In an effort to provide more clarity and certainty with respect to the LIBOR transition – and in particular to reduce the significant litigation risk associated with the transition -- the Alternative Reference Rates Committee (ARRC), a group of private-market participants convened by the Federal Reserve Board and the New York Fed, recently announced that it was proposing New York State legislation. The ARRC’s proposed legislation would apply to financial instruments and contracts that either have no fallback provisions or have fallback provisions that inadequately address the cessation of LIBOR. The ARRC’s effort is motivated by a desire to minimize contract disputes and unintended changes in the economic terms of contracts upon LIBOR discontinuance. The ARRC has focused on New York State because a substantial percentage of financial contracts incorporating LIBOR are governed by New York law.
As summarized by the ARRC, its proposed legislation would (1) prohibit a party from refusing to perform its contractual obligations or declaring a breach of contract as a result of the discontinuance of LIBOR or the use of a benchmark replacement that is recommended by the Federal Reserve Board, the New York Fed or the ARRC (a “Recommended Benchmark Replacement”), including any recommended spread adjustments or conforming changes; (2) establish that the Recommended Benchmark Replacement is a commercially reasonable substitute for and a commercially substantial equivalent to LIBOR; and (3) provide a safe harbor from litigation (the “Statutory Safe Harbor”) for the use of the Recommended Benchmark Replacement. The Statutory Safe Harbor would ensure that no person shall have any liability for damages to any other person, or be subject to any claim or request for equitable relief arising out of or related to the use of a Recommended Benchmark Replacement or the implementation or performance of benchmark replacement conforming changes.
The ARRC has proposed that this legislation become applicable on either a mandatory or permissible basis depending on the language of the relevant existing contract. The proposed legislation is to be mandatory if the contract lacks any fallback language or if the contract language requires a fallback to a LIBOR-based rate. In such a case, the legislation would (i) override existing fallback language that references a LIBOR-based rate and require the use of the legislation’s recommended benchmark replacement, (ii) nullify any existing fallback language that requires polling for LIBOR or other interbank funding rates and (iii) insert the Recommended Benchmark Replacement as the LIBOR fallback in contracts that lack fallback language.
The proposed legislation is to be used on a permissive basis if the legacy contractual language gives a party the right to exercise discretion or judgment regarding the fallback. In this case, that party can avail itself of the benefit of the Statutory Safe Harbor if it chooses to select the Recommended Benchmark Replacement as the fallback rate.
The parties to any contract may agree to opt out of any mandatory application of the proposed legislation at any time (either before or after the occurrence of a trigger event). The proposed legislation, moreover, would not override existing contract language that specifies a particular non-LIBOR based rate as a fallback to LIBOR (e.g., the prime rate).
The ARRC has expressed its belief that enacting its proposal would help to maintain consistency and provide comfort for lenders, consumers, businesses and investors. The ARRC’s proposal includes case studies exemplifying the application of the legislation to floating rate notes, securitizations, consumer adjustable rate mortgages, derivatives, procurement agreements and municipal bond markets.
It will be up to the New York State Senate and Assembly to decide whether to pass the ARRC proposal – and if they do, Governor Cuomo will have to approve the legislation for it to become law. No legislative proposal has yet been introduced in the New York State Legislature. Financial institutions are likely to rally around the proposal, but it is unclear whether (and if so, when) it will be introduced and whether there will be enough support for it to be enacted into law.
If New York State enacts the ARRC proposal or similar legislation, which would by its terms affect the obligations of parties under existing contracts, parties that believe the law disadvantages them might challenge its constitutionality. The United States Constitution’s Contract Clause provides that "[n]o State shall . . . pass any . . . Law impairing the Obligation of Contracts." Despite this sweeping language, however, US courts have for the most part not interpreted the Contract Clause as a bar to state legislation enacted to deal with a generalized economic problem, which suggests that constitutional challenges may face an uphill battle.
[View source.]
