LIBOR transition: English High Court allows unilateral application of term SOFR-based rate as reasonable alternative to LIBOR
16 October 2024
16 October 2024
On 15 October 2024, the English High Court handed down its judgment in Standard Chartered PLC v. Guaranty Nominees Limited and others, finding in favour of Standard Chartered (SC).
The Court held that SC may unilaterally apply a replacement rate of three-month CME Term SOFR plus the three-month ISDA spread adjustment of 0.26161% when calculating an upcoming dividend on preference shares linked to now-discontinued three-month USD LIBOR (3m USD LIBOR). It also held that the replacement rate is currently the "reasonable alternative" to USD LIBOR.
The decision is the first in which the High Court has opined on the consequences for financial instruments of LIBOR's cessation. Given its importance, the case was heard by both a High Court judge (Mr Justice Foxton) and a Court of Appeal judge (Sir Julian Flaux) on an expedited basis under the terms of the Financial Markets Test Scheme.
In the judgment, the Court held that:
The decision will be of particular relevance to issuers of financial instruments that transitioned from LIBOR without investor consent or relying on "deemed" consent, as it effectively confirms that unilateral transition to a reasonable alternative rate can be an acceptable approach for financial instruments without adequate fallbacks. It may also encourage issuers of non-transitioned securities to adopt this approach as part of their remediation strategy.
The High Court's endorsement of SC's SOFR-based replacement rate will also reassure firms that exercised discretion under English law instruments to transition from LIBOR to a risk-free rate, and reduce the potential for claims by out-of-pocket investors.
In brief:
SC's case was that, in the absence of 3m USD LIBOR, the terms of the preference shares allowed them to use a reasonable alternative rate. This, they said, would allow the holders to continue to receive a floating rate of interest, in line with the original terms, and give business efficacy to the contract.
SC put forward two arguments in support of this:
SC also asked the Court to rule on whether their proposed rate was a reasonable alternative or, if not, what rate would be.
The Court rejected SC's interpretation argument, finding that "in effect" referred to a LIBOR rate that was operative on a specific date, not a rate that replicates or replaces LIBOR ("a situation when no LIBOR rate is published on the relevant date, but a LIBOR rate first published on a prior date is treated as the effective LIBOR rate by the market (and so is “in effect” or operative) on the later date").
However, the judges agreed with SC's implied term argument, albeit a slightly modified version, finding that a term did indeed need to be implied.
The actual term implied by the Court was that, if the express definition of Three Month LIBOR ceases to be operable, dividends should be calculated using the reasonable alternative rate to 3m USD LIBOR on the date on which the dividend falls to be calculated.
The purpose of the Court's modification to SC's suggested implied term5 was to stipulate that, while SC's proposed rate is currently the reasonable alternative to 3m USD LIBOR - being widely used, including in financial instruments that bear similarities to the preference shares - determination of the reasonable alternative to a particular rate is an objective question for the Courts, not a matter for SC or any other interested party, and such reasonable alternative rate may change over time as different rates become available.
The defendants argued that both of SC's arguments should fail, and that a different term (in the first instance, for redemption of the preference shares) should be implied.
The Court accepted SC's implied term on the basis that:
The Court decided point (iii) on the basis that it was clearly the intention of both parties that the contract would continue beyond 3m USD LIBOR's discontinuation. This was evidenced by:
Very. This is an important case and will be seen as a bellwether for investors who might otherwise have sought to challenge the unilateral transition of financial instruments from LIBOR to alternative rates. Although the case concerns preference shares, there are clear economic parallels with other floating rate instruments, so the judgment has broad relevance.
Likely. The judgment's precedential value is likely to turn primarily on the definition of "LIBOR" in any given contract. However, the Court's conclusion that including fallbacks in the definition of a particular rate indicates an intention for the contract to continue after the rate's cessation will have broad relevance, especially for contracts entered into since LIBOR's cessation was first announced in 2017. In this regard, the judgment expressly states that the Court's rationale for agreeing with SC's implied term argument is likely to be "similarly persuasive" when considering the effect of LIBOR cessation on LIBOR-referencing debt instruments that do not contain fallbacks that expressly contemplate LIBOR's discontinuation.
The High Court's recognition that SC's implied term gave business efficacy to the preference shares is also likely to carry to other floating rate instruments.
No. It is not clear whether the "reasonable alternative rate" for 3m USD LIBOR will always be three-month CME Term SOFR plus the three-month ISDA spread adjustment for every contract. Although the experts agreed that, of the potential replacement rates available, SC's proposed rate is the closest to 3m USD LIBOR, the factual matrix for a particular contract could still lead to a different conclusion, particularly in light of the Court's ruling that the concept of a "reasonable alternative rate" is objective, temporal, and determinable by the Courts.
“Three Month LIBOR” definition, as used in the preference share terms:
“[primary meaning] the three month London interbank offered rate for deposits in US dollars which appears on page 3750 of Moneyline Telerate as of 11:00 a.m., London time, on the second business day in London prior to the first day of the relevant Dividend Period…;
[first fallback] provided that, if at such time, no such rate appears or the relevant Moneyline Telerate page is unavailable, it shall mean the rate calculated by the Company as the arithmetic mean of at least two offered quotations obtained by the Company after requesting the principal London offices of each of four major reference banks in the London interbank market, to provide the Company with its offered quotation for deposits for three months in US dollars commencing on the first day of the relevant Dividend Period to prime banks in the London interbank market at approximately 11:00 a.m.,
London time, on the second business day in London prior to the first day of the relevant Dividend Period and in a principal amount that is representative for a single transaction in US dollars in that market at that time;
[second fallback] provided further that if fewer than two such offered quotations are provided as requested, it shall mean the rate calculated by the Company as the arithmetic mean of the rates quoted at approximately 11:00 a.m., New York time, on the second business day in New York prior to the first day of the relevant Dividend Period, by three major banks in New York selected by the Company for loans for three months in US dollars to leading European banks and in a principal amount that is representative for a single transaction in US dollars in that market at that time;
[third fallback] provided however that if the banks selected by the Company,are not quoting as mentioned above, it shall mean three month US dollar LIBOR in effect on the second business day in London prior to the first day of the relevant Dividend Period.”
The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.