The London Interbank Offered Rate (LIBOR) has been the reference interest rate for millions of transactions for many years. LIBOR is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans. LIBOR serves as a globally accepted key benchmark interest rate that indicates borrowing costs between banks. It will cease to be used at the end of 2021 which raises the problem of what will replace it in existing contracts that will still be in operation after LIBOR ends. New York has passed legislation to address this issue, but it may not be the optimal solution for many companies. Businesses should discuss the implications of the law with legal counsel to determine what works best for their contracts moving forward.
When must contracts cease to rely on LIBOR?
The end of LIBOR is likely to have a substantial effect on the capital market and securitization industries as these transactions frequently use the LIBOR benchmark. While LIBOR-based contracts will cease at the end of 2021, there is additional time for parties to provide for a replacement benchmark until June 2023. However, due to the large number and complexity of contracts using LIBOR, many parties may not come to an agreement in time. This is the reason New York and other jurisdictions are stepping in to address what happens once the LIBOR rate is no longer available.
How has New York responded?
In April 2021, the New York LIBOR Legislation was enacted to provide for a LIBOR replacement. The law generally tracks the legislation proposed by the Alternative Reference Rates Committee (“ARRC”). The statute establishes a Recommended Benchmark Replacement as a statutory remedy. The Replacement automatically goes into effect on the LIBOR Replacement Date for contracts that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions in the event USD LIBOR ceases. This provision applies to contracts that use LIBOR explicitly or require a poll, survey, or inquiry of lending rates that are in turn based on LIBOR. The Recommended Benchmark Replacement rate is based on the secured overnight financing rate published by the Federal Reserve Bank of New York.
The law applies automatically to certain contracts. However, “Determining Persons” under a contract can also elect to use the Recommended Benchmark Replacement in their contract. In such instances, selection of the Recommended Benchmark Replacement will be:
- irrevocable;
- made by the earlier of either the LIBOR Replacement Date, or the latest date for selecting a Benchmark Replacement according to such contract; and
- used in any determinations of the Benchmark under or with respect to such contract occurring on and after the LIBOR Replacement Date.
Importantly, the law establishes a safe harbor from liability for opting to use the Recommended Benchmark Replacement. In addition, a party to a contract cannot claim breach of contract or refuse to perform as a result of another party’s selection or use of a Recommended Benchmark Replacement.
What is the effect of the law?
The law will minimize disruptions in the transition from LIBOR to a new benchmark where parties are unable to come to an agreement and their contracts lack an effective fallback provision with a replacement rate. Without this legislation, the parties would likely end up in court. However, the legislation only applies to contracts governed by New York law. As there is no federal law at this point, companies must seek legal guidance regarding contracts in other jurisdictions.
It is important to note that the law does not require parties to use the Replacement Benchmark Rate. If the contract already has a non-USD LIBOR-or SOFR (the Secured Overnight Financing Rate) based rate as a fallback, that rate will apply once LIBOR ceases. Further, parties can negotiate their own replacement rate prior to the LIBOR replacement date. This is the optimal solution as the parties can select the rate that best suits their circumstances.
In order to avoid any business disruptions, parties should be reviewing their contracts to determine which ones are tied to LIBOR and then seeking legal advice regarding how to address the replacement rate.
Photo by Dmitry Demidko on Unsplash
