The primary purpose of security is to reduce credit risk and obtain priority over other creditors in the event of the debtor’s bankruptcy or liquidation. For instance, a financier taking security for advance is concerned to see that if the debtor’s assets are insufficient to meet the claims of all his creditors, the financier will at least be able to look to his security to obtain total or partial payment.
However, there is no necessary connection between security and priority. For example, in a winding up, preferential creditors have priority over a floating charge, while the secured claims of directors of a company may in certain circumstances be subordinated to the claims of general unsecured creditor.
Priority ranking under the BOFIA
The general principle is that a secured creditor has priority over an unsecured creditor. However, Section 54 of the Banks and Other Financial Institutions Act seems to negate this principle when it provided that “where a Bank is unable to meet its obligations, or suspends payments, the assets of the Bank in the Federation shall be available to meet all the deposit liabilities of the Bank and such deposit liabilities shall have priority over all other liabilities of the Bank.”
Thus, priority ranking under the BOFIA is to the effect that depositors must have priority over the other secured /unsecured creditors. This issue was what led to the case of First Bank of Nigeria PLC V. Nigeria Deposit Insurance Corporation.
Rationale for priority of Bank deposits
The rationale for ranking depositors above secured /unsecured creditors is predicated on the Depositors Preference Rule. This rule is to the effect that in the event of insolvency of a Bank, the claims of depositors enjoy a privileged status. This is a powerful form of protecting depositors funds, as it effectively pledges the assets of the Bank for he benefit of depositors, which in turn largely reduces Bank runs.
This rule is further reinforced by the fact that depositors are not only viewed as creditors of the Bank but persons entitled to a claim for premiums charged on insurable deposits with the Bank. This is in sync with the objectives of the Nigerian Deposit Insurance Corporation and in accordance with Section 20 of the Nigerian Deposit Insurance Corporation Act which provides thus:
All deposits of a licensed Bank or any other financial institution shall be insured with the Corporation with the exception…
Facts of the case
Prior to the revocation of Lead Merchant Bank’s (LMB) licence, LMB was indebted to First Bank Nigeria (FBN) under a clearing and settlement banking transaction. To this end, FBN secured its interest with an unregistered legal mortgage over LMB’s property. However, upon liquidation of LMB by the Nigerian Deposit Insurance Corporation (NDIC), FBN made repeated demands from NDIC for the payment of LMB’s outstanding indebtedness to it. In response to the demand, NDIC contended that whilst it recognises FBN’s interest in the property of LMB, it must comply with priority ranking under the BOFIA in settling same; which is to the effect that depositors of LMB must have priority over other secured/unsecured creditors.
LMB is a financial institution as well as a company. There are two statutes that become relevant in the face of insolvency. The Companies and Allied Matters Act, 2004 (CAMA) and the Banks and Other Financial Institutions Act, 2004 (BOFIA). However, the BOFIA provides that where there is a conflict, it supersedes CAMA.
Finding of the Court
The learned trial Judge dismissed the contention of the First Bank by relying on Section 54 of the BOFIA. The trial Court applying a simplistic approach, held that the right of the mortgagee to institute an action has not crystalised since all the depositors have not been paid.
The learned trial Judge approached from a procedural perspective. This approach focussed on the fact that the provision of Section 54 of the BOFIA is a condition precedent which must be fulfilled by NDIC before FBN can realise its interest. This approach circumvents the complexities that would have otherwise arisen had a more substantive approach been adopted.
A substantive approach would entail a critical analysis which requires one to ask the question “if the Bank is unable to meet its obligations, what are the assets of the Bank that are available to meet the obligations of the Bank?” At this point, there is a divergence between the accounting treatment and legal treatment of the term “assets.” For the accountant, the asset of the Bank is equal to liability plus capital; whereas, for the lawyer, the assets of the Bank would be equal to net assets. In other words, the assets of the Bank comprise of ownership and possession which are inherently fluid.
So, the asset which may be applied to liquidate a depositor’s fund upon insolvency of a Bank is largely distinct from the assets of a typical company. For instance, depositors’ funds in the Bank’s portfolio are generally classified as a liability in the books of the Bank whilst its loans portfolio is often considered as an asset of the Bank. Thus, the assets of the Bank may include amongst others, cash and balance at the Central Bank of Nigeria, treasury bills and other eligible bills, loans and advances to Banks/customers, debt securities, equity shares (and other variable yield instruments), participating interest, tangible and intangible fixed assets, etc.
Hence, where a security interest is created that takes away the asset from the ownership of the Bank, then that asset cannot be said to belong to the Bank for purposes of distributing it amongst its creditors.
A substantive approach would have had the following effects:
- a critical analysis of the effect of Section 54 of BOFIA;
- a consideration of the various ways of creating a mortgage in the States covered by the Conveyancing Act of 1882 and the effect of the same on the “Bank’s Asset” particularly as it relates to transfer of ownership of the Bank asset in a Deed of legal Mortgage.
- an opportunity for Section 54 of the BOFIA to be redrafted to properly reflect the purpose of the Section.
These complexities are reinforced by the way in which a mortgage may be created. A mortgage may be created in one or two ways to wit:
- Mortgage created pursuant to Conveyancing Act. Under this regime, a mortgage transfers ownership of the assets to the mortgagee. It is an express or implied condition that ownership would be re-transferred to the mortgagor upon repayment of the facility.
- Mortgage created pursuant to the Property and Conveyancing Law. A regime that creates mortgage by charge by Deed expressed to be by way of legal mortgage.A charge does not involve the transfer of ownership to the charge. A charge is an equitable encumbrance on the asset. Unlike a mortgage, a charge does not give an immediate right to be paid from the charged property. A chargee must appoint a receiver or approach the Court for an order of sale.
What this dichotomy presents is a result which may never have been intended by the legislation; such that where mortgage is created in certain parts of the country, that mortgage asset is excluded from the assets of the Bank and no longer available for distribution by the creditors.
This anomaly could easily have been resolved by adopting a re-draft of Section 54 to make it similar to Section 41 of BOFIA, stating clearly that depositors’ funds enjoy priority over all other liabilities including over legal mortgage, etc. That Section 41 provides that “the Corporation liquidation expenses enjoy priority over all other liabilities including over legal mortgage or crystalised debenture.”
The foregoing notwithstanding, it must be stated that assuming without conceding that the learned trial Judge adopted a substantive approach in his Judgment, he would have arrived at the same conclusion. This is particularly so since FBN’s interest in the LMB’s property was secured by an unregistered mortgage. FBN is at best an unsecured creditor.
I will not end without referring to the effect of the new Secured Transaction in Movable Assets Act 2017. For the first time, we now have an Act that permits taking security over movable assets. The question that obviously arises is whether a Bank that has given security over its movable assets is subject to Section 54 of the BOFIA. Following the general principle that a charge is only an encumbrance, the asset continues to remain with the Bank.
 Suit No FHC/L/CS/1662/2016
 Applicable in most of the States in Nigeria other than the former Western Region.
 See Section 261 (1) of the Conveyancing Act 1882.
 Mortgage usually relates to land but may be used for other assets.
 Applicable in the States formerly part of Western Region.
 See Section 110 of the Property and Conveyancing Law 1959.