LIBOR transition: less is more | Allen & Overy LLP

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In the race for remediation, now is the time for lenders to ease off on business permissions and legal advice.

It has been a fortnight since “freedom day” in the UK. Nightclubs have reopened. Bar service resumed. Strangers can, once again, stand uncomfortably close to each other during their daily travels.

The next steps are a balance between resources and risks. As is the case with LIBOR remediation. In the countdown to the judgment – we are five months away from “C-Day” – and in a market saturated with amendment exercises, is it time to reduce the conditions precedent?

It’s a hard habit to break. Business authorizations and legal opinions – “CP” – are ingrained in the practice of the loan market. On transactions that create new substantial obligations or extend existing ones, CPs are a standard issue in the prudent lender’s arsenal. But when the only change to the deal is to swap one benchmark for another, the law already provides protections for the company’s capacity. And if switching a business loan from LIBOR to risk-free rates (RFR) proves ineffective or unworkable, the consequences for the foreseeable future appear likely to be benign.

Out on a limb

It was different at first. Throughout 2019 and 2020 – the years of the rate change pioneers – offers for Royal Dutch Shell, British American Tobacco, Tesco and GlaxoSmithKline lay the keystones on the RFR road. Progress has been rapid. By Q1 21, the various versions of the AML exposure drafts had been upgraded to recommended forms. By the end of the second quarter, the RFR details debate was, for the most part, over and the market had more or less settled. And now? Lenders and borrowers performing remediation exercises should review their resources with a view to reducing costs.

Blessed ignorance

Company authorizations have long reinforced the ability of debtors to enter into riders. Descriptions in the minutes prove knowledge of the terms. The usual conclusions beginning with “BE IT RESOLVED…” decide the debate.

As a general rule, the more seismic the separation from the original obligation, the more relevant the concern of questioning the change. On contentious transactions involving delicate transitions (restructuring and the like), CPs are essential. But where the only deviation from the original deal is the shift from LIBOR to a rate designed to create economic equivalence with its predecessor, the de minimis capacity risk does not justify what can become, for large multinational groups, a maximis costs.

Legal protection

But what if a debtor claims not to be bound by the terms of the rider agreement?

For English debtors, where a person deals in good faith with a company, the powers of the directors to bind the company, or to authorize others to do so, are deemed to be free from limitation under the constitution of the society.1 And how should this protection be invoked when the client is an English company? Lenders should require an administrator to sign any rider agreement on behalf of the debtor or, in the case of a group transaction, an administrator of the debtor’s agent.

Other countries have similar legislation to protect the interests of bona fide contracting parties. In France, Germany and Italy, the legal positions are roughly equivalent to those in the Companies Act 2006. Lenders living under CP-lite should ask a lawyer to confirm, for each jurisdiction, which agent should sign the rider agreement. Advice can generally be extended to all transactions; in LIBOR-land one size fits all very often.

Laws aside, the longer the period from the point of remediation, the greater the climb for a debtor to overcome if he seeks to assert that he has not accepted the relevant review. For English companies, and in the absence of objections, the finance parties may assume that after making the first interest payment, the borrower has confirmed the amended terms.

Aggravating concerns

Among the changes to the loan contracts resulting from the LIBOR restructuring, one calls for further reflection. In some jurisdictions, including France, Italy, Germany, and the United Arab Emirates, there is a general ban on compound interest. This restriction is likely to negatively affect the applicability of obligations to pay interest when it refers to a compound rate. A potential roadblock on the recovery route.

No PA can legalize the composition of interest in jurisdictions where it is prohibited, nor guarantee reimbursement of repayments. To understand the jurisdiction-specific risks involved in including compound interest provisions in a credit agreement, the best approach is to receive clear and accessible legal advice on enforceability. Highly qualified legal advice can hinder a lender’s ability to assess risk but, on the other hand, including such qualifications in these standard documents can help flag defaults. In the absence of a clear notice and in jurisdictions which do not yet encourage interest building, a CP applicability notice still appears to be a proportionate request.

Last tariff in force

FCA continues to recommend an active transition to RFRs. This is politically prudent: each successful transition creates a further drop in liquidity in the markets for the new benchmarks.

But what about loans to businesses that cannot (or will not) yet transition, the so-called “hard legacy”? And could the expected synthetic successor to panel banking LIBOR provide some support?

In its June 2021 consultation (the Consultation),2 the FCA has indicated that it proposes to use its new powers under the UK benchmarks regulation to require the ICE Benchmark Administration to publish LIBOR on a synthetic basis. Statements suggest that synthetic LIBOR appears to include the aggregate of:

1. the relevant forward-looking term RFR; and

2. the Fixed ISDA spread adjustments published by Bloomberg for the relevant currency and interest period (ISDA CAS).3

For the LIBOR liquidation window, which does not have a current closing date, the Consultation confirms that “Synthetic LIBOR remains LIBOR and should extend to… existing contracts outstanding”. Good news for parties to LMA-type loan agreements that were not remedied as of December 31, 2021, or for which remediation has gone badly.

So, on business credit transactions where the only change to the contract is the replacement of a benchmark rate, let’s look at the legislation and get rid of the CPs.

It is not a legal opinion relating to a specific situation and should not be relied on as such.

Footnotes

1Section 40 (1), Companies Act 2006.

2“Proposed decision under Article 23D BMR for LIBOR parameters 6 pounds sterling and yen” https://www.fca.org.uk/publication/consultation/cp21-19.pdf

3https://www.fca.org.uk/publication/consultation/cp21-19.pdf, by. 1.14.


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