LIBOR transition judgment - welcome guidance but approach with caution

The High Court recently handed down judgment in the first case in which the English court had to determine the effect of the abolition of LIBOR on certain financial instruments referring to that rate: Standard Chartered Plc v Guaranty Nominees Limited and others [2024] EWHC 2605 (Comm).

In recognition of the importance of the decision to the financial markets, the case was heard on an expedited basis under the terms of the Financial Markets Test Scheme.

The High Court concluded that the contract contained an implied term providing for the use of a reasonable alternative rate in the absence of LIBOR and ruled on the appropriate rate which should be applied to LIBOR-linked dividends following the discontinuance of the benchmark.

The court also made a general observation regarding debt instruments which the financial markets may find helpful: noting that its reasoning was likely to be similarly persuasive when considering the effect of cessation of LIBOR on debt instruments which use LIBOR as a reference rate but do not expressly provide for what is to happen if the publication of LIBOR ceases.

The judgment provides some welcome guidance to financial institutions regarding the courts likely approach to the exercise of contractual interpretation in the context of LIBOR contracts. However, there remains a risk of a different outcome in future cases, particularly those involving shorter term contracts or contracts with effective fallback provisions.

Background

In 2006, Standard Chartered plc (SC) issued perpetual preference shares for regulatory capital reasons. The preference shares were redeemable at SC’s option every 10 years and paid dividends at a fixed rate for the first 10 years and at a floating rate of “1.15% plus Three Month LIBOR” thereafter. The definition of “Three Month LIBOR” referred to a US dollar LIBOR screen rate with a waterfall of three fallbacks. The first two fallbacks relied on interbank lending quotations which were rendered redundant when US dollar LIBOR was discontinued. The third fallback required determination of “three month US dollar LIBOR in effect” on the second business day in London prior to the first day of the relevant dividend period.

Following the announcement that LIBOR would be discontinued, SC sought to amend the dividend rate to three-month compound Secured Overnight Funds Rate (SOFR) with a spread adjustment through a shareholders’ special resolution but failed to achieve the required 75% majority. SC brought the case to seek a declaration regarding the applicable rate to be used to calculate dividends on the preference shares following LIBOR cessation.

SC argued that the phrase “three month US dollar LIBOR in effect” (used in the definition of “Three Month LIBOR” in the terms governing the preference shares) should be interpreted as meaning a rate that effectively replicates or replaces three month US dollar LIBOR. Alternatively, SC argued a term should be implied into the preference shares terms allowing SC to use a reasonable alternative rate to three month US dollar LIBOR. SC also asked the court to decide whether its proposed rate was a reasonable alternative or, if not, what rate would be.

The defendants argued the preference shares terms contained an implied term that required SC to redeem the preference shares if LIBOR was discontinued.

Decision

The court rejected SC’s interpretation argument but agreed with its implied term argument.

The court concluded that, if the express definition of Three Month LIBOR was no longer operable, the contract contained an implied term that dividends should be calculated using the reasonable alternative rate to three month US dollar LIBOR on the date on which the dividend falls to be calculated. The court was satisfied that the implied term was necessary to give business efficacy to the preference shares, and that such a term was obvious, capable of clear expression and not inconsistent with the express terms of the preference shares.

The court found, at the current time, the reasonable alternative rate was the rate proposed by SC, i.e., three-month compound SOFR with a spread adjustment.

Reasons for judgment

In reaching its conclusion, the court noted:

• The contract was very long-term (potentially perpetual) and so it was important to take a flexible approach to interpretation as circumstances could change during the life of the contract. This flexible approach to interpretation applied to a contract’s express terms and the ascertainment of any implied terms.
• The role of LIBOR was a mechanism for measuring the cost of unsecured bank borrowing over time, which meant the provisions relating to LIBOR were not essential for the purpose of determining what happened when LIBOR was discontinued.
• The inclusion of three fallback provisions in the definition of Three Month LIBOR suggested a common intention that the preference shares should continue to operate even if LIBOR was not available.
• The definition also indicated that the parties intended a floating rate which would be updated and calculated in real time as the dividends came to be paid.