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Peter Ashford
Partner, Fox Williams LLP, London
pashford@foxwilliams.com

Kate Felmingham
Senior Associate, Fox Williams LLP, London
kfelmingham@foxwilliams.com

LIBOR (London Interbank Offered Rate), the benchmark for interest and investment rates, is going to be phased out by the end of 2021. LIBOR is currently based on five currencies, seven maturities, and is regulated by the Financial Conduct Authority (FCA). Globally there is approximately US$350tn in contract exposure to IBORs (Interbank Offered Rates), so the scale of the issue in the move away from IBORs is not to be underestimated. As with any big change, the shift away from LIBOR is likely to result in disputes and disputes lawyers should get up to speed with an issue that the finance world has been grappling with for some time.

In commercial contracts, LIBOR can appear in many guises such as reference rate for interest on late payments, investment returns, share price adjustments, or intragroup loans, and may be seen by the arbitral community as a benchmark rate for interest on arbitral awards. While financial institutions grapple with the market implications, lawyers must consider the contractual risks of this transition. The United Kingdom Government has recently announced that it is considering introducing legislation for the ‘tough legacy’ contracts, which are ‘those contracts that genuinely have no or inappropriate alternatives and no realistic ability to be renegotiated or amended’.¹ Although many contracts do provide fallback provisions where there is a temporary halt in the publication of LIBOR rates, they do not contain provisions for permanent cessation of the rate. In most situations (ie, templated agreements such as ISDAs),² agreements and protocols will mitigate this transition risk, but it is those non-templated commercial contracts that are likely to be most problematic.

Without negotiated amendments or transitional support, where LIBOR is referenced in a contract, that wording will remain, but the LIBOR to which it refers will, after 2021, probably be a ‘legislative LIBOR’, which uses the alternative reference rate plus a spread adjustment, and bears little or no resemblance to the way in which LIBOR is calculated today. For GBP LIBOR, that new rate will be SONIA (Sterling Overnight Index Average) which, crucially, is not a like-for-like replacement because SONIA is currently an overnight rate which has no term premia or credit risk taken into account.A spread adjustment will not go all the way to evening out the fact that SONIA will be intrinsically lower than LIBOR. The legislative fix will result in winners and losers which is likely to give rise to disputes, no matter how carefully drafted the legislation will be. The losers on the new ratemay well turn to pursuing a claim.

But more generally, there is a global review of IBORs where most central banks and regulators are revisiting and consulting on the robustness of this lynchpin of the financial markets. Other countries are at different points in their reviews, with different outcomes expected; some may keep the IBOR and adjust the methodology, and others will abandon it altogether. So even though some may end up being largely aligned, many jurisdictions are ‘doing their own thing’, and at their own speed.

From the arbitration world’s viewpoint, there will be a practical issue that an arbitral tribunal will need to assess an interest rate when dealing with a  contract that provides for LIBOR and it will have to work out what should be used in its stead. Or not. If a non-representative, or ‘zombie’, LIBOR³ rate remains, even though the markets do not use it, should the tribunal use that? To depart from a LIBOR rate, which is provided in the contract, may give cause for challenges in domestic courts. Also, even if the tribunal does decide to substitute SONIA, Secured Overnight Financing Rate (SOFR) or the relevant currency alternative for LIBOR, what adjustment (term premia or credit risk) should they apply to that new rate? Perhaps to avoid this, tribunals may look to any statutory interest rate of the seat which, in the case of England and Wales, is contained in the Senior Courts Act 1981 and the Judgments Act 1838 (for High Court cases). Under the former it is discretionary (typically awarded at one or two per cent above bank base rates) and under the latter has been set at eight per cent since 1993. Although these are objective rates in that neither party’s perspective or situation is usually taken into account, these rates also do not fully take into account any economic realities. Specifically, the Judgments Act 1838 interest is designed, in part, to have a coercive effect and prompt the payment of judgments.⁴

Where a contract does not include reference to LIBOR, and where interest on damages is awarded ‘to compensate a receiving party for being kept out of its money and provide it with a form of commercially realistic restitution without punishing the paying party’,⁵ LIBOR is still an attractive benchmark rate. However, given that SONIA is not a like-for-like replacement rate, it seems as though one battleground is likely to be the adjustments to be applied to LIBOR if tribunals are required to, or insist on, using it, or to SONIA as a proxy for LIBOR.

On the face of it, what does it matter if different jurisdictions end up with different approaches to LIBOR? Consider a contract where the arbitration agreement states that the substantive governing law is New York, and the seat is London. The next point to remember is that in some jurisdictions the quantification of damages (and interest) is governed by the law of the seat, rather than the substantive or governing law. (Although lawyers from a civil law system may disagree with this statement since they tend to consider remedies a part of the substantive law.) This fact is fundamental; while a party must establish some liability for interest under the substantive law (in this example, New York), the remedy that can be granted is that of the lex fori,that is, the law of the seat. The remedy, including assessment or quantification of damages or interest, are procedural matters that are governed by the rules of the forum. This has been confirmed many times by the English Court but the leading case is Harding v Wealands [2006] UKHL 32 (see also Allen and Others v Depuy International Ltd [2015] EWHC 926 (QB) which applies Harding and gives guidance on the distinction).

So where the United States legislation or regulator declares that the US$ LIBOR replacement will be SOFR plus a spread, that will apply only to New York law-governed contracts, whereas previously US$ LIBOR was under the auspices of the FCA and an English issue. What then does the English seated tribunal need to apply? Is the tribunal obliged to look to SONIA as the prevailing rate at the seat? Although market convention will presumably follow the legislation, the tribunal are not bound to do so. In a complex, multijurisdictional transaction, where there are different legislative solutions applying to different rates, at different points in time, a tribunal may be confronted with significant conflict of laws and quantum issues to resolve.

Where the differences in the assessment may be nuanced, this is an area where lawyers and, especially, tribunals, need to be asking the right questions of the quantum experts. It is more than anecdotal to say that lawyers are ‘not good’ at numbers so interest calculations, which post-2021 will become more contentious, need to be more fully addressed rather than mentioned as an afterthought at the very end of proceedings and awards.

Another obvious area where LIBOR and arbitration may meet is in the event that a pre-2021 award includes interest payable by reference to LIBOR. Where those damages are not paid before the end of 2021, then the interest rate calculations will no longer be able to be done as LIBOR is, arguably, not a published rate. In many of these types of cases, one would expect the tribunal to be functus officio, meaning that the award cannot be rectified or clarified by the tribunal. If the parties are not able to negotiate what rate should be used for any sums accrued from 1 January 2022, then a new dispute may arise.

Given that an award binds only the parties and is not binding precedent, will we be faced with a wave of arbitrations that ask the same fundamental questions: can a tribunal find a suitable replacement for LIBOR and will that ‘replacement’ be the same across various types of agreements and products; how are LIBOR remedies to be crafted where the governing law and lex fori are different; and how will enforcing courts deal with awards referencing LIBOR-based interest?

Notes

1. See www.parliament.uk/business/publications/written-questions-answers-statements/written-statement/Commons/2020-06-23/HCWS307/. The US is also proposing a legislative solution and is further advanced than the UK.
2. International Swaps and Derivatives Association’s Master Agreement.
3. LIBOR is currently compiled from data submitted by a panel of banks. After 2021, those banks may stop submitting data and contributing to the LIBOR rate that may still be published. This would mean that a non-representative LIBOR rate would still be available.
4. Incidentally, it is a good reason not to provide for post-award interest in an English seated arbitration. Judgment can then be entered in the terms of the award and the judgment then carries interest at eight per cent.
5. Chartered Institute of Arbitrators’ Guideline on Drafting Arbitral Awards, Part II – Interest

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