The global financial markets are currently preparing for the phasing out of the London Inter-bank Offered Rate (or LIBOR) and other Inter-bank Offered Rates (or IBORs). LIBOR is the most widely used benchmark interest rate globally, employed in an estimated US$350 trillion worth of financial contracts worldwide. LIBOR may also be used in commercial contracts – for example, in price adjustment mechanisms in share purchase agreements, price escalation clauses or as a reference rate for contractual interest on late payments. LIBOR may also be specified in arbitration clauses as a benchmark rate for interest on the award.
The clock is now ticking towards the deadline of the end of 2021 for the market to be ready but there is concern that many contracts will not be amended voluntarily by that time. Recognising the impact on existing contracts of the transition, the Tough Legacy Taskforce, part of the industry-led Working Group on Sterling Risk-Free Reference Rates, was set up to provide market input regarding the ‘tough legacy’ of products that may prove unable to be converted or amended to include robust fallbacks to address the end of LIBOR. Last month the Tough Legacy Taskforce published its report (the Tough Legacy Paper). As discussed in detail in our blog post here, the Tough Legacy Paper serves to highlight the difficulties in amendment of contracts, and particularly the complex relationship between contracts in different asset classes in many transactions.
Many financial instruments affected by the discontinuation of LIBOR will include arbitration clauses. As discussed below, whilst the substantive disputes arising from the end of LIBOR will be the same whether they are resolved in a court or by an arbitral tribunal, there are some additional considerations particular to the arbitration process which are relevant in the context of LIBOR discontinuation disputes. Further, even when determining a dispute which does not arise from the end of LIBOR, arbitral tribunals may have to grapple with how to award interest where an arbitration clause uses LIBOR as a reference point. Read more in the E-bulletin here.
Arbitration clauses in financial instruments and “end of LIBOR” disputes
As noted in the ICC Commission Report on Financial Institutions and International Arbitration, “[a]rbitration is increasingly a part of the strategic options considered for cross-border banking and financial disputes“. Arbitration clauses are included in all types of financial instruments in the loan, bond, securitisation and derivatives markets. As such, it is likely that some of the inevitable disputes arising from the phasing out of LIBOR will fall to be determined by arbitral tribunals.
Disputes may arise out of (i) legacy contracts which contain inadequate fall-back mechanisms to address the phasing out of LIBOR and/or which are affected by any possible legislative fix; and (ii) contracts entered into now whilst the replacement for LIBOR is uncertain, containing placeholder or temporary replacements for LIBOR. The nature of disputes arising in the loan, bond, securitisation and derivatives markets are discussed in detail in this E-bulletin. The E-bulletin focuses on English law agreements and illustrates the uncertainty of outcomes, where standard English contract law principles of construction are applied or attempts are made to imply terms to address the discontinuation of LIBOR in an anticipated range of different situations. Of course, similar issues will apply in relation to other IBORs, for each of which replacement risk-free rates are being developed, and tribunals may consider similar disputes under various different governing laws.
Arbitration of LIBOR discontinuation disputes – considerations for parties
There are a number of additional considerations when it comes to resolving disputes by arbitration relating to the end of LIBOR. These are relevant when legacy contracts contain arbitration clauses, as well as in the context of new contracts (or existing contracts which are being amended to address end of LIBOR uncertainty), where the parties are considering their dispute resolution options:
- Identity of arbitrator – parties who have chosen arbitration may be able to nominate an arbitrator. In view of the likely nuances behind the use of LIBOR in any given financial contract and the arguments that could be raised as to whether the replacement should be treated as an applicable substitute in the circumstances of a particular transaction, a party may wish to appoint an arbitrator with a solid practical knowledge of both the financial instrument in question but also the operation of that particular financial market. (See, for example, the reference to “a material “winner” and a material “loser” as a result of the transition from LIBOR” in the context of loan agreements, here).
- Challenges on a point of English law – as described here, LIBOR discontinuation disputes are likely to raise complex issues of English law. Under English law, an award can be appealed on the basis of an error on a point of English law (English Arbitration Act 1996, section 69). However, many of the institutional arbitration rules (such as the LCIA Rules and ICC Rules – model clauses for both of which are included in ISDA’s Arbitration Guide) exclude any non-mandatory rights of challenge to an award. The parties’ choice of institutional rules will typically determine whether section 69 challenges are automatically excluded and therefore whether any alleged error in the application of a potentially evolving area of English law by a tribunal sitting in London can be appealed. The issues arising from LIBOR discontinuation should undoubtedly give cause for parties to complex financial transactions to reflect carefully on whether the section 69 route should be preserved in their arbitration clauses.
- Non-precedential value of an arbitral award – an award will bind only the parties to it, and will not create a binding precedent. As a consequence, the resolution of a dispute by arbitration will not introduce any legal certainty with regard to the resolution of the same dispute under a financial instrument with the same contractual terms with a different counter-party. Where a party enters into multiple financial instruments on the same terms but with different parties and with the same potential for LIBOR discontinuation disputes, this could lead to multiple parallel proceedings with the attendant costs, delay, management distraction and potential for inconsistent outcomes.
- Powers of the tribunal – it is possible that a situation may arise in which, if there is no LIBOR, the tribunal is asked to step in and determine an applicable interest rate. As described in the E-bulletin, there is English jurisprudence which addresses the situation where a third-party determination is required for operation of a contractual formula. However, whether a tribunal can make a similar discretionary determination of a replacement reference rate will be dependent on the scope of the tribunal’s powers under the arbitration agreement, law of the seat and any applicable rules.
The impact of a potential legislative fix
Recently the Tough Legacy Taskforce of the Working Group on Sterling Risk-Free Reference Rates published its Tough Legacy Paper, that advocated a legislative fix to address legacy issues across all asset classes for those contracts that do not have robust fallbacks and “cannot be dealt with in any other way”. As the Tough Legacy Paper recognises, the question of whether the UK Parliament will deliver on this request is wholly uncertain and parties should continue to seek to agree contractual amendments which address LIBOR-related issues in their contracts.
In any case, and as discussed in detail in our recent blog post here, such legislation may have limited impact on the potential for disputes to arise, as the parties which bear the economic brunt of the switch in rates may seek to challenge the operation of the legislation in the context of contractual claims.
An arbitral tribunal in most jurisdictions has an obligation to apply the substantive law chosen by the parties and therefore, in the same way as many courts, will be bound to apply any mandatory rate-switching legislation which forms part of the substantive body of law which the parties have agreed is applicable to their contractual relationship. There is, however, less certainty in relation to the arbitration of such disputes if there is more than one relevant law addressing LIBOR phase out in relation to a particular transaction. This is because, unlike courts, arbitral tribunals in many jurisdictions are not compelled to apply a particular set of conflict of laws rules. Any UK legislative solution may not be consistent with the legislative response in another jurisdiction. As such, even if there are no conflict of laws issues, the impact of any inconsistencies on complex multi-jurisdictional, inter-linked transactions may be significant.
Arbitration of LIBOR discontinuation disputes – considerations for financial market institutions
As described in the E-bulletin, various financial market institutions such as ISDA and the LMA have made proposals for how to deal with LIBOR discontinuation and since 2017 has published documentation assisting parties with the transition. Such institutions may wish to intervene in significant disputes concerning the interpretation of their market documentation in the context of the end of LIBOR. Third party interventions in civil proceedings in the English court are possible (for example, ISDA has intervened in civil proceedings concerning the interpretation of provisions of the ISDA Master Documentation). Third party intervention is usually not possible in commercial arbitration and, where it is possible, it usually requires the consent of at least one of the parties and the tribunal. Moreover, even if a financial market institution intervened in an arbitration concerning LIBOR discontinuation, the impact may be limited by any confidentiality restrictions concerning the arbitration and publication of any award.
Pre-award interest, post-award interest: selection of an interest rate
Many arbitration clauses do not address the award of interest, leaving the award of interest (including the rate) to be determined by the tribunal under the powers granted by the law of the seat. For example, neither the LMA Developing Markets Loan Documentation which includes an arbitration clause, nor the model arbitration clauses in the ISDA Arbitration Guide, include any express provisions on interest.
However, there are contracts which specify that the tribunal shall award interest by reference to LIBOR. Depending on how it is drafted, such an interest provision may displace the default powers to award interest which a tribunal would otherwise have under the law of the seat. This leads to uncertainty as to whether the tribunal has any power under the law of the seat to substitute another reference rate.
Enforcement of awards based on LIBOR
After the phasing out of LIBOR, there is a risk that award creditors may encounter difficulties in enforcing awards which rely on LIBOR as a benchmark, whether underpinning the substantive decision or in the context of an award of interest.
In particular, enforcement of the interest component of an award which is benchmarked to LIBOR may raise issues. Accordingly, parties currently involved in arbitral proceedings should address the issue of the end of LIBOR before the tribunal, before an award is issued.
The disputes risk arising from the phasing out of LIBOR is significant and multi-jurisdictional and despite the speculation of a legislative fix in tough legacy contracts, parties should continue to try to resolve the issue of LIBOR discontinuation by way of contractual amendment.
The forum for dispute resolution may understandably be further down the parties’ list of key concerns with the present focus at least being on the mitigation of risks associated with LIBOR discontinuation. However, for parties who have included arbitration clauses in legacy contracts with LIBOR discontinuation implications, or who are reviewing their dispute resolution options in such contracts now, there are a number of considerations to bear in mind. One of the most noteworthy is the ability to appoint an arbitrator with significant market experience and expertise, in order that the complexities of the impact of LIBOR discontinuation on multiple linked transactions are understood and that the tribunal’s decision will not be made in isolation from the operation of the financial markets in which the financial instrument was entered into.
For more information, please contact Nick Peacock, Partner, Hannah Ambrose, Senior Associate, or your usual Herbert Smith Freehills contact.