2021 is seeing the phasing out of the long established London inter-bank offer rate (LIBOR), with global regulators reiterating that market participants cannot rely on LIBOR being published beyond 31 December. As the global financial market is transitioning from interbank offered rates to a new era of objective quantification offered by risk-free reference rates (RFRs), financial institutions and other lenders are dealing with the necessary amendments to a raft of legacy facilities.
At the same time lenders will need to be conscious that, in the case of secured facilities, any amendment to the underlying facility agreement may have an impact on the continued validity of security.
Zoë Hallam, Jon Le Rossignol, James Denham and Pascalle Palmer from our specialist Banking and Finance team explain what the consequences of
LIBOR transition might be for existing Guernsey, Jersey, Cayman Islands and/or British Virgin Islands (BVI) law governed security, and reflect on how lenders have documented this transition to RFRs.
Step 1 - Examining any LIBOR transition mechanics
The first step is to examine the underlying legacy facility agreement to check if it contains LIBOR transition language. In most facility agreements where the interest rate is linked to an inter-bank offer rate there will already be provisions contemplating a replacement screen rate. Nevertheless, unless a replacement rate is hardwired into the documentation, amendments will be required to transition to such rate.
Step 2 – Examining the definition of secured liabilities
Assuming that there is no replacement rate hardwired into the facility agreement, and that an amendment will therefore be required, we will need to examine the definition of “Secured Liabilities” or “Secured Obligations” in the Guernsey, Jersey, Cayman Islands or BVI law security agreement, and consider whether the amended obligations continue to fall within that definition. Most commonly, these definitions reference liabilities secured under a particular set of finance documents, including the relevant facility agreement. A well drafted definition should refer to those finance documents “as amended from time to time”, otherwise it may be difficult to conclude that that the existing security would continue to secure the obligations as amended. The definition of “Finance Document” itself should also be reviewed to check that it includes any document designated by the borrower and the lender/agent as such, including, importantly, any letter or agreement documenting the proposed amendment.
If the definition of “Secured Liabilities” or “Secured Obligations” refers to the underlying finance documents as may be amended from time to time, the next step is for the secured party to consider how to interpret it.
Step 3 – Considering how to interpret the definition of secured liabilities
The first issue is whether the amendment to the facility agreement to transition away from LIBOR is sufficiently fundamental that it can result in the amended agreement being treated as a new agreement (often referred to as the “tipping point” question).
The second issue is whether the purported amendment takes the secured obligations beyond the “general purview” of what was contemplated by the parties when entering into the original transaction.
In practice the first and second issues are difficult to distinguish, albeit as the purview principle has its origins in the law relating to guarantees there is arguably a lower threshold to engaging it, particularly in the case of third party security (where the security provider is granting security for the obligations of someone else and will usually not be party to the facility amendment agreement). The consequence for the existing security however, is the same; if the amendment is sufficiently fundamental that it could result in a new agreement, or if the amendment takes the secured obligations beyond the “general purview” of what was originally contemplated, new security is required.
If there is English law security in the transaction, then English counsel will likely also be considering the same issues and the position it takes regarding confirming or retaking security will also be persuasive (particularly as the body of case law around purview originates from the English courts).
Practical guidance and conclusion
- Banks and financial institutions are now fully engaged on LIBOR transition and the market's approach to dealing with secured facilities is becoming settled.
- Where the underlying facility agreement contains LIBOR transition language, or where an amendment is required to the underlying facility agreement solely to effect a transition away from LIBOR, secured parties are unlikely to require new security to be granted.
- However, secured parties' are generally requiring security confirmations and legal opinions in respect of offshore obligors where amendments are being made to secured facility agreements which are broader than dealing with solely the LIBOR transition.
- Where an offshore “Obligor's Agent” is acting as agent to execute an amendment agreement on behalf of other obligors there are generally no specific impediments to this as a matter of Guernsey Jersey, Cayman Islands or BVI law (and as distinct from considering an English obligor acting in the same capacity), provided the appointment is valid under the governing law of the document in which it was made (usually the facility agreement) and such appointment was duly authorised at the time of the original financing.
- However, if an amendment agreement contains a guarantee and/or security confirmation, we are commonly seeing secured parties required each obligor to execute the amendment agreement, rather than relying on any agency provisions.
- In a market where secured parties are increasingly seeking to examine and rely upon rights under security documents, erring on the side of caution is warranted and will typically be backed by a costs indemnity and further assurance clause in the finance documents.
- That said, the commercial background to the transaction, the approach foreign counsel take to any existing foreign security and the secured party's risk appetite will all have a bearing on whether new security is taken or a security confirmation is used.
- It is possible, where appropriate, to ‘layer' Guernsey, Jersey, Cayman Islands and BVI security, in other words leave the existing security in place and take new – albeit second ranking – security over the amended obligations which avoids resetting hardening periods in relation to the original security.
- In Jersey, if dealing with security originally created under the Security Interests (Jersey) Law 1983, there will likely be benefits to the secured party of taking new security under the law by which it has been superseded, being the Security Interests (Jersey) Law 2012.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.