Cashflows Trump Balance Sheets When Managing Loans Says Barrister Afolake Lawal


Friday, January 17, 2019  / 05.10PM  / Managing Editor, Teslim Shitta-Bey, and Legal Counsel/Chief Compliance Officer, Ayo Sogunro, Header Image Credit: GTI


Understanding business cash flows remains a far more critical consideration in the lending process than appreciating the size of a customer's balance sheet, indeed, "while balance sheet sizes are great, they do not pay the company's bills; corporations pay bills out of cash flows not accounting statements" notes Mrs. Afolake Lawal a Barrister-at-Law and co-founder of investment bank GTIIn a recent interview with Proshare's Managing Editor, Teslim Shitta-Bey and Legal Counsel/Chief Compliance Officer, Ayo Sogunro; Lawal took a look at the local credit market and existing legal provisions for loan recovery and explained the strengths, weaknesses and opportunities that Nigerian laws offer.


On the existing legal framework for debt recovery in Nigeria


Barrister Lawal believed that the remedy for debt recovery is largely available under the common law obligation of the debtor to seek out his creditor to repay the loan. She noted that there is an implied obligation in a contract that the borrower will repay the loan obtained from the lender, and the implied obligation becomes strengthened when incorporated as an express term in the contract between the parties.


According to the investment banker, there are legislations primarily on insolvency, bankruptcy and receivership under the Companies and Allied Matters Act (CAMA), considered as providing a legal framework for debt recovery. "We also have the Bankruptcy and Insolvency Act 2016, and the Rules of Procedure set out in the Bankruptcy Rules Cap B2, LFN 2004. The rules reflect the Federal High Court Rules with some modifications in conformity with the provisions of the Bankruptcy Act."


She noted that the Asset Management Company of Nigeria (AMCON) Act was also relevant to debt recovery; however, this particular act was not of "general application but specific to the recovery of the debt concerning eligible assets of delinquent debt bought over by AMCON." She emphasized the fact that the combined application of the various laws may appear to be a sufficient legal framework for loan recovery.



On the prospect for growth of the financial sector with existing legislation


Barrister Lawal noted that growth opportunities lie in increasing financial intermediation and inclusion, which involves expanding the provision of financial services to the underserved informal economy. According to her, "In most cases, the underserved possess some level of financial portfolios, and they have an intermediation need to manage their collection of transactions and relationships."


"When you analyse things at a deeper level, you realize that family members, moneylenders, savings clubs and neighbours constitute a form of informal financial service providers to this segment of the economy. For most participants here, cash flow analysis, as opposed to balance sheet analysis, is the way to begin to understand this market." Lawal noted that Microfinance institutions were leading the way in this regard, and that was because larger institutions still do not readily serve this market segment due to the potential for high defaults and the need for higher interest rates to compensate for the inherent riskiness of this loan market. "So, I think this segment represents a growth area, so long as services can be systematized. We already see some fin-techs playing in this space too, and that tells you there is a tremendous opportunity for big players who can properly align incentives in addressing this informal market segment."


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Source: EfinA


"Having said that, the legislation guiding debt recovery in Nigeria may inadvertently inhibit the growth prospects of the financial sector in the absence of much-needed changes. These relate to the delay in the administration of justice in this part of the world, which makes the entire system unsuitable for finance or the business community."



On lending philosophy of financial institutions in the light of the difficulty in debt recovery


Barrister Lawal believed that financial institutions are aware of the time, cost and effort spent in debt recovery through court proceedings. She noted that, at times, even negotiating for the restructuring of a loan is herculean and frustrating. "Consequently, some institutions have taken measures like prioritizing the use of movable assets as security for loans; lending for quick recovery of funds even to the detriment of the debtor's business; avoiding lending to certain sectors of the economy classified as high risk and so on," Lawal noted.


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Debt recovery cases handled


"We have worked on a couple of debt recovery matters on behalf of financial institutions and the following factors permeate through most of the matters

  • Lack of tangible security to protect the financial institutions
  • Recalcitrant and evasive debtors
  • Difficulty in tracing securities for the loans

"These features create a toxic local debt market that could hinder the growth and development of Nigeria's real sector."


Lessons and takeaways from handled cases


"The key takeaway is that financial institutions need to improve on their internal controls and risk assessment framework underlying their disbursements. Many loans get approval without comprehensive information about the borrower and valid and adequate collateral. If the loan becomes bad, these fundamental defects in the loan approval process in banks can make the recovery effort much more complicated."

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The AMCON Act and growth of the credit market

According to Lawal, AMCON's role in the financial market has been more that of a risk transfer or risk-sharing partner. "And in a way, this has been a good thing for the market, depending on who you ask. I know there are varying opinions on what AMCON was supposed to achieve and why it still exists, but that is not our focus. You recall that the establishment of the Act and AMCON came about by the crash of 2008 and the following defaults in the banking system. When viewed from this perspective, you can argue that AMCON has helped sanitize the process of loan origination in our banks."


Lawal also noted that "previously, you would not have cared so much about the quality of the loans issued, so long as the bank's borrower could guarantee interest payments and principal. Now, our banks are even more conservative regarding the loans they originate, and we see default levels at perhaps its lowest since 2008. By having AMCON absorb most of those bad loans on the books of the banks, you free up the banks to continue lending and maintain quality loans in their asset portfolio, invariably reducing their risk-weighted assets."


Since AMCON is a specialized institution, it could take on the burden of debt recovery or agree to restructure some of the toxic bank loans, without adversely affecting the banking system. "So, I think this much can be said about the purpose of AMCON's creation, regardless of its shortcomings."


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On the attitude of the judiciary towards debt recovery efforts


"From the cases that we have handled, we can infer that the judiciary understands the importance of AMCON's debt recovery drive and that they would do their best as professionals to ensure that the creditors get all that is due to them under the law, provided that such creditors follow the laid down procedures. Even though external observers may consider the number of pending debt recovery cases in the courts and the age of some of the cases as unduly long, it would be unfair to blame the judges for these as there are other issues like claimant and counsel-caused delays and the behaviour of uncooperative debtors that also inevitably prolong the recovery process."


Lawal pointed out that, "Judges may sometimes struggle to balance the need to administer justice and do it right, which may take time, with speed required in the business environment due to the time value of money."


"Often, debtors who have no answer to their liability explore the litigation route by going first to court to frustrate a legitimate recovery process and forestall the realization of the assets deposited as collateral securities. A discerning judge with knowledge of the intricacies of financial transactions would be able to see through the exploitation of the judicial process by this debtor. Thus, continued training for judges on financial issues like securitization and secured credit transactions, combined with technological innovations to assist court proceedings, would play a crucial role in keeping up with the intricacies of financial transactions and enable judges to adjudicate effectively."


A special court for handling debt recovery cases


According to GTI's cofounder, "we should have a specialized group of judges handling debt recovery matters. The question of whether the judges should operate in a special court or should remain in a specialized division of the existing courts is still open to debate considering the modalities involved in either of those options."


"One must consider the advantages or arguments for special courts - which include the view that special and focused courts would have subject matter experts as judges, which would lead to sounder judgments. Another argument is that a new court would have less backlog of cases and would somehow translate to faster resolutions. Additionally, it is important to note that the need to have specialized judges that are familiar with the intricacies of commercial transactions led to the creation of the specialized division of the courts in Lagos State like the Commercial Division. Ultimately, the position is that a focused judiciary will deliver the best form of justice for the sector."


Lawal observed that "as an example of the application of this position, it is easy to appreciate that labour-related disputes have been better under the new arrangement of the National Industrial Court than the previous arrangement. Debt and debt recovery are fast becoming the bane of the financial sector of the economy, and unless addressed, the economy may not experience much growth beyond the level of liquidity that is available to grow businesses. In conclusion, even if no new specialized courts for debt recovery exist, matters related to financial debt should be handled by judges with a specialized skillset in the subject matter."


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ADR against litigation in debt recovery matters


GTI's legal counsel believed that "litigation, for the most part, thrives on the ventilation of the rights of the parties. What comes out at the end of litigation is the declaration of right in favour of one party and against the other. It turns out a "win-and-lose" situation. ADR, on the other hand, de-emphasizes the ventilation of right and focuses on "interest" (nay commercial interests), which often turns out a "win-win" situation for the Parties."


"Due to the short timeframe it takes to resolve disputes via ADR, the time value of money makes ADR more advantageous to debt recovery than going the full hog of litigation with all its appellate trappings. From the client briefs that we have handled, the outcomes in terms of the recovery of the debts and settlement of the disputes have been even. Occasionally the ADR approach has yielded faster results where the debtor has shown a willingness to discharge their debts in a bid to protect their assets, preserve business relationships and avoid the publicity of litigation. Litigation is our last resort, and for some debtors, the threat of pending litigation and the risk of asset forfeiture is all the motivation they need to come to the negotiating table and agree on the way to discharge the debt that is fair to both parties."


Bankruptcy laws, and lender confidence


Lawyers still squabble over the robustness of Nigeria's bankruptcy laws, but Lawal insists, "the banks do not solely rely on bankruptcy remoteness to determine whether to lend to a counterparty. For the most part, it's seeing a cashflow pattern and balance sheet size and adjusting for risk. Of course, you want confidence that in the event of a default, you can proceed against your debtor, and incredibly our bankruptcy laws are robust in this regard. The primary protections are those contained in the Companies and Allied Matters Act, and they deal with arrangements with creditors, provisions concerning when and how to go about appointing a receiver for a company in administration, the rights of creditors and secured creditors and when they can exercise those rights, either individually or as a class."


She points out that the Bankruptcy Act 1979 is not typically used and has not functioned as a primary mechanism for debt recovery as occurs in other legal jurisdictions like England. "Then you have the courts whose role has always been to grant, issue or enforce an order or judgement in favour of a creditor once there is a valid case on the balance of probabilities. So, all these provisions and protection bring a measure of confidence to business in general and do form part of the base on which our financial institutions go about their lending business."


Existing laws and growth of the financial sector


The GTI Director said that she did not believe that existing laws on debt recovery and creditor/debtor relationship stifled the growth of the financial sector. "On the contrary, they have probably helped in creating a liberalized market. Bear in mind that most legislations are after the fact that is they come into existence following the occurrence of certain systemic activities and are attempts at curing a defect or an issue in the existing system. So, we have rules on corporate governance because of market infractions and abuse of corporate power; we have rules on margin lending because of its abuse before the 2008 crash. In 2010, we had the directive on divestment from non-banking operations due to the excesses of the banks at the time."


"Nevertheless, I think our laws do not do enough to give customers a fair idea of the cost of providing financial services. As such, we have some level of information asymmetry, and you see that each time the Central Bank mandates the banks to issue loans to specific sectors or customers; and then everyone supposes that the banks have always been keeping their rates high for arbitrage purposes."


"You would think that we have a true market economy, but for the most part, it isn't, and that is because aspects of our laws don't give you a good idea of who bears the cost for a particular compliance responsibility, apart from the usual excessive risk-taking of market players. Take corporate governance, for example, the requirement nowadays of having at least five (5) directors (and for the banks, it's more than that) means you are paying more salaries or fees to these directors; meaning the bank must find a way to bear that cost or transfer it to customers."


The New AMCON Act


On the new AMCON Act, Barrister Lawal believed, "the new AMCON Act depicts a strong attempt to tackle some of the main issues in debt recovery that have been raised by Asset Management Partners (AMPs) and AMCON itself. AMCON can now access financial details of debtors and place their accounts under surveillance - a new development that would relieve AMCON and its AMPs of the onerous responsibility and often futile endeavour of locating debtors' accounts in financial institutions. The Act, as it exists today, is very comprehensive as the powers concerning debt recovery are enormous. The powers are so extensive that some are considered unconstitutional."


About the Author


Barrister Afolake Lawal is a co-founder of the GTI Group. She is currently the Managing Partner of the Imperial Law Office. She has over 15 years of experience in Investment Banking, Corporate Finance, and Business Strategy. She is a Certified Pension Practioner and an Associate Member of the National Institute of Marketing of Nigeria. (NIMN).

She serves on the Board of International Breweries Plc. and Eterna Plc. (both companies quoted on the Nigeria Stock Exchange). She is currently the chairman of International Breweries Plc, Governance and Remuneration Committee.


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