In the global transition away from inter-bank offered rates, including LIBOR, recent developments in the US reflect a renewed focus on implementing a legislative solution to remediate so-called "tough legacy" contracts - those contracts that contain either no fallback provisions or inadequate fallbacks, and that are not remediated by the parties.
On 28 October 2020, the New York State Senate introduced Senate Bill S9070 (the NY Bill), which, if adopted, would amend the Uniform Commercial Code to introduce new statutory provisions that would apply if USD LIBOR were to be discontinued or cease to be representative of the underlying market.
The NY Bill largely replicates draft legislative proposals published by the Alternative Reference Rate Committee (the ARRC) earlier this year. It would apply to each contract, security or instrument that: (1) uses USD LIBOR as a benchmark and contains no fallback provisions or (2) contains fallback provisions that provide for a benchmark replacement that is based in any way on any USD LIBOR value. The NY Bill provides that, on the occurrence of certain trigger events, these "tough legacy" contracts, securities and instruments would be amended to replace references to USD LIBOR with the rate formally recommended by the Federal Reserve Board, the Federal Reserve Bank of New York, or the ARRC (or any successor).
The trigger events are broadly similar to those proposed under draft legislative proposals in the UK and the EU but, notably, do not include a statement of a future loss of representativeness, which has become a commonly accepted feature of contractual pre-cessation trigger events in the UK market.
The rate replacement would take effect by operation of law, and the new rate would incorporate any spread adjustment or conforming changes recommended by one of the relevant bodies mentioned above. Any existing fallback provisions based on dealer polls (such as the current fallbacks for floating rate options in the ISDA 2006 Definitions) or similar methods would be invalidated.
For contracts that fall outside the scope of the legislative solution, any person with authority under the relevant contract to determine a benchmark replacement or calculate a payment based on a benchmark (for example, under generic "rate switch" provisions that do not specify a replacement rate) would also be able to designate the recommended rate as the replacement for USD LIBOR and benefit from the safe harbour protections available under the NY Bill (outlined below).
The NY Bill also provides that:
- parties would be able to contract out of its provisions or agree on other non-LIBOR replacement rates which are not recommended by the bodies mentioned above;
- the use or implementation of a recommended replacement rate would be deemed to constitute a commercially reasonable substitute for USD LIBOR; and
- the use of a recommended replacement rate would be deemed to not constitute an amendment to the contract, a material adverse effect under the contract, or a breach of the contract.
Where a replacement rate is used, whether by operation of law or otherwise, the NY Bill provides a safe harbour from litigation, pre-empting claims for damages or equitable relief from out-of-pocket counterparties. Banks are likely to welcome this protection in particular.
A floor vote on the NY Bill is not expected until the New York State Legislature reconvenes in January 2021. However, following the recent US elections (including at state senate level), there is some uncertainty as to whether the legislation will be taken forward. Also, if the NY Bill is enacted into law, there has been speculation that it could be challenged as being unconstitutional on the basis that it varies the terms of private contracts.
Relatedly, federal legislation modelled on the NY Bill is also under development in the US.
The US solution to tough legacy contracts is still in the early stages of development, and is markedly less well progressed than proposed solutions in the UK and the EU (see our briefings here and here). This relatively "quick fix" legislative solution would be a welcome development, and would undoubtedly save market participants time and money if enacted in good time and, crucially, if found constitutional. However, divergences in the solutions proposed by the UK, the EU and the US could prove challenging and disruptive for international market participants engaged in cross-border transactions.
Authors: James Knight, Kirsty McAllister-Jones, and Mike Neary.
