16th December 2019
Many businesses will have loan agreements and other commercial contracts that include provisions tied to the LIBOR interest rate. LIBOR will be phased out by the end of 2021. Walker Morris’ Commercial Dispute Resolution specialists Gwendoline Davies and Louise Norbury-Robinson offer proactive, practical advice on the contractual risks associated with the loss of LIBOR.
Following on from the rate-fixing scandal of the mid-2000s, the Financial Conduct Authority (FCA) and the Bank of England have confirmed plans to phase out the London Interbank Offered Rate (LIBOR) by the end of 2021. LIBOR is the benchmark used by many financial institutions to set interest rates.
LIBOR is to be replaced, for GB Sterling, with an updated version of the Sterling Overnight Index Average (SONIA). SONIA, which is based on actual transactions (as opposed to the estimates on which LIBOR is based), is less likely to be open to manipulation.
However, worldwide, $ trillions in loans, including UK mortgages, credit card debt, business loans, investments and many other types of commercial contracts, are tied to LIBOR. So, on a practical level, what will the phase-out mean for businesses?
The key issue is how existing contracts which refer to LIBOR and which are due to continue beyond the end of 2021 (known as legacy contracts) will work.
In some cases parties will simply agree to amend their legacy contracts to refer to SONIA or some other appropriate rate or calculation; and in some cases contracts will allow a party to impose terms or a substitute rate to address the issue. However, many loan agreements and commercial contracts will not have envisaged, and will not cater for, the cessation of LIBOR. Many other loans and contracts will include provisions which were intended, at the time the contract was made, to deal with temporary interruptions to LIBOR and there is a significant risk that such clauses (known as fall-back provisions) might not work or suit the parties when LIBOR is permanently unavailable.
For example, reference bank rate fall-back provisions (which rely on a number of reference banks providing quotations which enable a rate to be calculated) will not work if banks are unwilling to take on the liability of providing quotations to be applied in contracts on a permanent basis. Other provisions, known as historic screen rate fall-back provisions, substitute a fixed contractual interest rate for what was the LIBOR floating interest rate. It is easy to see that, in some cases, that could entirely alter the economics of a contract – potentially to the significant detriment of a party. Finally, cost of funds fall-back provisions allow for calculation of an interest rate by reference to the costs of funding incurred by lenders. Such provisions can be unsatisfactory and imprecise because lenders’ costs of funding are generally calculated on a portfolio, rather than an individual contract, basis.
Nevertheless, where any loan agreement or commercial contract contains fall-back provisions which are unambiguous on their face, fundamental principles of contract law  mean that it would be unlikely that a court would interpret or imply terms so as to re-write how the contract should operate in the absence of LIBOR.
It seems inevitable, therefore, that disputes will arise over the coming months and years in relation to some legacy contracts. As this situation is largely unprecedented; and because, as the law stands, the courts are unable to undermine clear contractual wording based merely on commercial common sense and contemporary factual circumstances, it will be difficult to assess the merits and likely outcome of such disputes/litigation.
It is therefore essential that businesses understand and, where appropriate, devise strategies to deal with, the impact on their loan/contractual arrangements of the loss of LIBOR. There are some practical steps that businesses can, and should, take without delay:
For further advice and assistance in relation to the loss of LIBOR and the potential impact on your commercial contracts, please do not hesitate to contact Gwendoline, Louise or any member of Walker Morris’ Commercial Dispute Resolution team.
 See our previous briefing on frustration.