LIBOR Cessation, Implied Terms & Alternative Reference Rate: English High Courts Decides

LIBOR cessation is one of the most important issues in commercial law in the recent times. With trillions of dollars with contracts indexed to LIBOR and its recent cessation, it is important that courts world over deal with it in a fair manner. This article may be looked at for how international arbitral tribunals have dealt with LIBOR cessation.

Recently, the English Court in Standard Chartered plc v. Guaranty Nominees Limited, [2024] EWHC 2605 (Comm) has dealt with the issue. As has been noted in the aforementioned Some jurisdictions provided legislative solutions by prescribing the alternative reference rate through statute or delegated legislation. In some jurisdictions, courts read in an implied term of alternative reference rate. Standard Chartered plc v. Guaranty Nominees Limited decided by the English High Court is an example of the latter approach. Here, the English Court decided that where the three month USD LIBOR ceased or was incapable of operation, a reasonable alternative rate to it was an implied term.

The crucial question is how should courts (and arbitral tribunals) arrive at the alternative reference rate. Standard Chartered provides some guidance on the criteria:

• such rate is to be based on “robust underlying market”;
• while determining such alternative reference rate, courts should “have regard to the liquidity of that underlying market over time, market functioning issues, usefulness to all market participants and the ability to produce and maintain the alternative rates…”
• Such rate should “be able to test the rate by reference to historical data…”;
• It should “consider resilience to changing market conditions, structures and regulations; placing weight on the diversity of market participants, the stability of their participation and their credit quality over time; how changes in participation could affect the benchmark; the transparency of the benchmark and the need for an ongoing ability to assess the rate’s quality…”According to the court, such a rate was the “CME Term SOFR and adding the ISDA Spread Adjustment”.

The decision of the English High Court provides important guidance on two aspects. One, on the legal basis for implying a term on alternative reference rate to 3 months USD LIBOR, and two, determination of the alternative reference rate. 

Interest Rate Indexing in Commercial Contracts: Part II: LIBOR Retirement

With the legal world (and the rest of it) combating the Covid 19 and its effects, there is a development that is likely to substantially disrupt existing contracts and loan arrangements world over: LIBOR Retirement. 

This blog discussed index rate indexing in commercial contracts about a decade back: (See, Interest Rate Indexing in Commercial Contracts: Part I) where we discussed about Prime Lending Rate. (PLR) Thereafter, several developments had taken place, the main development being replacement of the PLR with the concept of Base Rate (see, here). This post is about the most commonly used international index in commercial contracts: the London Inter-Bank Offered Rate or the LIBOR. Some mistakenly refer to LIBOR as London Inter-Bank Offer Rate; it is “Offered Rate” and not “Offer Rate”.

What then is LIBOR?

LIBOR is the average rate at which an empanelled bank “could obtain unsecured funding for a given period in a given currency.”

How is LIBOR Calculated?

The LIBOR is calculated vis-à-vis business days in London for five currencies with seven maturity periods ranging from overnight to 12 months, producing 35 rates each business day. It is calculated by the Waterfall methodology. For further details, see here.

Why is LIBOR Important?

About US$ 350 trillion worth contracts world-over are indexed to LIBOR. Even in India, LIBOR is commonly used in high value commercial transactions. Numerous Joint Operating Agreements between various Petroleum companies use the LIBOR as interest rate index; so do various international agreements.

What was the LIBOR Scandal About?

On 27 July 2012, The Financial Times published an op-ed piece by Douglas Keenan about LIBOR manipulation since 1991 (here). The bankers were understating or overstating the rates and profiting from trades. This was not the first time the credibility of the LIBOR was questioned. See, for instance, this paper titled “Does the LIBOR Reflect Banks’ Borrowing Costs” by Snide & Youle which argues:

“Abstract

The London Interbank Offered Rate (LIBOR) is a vital benchmark interest rate to which hundreds of trillions of dollars of financial contracts are tied. Recently observers have raised concerns that the Libor may not accurately reflect average bank borrowing costs, it's ostensible target. In this paper we provide two types of evidence that this is the case. We first show that bank quotes in the Libor survey are difficult to rationalize by observable cost measures, including a given bank's quotes in other currency panels. Our second type of evidence is based on a simple model of bank quote choices in the Libor survey. The model predicts that if banks have incentives to affect the rate (as opposed to simply reporting costs), we should see bunching of quotes around particular points and no such bunching in the absence of these incentives. We show that there is strong evidence of the predicted bunching behavior in the data. Finally, we present suggestive evidence that several banks have large portfolio exposures to the Libor and have recently profited from the rapid descent of the Libor. We conjecture that these exposures may be the source of misreporting incentives.”

The manipulation was done to the tune of billions of dollars.

Aftermath of the LIBOR Scandal

Subsequent news reports and investigations led to transfer of administration from the British Bankers' Association to the Intercontinental Exchange (ICE) Benchmark Administration (IBA) in 2014. The LIBOR rates are regulated by the UK Financial Conduct Authority (UKFCA). Fines were imposed on several banks which were involved in the manipulation. LIBOR was upgraded with new technology and surveillance tools to ensure credibility. See, the publication of IBA, Roadmap for ICE LIBOR (18.03.2016), for details of the reforms undertaken.

Retirement of the LIBOR

Notwithstanding the investigations and the reforms undertaken, the credibility of the LIBOR took a severe hit. On 26 July 2017, nearly five years after the Financial Times op-ed, the UKFCA stated that it was not sustainable to prolong the LIBOR beyond 2021 for the reason that the banks were not lending to each other as much as they had previously and that there were not enough transactions in certain currencies so as to make a good estimate of the rates. Thus began the steps to retire the LIBOR rate. 

In April 2017, a working group, known as the Risk Free Rate Working Group in UK selected SONIA (Stering Over Night Index Average) as the replacement for the LIBOR. In the US, SOFR (Secured Overnight Financial Rate) is being used. There have been many alternatives proposed but all these options, including SONIA, are specific currency based. Further, the SONIA is an “overnight rate” while LIBOR used to, and still, publishes a three month rate as well. Both are not comparable. LIBOR will be maintained as a shadow benchmark rate till 2021.

Impact of COVID 19 and the LIBOR Transition

There has been a consistent view that the current plans of LIBOR Retirement are continued, it could create further destabilise the already unstable market (whose cause if the Covid 19 pandemic)(see, here, for instance).

LIBOR Retirement and Impact on International Transactions

LIBOR retirement would not have substantial impact on current transactions whose duration will end prior to LIBOR retirement (2021). It will affect future transactions and transactions whose duration would extend beyond 2021. 

For instance, if an agreement, say, a Joint Operating Agreement, extending beyond, and up to 2025, uses LIBOR as the index rate for interest, what should the parties do?

It is rare that parties would have opted in their contracts for an alternative in case LIBOR is not applied. Therefore, there are two options left for them:

Option 1

The first option is for the parties to renegotiate the contract and replace LIBOR with an alternative index rate. While choosing such a rate, the parties should take care to employ a credible index rate. 

Option 2

In case LIBOR is retired after 2021, the clause choosing LIBOR as the index rate would become void and the applicable interest rate will be dealt with by the applicable law. The rate of interest will be governed either by the law governing the arbitration or the substantive law of contract.

It is also theoretically possible that UK might adopt a legislative measure to provide that any reference to LIBOR in contracts would be interpreted to mean a new benchmark rate but such measures will create uncertainties, especially where the applicable law is not English law.

Conclusion

It is certain that the LIBOR retirement will affect trillions of dollars’ worth transactions. If the parties feel that LIBOR should no more be used, it is important for them to sit on the negotiating table to agree on the new index. If not, they run the risk of being bound by an interest rate index that could be highly unfavourable for them.

Power to Award Interest on Interest: Matter referred to a Three Judge Bench

Recently, a two judge Bench of the Supreme consisting of RM Lodha & HL Gokhale, JJ in Hyder Consulting (UK) Ltd. v. Governor, State of Orissa [SLP (C) 29407/2010] has referred the question pertaining to whether an arbitral tribunal could award interest on interest. The question before the court in the case concerned whether an arbitral tribunal could award post-award interest on the sum of the claim along-with pre-award interest. It was argued before the court that there were conflicting judgements on this issue. 

 

In State of Haryana v. SL Arora & Co. (2010) 3 SCC 690 (SL Arora), it was held by a two judge Bench of the Supreme Court that the tribunal cannot award post-award interest on pre-award interest. On the other hand, in ONGC v. MC Clelland Engineers (1999) 4 SCC 327, McDermott International v. Burn Standard Co (2006) 11 SCC 181 and UP Co-operative Fund Ltd v. Three Circles (2009) 10 SCC 374, it was held that the tribunal could award post-award interest even on pre-award interest. In view of the conflicting decisions, the Supreme Court deemed it fit to refer the matter to the Chief Justice of India for the constitution of a Three Judge Bench to resolve the question. In addition, the court also referred the question of whether the tribunal can award post-award interest on costs.

Section 31(7) which reads below deals with the provision on award of costs in arbitration:

“(a) Unless otherwise agreed by the parties, where and in so far as an arbitral award is for the payment of money, the arbitral tribunal may include in the sum for which the award is made interest, at such rate as it deems reasonable, on the whole or any part of the money, for the whole or any part of the period between the date on which the cause of action arose and the date on which the award is made.

(b) A sum directed to be paid by an arbitral award shall, unless the award otherwise directs, carry interest at the rate of eighteen per centum per annum from the date of the award to the date of payment.”

In SL Arora, the arbitrator awarded interest at 12% till the date of award (i.e., pre-award interest) on the claim and a post award interest on the claim and pre-award interest at 18% per annum. The said award was passed in June 2000. After the proceedings under Section 34 were dismissed, the party in whose favour the award was passed filed a petition in October 2004 for the execution of the award. In the execution petition, the execution petitioner claimed post-award interest at 18% on the claim amount as well as on the pre-award interest. The respondent in the execution proceedings contended that the arbitrator could not have awarded post-award interest on the pre-award interest. The court held that Section 31(7) does not empower the tribunal to order interest on interest for the following reasons:

(a) There is no reference in Section 31(7) to compound interest or inter4est on interest

(b) Section 31(7) does not require the interest accruing till the date of interest to be treated as a part of the principal for the purpose of calculating post-award interest.

(c) The said provision merely uses the words "a sum directed to be paid by an arbitral award shall carry interest" thereby indicating that interest shall be awarded only on the amount in the award and not pre-award interest. 

On the other hand, in McDermott, the Supreme Court held that it was within the discretion of the arbitral tribunal to grant post-award interest even on pre-award interest. [ONGC v. MC Clelland Engineers (1999) 4 SCC 327 and and UP Co-operative Fund Ltd v. Three Circles (2009) 10 SCC 374 may not be altogether relevant because these are decisions under the Arbitration Act, 1940.]

In view of the difference in views, the court referred the matter to the Chief Justice for decision by a three judge Bench. The order of the Court can be accessed from here.

Save on Post Award Interest in Section 34 Proceedings: Deposit the Award Amount in Court

According to a latest decision of the Supreme Court, a party can challenge the award under Section 34 of the Arbitration and Conciliation Act, 1996 (1996 Act) and at the same time save on the post-award interest in case the challenge proceedings ultimately fail by depositing the award amount in the court.

In HP Housing & Urban Development Authority v. Ranjit Singh Rana, a two judge Bench consisting of RMLodha & HLGokhale, JJ, has held that where the award amount is deposited in the court, the applicant is not liable to pay post-award interest from the date of depositing the amount in the court. The facts in brief are that an award in an arbitration between the parties was challenged and the applicant deposited the award amount in the court. On dismissal of the application for setting aside, the court held that the respondent in the petition under Section 34 was entiteld to post-award interest at 18% per annum as per Section 31(7)(b) of the 1996 Act. Section 31(7)(b) reads: 

"A sum directed to be paid by an arbitral award shall, unless the award otherwise directs, carry interest at the rate of 18 per centum per annum from the date of the award to the date of payment."

On appeal, the Supreme Court reversed the decision of the lower court. The Supreme Court construed the expression "date of payment" to include even deposit of the amount in the court, which was only "a payment to the credit of the decree-holder". Thus, it held: 

"The word 'payment' may have different meaning in different context but in the context of Section 37(1)(b); it means extinguishment of liability arising under the award. It signifies satisfaction of the award. The deposit of the award amount into the Court is nothing but a payment to the credit of the decree-holder. In this view, once the award amount was deposited by the appellants before the High Court on [] May 24, 2001, the liability of post-award interest from May 24, 2001 ceased."

The judgement can be accessed from here.

Roundup of Prominent Developments in India and Abroad on Arbitration

Union of India v. Krafters Engineers (Supreme Court of India)

In Union of India v M/s Krafters Engineers, the Supreme Court of India clarified the law on the power of the arbitrator to award interest when the contract prohibits it. See the comments in the Indian Corporate Law Blog and the Lex Arbitri Blog.

Jivraj v Hashwani (UK Supreme Court) Nurdin Jivraj v Sadruddin Hashwani is an important case decided (pdf) by the UK Supreme Court. The issue was whether an arbitration clause requiring that the arbitrators should be from a particular religious community was valid. The English Court of Appeal had previously held that such a requirement violated the English Employment Equality (Religion or Belief) Regulations 2003 and was therefore void. The Court of Appeal had also held since the arbitration clause became substantially different if the void portion of the arbitration was severed, the entire arbitration clause was void. The UK Supreme Court overturned the decision of the Court of Appeal and held that the Employment Equality (Religion or Belief) Regulations 2003 was not applicable as arbitrators were not employees under the Regulations but were independent providers of service. Comments on the judgement can be found in UKSC Blog, Kluwer Arbitration Blog, Indian Corporate Law Blog and Lex Arbitri Blog.

Barclays Bank v Nylon Capital (English Court of Appeal on Expert Determination)

 
In this case, the English Court of Appeal had to decide on the question as to whether the court should stay proceedings brought for a declaration as to the interpretation of an agreement for the reason that the issue falls within the domain of the expert appointed as per the expert determination clause in that agreement. The said clause provided that the expert shall determine the matters in dispute between the parties and such determination may include dispute as to the interpretation of any provision of the agreement or even his jurisdiction. Such determination was to be final and binding on the parties. The court decided as follows:

• Even if the agreement confers jurisdiction on the expert to decide a question pertaining to the jurisdiction of an expert, the court is the “final decision maker” on the question.
• In construction of arbitration clauses, there is a presumption that sensible businessmen intended that any dispute arising out of an agreement should be decided by the arbitral tribunal. However, there is no such presumption as regards expert determination clauses. Therefore, the question as to whether a matter was to be referred to an expert or not is a matter of construction of the expert determination clause with “no presumption either way”.
• It is an established principle that courts would not interfere with the determination of experts except in narrow circumstances. Courts would interfere where the expert determines the issue referred to him in a manner contrary to the mandate conferred upon him by the parties. Whether the expert had acted contrary to his mandate is a question of law.
• Unlike an arbitrator who is bound to proceed with fairness, an expert can determine how he can proceed, subject, of course, to any stipulation in the agreement.
• Where the court is asked to determine whether a dispute is within the expert’s jurisdiction and if the agreement provides that such a question should be decided by the expert, the court should decide, first, if there is a dispute; second, the court should decide if it is in the interests of justice and convenience that it should decide the dispute.
• When an expert determines questions pertaining to his jurisdiction, such determinations are not final even if the parties agree. Such determinations can always be challenged.
• Where a party challenges the jurisdiction of the expert to determine a dispute, the said party could approach the court and the court would determine the issue of jurisdiction of the expert.

Use of And/ Or in Legal Documents:

Indian Corporate Law Blog had a small post a few days back providing the link to an article on the use “And/ Or” in legal writing.

Kishanganga Arbitration:

Lex Arbitri has a post on the latest developments in the Kishanganga arbitration between India and Pakistan.

Sree Kamatchi Amman Constructions v. The Divisional Railway Manager (Works), Palghat and Ors.

Sree Kamatchi Amman Constructions v. The Divisional Railway Manager (Works), Palghat and Ors.

Decided by R.V. Raveendran and H.L. Gokhale, JJ on 20 August 2010, these Civil Appeal Nos. 6815-6816 of 2010 were pertaining to the question of award of interest.

In this dispute, the High Court had previously remitted the matter to the arbitral tribunal for making a reasoned award (the award was an unreasoned one) after fresh consideration. Instances where Courts have remitted the matter to the tribunals are rare. See, for example, Gayathri Projects Ltd. V. Airport Authority of India 2007(3) Arb. LR 416 (Del.); Union of India v. Prem Kumar Lihala 2005(Suppl.) Arb. LR 506 (Del.).

On remission, the tribunal considered the matter and had rejected all the claims raised by the Respondent (Railways) and a few claims raised by the Appellant (KAC). Hence the “cross petitions” under S 34. Dissatisfied with the decisions of the lower courts both KAC and Railways had approached the Supreme Court.

The Court had to consider two issues:

“(i) whether the contract between the parties contains an express bar regarding award of interest?

(ii) If so whether the arbitral tribunal was justified in refusing interest for the period between the date of cause of action to date of award?”

The court had to interpret Clause 16(2) of the General Conditions of the Contract. The said Clause read:

"No interest will be payable upon the earnest money or the security deposit or amounts payable to the Contractor under the Contract, but Government Securities deposit in terms of Sub-clause (1) of this Clause will be repayable (with) interest accrued thereon."

The court interpreted the expression “amount payable… under the Contract” to mean any amount that the Railways had to pay as a part of the Contract. Thus, the Contractor could claim no right under the Contract for interest.

While deciding on the second question, that is, the correctness of the tribunal in refusing to award interest, this blawgger noticed an interesting aspect. While discussing the law on the power of the tribunal to award interest, the court listed the leading judgements on the point and only then did it look at the statute. Does this imply that the court accorded a higher stature to its own judgements even compared to the statute? Or is this blawgger reading more into the judgement than what it actually says?

The relevant provision [S 31(7)] in the Arbitration and Conciliation Act, 1996 on interest is quoted below:

"(a) Unless otherwise agreed by the parties, where and in so far as an arbitral award is for the payment of money, the arbitral tribunal may include in the sum for which the award is made interest, at such rate as it deems reasonable, on the whole or any part of the money, for the whole or any part of the period between the date on which the cause of action arose and the date on which the award is made.

(b) A sum directed to be paid by an arbitral award shall, unless the award otherwise directs, carry interest at the rate of eighteen percentum per annum from the date of the award to the date of payment."

The judicial lingo used as regards interest rate is as follows:

Pre-reference interest: Interest prior to the period of reference to arbitration.
Pendente lite interest: Interest for the period when the litigation is pending.
Post-award interest: Interest between the date of award and the date of payment

Unlike the court, we shall first analyse the statutory provision. Note that S 31(7)(a) deals with pre-reference interest and pendente lite interest, and S 31(7)(b) deals with post-award interest. Note also that S 31(7)(a) is a Default Rule, and hence is subject to the contract to the contrary. However, prima facie, S 31(7)(b) does not seem to contain a Default Rule. Rather, it leaves it to the discretion of the arbitral tribunal. However, numerous judgements of the courts would tell us that the arbitral tribunal has to act within the “four corners” of the contract that forms the basis of their jurisdiction. Hence, if the contract provides for a particular post-award interest, the tribunal has no alternative but to enforce the same.

On the second question (whether the tribunal was justified in refusing to grant pendente lite interest?), the court held:

“Where the arbitral tribunal has exercised its discretion and refused award of interest for the period pendente lite… the award of the arbitrator could not be interfered with.”

The court was probably right in refusing to set aside the award of the tribunal on this point. But, where is the question of the arbitral tribunal having “discretion”? The contract is very clear: No interest is payable on any amount payable under the contract. That being so, from where does this “discretion” arise?

In the passing, it may also be noted that there were two decisions under the 1940 Act which were decisions supporting a contrary point. The SC held that these decisions were under the 1940 Act and were not binding, considering that the wordings in both the respective provisions on interest rate being dissimilar. 

P.S.: On further reading materials pertaining to default rules, see the link given above on default rules. A poser to the readers. What are the Default Rules in the Indian Contract Act, 1872 (at least in the provisions pertaining to contracts generally)?

Interest Rate Indexing in Commercial Contracts: Part I

Often, in many commercial contracts in India, the interest rate (especially for delay in payment under the contract or the rate of interest in the arbitral award) is linked to the Benchmark Prime Lending Rate (BPLR) of the State Bank of India (SBIPLR or SBAR).  These rates are chiefly used in loan agreements between businesses and banks. In international transactions, contract interest rates are usually linked to LIBOR. Recently, there has been a new development regarding BPLR, which has necessitated discussion on this topic.

In case  you are a student, we suggest you request your banking law lecturer to teach about interest rate indexes, LIBOR and BPLR because if you plan to become a business lawyer, whether as a teacher or a transactional lawyer or an advocate, you would necessarily be dealing with these aspects in one form or the other. The objective of this post is to introduce and discuss the notion of BPLR. In the next post in this series, we would be discussing the topic's current relevance. We would also  give links at the end of the next post to resources in case you want to have a deeper knowledge on this subject.

PLR and its Evolution:

Prime Lending Rate is the interest rate which a bank charges for loans to its most creditworthy borrowers. Section 4 of the Interest on Delayed Payments to Small Scale and Ancillary Industrial Undertakings Act, 1993 defines PLR in respect of SBI to mean "the Prime Lending Rate of the Stale Bank of India which is available to the best borrowers of the bank."

Many news paper editorials and other articles in the internet define BPLR to be the interest rate which bank charges for its most creditworthy borrowers. But defining BPLR as such is to ignore certain historical developments which we are noted below.

Prior to October 1994, interest rate on lending was heavily regulated. In October 1994, the lending rates were significantly deregulated: Banks could determine the lending rates for loans over Rs. 2 lakhs. However, the banks were also required to declare their prime lending rate, determined after approval of their board of directors. For loans above Rs. 2 lakhs, the PLR acted as the floor rate (minimum rate). In 1997, banks were allowed to charge PLR independent of each other. In April 1998 of the same year, for loans upto Rs. 2 lakhs, PLR was made the ceiling rate.  For loans in certain categories, banks were allowed to charge interest rate independent of PLR.

In the Statement by the Governer of the RBI on Monetary and Credit Policy for 2001-2002  (19 April 2001), Dr. Bimal Jalan noted that there were requests from bankers that the PLR should be mae a benchmark rate instead of making it a floor rate. The Governer noted that Sub-PLR loans were becoming common in the international arena, though the traditional view was that PLR should be the floor rate for loans for teh highest credit worthy borrowers. Dr. Jalan declared:

"83. Keeping in view the international practice and to provide further operational flexibility to commercial banks in deciding their lending rates, it has been decided to relax the requirement of PLR being the floor rate for loans above Rs.2 lakh. Banks will be able to offer loans at below-PLR rates to exporters or other creditworthy borrowers including public enterprises on the lines of a transparent and objective policy approved by their Boards."

However, the policy of PLR being the ceiling rate for below Rs. 2 lakh loans continued. 2002 was the year in which the RBI got serious about monitoring of lending rates and required banks to furnish information on the lending rates. The PLR of different banks varied widely. Hence, in his Statement on Monetary and Credit Policy 2003-2004 (29 April 2003), the Governer of the RBI advised the banks to announce a Benchmark Prime Lending Rate.(BPLR) with the approval of their boards. In calculating the BPLR, the banks were advised to take into consideration:

1. actual cost of funds,
2. operating expenses and
3. a minimum margin to cover regulatory requirement of provisioning/capital charge and profit margin.

 The purpose of this recommendation was to ensure that PLR of banks tends towards the actual cost of lending. Pursuant to this, the IBA [Indian Banks Association] issued detailed guidelines in November 2003 [I tried to find this circular in the internet but could not. In case anyone has a copy, kindly share it with us.] on the determination of the BPLR. The Report of the Working Group on BPLR (October 2009) observes, on the difference in purpose of the PLR and the BPLR:

"The BPLR system was expected to be a step forward from the PLR system, which more or less represented the minimum lending rates, to that of one which stood as a benchmark or a refernce rate around which most of the banks' lending was expected to take place."

For now, readers can check out this page of Indian Banks Association for BPLRs of various banks. More on this topic in a subsequent post.