Transition From LIBOR to SOFR - LIBOR Act Takes Out Some of the Bumps

 By June 2023, the estimates go, the Secured Overnight Financing Rate (SOFR) will replace the London Interbank Offered Rate (LIBOR).

IN THE MEANTIME

For more than four decades, LIBOR had been the benchmark for establishing adjustable rates for corporate debt, mortgages, and loans.

That was then.

Meanwhile, there is the transition. One piece that has been problematic is what is known as the “tough legacy” contract. Although it doesn’t have a formal definition, it accounts for more than $200 trillion dollars of financial instruments referencing LIBOR. Essentially that kind of contract has no effective fallback provisions that either are downright impossible or pretty near that to amend before the total shift to SOFR. That could trigger litigation.

THE LIBOR ACT TO THE RESCUE

On March 15, 2022, the Adjustable Interest Rate (LIBOR) Act – the LIBOR Act, for short – was signed into law by US President Joe Biden. That was part of the Consolidated Appropriations Act of 2022.

In this Client Memorandum, Wall Street law firm Paul Weiss explains for those of you with those “tough legacy” contracts how the LIBOR Act provides a clear uniform federal solution for the transition phase.

The short version is this: The LIBOR Act replaces the remaining references to the most common LIBOR tenors with a benchmark interest rate which will be set by the Board of Governors of the Federal Reserve. That will be based on SOFR. Also, it establishes a safe harbor from litigation for claims generated by selecting or using the Federal Reserve identified benchmark.

Overall, that approach, especially since it’s national, may provide three key benefits:

• Resolves issues with the patchwork system of state legislation.
• Mitigates market risk.
• Reduces possible litigation emerging from challenging legacy contracts.

ADVANTAGES IN MORE DETAIL

Paul Weiss gets granular on the potential benefits. They are:

Uniformity

There are two preemption provisions.

One preempts other replacement benchmark legislation for the most common tenors – the overnight, one-month, three-month, six-month, and 12-month USD tenors. (It excludes the less common one-week and two-month tenors.)

The other preempts state and local laws that limit the manner in which interest is calculated in relation to the replacement benchmark rate. That is, the national framework prevents conflict of law issues generated by states with competing legislation.

Certainty

As many know, state legislation runs into legal challenges on the Contract Clause and TIA grounds. The LIBOR Act resolves those two matters.

Here’s why, Paul Weiss explains.

Federal legislation is not subject to the Contract Clause. That’s because the clause explicitly and strictly applies to state government. But it does not in itself restrain the federal government from limiting the right to contract.

In addition, the LIBOR Act forestalls challenges on the TIA. That is by expressly amending Section 316(b). That amendment makes this clear: “the right of any holder of any indenture security to receive payment of the principal and interest of and interest on such indenture security to receive payments of the principal of and interest on such indenture security shall not be deemed to be impaired or affected” by the automatic replacement of LIBOR with a replacement benchmark rate.

QUESTIONS, NEED FOR LEGAL GUIDANCE

Paul Weiss experts on this development are listed in the Client Memorandum.

Editor-in-Chief Jane Genova has special expertise in financial and regulatory matters. Now and then she does freelance assignments for professional services firms such as Paul Weiss. You can connect with her at janegenova374@gmail.com.