High Court implies contractual terms following LIBOR cessation

The High Court has implied a term into a contract to the effect that where the contract specifies a calculation should be carried out by reference to LIBOR, where LIBOR is no longer published a reasonable alternative should be used.

Introduction

LIBOR, the London Interbank Offered Rate, was finally discontinued on 30 September 2024.  The abolition of LIBOR, which had been a globally recognised benchmark since 1986, left questions over how contracts whose terms referred to LIBOR would be construed going forwards.

This case was heard under the Financial Markets Test Case Scheme established by CPR Practice Direction 63AA, aimed at hearing cases which raise issues of general importance in relation to which immediately relevant authoritative English law guidance is needed.

Background

The case concerned preference shares (the Shares) issued by Standard Chartered (SC).  The sole registered holder of the Shares was Guaranty Nominees Ltd, the First Defendant, as nominee for JPMorgan Chase Bank NA (JPM).  JPM had issued American Depositary Shares (ADSs) in relation to the Shares.  The Second to Fifth Defendants were funds which held undisclosed amounts of the ADSs (around 10%), and it was the holders of those ADSs who held the economic interest in the Shares and so to whom any dividends would be paid.  The First Defendant took no active role in the proceedings.

Dividends on the Shares were to be paid a fixed rate for the first 10 years and at a floating rate of "1.51% plus Three Month LIBOR” thereafter.

With the abolition of LIBOR, this definition was no longer of use.  The terms of the Offering Circular for the ADSs did contain three 'fallback' options if LIBOR was not available.  The first two of those fallbacks involved using an average of the rates quoted directly by certain major reference banks.  It was common ground between the parties that those two fallbacks were not operable in the circumstances, because banks would not provide the required quotations.  The third option (the Third Fallback), which was the focus of the construction arguments before the court, set out that the parties could, if the reference banks were not providing the requested quotations, use: "…three month US dollar LIBOR in effect on the second business day in London prior to the first day of the relevant Dividend Period".  

Parties' positions

SC sought a declaration from the court, supported by an expert report.  SC's primary position was that the wording of the Third Fallback should be construed as meaning "a rate that effectively replicates or replaces three month USD LIBOR".  SC's alternative position was that a term should be implied into the terms governing the Shares that SC could use "a reasonable alternative rate to three month USD LIBOR".  In either case, SC's position was that a certain rate (known as the Proposed Rate, which is already widely used in the market as a substitute for 3 month USD LIBOR) should be used.  The Proposed Rate was produced by taking the daily rate for overnight lending secured by US Treasuries as published by the Chicago Mercantile Exchange Group Benchmark Administration (CME Term SOFR) and adding the ISDA Spread Adjustment (a fixed spread adjustment endorsed by ISDA).

The Second to Fifth Defendants successfully applied to be joined to the proceedings in order to oppose SC's position.  Those Defendants also filed their own expert report.  The Defendants' position, in summary, was that the court should imply a term that if the relevant LIBOR rate was not available, SC was obliged to redeem the Shares, and if that was not immediately possible then SC should pay dividends according to certain calculations until redemption did become possible.  The Defendants did not agree with SC's interpretation of the Third Fallback: on their construction, the Third Fallback could simply not be operated.  The Defendants also considered that using an alternative rate calculation was problematic because it would "raise the spectre of rival arguments as to which rate to use at each dividend calculation date."

Decision

The court considered the construction of wording of the Third Fallback and considered each of the parties' interpretations. The court also considered the law on implied terms and the parties' arguments as to whether their respective terms should be implied.

Ultimately, the court agreed with SC's alternative position in finding that a term should be implied 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." 

This implied term was, the court said, necessary to give business efficacy to the contract. The court considered that in all the circumstances the reference to LIBOR was "non-essential"; it really reflected "essentially a measure of the wholesale cost of borrowing over time" and its lack of operability should not stand in the way of the contract being performed. 

The court also considered that the implied term sought by the Defendants was not particularly clear, nor was it necessary to give business efficacy to the contract. It was also relevant that if the Defendants' primary position had been correct (that the absence of LIBOR should mean that the contract should come to an end), this would be contrary to the express terms of the contract which stipulated that the Shares were redeemable only at SC's election.

The court also agreed that in the present circumstances the Proposed Rate should be used.  The court did not accept the Defendants' concerns regarding potential rival rates on each dividend date, noting that the Proposed Rate was well established, had involved "many years' work by regulators, analysts and market participants" and that the Proposed Rate was accepted by both experts as the best available rate.

Wider relevance

Despite extensive work on the LIBOR transition, there will be many extant contracts and financial instruments which refer to LIBOR but do not expressly provide for what happens now LIBOR is not available.  This judgment will provide some clarity on the approach the courts may take to cases coming before it in which parties disagree as to the appropriate solution.

It is notable that in its reasoning, the court expressed the view that an implied term such as that proposed by the Defendants would likely be unworkable in debt instruments generally, since it would trigger immediate repayment without any statutory limitations on redemption of share capital and would unfairly place the cessation of LIBOR on the same footing as an event of default.  Parties should not assume therefore that if LIBOR is unavailable, the court will imply a term that the contract cannot continue.

The case is Standard Chartered PLC v (1) Guaranty Nominees Limited (2) D E Shaw Galvanic Portfolios LLC (3) Olifant Fund Ltd (4) FFI Fund Ltd (5) FYI Ltd [2024] EWHC 2605 (Comm).