LIBOR transition: English High Court allows unilateral application of term SOFR-based rate as reasonable alternative to LIBOR

What has happened?

On 15 October 2024, the English High Court handed down its judgment in Standard Chartered PLC v. Guaranty Nominees Limited and others, finding in favour of Standard Chartered (SC).

The Court held that SC may unilaterally apply a replacement rate of three-month CME Term SOFR plus the three-month ISDA spread adjustment of 0.26161% when calculating an upcoming dividend on preference shares linked to now-discontinued three-month USD LIBOR (3m USD LIBOR). It also held that the replacement rate is currently the "reasonable alternative" to USD LIBOR.

The decision is the first in which the High Court has opined on the consequences for financial instruments of LIBOR's cessation. Given its importance, the case was heard by both a High Court judge (Mr Justice Foxton) and a Court of Appeal judge (Sir Julian Flaux) on an expedited basis under the terms of the Financial Markets Test Scheme.  

Key findings

In the judgment, the Court held that:

• where the definition of a particular LIBOR rate includes fallbacks, the Court will infer an intention for the contract to continue even if the rate is discontinued;
• if the express definition ceases to be capable of operation, as a matter of business efficacy, the Court will look to imply a term providing for a final fallback to the prevailing reasonable alternative rate;
• the determination of the "reasonable alternative rate" is an objective matter, and not one where the issuer has a broader discretion;
• the determination of the "reasonable alternate rate" should be as at each dividend date, to allow for the possibility of change with market developments; and
• as matters stand, CME Term SOFR plus the applicable ISDA spread is currently the reasonable alternative to USD LIBOR.

The decision will be of particular relevance to issuers of financial instruments that transitioned from LIBOR without investor consent or relying on "deemed" consent, as it effectively confirms that unilateral transition to a reasonable alternative rate can be an acceptable approach for financial instruments without adequate fallbacks. It may also encourage issuers of non-transitioned securities to adopt this approach as part of their remediation strategy. 

The High Court's endorsement of SC's SOFR-based replacement rate will also reassure firms that exercised discretion under English law instruments to transition from LIBOR to a risk-free rate, and reduce the potential for claims by out-of-pocket investors.

What are the facts of the case?

In brief:

• SC issued perpetual preference shares in 2006 with a dividend rate that subsequently switched to 3m USD LIBOR plus 1.51%. SC had the right to redeem the shares in January 2017 and every ten years thereafter;
• the contractual definition of "Three Month LIBOR"¹ contained a primary meaning (being the rate published on Telerate) and three fallbacks;
• the first two fallbacks relied on interbank lending quotations. The High Court proceeded on the basis that it would not be possible to obtain any such quotations. The final fallback required the 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;
• in March 2021, the FCA announced that all LIBOR rates would be discontinued immediately after 30 June 2023;
• in 2022/23, SC attempted to transition from LIBOR to a SOFR-based rate² with investor consent, but the consent solicitation process was unsuccessful;
• in accordance with the UK Benchmarks Regulation³, between 30 June 2023 and 30 September 2024 dividends were determined based on synthetic three-month USD LIBOR, which was calculated as CME Term SOFR plus the 0.26161% ISDA spread adjustment (the same methodology as SC's proposed rate). Synthetic three-month USD LIBOR was discontinued on 30 September 2024;
• the next quarterly dividend period will commence on 30 October 2024;
• SC brought the case to seek a declaration from the Court that it may use its proposed rate to calculate the next dividend payment and all payments thereafter. SC's proposed rate is the same as synthetic three-month USD LIBOR, and is also the fallback rate for similar contracts under US law; and
• the defendants, indirect holders of the preference shares, opposed SC's position, and sought a ruling that SC must redeem the preference shares as soon as legally possible.

What was SC's case?

SC's case was that, in the absence of 3m USD LIBOR, the terms of the preference shares allowed them to use a reasonable alternative rate. This, they said, would allow the holders to continue to receive a floating rate of interest, in line with the original terms, and give business efficacy to the contract.

SC put forward two arguments in support of this:

1. that the phrase "three month US dollar LIBOR in effect" (in the third fallback⁴) should be interpreted as meaning a rate that effectively replicates or replaces 3m USD LIBOR after synthetic three-month USD LIBOR has ceased (SC's interpretation argument); or
2. alternatively, that a term should be implied into the preference share terms allowing SC to use a "reasonable alternative rate" (SC's implied term argument) in place of 3m USD LIBOR.

SC also asked the Court to rule on whether their proposed rate was a reasonable alternative or, if not, what rate would be.

SC's interpretation argument rejected

The Court rejected SC's interpretation argument, finding that "in effect" referred to a LIBOR rate that was operative on a specific date, not a rate that replicates or replaces LIBOR ("a situation when no LIBOR rate is published on the relevant date, but a LIBOR rate first published on a prior date is treated as the effective LIBOR rate by the market (and so is “in effect” or operative) on the later date"). 

SC's implied term argument accepted

However, the judges agreed with SC's implied term argument, albeit a slightly modified version, finding that a term did indeed need to be implied. 

The actual term implied by the Court was that, if the express definition of Three Month LIBOR ceases to be operable, dividends should be calculated using the reasonable alternative rate to 3m USD LIBOR on the date on which the dividend falls to be calculated. 

"Reasonable rate" caveat

The purpose of the Court's modification to SC's suggested implied term⁵ was to stipulate that, while SC's proposed rate is currently the reasonable alternative to 3m USD LIBOR - being widely used, including in financial instruments that bear similarities to the preference shares - determination of the reasonable alternative to a particular rate is an objective question for the Courts, not a matter for SC or any other interested party, and such reasonable alternative rate may change over time as different rates become available.

What was the defendants' case?

The defendants argued that both of SC's arguments should fail, and that a different term (in the first instance, for redemption of the preference shares) should be implied.  

Why did the High Court side with SC on implied terms?

The Court accepted SC's implied term on the basis that:

• it was necessary to give business efficacy to the contract – the Court said here that, if a calculation mechanism is no longer operable, the Courts will generally be willing to imply a term "by reference to what is reasonable to enable the contract to be carried out";
• it was capable of clear expression and did not contradict any express terms of the preference shares; and
• the implied term was "so obvious that it goes without saying"

The Court decided point (iii) on the basis that it was clearly the intention of both parties that the contract would continue beyond 3m USD LIBOR's discontinuation. This was evidenced by: 

• the fact that both parties were seeking the implication of a term to facilitate this;
• the terms of the shares themselves, including that the shareholders had agreed to a dividend calculation method that allowed scope for changes in the make-up of the rate over time; and
• the classification of the shares as SC Tier 1 capital.

How relevant is this to the financial markets? 

Very. This is an important case and will be seen as a bellwether for investors who might otherwise have sought to challenge the unilateral transition of financial instruments from LIBOR to alternative rates. Although the case concerns preference shares, there are clear economic parallels with other floating rate instruments, so the judgment has broad relevance. 

Will this have precedential value for other non-transitioned financial instruments?

Likely.  The judgment's precedential value is likely to turn primarily on the definition of "LIBOR" in any given contract. However, the Court's conclusion that including fallbacks in the definition of a particular rate indicates an intention for the contract to continue after the rate's cessation will have broad relevance, especially for contracts entered into since LIBOR's cessation was first announced in 2017. In this regard, the judgment expressly states that the Court's rationale for agreeing with SC's implied term argument is likely to be "similarly persuasive" when considering the effect of LIBOR cessation on LIBOR-referencing debt instruments that do not contain fallbacks that expressly contemplate LIBOR's discontinuation.

The High Court's recognition that SC's implied term gave business efficacy to the preference shares is also likely to carry to other floating rate instruments.

So is CME Term SOFR plus the ISDA spread the only acceptable replacement for USD LIBOR?

No. It is not clear whether the "reasonable alternative rate" for 3m USD LIBOR will always be three-month CME Term SOFR plus the three-month ISDA spread adjustment for every contract. Although the experts agreed that, of the potential replacement rates available, SC's proposed rate is the closest to 3m USD LIBOR, the factual matrix for a particular contract could still lead to a different conclusion, particularly in light of the Court's ruling that the concept of a "reasonable alternative rate" is objective, temporal, and determinable by the Courts.

Annex

“Three Month LIBOR” definition, as used in the preference share terms:

“[primary meaning] the three month London interbank offered rate for deposits in US dollars which appears on page 3750 of Moneyline Telerate as of 11:00 a.m., London time, on the second business day in London prior to the first day of the relevant Dividend Period…;

[first fallback] provided that, if at such time, no such rate appears or the relevant Moneyline Telerate page is unavailable, it shall mean the rate calculated by the Company as the arithmetic mean of at least two offered quotations obtained by the Company after requesting the principal London offices of each of four major reference banks in the London interbank market, to provide the Company with its offered quotation for deposits for three months in US dollars commencing on the first day of the relevant Dividend Period to prime banks in the London interbank market at approximately 11:00 a.m.,
London time, on the second business day in London prior to the first day of the relevant Dividend Period and in a principal amount that is representative for a single transaction in US dollars in that market at that time;

[second fallback] provided further that if fewer than two such offered quotations are provided as requested, it shall mean the rate calculated by the Company as the arithmetic mean of the rates quoted at approximately 11:00 a.m., New York time, on the second business day in New York prior to the first day of the relevant Dividend Period, by three major banks in New York selected by the Company for loans for three months in US dollars to leading European banks and in a principal amount that is representative for a single transaction in US dollars in that market at that time;

[third fallback] provided however that if the banks selected by the Company,are not quoting as mentioned above, it shall mean three month US dollar LIBOR in effect on the second business day in London prior to the first day of the relevant Dividend Period.”