September 23, 2020
By: Todd A. Bickel
The London Inter-Bank Offered Rate (LIBOR) is likely soon to become extinct. For decades, LIBOR indexes have been among the primary sources used by commercial lenders in floating rate loan transactions, but in 2017, the regulating body for LIBOR announced that its publication of those indexes may cease after December 2021. Since then, banks have been wrestling with how best to handle outstanding loans on their books which use LIBOR to determine the interest rate, and also how to price and document new loan transactions when both bankers and borrowers are accustomed to LIBOR-based interest rates.
Until the 2017 announcement, the prospect of LIBOR disappearing was virtually unthinkable, so even though most traditional commercial loan documentation addressed the potential unavailability of LIBOR, it was seldom – if ever – negotiated. That language oftentimes provides that in the unlikely event LIBOR cannot be determined, the lender would unilaterally substitute a new interest rate or a new index to determine the interest rate that may or may not also include some “guardrails” for this process, such as requiring the lender to be “reasonable” in its determination and/or requiring the substitute index to be similar to LIBOR. Since these types of “lender’s discretion” provisions in existing loan documents signed prior to the 2017 announcement could now be fertile ground for disputes and potentially strained relations between a borrower and lender, in most cases it is advisable for the parties to start discussing how the interest rate will be determined well in advance of LIBOR’s demise, and possibly entering into a written amendment containing more definitive terms.
While it is well-known that LIBOR is unlikely to be with us much longer, due in part to familiarity and custom, commercial lenders nevertheless continue to compete for new lending business by including LIBOR-based interest rates in their loan proposals to prospective borrowers. The latter likewise are comfortable dealing with an index and terminology they’ve known for years. Now that LIBOR’s disappearance is not merely theoretical, however, commercial loan documentation typically has more detailed and refined provisions to address that disappearance. Not surprisingly, these provisions are much more commonly negotiated than they were prior to 2017.
This language commonly falls into three categories: (1) a more robust form of the “lender’s discretion” provision discussed above, with clearer “guardrails” governing the lender’s selection of an alternate index and resulting interest rate; (2) a predetermined substitute index which automatically replaces the discontinued LIBOR, which most likely will be the index known as “SOFR” (Secured Overnight Financing Rate); or (3) in cases where a borrower’s bargaining position is particularly strong, terms which provide that the Borrower and Lender are to agree on the substitute index and/or rate.
Careful attention to LIBOR language in existing and future loan transactions on the part of both commercial lenders and borrowers will be particularly important during the next eighteen months as the industry transitions away from this long-standing index.