On March 6, 2020, the Alternative Rate Reference Committee (ARRC), the Federal Reserve's LIBOR-transition working group comprised of private-sector entities and industry regulators, issued a press release of its New York State legislative proposal for amending financial contracts that lack adequate fallback language. The proposed New York law would apply to certain LIBOR-based financial contracts executed prior to LIBOR's discontinuation and amend them, by operation of law, to include ARRC's recommended fallback rate plus a spread adjustment. ARRC drafted the law to provide legal certainty and to minimize the potentially adverse economic consequences associated with the industry's transition away from LIBOR.
Background: ARRC's Fallback Language and Replacing LIBOR
LIBOR is predicted to be discontinued by the end of 2021; however, a substantial number of financial contracts reference LIBOR, most of which do not include provisions (known as "fallbacks") that provide an alternative benchmark rate in the event that LIBOR is temporarily or permanently discontinued. To address this issue, ARRC has (1) recommended a Secured Overnight Financing Rate (SOFR)—SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities in repurchase markets that the Federal Reserve Bank of New York began publishing in 2018—plus a spread adjustment to replace LIBOR and to operate as a fallback, (2) released a transition plan promoting the use of SOFR voluntarily, and (3) conducted five market-wide consultations to determine how best to implement SOFR-based fallback language into existing LIBOR-based financial contracts. Through those consultations, ARRC observed that many market participants were unable to amend their existing agreements to remove LIBOR-based fallback language. Several products, including floating rate notes, securitizations, consumer adjustable rate mortgages, derivatives, business loans, procurements and municipal bonds, contain procedural and substantive barriers that complicate amending the agreements underlying them. Accordingly, primarily because (1) a substantial number of financial contracts referencing USD LIBOR are governed by New York law, and (2) amending bilaterally has proven challenging, ARRC's proposal for implementing its recommended fallback provisions is a New York law that would legislatively incorporate ARRC fallbacks into existing ("legacy") contracts. Legislative action is expected to provide help maintaining consistency and financial stability for consumers, businesses, lenders and investors as well as reduce the burden on New York courts that would otherwise arise from disputes relating to contracts referencing LIBOR.
The Legislative Proposal: Key Takeaways
The proposed legislation activates when either (1) a "permanent cessation trigger" occurs, or (2) a "pre-cessation trigger" occurs. A permanent cessation trigger is defined as a public statement by the administrator of LIBOR—or the administrator's regulator—announcing that LIBOR has ceased or will cease. A pre-cessation trigger is defined as a public statement by the regulator of LIBOR's administrator announcing that LIBOR is no longer available. At its core, the proposed legislation:
- prohibits a party from refusing to perform its contractual obligations, or declaring a breach, as a result of LIBOR discontinuation or the use of the legislation's recommended benchmark replacement rate;
- establishes that the recommended benchmark replacement is a commercially reasonable substitute for and a commercially substantial equivalent to LIBOR; and
- provides a safe harbor from litigation for the use of the ARRC-recommended benchmark replacement rate.
To accomplish these objectives, the proposed legislation has mandatory and permissive application depending on the nature of the agreement.
On a mandatory basis, the proposed legislation:
- overrides legacy fallback language that references a LIBOR-based rate (such as "last quoted LIBOR") in favor of the legislation's recommended benchmark rate;
- nullifies legacy fallback language that requires polling for LIBOR or other interbank funding rates; and
- inserts the legislation's recommended benchmark replacement as the LIBOR fallback in legacy contracts that do not contain fallback language.
There is no override of legacy fallback language that expressly references a non-LIBOR-based rate (e.g., the prime rate) as is common in business loans.
On a permissive basis, the proposed legislation:
- allows parties with the right to select their agreements' governing fallback rates to avail themselves of the litigation safe harbor if they select the ARRC-recommended benchmark replacement rate; and
- permits parties to mutually opt out of the proposed legislation's mandatory application at any time.
The proposed legislation does not categorically exclude any product from its definitions. Accordingly, ARRC encourages parties for whom the legislation is not effective, to exercise their opt-out rights and negotiate bilaterally. Further, the proposed legislation would provide safe-harbor protection with respect to conforming changes in documents made to accommodate administrative/operational adjustments for the statutory endorsed benchmark rate.
Potential Legal Implications
As noted above, the proposed legislation is designed to create more certainty for legacy LIBOR-based financial products and to minimize potential litigation that might otherwise arise in connection with the cessation of LIBOR. Absent the legislation, it is possible that the uncertainty around a replacement for LIBOR in legacy agreements could lead to legal disputes.
While it was initially believed that the proposed bill would be folded into the New York State budget bill, with the expectation that it would be included in the round of bills incorporated into the budget on April 1st, it remains uncertain that the bill will be passed by the June 2nd recess due to the current expectation that the legislature will be focused on COVID-19-related matters.