On March 15, 2022, President Biden signed the Adjustable Interest Rate (LIBOR) Act into law (the “LIBOR Act”).1 The LIBOR Act provides a clear and uniform federal solution for transitioning legacy contracts that either lack or contain insufficient contractual provisions addressing the permanent cessation of LIBOR by providing for the transition from LIBOR to a replacement rate and avoiding related litigation.
Automatic Transition to Benchmark Replacement
The key provision of the LIBOR Act—Section 104(a)—provides:
• on the LIBOR replacement date – the first London banking date after June 30, 2023, unless the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) determines that any LIBOR tenor will cease to be published or representative on a different date2
• the Board-selected benchmark replacement – a benchmark replacement identified by the Federal Reserve Board that is based on SOFR, including a tenor spread adjustment that is consistent with ISDA’s IBOR Fallbacks Protocol for categories of LIBOR contracts identified by the Federal Reserve Board, with the tenor spread adjustment for consumer loans transitioning on a linear basis over a one-year period3
• shall be the benchmark replacement – a benchmark, interest rate or dividend rate to replace LIBOR or any rate based on LIBOR under a LIBOR contract4
• for any LIBOR contract – any contract, agreement, indenture, organizational document, guarantee, mortgage, deed of trust, lease, [debt or equity] security…, instrument or other obligation or asset that, by its terms, uses LIBOR as a benchmark5
• that, after disregarding as null and void any reference in the fallback provisions to (i) a benchmark replacement based in any way on LIBOR (e.g., a fallback to the last-quoted LIBOR value), except to account for the difference between the replacement rate and LIBOR (i.e., a spread adjustment) or (ii) a requirement to poll for quotes or information concerning interbank lending or deposit rates6
• either contains no fallback provisions – terms in a LIBOR contract for determining a benchmark replacement7
• or contains fallback provisions that identify neither a specific benchmark replacement nor a determining person – any person with the authority, right or obligation to determine a benchmark replacement, as identified by the LIBOR contract or its governing law.8
Incorporating Conforming Changes
If the Board-selected benchmark replacement becomes the benchmark replacement for LIBOR under a LIBOR contract as a result of application of the LIBOR Act, benchmark replacement conforming changes—technical, administrative or operational changes, alterations or modifications that the Federal Reserve Board determines would address issues affecting the implementation, administration and calculation of the Board-selected benchmark replacement9—also shall become an integral part of the LIBOR contract automatically, without the need for consent by any person.10 In the case of commercial loans, but not consumer loans,11 benchmark replacement conforming changes may include changes reasonably determined by a calculating person (a person, which may be the determining person, responsible for calculating or determining any valuation, payment or other measurement based on a benchmark12) to be necessary or appropriate after due consideration of the conforming changes determined by the Federal Reserve Board.
Effect on Determining Persons
Subject to the rules of construction described below, the LIBOR Act authorizes a determining person to select the Board-selected benchmark replacement as the benchmark replacement in a LIBOR contract, in which case that selection will be irrevocable and used in any benchmark determination under the LIBOR contract occurring on or after the LIBOR replacement date.13 Any such selection by a determining person must be made by the earlier of the LIBOR replacement date and the latest date for selecting a benchmark replacement pursuant to the terms of the applicable LIBOR contract.
If a designated determining person does not select a benchmark replacement by the date described in the preceding paragraph, then the Board-selected benchmark replacement automatically will become the benchmark replacement for the LIBOR contract on and after the LIBOR replacement date.14
Safe Harbor Provisions
The LIBOR Act provides a number of provisions protecting the selection and use of the Board-selected benchmark replacement as a replacement for LIBOR, and the continuity of the related LIBOR contract. The purpose of the safe harbor is to help protect lenders, trustees and other persons involved in determining or calculating the benchmark replacement from related litigation.
The LIBOR Act deems a Board-selected benchmark replacement, as well as its selection or use, and any benchmark replacement conforming changes to constitute (i) a commercially reasonable and substantially equivalent replacement for LIBOR; (ii) a reasonable, comparable or analogous rate to replace LIBOR; (iii) a replacement based on a similar or comparable methodology to LIBOR; (iv) substantial performance by a LIBOR contract party of a LIBOR-linked right or obligation; and (v) of particular importance for consumer loans, a replacement rate with substantially similar historical fluctuations to LIBOR.15
Furthermore, neither the selection or use of a Board-selected benchmark replacement nor the determination, implementation or performance of benchmark replacement conforming changes may (a) be deemed to impair or affect the payments or payment rights of a party to a LIBOR contract; (b) have the effect of discharging or excusing performance, giving a right to unilateral termination or suspension of performance, constituting a breach or otherwise voiding or nullifying a LIBOR contract; or (c) be deemed an amendment or modification of a LIBOR contract or to prejudice, impair or affect the rights or obligations of any party to a LIBOR contract.16
The safe harbor provision afforded by the LIBOR Act protects any person from any claim or liability arising out of the selection and use of the Board-selected benchmark replacement; the implementation of benchmark replacement conforming changes; and, with respect to commercial LIBOR contracts, where a calculating person has discretion in establishing benchmark replacement conforming changes, the determination of benchmark replacement conforming changes.17
Preemption of State Law and Amendment of Other Federal Laws
The LIBOR Act and the regulations to be promulgated under it supersede any provision of any state or local law relating to the selection or use of a benchmark replacement for LIBOR and related conforming changes.18 As a result, the legislation already enacted in several states will be preempted, and pending legislation in several additional states can be expected to be abandoned.
Additional provisions of the LIBOR Act amend Section 316(b) of the Trust Indenture Act of 1939, which states that the right of a holder of an indenture security to receive payment of principal and interest on respective due dates may not be impaired or affected without the consent of that holder.19 The LIBOR Act explicitly provides that the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security shall not be deemed to be impaired or affected by any change occurring as a result of the application of the LIBOR Act to that security.20
The LIBOR Act also amends the Higher Education Act of 1965 by revising the calculation rule to address the cessation or non-representativeness of 1-month LIBOR by substituting 30-day SOFR plus the ISDA 1-month tenor spread adjustment.21
Of note is that an earlier iteration of the LIBOR Act provided that neither the selection or use of the Board-selected benchmark replacement nor the determination or implementation of benchmark replacement conforming changes would be treated as a sale, exchange or other disposition of property under the Internal Revenue Code. This language was not included in the final version of the LIBOR Act, and, as a result, US federal income tax implications of the LIBOR Act are governed by the final Treasury regulations published by the Internal Revenue Service on December 30, 2021,22 which generally provide broad relief from the potential US federal income tax consequences of LIBOR transition.
Use of Credit Sensitive Rates in Loan Transactions
The LIBOR Act addresses loan transactions specifically, providing that a bank supervised by a federal financial institution regulatory agency may make a non-IBOR loan—a term encompassing benchmark replacements for both USD and non-USD LIBOR—using any benchmark, including a non-SOFR benchmark such as Ameribor or the Bloomberg Short-Term Bank Yield Index (BSBY), that the bank determines is appropriate for its funding model, operational capabilities and risk management, as well as the needs of its customers. The provision, which was absent in state versions of benchmark replacement legislation, as well as the initial House version of the LIBOR Act, also restricts federal regulators from taking action against supervised banks merely for using a benchmark that is not based on SOFR in a loan transaction.23 Nonetheless, the use of any benchmark must comply with applicable law, including any safety and soundness guidelines of applicable federal regulators. Furthermore, market participants should keep in mind that while the choice of a non-Board-selected benchmark replacement enjoys this specific protection, such a choice will not benefit from the other protections of the LIBOR Act, including the various safe harbor provisions.
Section 105(e) of the LIBOR Act provides an additional protection, stipulating that the LIBOR Act cannot be construed to create a negative inference or presumption regarding the validity or enforceability of a benchmark replacement that is not the Board-selected benchmark replacement or any contract modifications that are not benchmark replacement conforming changes, other than the provisions nullifying fallbacks based in any way on LIBOR or requiring bank polling regarding lending or deposit rates.
Rules of Construction
The LIBOR Act includes a list of “rules of construction”24 that provide limits on its application and scope. These rules of construction provide that nothing in the LIBOR Act may be construed to alter or impair any of the following: (i) any written agreement specifying that a LIBOR contract shall not be subject to the terms of the LIBOR Act; (ii) any LIBOR contract that contains fallback provisions that identify a benchmark replacement that is not based in any way on any LIBOR value—for example, the prime rate or the effective federal funds rate—other than fallbacks based on polling requirements; (iii) any LIBOR contract as to which a determining person elects to use a benchmark replacement other than the Board-selected benchmark replacement (but not an election pursuant to any polling requirements); (iv) the application to a Board-selected benchmark replacement of any pre-existing cap, floor, modifier or spread adjustment; (v) any provision of federal consumer financial law that requires notice to borrowers of changes in terms or that governs the reevaluation of rate increases on open-ended credit card accounts; and (vi) the rights or obligations of any person, or the authorities of any agency, under federal consumer financial law, except as protected by the LIBOR Act’s safe harbor provisions.
Federal Reserve Board Rulemaking
Not later than 180 days after the date of enactment, the Federal Reserve Board is required to promulgate regulations to carry out the terms of the LIBOR Act.25
As the market begins to consider how the provisions of the LIBOR Act apply to their portfolios, we highlight a couple of recent issues.
Fallback provisions in older legacy contracts can be difficult to evaluate, especially those that are sparse and do little more than designate a party to determine “a comparable rate” or similar language. In such a case, where the provision does address how to determine a benchmark replacement and does identify a determining person but does not identify a specific benchmark replacement, the automatic benchmark replacement provisions of Section 104(a) of the LIBOR Act would not apply. Nonetheless, the determining person and LIBOR contracts that they are authorized to amend still may be protected under the LIBOR Act. If the determining person fails to choose a benchmark replacement and allows the Board-selected benchmark replacement and related benchmark replacement conforming changes to become the benchmark replacement on the LIBOR replacement date pursuant to Sections 104(c)(3) and (d), the protections of Sections 105(a), (b) and (d) will apply. If the determining person affirmatively selects the Board-selected benchmark replacement as the benchmark replacement, the additional protection of the Section 105(c) safe harbor will apply.
Choosing the SOFR-based rate that enjoys protection under the LIBOR Act is important, especially for non-loan products. Two Term SOFR Reference Rates are quoted and available for use as of March 16, 2022: Term SOFR as published by CME Group Inc. and ICE Term SOFR as published by ICE Benchmark Administration Limited. While it appears, based on a chart prepared by the Loan Syndications & Trading Association from the limited available data, that the two rates move similarly, and although both rates are published for four tenors (1-, 3-, 6- and 12-month), it is CME’s Term SOFR—currently the 1-, 3- and 6-month tenors only—that was recommended by the Federal Reserve Board’s Alternative Reference Rates Committee on July 29, 2021. As a result, market participants should identify clearly in applicable transaction documentation the rate being selected as the benchmark replacement for LIBOR-linked products.
1 The LIBOR Act was included in the Consolidated Appropriate Act, 2022, a copy of which is available at https://www.congress.gov/117/bills/hr2471/BILLS-117hr2471enr.pdf. See pgs. 777-786.
3 See LIBOR Act § LIBOR Act §§ 103(6), 103(20), 104(e). The tenor spread adjustments defined in the LIBOR Act are those fixed on March 5, 2021, by Bloomberg Professional Services, for purposes of the International Swaps and Derivatives Association 2020 IBOR Fallbacks Protocol and related Supplement, as a result of the March 5, 2021, announcement by the UK Financial Conduct Authority of the future cessation and loss of representativeness of the LIBOR benchmarks. See https://assets.bbhub.io/professional/sites/10/IBOR-Fallbacks-LIBOR-Cessation_Announcement_20210305.pdf. The Board-selected benchmark replacement is expected to be CME Group Inc.’s version of Term SOFR, as discussed below.
7 See LIBOR Act § 103(11). We note that most syndicated loan facilities in the United States provide a fallback to an alternative base rate, and therefore are not expected to be affected by the LIBOR Act provisions.