Judgment handed down in LIBOR test case

The recent decision in Standard Chartered plc v Guaranty Nominees Ltd & ors is understood to be the first time the High Court has had to rule on declarations as to the appropriate interest rate to be applied in place of LIBOR since the benchmark rate was wound down.

Background

In 2006, Standard Chartered (SC) issued preference shares to Guaranty Nominees (GN) as nominee for JP Morgan Chase Bank NA (JPM) (the Preference Shares) for the purposes of raising capital. JPM in turn issued American Depositary Shares (the Depositary Shares), the holders of which therefore held the economic interest in the Preference Shares. Between them, the Second to Fifth Defendants (the Funds) held just over 10% of the value of the Depositary Shares.

Under the terms of the Preference Shares, dividends were payable at a fixed rate of 6.409% pa until 30 January 2017 and thereafter at a floating rate of “1.51% plus Three-Month LIBOR”. The definition of “Three Month LIBOR” contained a primary meaning with three alternatives, referred to in the judgment as the First, Second and Third Fallbacks. 

Following an unsuccessful attempt to amend the dividend rate for the Preference Shares consensually by special resolution in light of the wind down of LIBOR, SC announced in June 2023 that dividends would be calculated by reference to 3-month synthetic LIBOR. In April 2024, SC issued proceedings for declaratory relief. 

It was common ground that, since synthetic USD LIBOR ceased to be published at the end of September 2024, it was no longer possible to operate the First or Second Fallbacks. The Third Fallback was in the following terms:

“…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.”

SC’s primary case was that the words “three month US dollar LIBOR in effect” should be construed as “a rate that effectively replicates or replaces three month USD LIBOR”. Alternatively, SC contended that an implied term should apply to the effect that SC was entitled to use a reasonable alternative rate to 3-month USD LIBOR.

In either case, SC submitted that the alternative rate, supported by expert evidence, should be CME Term SOFR plus the ISDA Spread Adjustment (the Proposed Rate). 

In response, the Funds argued that the Preference Shares should be redeemed pursuant to a two-stage approach. Under a “stage one” implied term, the Funds contended that SC should redeem the Preference Shares shortly before 3-month USD LIBOR ceased (the “Impossibility Redemption Date” (IRD)), paying (i) the amounts paid up plus (ii) the dividends accruing between the last dividend payment date and the IRD. 

To the extent the Preference Shares could not be redeemed in that way, the Funds said a “second stage” term should be implied.  Under that term, until such time as SC could redeem the Preference Shares, it would pay to the holders an equivalent of a dividend, with a dividend rate of either (i) the last published LIBOR rate + 1.51% or (ii) 6.409%.

Judgment

Following a 3-day hearing before Chancellor of the High Court Sir Julian Flaux and Mr Justice Foxton on an expedited basis under the Financial Markets Test Scheme (underling the importance of the issue to the wider financial market), judgment was handed down on 15 October 2024. 

Interpretation

The Court rejected SC’s primary argument that the words “three month US dollar LIBOR in effect” in the Third Fallback should be construed as “a rate that effectively replicates or replaces three month USD LIBOR”.  The Court considered that, in the context of the Third Fallback, “in effect” meant “in force” or “in practice” at the time rather than, as SC contended, “effectively”. 

Implied terms

The Court had little hesitation in finding that all the relevant criteria[1] to imply a term into the Preference Shares were met. It held that it was appropriate to imply the following term (essentially endorsing SC’s proposed 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”.

In reaching this conclusion, the Court considered that it was clear from the express terms of the Preference Shares that the parties did not intend issues with the availability of LIBOR to frustrate the contract – the inclusion of the three fallback provisions was evidence of this. 

In contrast, the Court found that the Funds’ proposed implied term, requiring redemption of the Preference Shares, failed to satisfy any of the relevant criteria for implied terms, and described the proposed term as “wholly untenable”. 

Alternative rate

Both parties adduced expert evidence as to the appropriate alternative rate.  The experts agreed that of the available reference rates, the Proposed Rate was the closest to 3-month USD LIBOR.

There was, however, considerable disagreement between the experts as to how closely the Proposed Rate would match 3-month USD LIBOR over time.  The Court accepted that there could be economic conditions in which the Proposed Rate could be materially less than what 3-month USD LIBOR was likely to be and vice versa, but held that the possibility of differences did not put the Proposed Rate outside the scope of the implied term.

To guard against the scenario where the Proposed Rate was no longer a reasonable alternative rate, the Court’s implied term introduced a temporal provision, requiring an assessment as to the reasonable alternative rate as and when dividends fell to be calculated. 

Key takeaways

This decision provides helpful guidance for any contracting parties dealing with disputes arising out of the wind-down of LIBOR and what rate should be used as a replacement.

In particular, it will make it harder for parties attempting to get out of or unwind a contract on the basis that the cessation of LIBOR had frustrated the ability to perform the contract.  The Court was clear that this could not have been the intention of the parties given the fallback scenarios that had been drafted and that an implied term about a replacement rate was appropriate to ensure continued business efficacy.  Whilst that leaves a question of what happens with contracts where there are no fallback provisions, the judgment emphasised that the Court’s reasoning for implying a term was likely to be persuasive in scenarios with no fallback provisions.  

The Court’s approval of the Proposed Rate is a relatively uncontroversial outcome.  As the judgment itself notes[2], the Proposed Rate has already been endorsed by regulators and widely adopted by market participants as an alternative to LIBOR:

“The reality is that it has involved many years’ work by regulators, analysts and market participants to arrive at the rate which both experts accept is the best available rate, and the Proposed Rate is now a well-established rate used across the financial markets in a variety of financial instruments. The use of the Proposed Rate as a replacement has been endorsed by financial regulators of the major markets in the US and the UK. Further, the benefits of continuity and predictability which will follow from the continued use of the same replacement rate will themselves be matters that can be relied upon to support the contention that this remains the reasonable alternative rate, even if other alternatives become available. Against that background, identifying a viable superior rate will be no mean undertaking, and will become more difficult over time.”

By acknowledging, however, that there may be economic circumstances where the Proposed Rate was no longer a reasonable alternative rate to 3-month LIBOR and introducing a temporal assessment each time a calculation was due, the Court has left open scope for future arguments. Going forwards and as the cessation of LIBOR gets further into the past, it may become harder and harder to say what 3-month LIBOR would have been and what is therefore a reasonable alternative rate.