Sunday, January 03, 2021 / 05.57PM / By Proshare Content/Research /
Header Image Credit: Ecographics
Ecobank Transnational Incorporated (ETI) Plc released its
9month 2020 result in November 2020 with sufficient optimism about its strong
short-term outlook. Indeed, analysts have noted that the group’s balance
sheet-cleaning exercise involving a one-off charge for the total write-down of
its cost of goodwill incurred on the acquisition of Oceanic Bank Plc in 2011,
would brighten its financial results in the year ended December 2020. Although
the 9 months 2020 audited accounts of the behemoth were sprinkled with large
one-off charges to its P&L from the restructuring of operations and
goodwill write-offs during the year, the group remains hopeful that it would
present shareholders with a strong year 2020 performance which it believes
would be followed by a more impressive outlook in 2021.
The
problem with this outlook, however, is that a recent Court of Appeal (CoA)
judgment delivered on November 24, 2020, has put observers on notice on the
possibility of a contingent obligation of the Nigerian operations of the
lending group which could throw a wrench in the group’s business as a liability
of N22.5bn may crystalize in forthcoming years.
The Short of a Long Story
Trouble
started when Dr. Oba Otudeko, Chairman Honeywell Group, and Broad
Communications Limited filed an action at the Federal High Court (FHC) in 2006
challenging the Delta State Government’s purchase of O & O Network’s shares
in Airtel Nigeria.
According
to Broad Communication Limited and Dr. Otudeko, the sale of the shares was
unlawful, and a breach of a Shareholders’ Agreement approved and signed by
shareholders in Airtel Nigeria (warehoused in O&SO).
After
the suit was filed, efforts were again made in 2015 to sell the disputed
shares.
To
forestall the attempt to negate the court’s final judgment on the suit, Otudeko
and Broad Communications published a “Buyer Beware” notice on the
disputed shares. Despite this and the persistent attempt by O&O Networks to
sell the shares, the Federal High Court on the 5th of February 2015 per Justice
Tsoho gave an order restraining all parties from dealing or tampering with the
shares in the custody of ETI pending the final determination of the
suit.
However,
in what was alleged to be a disregard of the orders of the court, O & O
Networks and ETI entered an arrangement with Bharti Airtel Nigeria Limited
for the sale of the disputed shares to Bharti Airtel Nigeria Limited for the
sum of N22.5Billion in 2018 contrary to the order of Justice Tsoho’s.
Following
the discovery of the sale despite the court order, Dr. Otudeko and Broad
Communication through their solicitor filed an application urging the court to
direct O & O Network Limited to deposit the sum of N22.5 billion being the
proceeds of the sale into an interest yielding account in the name of the Chief
Registrar of the Federal High Court pending the determination of the
substantive suit by the court.
In
delivering her ruling on March 7, 2019, Justice Olatoregun held that the order
to maintain the status quo earlier made by the Honorable Justice Tsoho on
February 5, 2015, was in force and that O & O Networks ought not to have
agreed with Bharti Airtel as this amounted to the disobedience of an existing
court order.
Based
on 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 the
custody of the Federal High Court within 7 days (see
illustration below).
Illustration: The Journey of A Judgement
Presumably, the restrictions on O & O Ltd. from selling the shares
it 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 January
2021) 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 was
the case, O & O Ltd. was prohibited from dealing with its shares in the
manner it would appear it had done and in line with observations of the Federal
High 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 Federal
High Court restricting any dealing on the shares would appear to be a
disregard of the orders of the court and it was surprising that in addition to
declaring that the company deposits the proceeds of the share sale in a
nominated account, no other punitive order was made. Nevertheless, O&O Ltd.
may choose to appeal against the Appeal Court’s decision and escalate
litigation to the Supreme Court to vacate the order of the lower court. It is
however unlikely, in the
opinion of some lawyers, that the Supreme
Court would rule in favour of O & O Ltd considering the terms of the initial shareholder agreement relied upon by the respondent.
Given
the potential legal outcome of the litigation of Oba Otudeko and Broad
Communications 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 if
the 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 Nigeria
Limited shares owned by O&O Limited
to the Delta State Government (see illustration 1 below).
Illustration 1 ETI’s Possible Contingent
Liabilities; A Cold Harmattan Ahead?
A Tidy Bit of Arithmetic
In its 9 months, 2020 audited financial statement
ETI reported a gross earning of US$1.6bn, while its profit before tax over the
period was US$90.78m. The Nigerian operations of the group posted a profit
before 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 Nigerian
operations would have recorded a loss of US$20m in 9months 2020. This would
also have affected the group’s PBT for 9months 2020 with the group posting a
hypothetical PBT of US$33.62m (as against its reported US$91m) if the banking
giant had decided to fully provide for the contingent liability (see Table 1 below which gives ETI’s P&L performance in
9months 2020 region by region).
But
should the bank have provided for a court judgment that had not yet been
determined? The Appeal Court decided
in November 2020 before the 9months audited account was released that ETI place N22.5bn with the high court registrar until a final determination of the
case was taken. This, according to legal
authorities, was consistent with past orders in such cases. The amount was to
be placed in an escrow account until a final judgment is given.
Prudent
accounting practice, according to some analysts, suggests that ETI should have
informed shareholders in a note to the 9 months 2020 accounts of the size and
nature of the contingent liability, even if the banking group deemed it
unnecessary to make provisions in its books (see
illustration 2 below).
Illustration 2: Making That Contingent Liability Decision
However,
group executives feel differently. A discussion with the top executives of the
bank 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
As
far as the senior executives of the continental banking group are concerned an
internal assessment of the situation suggests that no liability will arise and
the probability of the court awarding a judgment against O&O is low/remote.
On
Proshare’s further probing the bank executives reaffirmed their position
that there was no court judgment against O&O and that they strongly believe
that when the substantive matters are heard in court, there would not be a
judgment award against the company.
Nevertheless,
the executives said that they would regularly review their position as progress
is made at the courts.
Table 1: Understanding ETI Zone by Zone
Source: ETI Audited Financial Statement 9 Months 2020
The
Liability Debate
Opinions differ concerning how to treat the
N22.5bn potential liability. While some accountants say that the banking group
need not make any provision for the payment since the legal case was ongoing
and was likely to proceed to a higher court (Supreme Court) for final
determination of the substantive matter, other accounting professionals insist
that since the liability has been identified as a potential outcome that has a
material impact on the banking group’s P&L, the bank should at least
disclose the possibility of crystallization of the amount even if no immediate
provision need be recognized.
The International Accounting Standard (IAS) that
appears to address the issue is IAS 37.
The
broad requirements of IAS 37 are summarized below:
The Ernst and Young generally accepted accounting principles (“GAAP”)
Manual for IAS 37
Objective
The objective of IAS 37 is to ensure
that appropriate recognition criterion and measurement bases are applied to
provisions, contingent liabilities, and contingent assets and that sufficient
information is disclosed in the notes to the financial statements to enable
users to understand their nature, timing, and amount. The key principle
established by the standard is that a provision should only be made when there
is a liability i.e. a present obligation resulting from past events. The
standard, therefore, aims to ensure that only genuine obligations are dealt
with in the financial statements – planned future expenditure, even where
authorized by the board of directors or equivalent governing body, is excluded
from recognition.
Recognition of a provision
An entity must recognize a provision
if, 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 that
creates a legal or constructive obligation and, therefore, results in an entity
having no realistic alternative but to settle the obligation. [IAS 37.10]
A constructive obligation arises if
past 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 return
merchandise within, say, a 30-day period. [IAS 37.10]
A possible obligation (a contingent
liability) is disclosed but not accrued. However, disclosure is not required if
payment is remote. [IAS 37.86]
In rare cases, for example in a
lawsuit, it may not be clear whether an entity has a present obligation. In
those 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 a
present obligation exists at the balance sheet date. A provision should be
recognized for that present obligation if the other recognition criteria
described above are met. If it is more likely than not that no present
obligation exists, the entity should disclose a contingent liability, unless
the possibility of an outflow of resources is remote. [IAS 37.15]
Measurement of provisions
The amount recognized as a provision
should be the best estimate of the expenditure required to settle the present
obligation at the balance sheet date, that is, the amount that an entity would
rationally pay to settle the obligation at the balance sheet date or to
transfer 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 consider
future 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.
Running
Battles
Ecobank’s run-in with Oba
Otudeko/Honeywell Group is not new (see Proshare’s earlier 2019 reports, Court Orders Ecobank to Pay
N22.5b 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 on
corporate governance (see illustration 2 below).
The struggles between Oba
Otudeko and various alter egos such as Honeywell have had a long and checkered
history with ETI that unveils the underlying challenges in the
management of bank debt and debtors.
This was highlighted in a
2019 DebtorsAfrica report on Nigeria’s credit creation process and its
difficulties.
According to the report on
pages 10 and 11 the new paradigm for lending and borrowing would need to run
along the following tracks:
“Rather than lenders and
customers finding themselves locked in interminable arguments over repayment
plans and default on repayment pledges, the pre-agreed resolution mechanism
kicks-in and pulls the loan repayment process into a remedial default mode
designed to restructure the Facility in a way that averts delinquency”.
The report further noted
that to support a process that breaks the bone of asymmetric information with
the attendant problems of borrowers having more knowledge than lenders on their
character and credit history, an online digital delinquent loans register
should be created across the African continent.
According to the report:
“A digital library of
publicly available delinquent bank debtors provides lenders insight into the
character and managerial capacity of borrowers. The digital library places both
a moral and business burden on delinquent borrowers as prospective lenders
would use the library to fact-check the borrowing history of a loan applicant
and use the history to set up a character rating index that would guide credit
appraisal memorandums (CAMs) and inform the acceptance or decline of credit
requests”.
The pressure of having
lenders able to quickly and effortlessly review the nature of past loan
facilities and repayment records of a prospective borrower creates a borrowing
environment that is sensitive to historical loan performance data and past loan
resolution difficulties. The register profiles the corporate boards of
borrowing entities and helps lenders assess the fitness of the company’s
leadership as a borrower. Leveraging the psychology of ‘social proofing’, the
failure of a borrower to abide by the terms of a loan agreement with one lender
would put other lenders on notice to decline the loan request of a previously
delinquent borrower until such a time the borrower redeems the earlier
facility. The soundness of the psychology has been vindicated by the numerous
requests from delinquent borrowers for media houses to bring down digital
stories posted online or references to earlier delinquencies associated with
the companies.
In respect of the ongoing
legal process between Oba Otudeko and O&O, a common denominator in the
various legal battles is the now-defunct Oceanic Bank which was acquired by
Ecobank Transnational Inc. (ETI) in 2011.
Oceanic
Bank acquired an equity interest in Airtel as a
result of a loan default by Adewale Tinubu who took a loan from Oceanic Bank by
collateralizing the facility with his shares in Airtel. “Tinubu” owned the
Airtel shares under a special purpose vehicle called O&O Networks
(‘O&O’). On default of his loan payment, the erstwhile Oceanic Bank took over
the Airtel shares still housed in O&O.
When
ETI acquired Oceanic Bank in 2011 it acquired all the Oceanic Bank’s assets and
liabilities including the Airtel shares owned by O&O. O&O subsequently
became an SPV for a broader number of shareholders including Oba Otudeko and
Broad Communications. This was, however, the beginning of the O&O,
Otudeko/Broad communications Jujitsu.
The
Otudeko corner insisted that by the terms of the shareholder’s agreement signed
by the parties in O&O existing shareholders had the right of first
refusal to purchase the Airtel shares before O&O could offer the shares
to third parties for purchase. The issue remains a matter for determination by
courts of the competent local jurisdiction.
The
issue of greater concern from an analyst’s point of view is the governance
guidance in the course of the various transactions and the oversight expected
from financial regulators. The sale of the shares by O&O to the Delta State
Government was a private arrangement that did not involve the Securities and
Exchange Commission (SEC) oversight but is worrisome where a state government
buys shares in a private company using state resources.
Of
particular concern is that most of these kinds of share acquisitions are
canopied under a fog of beneficial ownership. But the concern in this
particular 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 of
giving existing shareholders the right of first refusal in buying its Airtel
shares.
Without
going through long and circuitous court processes, some informed analysts have
advocated that the domestic investment climate could be improved by an
SEC-administered resolution mechanism for private equity transactions involving
a variety of parties, such as the case of O&O, Otudeko, and ETI.
The
jury is still out on whether this suggestion would help the system improve the
quick resolution of conflict but what is clear is that the present legal
framework is slow and could be jammed by clever legal contrivances.
The
possibility of speedy resolution of conflicts in matters related to equities
and perhaps fixed income assets would help in encouraging capital importation
by way of foreign portfolio investments (FPIs) and should be seen as an urgent
requirement for improving foreign and domestic investment. Some lawyers have
argued that since the Investment and Securities Tribunal (IST) can only deal
with matters related to capital market operators (CMOs), private companies in
dispute might find the alternative dispute resolution (ADR) channel a more
pragmatic approach to commercial dispute determination.
ETI has acted prudently by making total provision for its cost-of-carry
of Oceanic Bank goodwill over the last ten years. Working-off the goodwill from
its books in 9months 2020 is a decent piece of financial spring cleaning (see illustration 4 below). Also, writing off its
restructuring obligations in the year was equally useful in clearing up the books
to allow the organization to breathe without burden. This move by ETI’s
management seems to comply with the expected governance standard of a
continental financial powerhouse.
However,
a few niggling problems remain.
The
contingent liability of the O&O Network share sells hangs over the ETI operations like a hawk.
The
fact that it has not been explicitly recognized in the bank’s books, if not as
a contingent liability at least as a potent business risk, is worrying.
It
would have been a governance boon if the group had in its recent financial
statements reported that the business dispute was not sufficiently problematic
to be classified as a contingent liability.
Admittedly
the judgment call belongs to the management and board, but shareholders would
have felt more comfortable with recognition and assurance as a stakeholder
engagement strategy.
Illustration 4: ETI’s Goodwill Waterfall
Corporate
Nigeria must increasingly tighten its stakeholder communication channels to
help investors, for example, gain a full sense of the business’s strengths and
vulnerabilities.
While
IAS rules such as IAS 37 allow for judgment calls, such latitude should be
adopted with due care for ensuring that investors are properly apprised of the
organisations weaknesses, strengths, opportunities, and threats.
For
corporations listed on official capital market exchanges such as the Nigerian
Stock Exchange (NSE), the disclosure requirements are raised more than a few
notches. The ETI, O&O Network, Oba Otudeko, and Broad Communication
tangle are instructive not in its simplicity but in the guidance, it offers on
issues such as shareholders’ rights of first refusal and the clever ways SPVs
can be used to acquire and sell shares; the obligations, responsibilities, and
blowbacks.
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Source: www.proshareng.com
