English High Court implies an alternative reference rate in post-LIBOR test case

The decision in Standard Chartered v Guaranty Nominees [2024] EWHC 2605 (Comm) considers how to interpret contractual provisions referencing LIBOR rates when LIBOR rates are no longer published. The decision (available here) is of interest to all parties with legacy financial instruments that use a LIBOR reference rate for pricing. This is only the second time that the Financial Markets Test Case Scheme has been used. 

The claim arose from the cessation of LIBOR

Dividends on preference shares issued by Standard Chartered in 2006 were stated to be calculated with reference to the three-month USD LIBOR rate. Developments over many years have culminated in the cessation of LIBOR reference rates (see our blog here). The dividend calculation provision and the fallback provisions of the preference shares therefore became inoperative. Standard Chartered sought but failed to obtain consent from investors to use SOFR plus an adjustment spread proposed by ISDA, a risk-free rate, as an alternative (the Proposed Rate).

The primary case advanced by Standard Chartered was that the express fallback provisions of the relevant instrument could be interpreted in such a way that, following the cessation of LIBOR reference rates, “permits the use of a rate which is effectively LIBOR – either because it is the rate which is being used in transactions where LIBOR was previously used, or because it is closest in its outcome to 3-month USD LIBOR, or some combination of the two” (para 54). This argument turned on the meaning of the words “in effect” in one of the fallback provisions, which referred to the use of the “three month US dollar LIBOR in effect”.  Standard Chartered sought, in the alternative, to persuade the High Court to imply a term into the wording of the relevant instrument, such that: (i) Standard Chartered would be able to itself determine a reasonable alternative reference rate to three-month USD LIBOR; and (ii) this discretion be subject only to a duty to act reasonably and in good faith (which is usually described in case law as the Braganza duty). Standard Chartered submitted that, in either case, the Proposed Rate “meets the requirements for the alternative rate” (para 34). Contrastingly, the active defendants (certain investors in the preference shares) sought an implied term for the automatic redemption of the shares as soon as legally possible.

Ultimately, the Court elected only to imply a term that the dividends should be calculated using the reasonable alternative rate. However, the decision made it clear that the Court, rather than Standard Chartered, is the “ultimate arbiter” in the “identification of the reasonable rate” (para 66(i)). In this case, the Court determined that the reasonable alternative, on the facts, is the Proposed Rate.

Establishing the need for an implied term

The Court reviewed the UK authorities on the proper construction and implication of terms into contractual agreements. A term must be implied when necessary to give business efficacy to the other terms of the contract. This was deemed to be the case here, on the basis that the preference shares were expected to be perpetual since: (i) they were issued to raise Tier 1 capital for regulatory purposes; and (ii) they have no maturity date, although Standard Chartered does have a periodic option to redeem the shares.

Accordingly, the Court decided that, if the express definition of Three-Month USD LIBOR ceases to be capable of operation, dividends from the preference shares should be calculated using the reasonable alternative rate to Three-Month USD LIBOR at the date the dividend falls to be calculated. The Court observed that it is “reluctant to contemplate the failure of partly executed contracts merely because they do not address a particular circumstance or eventuality which has come to pass” (para 52). 

Determining the reasonable alternative rate

The Court made clear that “the identification of the reasonable rate is an objective question”, emphasising the importance of the alternative reference rate being: 

1. based on a robust underlying market, including a consideration of the liquidity of that market across time; 
2. capable of being tested using historical data; and 
3. resilient to ”changing market conditions, structures and regulations” (para 70).

Several factors arising from expert evidence played into the decision that the Proposed Rate is the reasonable alternative rate, which the Court viewed as ”so obvious that it goes without saying” (para 69). Nonetheless, the Court expressly acknowledged that “the universe of available alternative reference rates might change over the life of the Preference Shares”, leaving the door open for future re-evaluation (para 66(ii)). 

Looking ahead

Whilst this test case relates to preference shares, the principles and key findings set out by the Court are applicable to a wide range of legacy financial instruments using pricing mechanisms that refer to USD LIBOR or other floating rates. The Court will not necessarily imply the same alternative reference rate in all circumstances but will be influenced by expert evidence on market conditions and practice and how best to give effect to the original arrangement. 

The transition away from using LIBOR reference rates towards risk-free rates has largely been achieved without major market disruption. However, there remain some long-term financial instruments with fall-back provisions that are either absent or do not operate in the way intended now that LIBOR reference rates are not available. 

Parties in this situation should attempt to vary terms by mutual consent. But, in the absence of a consensual amendment, this decision provides guidance on the approach that the English courts are likely to take in order to arrive at an alternative reference rate. Indeed, the Court stated that:

“the arguments which have led us to find the implied term at [66] above, and to reject the Funds’ implied term, are likely to be similarly persuasive when considering the effect of the cessation of LIBOR on debt instruments which use LIBOR as a reference rate but do not expressly provide for what is to happen if publication of LIBOR ceases” (para 86).

The Financial Markets Test Case Scheme

We will end with a procedural footnote. This is the second decision under the Financial Markets Test Case Scheme. The first was FCA v Arch, the FCA’s business interruption insurance test case brought at the height of the Covid-19 pandemic. The Test Case Scheme is available in Financial List claims which raise “issues of general importance in relation to which immediately relevant authoritative English law guidance is needed”, and it enables qualifying claims to be determined without a present cause of action between the parties to the proceedings. In other words, it is an exception to the general position that English courts do not answer theoretical questions. It is intended to allow the courts to promote integrity in financial markets by resolving uncertainty quickly. FCA v Arch arose in extraordinary circumstances and, arguably, raised more questions than it answered. The Test Case Scheme seems to have achieved a timely resolution for Standard Chartered, but it remains to be seen whether this will prevent the need for further litigation to answer important questions about the cessation of LIBOR reference rates.