The issue

In the current turmoil in the financial market, London Interbank Offered Rate (LIBOR) may not be an accurate reflection of a lender’s actual cost of funding loans that it is to make or has already made. Illiquidity in the interbank market has affected the vast majority of banks and the present high cost of funds is not limited to banks with a weaker credit. In these circumstances there is evidence that lenders are in certain cases invoking, or considering invoking, market disruption provisions in facility agreements so that floating rate interest (or at least the non-margin or profit element) payable under a facility agreement more closely reflects their actual (and increased) cost of LIBOR.

Market disruption clauses in financings have been an industry standard for many years but to date have been rarely, if ever, invoked. Market disruption is relevant for funded loans as well as those which have yet to fund. A lender would normally have the right to invoke a market disruption clause at the beginning of an interest period when it becomes apparent that the quoted LIBOR rate that would be applicable to the next interest period is not an accurate measure of its cost of funds. With many real estate finance facilities having imminent interest payment dates to reflect the September rent quarter date, market disruption may rapidly become a very live issue in the real estate market.

Agent banks or lenders may have already alerted borrowers to the possibility that the clause may be invoked and those borrowers may already be working with the lenders to reduce the impact of the market disruption, an approach that has been recommended by the Association of Corporate Treasurers.

It is possible, however, that some lenders will wait until the contractual deadline to notify borrowers that the market disruption provisions will be invoked; in standard Loan Market Association (LMA) documentation this deadline is close of business on the rate fixing date.

Options for borrowers

Whilst there are limited options for borrowers, as these clauses are drafted to protect the lenders, the lender’s right to invoke market disruption will depend on the drafting of the relevant facility agreement. Market disruption provisions come in a number of variations and will need to be considered on a case by case basis in detail to establish how they operate and how and when they can be invoked.