The Companies (Winding Up Amendment) Act 2011 and the International Business Companies (Winding Up Amendment) Act 2011 (the "Winding Up Acts") have introduced statutory provisions which ensure that netting agreements will be enforceable in the event that a party to such an agreement fails and is placed in liquidation. At the same time, the Winding Up Acts have extended the scope of netting which will be permissible in the winding up context.

Netting Explained

A netting agreement is a contract whereby each party agrees to set off (i.e. 'net out') the amounts that it owes against amounts owed to it. Netting agreements can be either bilateral, i.e. between two parties, or multilateral, involving several parties.

A basic example of a bilateral netting contract is where Party A owes B $100 and Party B owes A $50. In the absence of a netting agreement, A will pay $100 to B and B will pay A $50. However, if a netting agreement is in operation, the amounts owing will be netted off and the netted balance will be payable. In this example, A will pay B $50 and B will pay A nothing. "Multilateral netting" arrangements involve settlement between more than two persons. For example, take the case where A owes B $100. Here, B owes C $20. C owes B $30 and A $20. Without a netting agreement, A owes $100, B owes $20 and C owes a total of $50. However, using a multilateral netting agreement, A owes $80, B owes nothing and C owes $30.

Netting allows parties to reduce their exposures and consequently reduce their risk. For this reason, it is used widely in international financial markets as a means of lowering/managing the risks to which banks and other large institutions are exposed.

Significance of the Winding Up Acts

Solvent companies are generally free to agree to any lawful terms in the course of their dealings. This is a function of the well-known concept of "freedom of contract." So long as parties to a netting agreement were both solvent, they were free to net out their obligations on any basis they desired (including netting on a bilateral or multilateral basis).

However, in the event of winding up proceedings being brought in respect of a company, The Bahamas' insolvency regime supervenes and governs the disposal of that company's assets. Only that species of set-off specifically permitted by the insolvency legislation is allowed in the insolvency context. This is because set-off is essentially an exception to the pari passu rule, i.e. the fundamental principle of insolvency law which provides that in an insolvency, unsecured creditors are to rank equally and if there are not enough assets to satisfy all of the claims, they will each receive a pro rata share of the pool of funds.

Prior to the Winding Up Acts, set-off in the winding-up context was governed by Section 266 of the Companies Act (and Section 154 of the International Business Companies Act) which caused the set-off provisions contained in Section 37 of the Bankruptcy Act to apply to companies.

The statutory set-off available under this 'old' regime was restricted to mutual dealings between the same parties and, therefore, would not apply to multilateral netting agreements.

The Winding Up Acts

Section 236 of the Companies (Winding Up Amendment) Act 2011 provides that:

"Subject to subsection (2), the property of the company shall be applied in satisfaction of its liabilities pari passu and subject thereto shall be distributed amongst the members according to their rights and interests in the company.

The collection in and application of the property of the company referred to in subsection (1) is without prejudice to and after taking into and giving effect ...to any contractual rights of set-off or netting of claims between the company and any person or persons (including without limitation any bilateral or any multi-lateral set-off or netting arrangements between the company and any person or persons) and subject to any agreement between the company and any person or persons to waive or limit the same."

Section 89 of the International Business Companies (Winding Up Amendment) Act, 2011 provides that the foregoing provisions apply mutatis mutandis to the winding up of companies incorporated or formed in this jurisdiction under the International Business Companies Act, 2000.

The Winding Up Acts represent a significant and welcome development. They serve to provide local and foreign counterparties dealing with Bahamian companies with even greater certainty as to the enforceability and inviolability of netting arrangements in this jurisdiction.

They also effect a change which is somewhat revolutionary to the extent that multi-lateral netting arrangements will now 'survive' the insolvency of Bahamian company counterparties.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.