New legislation would ease benchmark transition for tough-to-amend contracts governed by NY law.
New York State Senator Kevin Thomas has introduced a bill that would provide a legislative fix for contracts that lack adequate fallbacks for the discontinuation of LIBOR. The language of the bill is consistent with a proposal published in March 2020 by the Alternative Reference Rates Committee (ARRC).
If adopted, the legislation would apply to all contracts, securities and financial instruments governed by New York law, capturing a large portion of the agreements that will be affected by LIBOR’s demise. For those contracts that cannot be amended to add appropriate fallback provisions or fix issues with flawed fallbacks, this legislation would impose a benchmark replacement to minimize disputes and negative economic consequences arising from the cessation of LIBOR.
For example, the existing fallback mechanism in certain floating rate notes would simply default to the LIBOR rate that was most recently available. Such fallbacks were designed to provide a stopgap in case LIBOR became unavailable on a temporary basis due to a short-term disruption, and were not intended to address the possibility that LIBOR would cease to be available. But with LIBOR set to be discontinued on a permanent basis, the presence of these types of fallbacks in contracts that are difficult to amend would have the effect of permanently converting floating rate instruments into fixed rate instruments, upsetting the commercial expectations of market participants and resulting in potentially severe economic consequences for the parties. Such consequences would significantly increase the risk of litigation. To avoid this outcome, the legislation would override such fallbacks in favor of benchmark replacement rates (including spread adjustments to account for differences between such rates and LIBOR) recommended by the Federal Reserve Board, the Federal Bank of New York or the ARRC.
The proposed legislation would also establish that these recommended replacement rates are functionally equivalent to LIBOR for contractual purposes. Parties responsible for rate calculations under the contract would be allowed to adopt a recommended replacement benchmark under the legislation without risking litigation or liability. Parties obligated to make LIBOR-linked payments would be deemed to satisfy those obligations by making payments based on the adopted replacement. And no party could declare a breach of contract, terminate the contract or be excused from performance due to the discontinuation of LIBOR or the adoption of the recommended replacement benchmark rate.
If passed into law, this bill would help address some of the toughest hurdles in the transition away from LIBOR. It is not, however, a comprehensive solution for all of the transition-related issues facing the US market. Despite its broad application, the legislation is not intended to actually provide a fallback mechanism for all agreements. The law would not override existing fallback provisions that reference a different rate, such as SOFR or the prime rate, and parties would also be free to mutually agree that it does not apply to their contract. In addition, this legislation would only apply to agreements governed by New York law. In the absence of federal legislation, similar laws would need to be adopted in every state to provide uniform coverage. And in states without motivated legislatures, market participants that have chosen local law to govern their documents without appropriate fallbacks will continue to face contractual uncertainty and potentially detrimental economic outcomes when LIBOR is discontinued.
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