The High Court has held that, when the terms of payment on preference shares became unworkable due to the cessation of LIBOR, payments would continue but would be referenced to the nearest equivalent rate.
What happened?
Standard Chartered plc v Guaranty Nominees Ltd and ors [2024] EWHC 2605 (Comm) concerned the terms of preference shares issued by Standard Chartered (SC).
SC had issued the preference shares to raise "Tier 1" regulatory capital. The sole holder of the shares was a depositary, which in turn issued American depositary receipts (ADSs) linked to the shares. The ADS holders included a series of funds.
The terms of the preference shares required SC to pay a semi-annual dividend at a fixed rate for an initial period, then at a floating rate of "1.51% plus Three Month LIBOR". The shares were redeemable but perpetual – that is to say, there was no fixed date for their redemption. Rather, SC had the option to redeem them at specific times. This was consistent with regulatory requirements for Tier 1 capital.
SC's articles of association set out in detail how to calculate "Three Month LIBOR". In the first instance, they referred to the rate quoted by Moneyline Telerate for US dollars (USD).
If that failed, the articles contained three successive, detailed fallback methods for establishing a suitable rate of a kind commonly found in financial instruments. The parties produced evidence that, for various reasons, these fallback methods were no longer capable of being used.
In the United States, the Federal Reserve System recommended replacing USD LIBOR with a new rate. This rate was based on the Secured Overnight Funds Rate (SOFR) published by the Chicago Mercantile Exchange, supplemented by a fixed spread adjustment determined by the International Swaps and Derivatives Association (ISDA). The judgment refers to this as the "Proposed Rate".
In the UK, the Financial Conduct Authority and Bank of England had also voiced their support for the Proposed Rate as a replacement for USD LIBOR. To ease the transaction away from LIBOR, 1-, 3- and 6-month USD LIBOR, settings continued to be published on a synthetic basis. But, at the end of September 2024, synthetic USD LIBOR also ceased to be published in the UK. The withdrawal of synthetic USD LIBOR coincided with the dates of the hearing in this case.
The issue before the court was the impact of the withdrawal of USD LIBOR on the preference shares in circumstances where none of the agreed fallback methods was still available.
What did the court say?
The court held that payments would continue to accrue on the preference shares but would be linked to the Proposed Rate instead of USD LIBOR.
To achieve this, the court implied a term into SC's articles that, if LIBOR were to cease to be available (as, in fact, happened), dividends would be calculated using a "reasonable alternative rate".
The court can imply a term into a contract (including a company's constitution) only if certain conditions are met. In short, these are that:
- the contract is ambiguous or unclear and it is not possible to interpret in a way that makes it work properly;
- the term to be implied is clear, reasonable and equitable and does not contradict any express terms within the contract; and
- the implied term is necessary to give business efficacy to the contract.
When deciding whether a term is necessary, the court will ask whether the contract would lack coherence without the term or whether the term is so obvious that it goes without saying.
In this case, the court found that the parties did not intend for any issues with the availability of LIBOR to prevent the continued operation of the preference shares. This was evident from the fact that the articles provided fallback scenarios should it not be possible to ascertain the appropriate LIBOR rate, even though the fallback scenarios agreed here were no longer capable of applying.
The court also drew on previous cases in other contexts in which the court had substituted alternative calculation mechanisms where the contractual mechanism could no longer function properly.
In deciding which rate was a reasonable alternative, the court found the Proposed Rate to be most suitable. It had become "a well-established rate used across the financial markets" and had been "endorsed by financial regulators of the major markets in the US and the UK".
The judge declined to apply SC's suggestion that its board had an implied power to fix a reasonable alternative rate (although SC had argued that its board would have fixed the Proposed Rate). The identification of any reasonable replacement needed to be objective (with the court as the ultimate arbiter), rather than at SC's discretion.
The funds had suggested that, following the cessation of USD LIBOR, it was an implied term that SC would redeem the preference shares on notice from the holder and, until then, it would pay dividends at one of the previous rates set out in the articles, which would continue to apply as a fixed rate.
The court declined to follow this approach, noting that an automatic redemption was not necessary to fulfil the terms of the shares and, in fact, ran counter to the notion that the preference shares were a long-term capital investment designed to constitute Tier 1 capital and redeemable only at SC's option.
What does this mean for me?
New contracts are no longer drafted to refer to LIBOR for obvious reasons.
For existing arrangements, many parties will by now have amended their contract terms to refer to a different rate instead of LIBOR.
The most appropriate rate will likely depend on the currency to which LIBOR was referenced. For example, the replacement rate of sterling LIBOR in the UK is the Bank of England's Sterling Overnight Index Average (SONIA) rate.
However, it is also acceptable and not uncommon simply to refer to the base rate of a particular bank, with an added margin. This may be particularly useful or appropriate if both contract parties retain deposits at the same financial institution.
In some cases, however, references to LIBOR will linger. This may happen where the parties cannot agree on a replacement rate, or where amending the arrangement is difficult due to particular procedures. (For example, in this case, it would have required a special resolution of SC's shareholders to amend its articles of association and so change the reference to LIBOR.)
In these cases, the courts will be ready to substitute an appropriate alternative, rather than allow the contract to fail.
Indeed, in comments towards the end of the judgment, the court suggested that a similar approach would apply beyond preference shares to debt instruments more generally. It is, therefore, appropriate to assume that the same position will apply to loan facilities, bonds and notes that refer to LIBOR and do not explicitly provide for an available alternative rate, or where none of the methods of calculating an alternative rate which are stipulated can apply.
The fact that the court will substitute an objectively reasonable replacement rate should give contract parties comfort that their arrangements will not be substantially altered by legal proceedings.
Nonetheless, this exercise will necessarily involve applying a rate the parties cannot have envisaged at the time they made their bargain. Businesses would therefore be wise to review their contractual arrangements to identify any remaining references to LIBOR and, where possible, engage in discussions to introduce a suitable replacement.
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.