The Energy Mergers & Acquisitions Review: Nigeria
There are two broad sub-markets in issue in Nigeria: the oil-and-gas sub-market and the electric power sub-market. Each sub-market has a separate regulator – the Department of Petroleum Resources (DPR) for oil and gas and the Nigerian Electricity Regulatory Commission (NERC) for electric power – and caters primarily to different major buyers: foreign traders for oil and gas, domestic consumers and businesspeople for electric power. The contrast between the two markets permeates this field.
Low international prices for oil and gas and for electric power domestically mean that acquisition financing has been harder to access than it was previously. The lower prices for oil and gas are functions of the foreign markets and the covid-19 pandemic. The low price of domestic electric power is a function of Nigerian regulation. Uncertainly about the regulatory environment in either sub-sector does not appear to us to have been a factor in determining the level of M&A activity. For example, the failure to pass the much-needed Petroleum Industry Bill (PIB) does not appear to have had an effect on M&A activity. The PIB is concerned with the issues of (1) tax-burdens; (2) the division of power between bureaucrats and political appointees; and (3) the creation of government-controlled agencies and business organisation.
While the M&A market for energy has been less busy lately than it has been at other times in the course of the past six years, it is far from being inactive. The oil and gas market has been especially active because the largest international oil company (IOC) producer in this market has been carrying out a programme to divest a range of onshore acreage assets with a view to focusing on larger offshore acreage assets. The electric power market has also been unusually active because of a federal government programme to sell several generation and distribution companies. The divestment and privatisation programmes are winding down and will run their course soon.
Also, there have been owners selling and would-be buyers bidding to buy or trying to sell oil and gas assets upstream, midstream and downstream. The success of the divestment programme mentioned above has prompted other IOCs to initiate their own acreage divestment programmes. Interest in buying and selling electric power companies also remains strong, although few deals have actually been concluded. The oil and gas sector has also been active within the ongoing marginal field bid round.
Year in review
The covid-19 pandemic, with its attendant lockdown period, affected the market during 2020. However, looking at the year in review, the federal government of Nigeria sold its interest in Afam Power Plc and Afam Three Fast Power Limited (one of the six successor generation companies incorporated following the unbundling of the Nigeria power sector) for 105.3 billion naira to Transcorp Power Consortium. Within the year, the Federal Government of Nigeria, through the Department of Petroleum Resources announced the commencement of the marginal field bid round for indigenous companies and investors interested in participating in exploration and production (E&P) business in Nigeria. A total of 57 oil fields, spread across land, swamp and shallow water terrains, are on offer.
Major M&A deals concluded and announced in the recent past include in the downstream (e.g., Forte Oil), midstream (e.g., Seven Energy) and upstream (e.g., Seplat) oil-and-gas sub-sectors, and also in the thermal (e.g., Transcorp Afam) and solar power (e.g., NEOT) sectors. We are aware of several deals that are still being negotiated but not announced in every one of the foregoing areas as well as for electric power distribution companies.
Three legislature and regulatory developments are especially noteworthy. First, the Deep Offshore and Inland Basin Production Sharing Contracts (Amendment) Act (2019) passed into law. This Act reviews and increased the royalty rates for deep offshore production sharing contracts and calls for the review of the fiscal terms of such contracts every eight years. It is not surprising that many industry actors have taken a very dim view of it. Industry actors also take a dim view of the Finance Act, 2019 considering the removal of tax incentives erstwhile available to the oil and gas industry. The Finance Act (1) removes the exemption from withholding tax that previously applied to dividends paid out of the profits of upstream petroleum production operations under Section 60 of the Petroleum Profits Tax Act and (2) states that companies enjoying gas utilisation incentives in respect of their qualifying capital expenditure shall not enjoy any other tax incentives.
Nigeria now has a dedicated, sector-neutral merger control regulator in the Federal Competition and Consumer Protection Commission (FCCPC) established under the Federal Competition and Consumer Protection Act (2018) (FCCPA). Before the FCCPA, (1) the capital markets regulator doubled as the merger control regulator, and (2) changes of control that are either indirect or occur at the level of foreign parent companies rather than within a Nigerian company were not regulated under Nigerian general merger control law. All of these have now changed. Further to the Competition Act, the FCCPC exercised its powers thereunder and issued the Merger Review Regulations 2020 on 23 November 2020 (the Regulations). The Regulations:
- provide the requirements for the approval of a merger by the FCCPC;
- outline the jurisdictional limits of mergers under the Competition Act;
- clarify the process for merger notification and handling of notified mergers;
- provide guidance on the regulatory review process; and
- prescribe the procedure for remediation and disposition of notified mergers.
Also within the past year, the President of Nigeria, President Muhammadu Buhari signed into law the new Companies and Allied Matters Act 2020 (New CAMA). The New CAMA brings major changes to the M&A landscape in Nigeria. Under the instant companies' law regime: (1) private companies are mandated to restrict transfer of their shares; (2) companies are restricted from acquiring their own shares (share buyback and repurchase); and (3) financial assistance to shareholders and prospective shareholders is prohibited. All of these have changed under the New CAMA. In addition, the New CAMA provides for the disclosure of significant control and substantial shareholdings in companies by notice to the Corporate Affairs Commission (the Nigeria companies registry).
Legal and regulatory framework
Energy M&A deals need both sector-regulator approval (DPR and NERC) and sector-neutral merger control approval to be concluded. The sector-neutral merger control authority is now the Federal Competition and Consumer Protection Commission (the FCCPC). It used to be the Securities Exchange Commission (SEC) until early 2019.
General merger control approval is needed for all energy sector mergers where the acquirer and the target combined are worth the equivalent of US$1.4 million in either turnover or assets. This is the position under the FCCPA whether the merger is structured as an acquisition of shares or otherwise.
The approval of the stock exchange and the securities regulator is also needed where merging companies are either listed or just public companies. The focus of these approvals is on making full disclosure to investors, while that of the general merger control regulator is on protecting competition and consumers.
A simple asset or shares acquisition may be effected purely by contract. Where liabilities (not only assets) are to be transferred, the parties may achieve their aims either by contract with the consent of the creditors (novation) or by court order where the court is satisfied that the interests of the creditors will not be unfairly prejudiced.
The statute that sets out the mechanism for effecting a transfer of liabilities by court order is the Companies and Allied Matters Act (2020). It empowers the courts, following a meeting of the shareholders and the approval of a 75 per cent majority to 'sanction an arrangement' whereby the assets and liabilities of two or more companies may become vested in only one company.
The approval of the sector regulators is also needed both by statute and by regulation. The DPR, acting for the Minister for Petroleum Resources, must approve acquisition transfers, whether of acreage, assets or of operating licences in petroleum companies. Where the assets are marine vessels or licences to operate them, disclosure to the shipping regulator is needed but not its consent. Similarly, NERC's approval is required for acquisition transfers of shares, licences or assets of companies holding NERC licences. Every company operating assets generating more than 1MW or running a distribution network with more than 100KW capacity or transmission network must have a NERC licence.
Clearance from the tax authorities is also needed in respect of companies' income tax where there is to be a merger or an acquisition by transfer of assets.
Cross-border transactions and foreign investment
Both foreign and domestic players have been active in the oil and gas and electric power sub-markets. For example, of the deals mentioned in Section II: (1) the two parties in Forte Oil were Nigerian; (2) Seplat is a Nigerian but listed in London and acquired Eland which is a UK company listed in the UK; (3) the acreage-divesting IOCs are all foreign; and (4) NEOT is European.
There are no prohibitions against foreign involvement in the energy market in Nigeria. Foreign nationals may fully own, invest and participate in Nigerian companies except enterprises producing arms and ammunition; narcotics and psychotropic substances; and military and paramilitary, police, customs, immigration and prison service uniforms and accoutrements. However, in practice, the DPR does not give more than a 40 per cent of the equity (as distinct from economic) interest in an oil field to a foreign-controlled company; and will give that 40 per cent to the foreign controlled company only where that company has incorporated a subsidiary in Nigeria for the purpose.
Further, a foreign company can invest in but cannot operate assets in Nigeria directly and in its own right. It must incorporate a company in Nigeria to do so (except in very rare cases where it gets special exemption from registration as an invitee to Nigeria by the federal government to execute any specified individual or loan project, or as an engineering expert engaged on an individual specialist project).
The Nigerian company must then be registered with the Nigeria Investment Promotion Commission (NIPC) before it starts operations. NIPC's prevailing practice is to decline to register businesses in which foreign nationals do not invest at least 10 million naira.
However, the Nigerian Oil and Gas Industry Content Development Act 2010 (LCA) provides for exclusive consideration to be given Nigerian indigenous service companies in the award of certain contracts in the oil and gas sector.2 The LCA also provides for preferential rights to be given to Nigerian independent operators in the award of oil blocks, oil field licences and oil lifting licences.3 While the terms 'Nigerian indigenous service company' and 'Nigerian independent operator' are not defined, a Nigerian company is defined under the LCA as 'a company formed and registered in Nigeria in accordance with the provision of the Companies and Allied Matters Act with not less than 51 per cent equity shares held by Nigerians'. The LCA does not exclude companies registered in Nigeria with majority foreign participation from participating in the Nigerian oil and gas sector. The LCA only provides that companies that are majority-owned by Nigerians will have priority over such companies regarding getting rights to oil leases, oil lifting, oil trading, providing training services and funding from the government and third parties.
Similarly, under the NERC Regulation on National Content Development for the Power Sector 2014 (the Regulation) licensees under the Electric Power Sector Reform Act 2005 are to ensure that qualified Nigerian companies are given first consideration for the supply of goods and works, and for the provision of services in the electric power sector. The term Nigerian company is not defined under the Regulation; however, a Nigerian operator is defined as 'a company incorporated in Nigeria with the object of providing goods and services for the Nigerian Electricity Supply Industry (NESI)'.
Parties to M&A transactions are free to choose the governing law and dispute resolution clauses for their transaction documents. The parties' choice of law to govern the transaction documents would be upheld by Nigerian courts in proceedings in relation to all matters relating to the construction, validity and performance of the transaction. Such choice of law will be upheld by Nigerian courts, provided the choice of law was not made in bad faith or contrary to mandatory Nigerian statutes or Nigerian public policy.
Loans, bonds, equity offerings (whether private or public) and share exchange, cash holdings and sales have all been used extensively to pay for energy sector M&A transactions. This has been so across the various areas of the sector. Existing cash holdings are an obvious way to pay for smaller acquisitions.
Some electric power privatisation acquisitions are paid for by the parent company of the acquirer issuing bonds and shares to put in place a 'war chest' for the acquisition. It is also not unusual for acquirers to take out loans and issue bonds to pay off or pay down the creditors of target distressed companies as part of the process of acquiring them. Three points deserve further comment.
First, the old common law rules against a company financing the acquisition of its own shares have now been revised by the New CAMA. Where an acquisition is to be financed with debt, there will typically be an acquisition vehicle that will be the borrower of record and hold shares in the target, and that the target's assets may or may not be used as collateral. Most privatisation energy acquisitions were financed using such a structure. The use of the target's assets as collateral were absolutely prohibited under the previous financial assistance rule. However, the New CAMA has modified the financial assistance rule by the following actions:
- defining financial assistance as 'a gift, guarantee, any form of credit or any other financial assistance given by a company, the net assets of which are thereby reduced up to 50 % or which has no net assets', thereby allowing assistance that does reduce the target's company's net assets by up to 50 per cent; and
- allowing private companies to give financial assistance where:
- the net assets of the company are not reduced and where such net assets are reduced, the assistance is provided out of distributable profits;
- the assistance is approved by special resolution of the company in a general meeting; and
- the directors of the company or holding company make a statutory declaration before the financial assistance is given.4
Second, the use of forward sale financing structures to pay for oil and gas sector acquisitions is emerging. These structures were originally developed in project contexts. Under the structure, the acquirer would sell future oil production forward, get a large payment now of much of the price and apply that to pay for the acquisition.
Third, careful tax planning is critical to optimal structuring. At the risk of oversimplification, it is broadly correct to say that acquisitions of shares and formal mergers are more tax-efficient than asset acquisitions with respect to capital gains tax and stamp duty rates. Further, the rules governing official clearance for the adjustments to be made to companies' income tax on the commencement and cessation of business apply to midstream and downstream oil and gas companies and electric power companies, but not to upstream petroleum companies.
On the face of the legislation, capital gains tax at 10 per cent and stamp duty on sale documents for acreage at 1.5 per cent are chargeable on assets sales transactions. Both compliances with these rules and the enforcement of the rules has been patchy. Formal mergers are exempt from capital gains tax where the disposal of assets is after one year of the merger process and there is no subsequent disposal of assets within one year of the merger. Share sales are exempt from capital gains tax and attract only nominal stamp duty. These rules present obvious opportunities for tax planning.
Undertaking a due diligence exercise is one of the essential aspects of entering into an energy M&A transaction. Legal, financial and environmental due diligence are commonly conducted in energy M&A transactions in Nigeria. There are no peculiarly Nigerian considerations on project and asset evaluations.
The pertinent aspects of the legal due diligence are usually in respect of the corporate structure, regulatory (including environmental) compliance, security arrangements over assets, existing litigation or arbitration. Depending on the target company, a search may have to be conducted at both the lands registry, Corporate Affairs Commission (CAC) and other relevant registries. It is prudent to make inquiries at the offices of the sector regulators.
Other aspects of legal due diligence in energy M&A transactions include:
- material contracts;
- bank and pension liabilities;
- employment contracts;
- intellectual property and technology rights;
- pending and potential litigations and claims; and
- tax and other statutory and regulatory compliances (including environmental impact assessment approvals, work programme approvals in the oil and gas sector).
It is crucial to conduct the above due diligence inquiries prior to consummation of M&A transactions as this will help the purchasing company to assess and provide possible solutions to mitigate legal risks and obligations identified.
It is advisable to ensure that the target company and its shareholders make representations and warranties in the transaction documentation to the effect that there are no existing liens and regarding the authority and title to, and tax of, critical assets. The target company and shareholders should also undertake to indemnify the acquirer in the event of a breach of any of the representations and warranties, and as to other commercial matters that the parties may agree.
However, an acquirer cannot completely eliminate the risk that there may be prior security interests, because there are security interests that are not required by law to be registered at the CAC (e.g., charges over shares, and pledges of goods), and prior registered interests may not be disclosed in the course of a search owing to possible administrative lapses at the relevant registry.
This is not unusual under company charges registration regimes that, like Nigeria's, are descended from the prevailing English law position in the twentieth century. Similarly, for litigation, arbitration or administrative proceedings, there are no electronic, complete and publicly available docket-disclosure sources.
A financial due diligence exercise is usually undertaken by financial advisers to evaluate the financial prowess or position of the target company and to reveal the accounting and financial control systems of the company, the value of its assets and liabilities, product development and competitors, solvency or insolvency status of the company, capacity of the company to raise short-and long-term loans and to service its outstanding debts, loans etc.
Purchase agreements and documentation
The enactment of the FCCPA has resulted in purchase agreements being structured for completion to occur after the approval of the FCCPC has been obtained. Parties ensure that no action that may be interpreted as an 'implementation' of the merger is undertaken until this approval has been sought and obtained. Even for purchases that are structured as asset sales, it is imperative to obtain this approval as any uncertainty that hitherto existed as to whether merger control approval was required for asset sales no longer exists. The criteria for the determination of whether an asset sale requires prior merger control approval are now clearly stated in the FCCPA.
For a typical energy M&A, whether in the oil and gas sector or in the electric power sector, it is usual for the target company, and in some cases the shareholders, to give extensive representations and warranties around: (1) the good standing of the target; (2) ownership of the shares; (3) authority to consummate the transaction (4) ownership of assets; and (5) financial standing of the target company. Others include representations and warranties around liabilities that may arise from environmental issues in the purchase agreements. Such representations and warranties are considered fundamental warranties and therefore claims may be made therefrom for longer durations compared to other warranties. It is also advisable to ensure that the target company and the shareholders make representations and warranties in the transaction documentations to the effect that there are no existing liens. It is also usual to have the target company and shareholders undertake to indemnify the acquirer in the event of a breach of any of the representations and warranties, and in respect of unpaid taxes.
Key regulatory issues
As previously mentioned, the key regulatory issues are the need for (1) sector-neutral merger control approval from the FCCPC and (2) sector-specific approval from NERC (for holders of NERC licences) or the DPR (for oil and gas sector actors). There are also requirements relating to tax, to getting environmental impact assessments and to meeting environmental standards and holding the right permits.
To the extent that the employer of record of any employee is to change as a result of an M&A deal, (1) the approval of the DPR is needed in the case of oil and gas targets; (2) that of the Minister for Labour is needed for manual or clerical employees in both sub-sectors; and (3) that of the Minister for Interior is needed for foreign employees in both sub-sectors.
Representations and warranty insurance is still quite uncommon in Nigeria, and is largely unused in energy M&A deals. It is usual for the parties under an M&A transaction to escrow certain part of the consideration to mitigate transaction risks.
For most M&A contracts, the dispute resolution clause contains one or more options to be adopted in resolving disputes that may arise in connection with the transaction. The agreement often provides for both informal and formal dispute resolution mechanisms. M&As resulting from insolvency are usually characterised by acrimonious litigations. However, the courts will enforce the parties' choice of dispute resolution and governing law.
Parties may agree to subject eventual dispute to either negotiation, mediation or arbitration, or a combination thereof. The formalities governing the resolution mechanism will be spelled out under the dispute resolution clause. The parties may also choose to resolve their disputes by way of litigation.
In either case, the parties are at liberty to agree the governing law and the courts with jurisdiction with respect to claims arising from the contracts. Nigerian courts will recognise and enforce choice of foreign law and foreign jurisdiction clauses subject to public policy-type considerations. In any event, (1) tax, immigration and other matters asserting claims against governmental authorities and (2) matters on the dissolution or corporate status of a Nigerian insolvent company are ultimately controlled by mandatory domestic legislation irrespective of contractual agreements between the parties.
Arbitration is fast becoming popular and the preferred dispute resolution mechanism for most oil and gas contracts in Nigeria. It is also common for parties to agree to international arbitration with a foreign seat and venue for the arbitration. Nigerian courts generally recognise international arbitration contractual provisions and awards. There are grounds for refusal of recognition or enforcement, including because of public policy issues and where the subject matter is not arbitrable under Nigerian law.
Nigeria is a party to the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) and the ICSID Convention. Criminal matters are not arbitrable in Nigeria.
The pipeline of energy sector M&A deals is robust, but the closing of deals may be delayed. The pipeline is robust for four reasons:
- three IOCs have acreage divestment programmes;
- the federal government is expected to embark on its own divestment programme soon;
- a number of energy sector companies are distressed and many of their creditors are keen to sell them; and
- the federal government is keen to sell off privatised power sector companies that are in breach of the targets agreed with them at the time of privatisation.
Delays may arise from the fact that (1) the targets may have owners who are unwilling to sell although they are under pressure from their creditors and the federal government to do so (pursuant to (c) and (d) above); (2) financing is not easy to obtain in these times of widespread validity and low prices; and (3) regulators may be their usual dilatory selves in giving the approvals needed.