LIBOR cessation: High Court decides that a contract providing for payments referring to LIBOR contains implied term to use alternative rate

On 15 October 2024, in Standard Chartered PLC v Guaranty Nominees Ltd & Ors [2024] EWHC 2605 (Comm), the English High Court gave its first judgment on the effect of the cessation of LIBOR on contracts which reference LIBOR.

The case was determined under the Financial Markets Test Case Schedule for cases which raise issues of general importance to the financial markets.

The Court concluded that the contract, which referenced three month USD LIBOR, contains an implied term that a reasonable alternative to three month USD LIBOR is to be used where the definition of three month USD LIBOR is no longer operative. The Court found that a reasonable alternative rate for the relevant contract should be based on three month CME Term SOFR (a forward-looking rate calculated on a futures basis by reference to trading in derivatives referencing the Federal Reserve’s Secured Overnight Funds Rate (SOFR) on the Chicago Mercantile Exchange) with a Spead Adjustment which had been recommended by the International Swap Dealers’ Association and endorsed by a number of regulators and market participants.

Financial institutions are likely to welcome the decision, because it upholds contracts that refer to LIBOR by implying a term for a reasonable alternative rate.

Background - LIBOR cessation

LIBOR (the London Interbank Offered Rate) was a borrowing rate calculated by reference to various banks’ lending rates and overseen by the British Bankers’ Association. It was used for decades. The volume of annual debt issuances using LIBOR was over USD1,000,000,000. From around 2017 onwards, regulators decided to phase out LIBOR, with the last publication of any LIBOR rate (in fact by then a synthetic version) in September 2024.

The effect of the cessation of LIBOR has been very closely watched by banks, funds, corporations and lawyers. There was speculation about whether courts would decide that contracts referring to LIBOR should be interpreted as if a different rate applied, or be subject to implied terms, or treated as frustrated, which would terminate the contract.

The facts of this case

In 2006, Standard Chartered PLC (the Bank) issued preference shares with a value of USD750 million. The preference shares were perpetual (i.e. always outstanding) subject to the Bank’s option to redeem them every ten years. The preference shares stated that they would pay a dividend at a floating rate of 1.51% plus three month LIBOR.

The Bank sought a declaration from the English High Court about the rate of the dividends upon the cessation of LIBOR. The Bank made two main arguments. First, it argued that in the event reference bank contractual fallback options were also unavailable, then the last contractual fallback option in the preference share documentation ‘three month US dollar LIBOR in effect on the second business day in London prior to the first day of the relevant Dividend Period’ should be interpreted to mean a rate that effectively replicates or replaces three month USD LIBOR. Alternatively, the Bank argued that the preference shares contained an implied term that a reasonable alternative rate could be used.

The Bank argued that on either view, that appropriate rate would be based on the Federal Reserve’s SOFR with a spread adjustment calculated by the International Swap Dealers’ Association (which has been widely used in the financial markets as LIBOR has been phased out).

Four funds which own some of the preference shares argued that the preference shares contained an entirely different implied term: that the Bank was required to redeem the preferences shares upon the cessation of LIBOR.

Decision

The High Court rejected the argument that the express final contractual fallback clause could be interpreted to mean that a rate that effectively replaced or replicated LIBOR could be used. The natural meaning of “in effect” referred to using a historic LIBOR rate published on a prior date as the effective LIBOR rate in the case of temporary unavailability of the screen rate.

However, the High Court did decide (largely agreeing with the Bank) that the preference shares contained an implied term ‘that if the express definition of Three Month LIBOR ceases to be capable of operation, dividends should be calculated using the reasonable alternative rate to three month USD LIBOR at the date the dividend falls to be calculated’ (paragraph 66).

The Court decided this in accordance with the usual test for an implied term, including that it must be necessary to give business efficacy to the contract or be so obvious as to go without saying, must be capable of clear expression, must not be inconsistent with the express terms, and must be reasonable and equitable.

The Court held that the implied term met these requirements. In particular, the preference shares were long-term instruments which should be approached flexibly, the clauses showed that LIBOR was a mechanism for measuring borrowing rather than an end in itself, and the ‘fall-back’ clauses (providing for certain alternative calculation mechanisms) indicated that the parties intended that the contract constituted by the preference shares should continue even if LIBOR were not published.

The Court rejected the different implied term argued for by the funds. The preference shares were intended to provide long-term capital in return for dividends, whereas the funds’ implied term would have the opposite effect. The funds’ implied term was not so obvious as to go without saying, in particular because redemption would depend on an event outside the control of the Bank (and the shareholders). It was also not capable of clear expression.

Having decided on the implied term, the Court also accepted the Bank's argument that the three month CME Term SOFR rate plus the ISDA adjustment spread was a reasonable alternative rate to use.

The Court also expressed a view that the arguments in favour of the implied term in this case are likely to be similarly persuasive when considering the effect of the cessation of LIBOR on debt instruments which use LIBOR as a reference rate to measure the wholesale cost of borrowing over time, where contractual fallbacks for LIBOR cessation are not in place, or are ineffective. In those contracts, the specific reference to LIBOR is likely to be a non-essential term, and the cessation of LIBOR should not defeat the continuation of the contract. The Court noted that any implied term by which the cessation of LIBOR would give rise to immediate repayment of the debt would be unworkable in debt instruments and be akin to acceleration following a defined event of default which are generally carefully agreed by the parties due to their severe consequences.

Key takeaways

The case brings a welcome degree of stability to the question of LIBOR cessation. The English Court seeks to uphold parties’ bargains, and it has done so in this case.

That said, it is important to keep in mind that the interpretation of every contract depends on the specific language used against the factual background. There may remain a risk of future litigation regarding other types of contract or clauses where different language has been used.

If you need any assistance on legacy LIBOR-referencing contracts, please contact us.

For further information on this topic, see our other resources:

IBOR transition - are you prepared?

The outlook for 2023: What to expect in the syndicated loans market

Inside Disputes blog: Libor discontinuation