U.S. Passes Targeted Relief for “Tough Legacy” LIBOR Contracts

June 1, 2022

By Tyler J. Bush

The impending cessation of LIBOR has been a hot topic on the minds of borrowers and lenders alike over the last few years. Even before the official dates of LIBOR’s phase-out were announced by regulators on March 5, 2021, concerned parties were already discussing (and, at times, fretting over) what would replace this long-standing regime. Fortunately for many, the transition away from LIBOR appears to be relatively smooth, as banks have shifted to reliable alternatives (the Secured Overnight Financing Rate (SOFR) is a popular example).

However, the relief afforded by such alternatives isn’t readily available to all. Numerous existing LIBOR contracts either do not contain appropriate fallback provisions permitting them to convert to a non-LIBOR alternative or cannot easily be amended to provide fallback provisions. These so-called “tough legacy” LIBOR contracts include a variety of derivatives, bonds, loans, and occasionally, mortgages. Contracts that reference LIBOR in bond transactions where amendments require approval from a majority of bondholders present a specific example of a “tough legacy” LIBOR contract, as they are difficult to amend. In these circumstances, simply presenting an effective LIBOR alternative is not enough, and relevant state-enacted measures cannot fix this nationwide issue. This has presented a potentially critical problem for an estimated $16 trillion worth of “tough legacy” contracts that have been left without clear, uniform guidance. Without federal action, borrowers and lenders would face uncertainty and potentially expensive litigation.

Thankfully, Congress passed and the President signed an omnibus package that included the Adjustable Interest Rate (LIBOR) Act. This Act, which was widely supported by legislators and industry leaders, is designed to create a uniform process across the U.S. for replacing LIBOR in existing contracts. The Act states that its purpose is “(1) to establish a clear and uniform process, on a nationwide basis, for replacing LIBOR in existing contracts the terms of which do not provide for the use of a clearly defined or practicable replacement benchmark rate, without affecting the ability of parties to use any appropriate benchmark rate in new contracts; (2) to preclude litigation related to existing contracts the terms of which do not provide for the use of a clearly defined or practicable replacement benchmark rate; and (3) to allow existing contracts that reference LIBOR but provide for the use of a clearly defined fallback and practicable replacement rate, to operate according to their terms.”

What is notable about the operative text of the Act is that it manages to provide a considerable amount of flexibility to ensure all impacted parties are able to smoothly transition from LIBOR, while also ensuring that the law is tailored narrowly enough to avoid unduly burdening LIBOR contracts that already contain effective fallback provisions for determining a benchmark replacement. In general, existing contracts that (1) contain no fallback provisions (after nullifying any benchmark replacement language that is based in part on LIBOR or requires a person to conduct a poll, survey, etc.) or (2) contain fallback provisions that neither identify a specific benchmark replacement nor a person with the authority, right, or obligation to determine a replacement (i.e., a “Determining Person”) will automatically be changed on the first London banking date after June 30, 2023 to use the “Board-Selected Benchmark Replacement.” The Act provides that the “Board-Selected Benchmark Replacement” is a benchmark replacement identified by the Federal Reserve Board that is based on SOFR (incorporating any Tenor Spread Adjustments, as identified in the Act). If an existing LIBOR contract does identify a Determining Person, such Determining Person will have the ability to select the “Board-Selected Benchmark Replacement,” which will invoke certain safe harbor provisions in the Act. In short, these safe harbor provisions provide that the selection of the “Board-Selected Benchmark Replacement” will not discharge or excuse performance under any LIBOR contract and will provide a shield from litigation, among other benefits. Beyond the benefits of the safe harbor provisions, the Act will not impair the contract if the Determining Person does not elect to use the “Board-Selected Benchmark Replacement.” Furthermore, existing contracts that identify a LIBOR replacement that is not based in any way on LIBOR values will not be impacted by this legislation. Relatedly, the Act states that it will not alter or impair any written agreement specifying that a specific LIBOR contract shall not be subject to such Act.

While some in the general public may view this as a “boring” issue, the passage of this crucial piece of legislation is a pleasant reminder that Congress is still able to work together in a bipartisan manner to pass important, highly technical bills.