In Standard Chartered plc v Guaranty Nominees Limited & Ors [2024] EWHC 2605 (Comm), the High Court considered the effect of the cessation of LIBOR on legacy contracts which reference that rate. In what is understood to be the first case in which the High Court has had to determine this issue, it was held that the relevant contractual terms included an implied term that if three-month USD LIBOR ceased to available, a ‘reasonable alternative rate’ should be used instead. In this case the reasonable alternative rate was held to be CME Term SOFR with a fixed spread adjustment of 0.26161% per annum (the ‘ISDA Spread Adjustment’).

This judgment will provide helpful guidance to the financial markets when it comes to construing ‘tough legacy’ LIBOR contracts. In addition, while this case concerned dividends payable to preference shareholders, the High Court noted that there were ‘similarly persuasive’ arguments for adopting a similar approach to ‘tough legacy’ debt instruments.

It may however be too soon to consider this issue settled. The fact that the experts agreed on the appropriate alternative rate was very influential in determining that CME Term SOFR was the appropriate alternative. In different types of contracts and different circumstances in which experts disagree, a different result is certainly conceivable.

Background

In 2006 the Claimant, Standard Chartered plc (‘SC’), issued preference shares (the ‘Preference Shares’) for the purpose of raising Tier 1 Capital. The Second to Fifth Defendants (the ‘Funds’) held the economic interest in these shares.

The dividends payable under the Preference Shares were paid at a fixed rate for the first 10-years, and at a floating rate of 1.51% plus three-month USD LIBOR thereafter. While the terms of the Preference Shares included fallbacks if three-month USD LIBOR was unavailable, these were no longer workable.

Therefore, in anticipation of LIBOR’s cessation, SC launched a consent solicitation process to amend the dividend rate contained within the terms of the Preference Shares and remove the reference to three-month USD LIBOR. However, this proposal failed to achieve the votes needed to become effective. Consequently, SC commenced proceedings, seeking a declaration from the High Court regarding the applicable rate in the absence of LIBOR.

The issue before the High Court

Both parties agreed that a term had to be implied into the terms of the Preference Shares in order to address the cessation of LIBOR, as the Preference Shares would otherwise lack commercial coherence. The key issue was therefore what term should be implied. SC’s case was that an implied term should be read into the Preference Shares which would allow SC to select a ‘reasonable alternative rate’ if three month USD LIBOR ceased to be available (the ‘SC Proposed Term’).

SC also submitted that the alternative rate in this instance should be CME Term SOFR plus the ISDA Spread Adjustment. Conversely, the Funds argued that the Preference Shares should be read to contain an implied term that required SC to redeem the Preference Shares upon the cessation of LIBOR.

The decision of the High Court

The Court applied the conventional test for implied terms: that a term may be implied into a contract where it is either(i) necessary to give business efficacy to the contract; or (ii) is so obvious that it goes without saying (the officious bystander test). Furthermore, in order for a term to be implied, that term must be capable of clear expression, not contradict any express terms of the contract, and be reasonable and equitable.

The High Court also noted two features of the Preference Shares which favoured a more flexible approach to implying a term:

(i) that the Preference Shares constitute long term contracts, and that the drafters of such contracts could not have envisaged every scenario that might arise over the course of their lifetime. The High Court explained that in such circumstances the courts are more willing to adopt a flexible approach to their interpretation and, when confronted with an issue during the life of a long-term contract which the contract did not foresee, the courts will look to adopt an interpretation that best aligns with its purpose; and

(ii) that LIBOR was not essential to the long-term bargain between the parties. The High Court stated that LIBOR was only a mechanism to measure the cost of unsecured bank borrowing, and was therefore ‘a means to an end, not Holy Writ in itself’. Indeed, the existence of fallbacks reflected the parties’ intention that issues with LIBOR’s availability should not disrupt the payment of dividends under the Preference Shares’ terms, even if this required using alternative rates with different outcomes to LIBOR. The use of a floating rate within the fallbacks also made clear the parties’ desire to ‘future-proof’ the amount of the dividend by using a measure which took account of changes in the cost of borrowing.

The Court therefore accepted that in the circumstances it was necessary for business efficacy to imply a term into the contract and in doing so the Court broadly favoured SC’s approach that if three month USD LIBOR ceases, a ‘reasonable alternative rate to three month USD LIBOR’ should be used. However, the High Court was unwilling to accept SC’s contention that it should be granted sole discretion to choose the reasonable alternative rate, stating that the identification of a reasonable alternative rate was an objective question, of which the ultimate arbiter is the court.

In finding for SC, the Court rejected the implied term proposed by the Funds for the following reasons:

1. It failed the business efficacy test. The purpose of the contract was the long-term provision of regulatory capital to SC in return for dividends. SC’s proposed term fulfilled this purpose, while the Funds’ proposed term would end the contract.
2. It failed the officious bystander test. The automatic redemption of the Preferences Shares due to an external event (i.e. the unavailability of LIBOR) would disrupt SC’s ability to make long-term investments, risk the stable income stream for preference shareholders, and could involve considerable periods of uncertainty. It was not obvious that parties would have agreed to such a term.
3. The Preferences Shares could only be redeemed (i) unilaterally, (ii) at SC’s option, and (iii) at specific intervals. Conversely, the Funds’ proposed term implied mandatory, automatic redemption, conflicting with express terms of the contract and the Preferences Shares’ purpose as Tier 1 Capital.
4. The Funds’ proposed term lacked clarity. For instance, if the FCA/PRA imposed conditions on the redemption of the Preference Shares, as they were entitled to do, it was unclear whether the Funds’ proposed term would require SC to satisfy those conditions.

For these reasons, the Court rejected the Funds’ proposed term and preferred SC’s proposal.

The Court also agreed with SC that CME Term SOFR with an ISDA Spread Adjustment was the appropriate alternative rate in this instance. The expert witnesses adduced by both parties were in agreement on this point, and the Court noted that CME Term SOFR was in widespread use across the market as a replacement for USD LIBOR.

What are the broader implications of this judgment?

The cessation of LIBOR has left in its wake a number of ‘tough legacy’ contracts which reference LIBOR, and which do not have workable fallbacks. While some jurisdictions (such as the United States) passed laws which automatically replaced references to LIBOR in these legacy contracts, the UK chose a different approach. Instead, pursuant to powers granted to it under the UK’s Benchmarks Regulation, the FCA required LIBOR’s administrator to continue publication on a changed methodology (‘synthetic LIBOR’) for a temporary period to support the orderly cessation of LIBOR. However, synthetic LIBOR has now permanently ceased being published and the remaining legacy contracts are therefore those on which agreement as to an alternative rate could not be reached. In relation to those contracts, this judgment provides helpful guidance on the approach that the English courts are likely to take if asked to construe similar clauses again in the future.

While this judgment concerned preference shares, it is probable that the English courts would adopt a similar approach when construing ‘tough legacy’ debt instruments. Indeed, the High Court noted that the arguments for implying a contractual term that imposed the use of a ‘reasonable alternative rate’ in the absence of LIBOR would be ‘similarly persuasive’ with respect to ‘tough legacy’ debt instruments.

However, whilst persuasive, there is no guarantee that in respect of other equity or debt instruments the courts would take the same approach as the High Court in this case. Indeed, the High Court placed significant weight on the long term nature of the Preference Shares and the company law issues which made redemption unviable in reaching its judgment. These factors were key to indicating that redemption of the Preference Shares did not accord with the parties’ intentions. The courts may therefore diverge from this case and adopt a different approach with respect to debt or equity instruments which have different characteristics.

Similarly, this judgment should not be considered to have concluded that CME Term SOFR is the ‘reasonable alternative rate’ to LIBOR in all circumstances. The court was keen to highlight that the ‘reasonable alternative rate’ should be determined objectively, and what is objectively reasonable may vary according to the circumstances of the case. In this case both parties were in agreement that CME Term SOFR was the most suitable alternative rate to three month USD LIBOR, a position that was supported by extensive evidence from public and private sector working groups and other bodies. However, this could be decided differently in future cases if there is a disagreement in the expert evidence regarding the appropriate alternative rate.

Taking a step back, the approach adopted by the Court clearly demonstrates a desire to ensure the continued operation of the contract and reach a resolution which accorded with its commercial purpose. Indeed, rather than adopting an interpretation which would accept that the contract was unworkable and allow for redemption of the preference shares, the Court considered market practices via expert evidence and derived an alternative rate.

This case is also of procedural interest as it used the Financial Market Test Case Scheme, a pilot set up by the Court to “facilitate the resolution of market issues to which immediately relevant English law guidance is needed” on an expedited basis where the issue is of general market importance. The scheme allows for certain cases of particular importance or urgency to be heard by two judges, in this case, a High Court Judge and the Chancellor of the High Court, an otherwise unusual step which is likely to give this judgment elevated status in the minds of judges that are applying these findings to later cases.