Navigating contracts in the wake of LIBOR cessation

In-depth analysis

The recent High Court case of Standard Chartered Plc v Guaranty Nominees Ltd and other companies [2024] EWHC 2605 has clarified how contracts that reference the London Interbank Offered Rate (LIBOR) should be interpreted following the cessation of the publishing of LIBOR as a benchmark rate.

Following the initial phasing out of LIBOR from the end of 2021 onwards and the cessation of the publication of LIBOR in mid-2023, there has been some ambiguity about how contracts that reference LIBOR would be interpreted.

On 15 October 2024, in a case brought under the Financial Markets Test Case Scheme before the High Court, the Court considered what a reasonable alternative rate might be in a contract that referenced LIBOR (and where no suitable alternative rate was provided for in such contract).

The Court decided that an alternative rate (being Term SOFR plus an ISDA credit adjustment spread) could be implied into the contract.

Background

The case before the court related to $750,000,000 perpetual preference shares issued in December 2006 by Standard Chartered PLC (Standard Chartered). The registered shareholder was Guaranty Nominees Limited (Guaranty Nominees), which in turn issued depositary shares to investors who then held the economic interest in the preference shares.

Under the terms of the offering circular for the depositary shares, dividends were to be paid (after an initial 10-year period at a fixed rate of 6.409%) by reference to a floating rate of "Three Month LIBOR" (being the screen rate for 3-Month USD LIBOR in the relevant dividend period).

Where no such LIBOR rate was available, the terms provided for three express fallbacks, defined as the "First Fallback", "Second Fallback" and the "Third Fallback":

the First Fallback: that quotations for three-month deposits in US dollars be obtained from four major reference banks in the London interbank market
the Second Fallback: that quotations for three-month loans in US dollars to European banks be obtained from three major New York banks
the Third Fallback: the "three month US dollar LIBOR in effect on the second business day in London prior to the first day of the relevant Dividend Period".

Both Standard Chartered PLC and Guaranty Nominees agreed that the First and Second Fallbacks were unworkable.

In the knowledge that the cessation of LIBOR was fast approaching, Standard Chartered sought via a “consent solicitation process” to replace three month USD LIBOR as the dividend rate for the Preference Shares with three month compound SOFR (the Secured Overnight Funds Rate) plus a fixed spread adjustment published by the International Swaps and Derivates Association (ISDA). However the special resolution that Standard Chartered sought to have passed did not meet the required 75% majority threshold to make that change.

On 12 April 2024 Standard Chartered issued a claim against Guaranty Nominees seeking a declaration that an alternative benchmark rate could be used to calculate the dividends. The High Court was asked by Standard Chartered to consider the "three month US dollar LIBOR in effect" as "a rate that effectively replicates or replaces three month USD LIBOR". Standard Chartered wanted to persuade the Court that Term SOFR was the closest rate to LIBOR and should therefore be used in place of LIBOR where the Final Fallback applied.

Various funds as holders of the depositary shares joined the proceedings to oppose the claim (the Funds) and took an active role in the proceedings (as opposed to Guaranty Nominees, which became a nominal defendant).

Judgment

The Court held that the Third Fallback contemplated a situation where LIBOR was temporarily unavailable and a prior LIBOR rate could be treated as the effective LIBOR rate. This was not the case here where LIBOR had been phased out altogether and would not be published again. Therefore, none of the three express fallbacks were applicable and the Court instead considered what terms should be implied into the contract.

Counsel for the parties presented two competing views as to what terms should be implied:

counsel for Standard Chartered considered that this should be "a reasonable alternative rate to three month USD LIBOR"
counsel for the Funds considered that where LIBOR ceased to be available, a term should be implied into the terms of the Preference Shares that Standard Chartered shall redeem the Preference Shares.

Ultimately, the Court took the view that it was clear from the relevant contractual terms that the parties did not intend issues with the availability of a LIBOR rate to prevent the continued performance of the contract. The fact the terms of the preference shares contained extensive fallback provisions for instances where LIBOR was unavailable was important, as it showed that there was an intention for the contract to continue.

The Court held that the role of LIBOR within such contract (i.e. with respect to the preference shares) was "machinery" that was "a non-essential part of the contract". Its inclusion was for the purpose of quantification, and where the Court could step in and assist by providing a fair reference for quantification in place of LIBOR it was able to do so.

The Court considered the decisions in:

Sudbrook Trading Ltd v Eggleton [1983] 1 AC 444: which related to property valuations and permitted the Court to decide on an alternative where the mechanism for the ascertainment of a purchase price was a "subsidiary and non-essential" part of the contract;
Didymi Corporation v Atlantic Lines and Navigation Co Inc (The Didymi) [1988] 2 Lloyd's Rep 108, 115: in which Bingham LJ followed the decision in Sudbrook Trading Ltd v Eggleton and considered that the most important consideration was whether the provision in question related to "an essential term of the agreement or to the existing of any contract at all" as opposed to "a subsidiary and non-essential question of how a contractual liability to make payment according to a specified objective is to be quantified?".

Therefore, in order to give business efficacy to the arrangements, the Court implied a term that if the express definition of three month USD LIBOR ceases to be capable of operation then dividends should be calculated using a reasonable alternative to three month USD LIBOR at the date the dividend falls to be calculated.

It was decided that the rate produced by taking the Term SOFR rate published by the Chicago Mercantile Exchange Group Benchmark Administration (CME) and adding the ISDA Spread Adjustment was found to meet the requirements for the alternative rate.

The judgment considered that the "reality" was that such a reference rate had "involved many years’ work by regulators, analysts and market participants to arrive at the rate which both experts accept is the best available rate." They also considered that it was a well-established rate that had been endorsed by financial regulators of the major markets in the US and the UK.

Against such a background, the Court though that identifying a viable superior rate would be very difficult. However, the Court varied the implied terms that Standard Chartered contended for, as it considered that:

the identification of a reasonable rate was an objective question, of which the ultimate arbiter was the court, rather than this being something Standard Chartered could decide on its own (which, if it were so, could only then be challenged on the basis set out in Braganza v BP Shipping [2015] UKSC 17).
the universe of available alternative reference rates might change over the life of the Preference Shares – for example, if LIBOR were to be published again (or some other similar substantial interbank unsecured lending market to be re-established).

Comment

From the moment it became clear that LIBOR would cease, how LIBOR-referencing contracts (in which any and all available fallbacks fail or are not applicable) would be treated has been a point of speculation.
This judgment, the first occasion in which the English courts have considered the effects of the cessation of LIBOR, has provided useful and welcome clarification that an alternative rate to LIBOR may be implied into a LIBOR-referencing contract where other fallbacks fail and crucially where such implication is appropriate.
Factors that a court may take into account in considering this issue are the importance of giving business efficacy to agreed arrangements and whether it is possible to draw the inference that the parties intended the contract to continue notwithstanding the failure of fallbacks to provide a workable alternative rate.