured trade finance, energy and natural resources, due diligence issues and advisory services, foreign investment advisory services, taxation and real estate.
Ed"s Note - This article was originally published by the author here.