English High Court takes pragmatic approach to dealing with LIBOR's tough legacy

Before the last USD LIBOR tenor ceased to be published on 30 June 2023, the Adjustable Interest Rate (LIBOR) Act was enacted at federal level in the US. The legislation was intended to provide certainty by putting in place a clear and consistent framework for replacing LIBOR in existing financial contracts that do not have adequate fallback provisions.

No equivalent legislative solution was implemented in England and Wales. Therefore, it was only a matter of time before a dispute linked to the discontinuation of a LIBOR tenor in an English law agreement came before the English courts.

In October, Standard Chartered Plc v Guaranty Nominees Limited and Others¹ was determined under the Financial Markets Test Case Scheme for cases which raise issues of general importance to the financial markets.

While the case was heard in the context of the calculation of dividends on perpetual preference shares, it is highly relevant for finance transactions. The judges themselves observed that the arguments in this case were likely to be "similarly persuasive when considering the effect of the cessation of LIBOR on debt instruments which use LIBOR as a reference rate but do not expressly provide for what is to happen if publication of LIBOR ceases".²

Background

The English court had to decide how dividends on perpetual preference shares (issued by Standard Chartered PLC in 2006 for the purpose of raising Tier 1 regulatory capital) should be calculated following the cessation of LIBOR.

The preference shares, issued in 2006, were initially tied to a fixed dividend rate. However, this fixed rate transitioned to a floating rate based on three-month US Dollar LIBOR after 2017. The documentation included a defined fallback regime (similar to the fallbacks seen in legacy LIBOR-referencing syndicated loan agreements or bond issues) for determining the dividend rate if LIBOR was unavailable. However, the fallback mechanisms were no longer operable after the cessation of synthetic USD LIBOR in September 2024.

Consequently, Standard Chartered sought declarations concerning the rate by reference to which the dividends payable on the preference shares should be calculated for the dividend periods commencing on or after 30 October 2024.

The term implied by the court

The parties agreed that a term needed to be implied into the documentation to address the cessation of LIBOR. However, they disagreed over what that term should be.

The court concluded that to give "business efficacy" to the contract, it was necessary to imply into the contract a term enabling use of a "reasonable alternative" rate to three-month USD LIBOR.

The reasonable alternative rate accepted by the court in this case was Term CME SOFR³ plus a fixed spread adjustment published by ISDA (intended to address the difference (or "spread") between LIBOR and SOFR). The court recognised that arriving at this rate (now a well-established rate used across the financial markets in a variety of financial instruments) had involved many years' work by regulators, analysis and market participants.

An alternative argument made by the underlying investors was the implication of a term which required the automatic redemption of the preference shares upon the cessation of LIBOR. However, the court said they regarded this as "wholly untenable". Notably, the court also considered some of the consequences of this sort of implied term for debt instruments, saying that in the context of a debt instrument this implied term would be "at least as, if not more, unworkable"⁴, as it would trigger an immediate repayment obligation.

Helpful for finance documents, but not conclusive?

This judgment will no doubt provide considerable comfort for lenders and the issuers of bonds where interest on the underlying debt is referable to LIBOR, yet an "active" transition away from LIBOR has not yet been achieved. While this rump of these deals is now small, there do remain so-called "tough legacy" deals in the market, with no equivalent legislative framework to the Adjustable Interest Rate (LIBOR) Act enacted in the US.

It is also useful that the judgment specifically stated that the arguments in the case would be "similarly persuasive" in the context of debt instruments.

However, as helpful as this judgment it is, it also remains important to remember the context:
 

• Although the court made it clear that the same principles would likely apply to debt instruments, the case was concerned with the calculation of a dividend on perpetual shares. Perpetual shares have no stated maturity and "the bargain embodied in the Preference Shares was, on any view, a very long-term contract"⁵. Moreover, the shares had been issued to raise Tier 1 capital. The court could take a different view to a shorter-term arrangement where there is no capital adequacy overlay.
• The judgment made it clear that it is the court which will identify the reasonable alternative rate, rather than a party having discretion to decide. The court determined in this case that Term CME SOFR plus the fixed ISDA spread adjustment was the reasonable alternative rate. However, the court also acknowledged that "the universe of available alternative reference rates might change over the life of the Preference Shares"⁶ and for this reason, it was the reasonable alternative rate "as matters stand".

In summary...