An introduction to netting and set-off – Qatar and Qatar Financial Centre
Financial Services Focus
Financial institutions undertaking derivative transactions are keen to understand whether set-off and/or netting of transactions is permissible
Law Update: Issue 365 - Financial Services Focus
Mohammad MithaSenior Counsel,Banking & Finance
Financial institutions undertaking derivative transactions are keen to understand whether set-off and/or netting of transactions is permissible, both pre-insolvency and post-insolvency when dealing with their derivatives counterparties in the State of Qatar.
In this article, we explore the legal position on set-off and netting as applicable in Qatar and Qatar Financial Centre – concepts which are most relevant to derivative transactions.
There are two separate jurisdictions in the State of Qatar, (i) the Qatar Financial Centre (“QFC”) and, (ii) Qatar itself (that is, outside of the QFC) (“Qatar”).
While QFC is a netting friendly jurisdiction, there is currently no law in Qatar that specifically deals with netting of derivatives transactions, and therefore reliance is placed on the concept of set-off as discussed below.
As mentioned above, since there is no formal netting law in Qatar that allows for close-out netting, reliance is typically placed on the set of provisions under the Civil Code (Law No. 22 of 2004) of Qatar.
Financial institutions frequently inquire about the pre-insolvency and post-insolvency position and the ease with which they would be able to exercise their right to set-off obligations owed by the counterparty against what it owes to the counterparty.
Prior to any bankruptcy proceedings initiated in Qatar, contractual set-off is permitted in accordance with Articles 390 to 397 of the Civil Code. It is possible to exercise set-off where funds being set-off are undisputed and have matured, notwithstanding the fact that the place of settlement of debts may differ or that the currency of obligations may differ. However, if a court order is issued ordering the bank to freeze a bank account, the bank will not be permitted to set off funds from the said account. There are however exceptions to the above, and set-off may not be exercised under the following scenarios:
if the subject matter of one of the two debts arose as a result of acquiring an asset without the consent of its owner;
if the subject matter of one of the two debts was to return an asset placed in custody of the other party for a specified purpose or provided on loan;
if one of the two debts was a right which is not subject to attachment; and
if one of the two debts consists of alimony.
The main issue arises where the Qatar counterparty may be facing insolvency. Insolvency and bankruptcy provisions are set out in the Commercial Code (Law No. 27 of 2006) of Qatar.
After the adjudication of bankruptcy, Article 632 of the Commercial Code restricts the ability of a creditor to use set-off as a remedy unless there is a link or interconnection between the payment obligation of the bankrupt entity and the funds of the debtor which are in the possession of the creditor. What constitutes interconnection between obligations is not specifically described or defined under the Commercial Code. However, examples guide towards obligations arising from the same subject matter or economically linked transactions. Each transaction would have to be assessed on a case by case basis as there is no case law in Qatar that deals with this issue, and also because the insolvency regime in Qatar remains largely untested.
In contrast to the legal regime in Qatar, the Qatar Financial Center is a netting friendly jurisdiction. The QFC has issued Netting Regulations in 2017 (the “Netting Regulations”) which deals with the enforceability of certain types of financial contracts and the ability of financial institutions apply close-out netting provisions and to terminate, liquidate and/or accelerate any payment or delivery obligations or entitlements between two contracting parties, particularly in the case of a insolvency situation.
The Netting Regulations applies to any qualified financial instruments (which include without limitation netting agreements and collateral arrangements) which are governed by QFC law or which is entered into by a person incorporated or registered in the QFC or organised under a QFC Law.
Article 9 of the Netting Regulations defines qualified financial instruments as a financial instrument or transaction under which: (a) payment or delivery obligations are to be performed, or title to commodities or assets is to be transferred; or (b) obligations to make payments or deliveries or to transfer title to commodities or assets, are to be entered into or incurred. Further, Article 9(2) of the Netting Regulations lists the types of instruments, agreements or transactions are considered qualified financial instruments, which list case be further amended based on decisions issued by the QFC Authority and QFC Regulatory Authority.
Pursuant to the Netting Regulations:
Netting agreements and qualified financial instruments are enforceable in accordance with their terms, both pre and post insolvency of a counterparty; and
Collateral arrangements related to or forming part of an agreement are considered as a netting agreement and qualified financial instrument.
As such, a netting agreement (including a collateral agreement) will be enforceable against the insolvent party and (where applicable) the collateral provider, all in accordance with the terms agreed in the netting agreement and/or the collateral agreement.
The Netting Regulations also place certain restrictions and limitations on the powers of a liquidator of the insolvent entity in the QFC.
The liquidator will not be able to repudiate contracts or transactions in a manner that would prevent the creditor or secured party from exercising close out netting provisions or from liquidating a relevant collateral under a netting agreement.
The Netting Regulations is a special law, which according to Article 7 of the Netting Regulations, will take precedence over any other regulations in force in the QFC in case of conflict or variance.
The QFC has robust regulations on netting transactions which allow parties (that fall within the ambit of the Netting Regulations) to freely agree to provisions to regulate their contractual relationship with the comfort that such transactions will, in accordance with the Netting Regulations, be upheld and enforced. Granted that there is no case law precedent in the QFC courts that would validate the applicability of the Netting Regulations, however, the Netting Regulations do, in uncertain terms, require the enforcement of a netting agreement in accordance with its terms.
On the contrary, Qatar law (outside the QFC) do not provide that level of comparative comfort to financial institutions entering into derivative transactions with Qatar counterparties. While the concept of set-off under the Qatar Civil Code is akin to the concept of close-out netting under the derivative transactions (such as ISDA Master Agreement), there is no certainty provided under Qatar law (similar to that under the QFC Netting Regulations) that such netting transactions will be held enforceable on its terms, particularly when the Qatar counterparty could be facing insolvency. Such matters have simply not been tested before the Qatar courts.
For further information,please contact Mohammad Mitha.
Published in February 2024
