The financial industry is bracing itself both for the coming LIBOR transition and for the litigation that is likely to follow. In March of this year, the Alternative Reference Rates Committee (“ARRC”), a group of private-market participants and regulators convened by the Federal Reserve Board and the New York Fed to oversee the transition from LIBOR, proposed legislation in New York that would protect parties that adopt ARRC’s recommended replacement for LIBOR, the Secured Overnight Funds Rate (“SOFR”). While not all dollar-denominated agreements referencing LIBOR are governed by New York law, a majority are. A legislative “fix” in New York could, therefore, go a long way toward providing clarity to parties facing LIBOR uncertainty. However, with this year’s legislative session having ended, the New York legislature is unlikely to enact a “fix” -- if at all -- until well into 2021. With the LIBOR cliff looming, the question now is whether Congress can address the problem on a national basis.
Last week, a draft bill mirroring ARRC’s proposed New York legislation was circulated in Congress. This discussion draft indicates that the proposed federal legislation would expressly preempt state law concerning the LIBOR transition and would:
- Prohibit a party from refusing to perform its contractual obligations or declaring a breach as a result of a LIBOR discontinuance or the use of the legislation’s recommended benchmark replacement;
- Establish that the ARRC-recommended benchmark replacement is a commercially reasonable substitute for and a commercially substantial equivalent to LIBOR; and
- Provide a safe harbor from litigation for the use of the ARRC-recommended benchmark replacement rate.
On a mandatory basis, the proposed legislation would:
- override legacy fallback language that references a LIBOR-based rate in favor of the legislation’s recommended benchmark rate;
- nullify legacy fallback language that requires polling for LIBOR or other interbank funding rates; and
- insert the legislation’s ARRC-recommended benchmark replacement as the LIBOR fallback in legacy contracts without existing fallback language.
On a permissive basis, the proposed legislation would:
- permit parties to exercise discretion or judgment regarding the fallback rate to avail themselves of the litigation safe harbor if they select the recommended benchmark replacement as the fallback rate; and
- allow parties to mutually opt-out of any mandatory application of the proposed legislation, at any time.
Although the proposed legislation, if enacted, would provide considerable clarity and protection as parties transition away from LIBOR, it would not eliminate entirely the prospect of litigation. For example, because the US legislation may differ in approach from “fixes” ultimately adopted by the UK, the EU, or others, disputes may well arise regarding the choice of law to apply. Further, an aggrieved party may challenge the statute as an impairment of contract that violates the Due Process clause of the Constitution. A challenge might also be made under the Trust Indenture Act (“TIA”), which provides that the rights of holders of certain securities to receive interest payments cannot be “impaired or affected” without the consent of the holders. The discussion draft of the federal bill attempts to address the TIA by deeming that adoption of the bill’s benchmark replacement and related benchmark-conforming changes would not impair any person’s rights under any affected contract. Despite this, affected parties would likely be willing to litigate the effectiveness of such an attempt to override the protections afforded by the TIA.