As a general rule, loan documentation typically provides that if LIBOR is no longer available, the interest rate for a credit facility will be determined utilizing a prime-based rate. For loans originated or amended recently, as an alternative to the using the Prime Rate as the reference index if LIBOR is no longer available, loan documentation may also include a detailed “fallback” mechanism that allows the loan documents to be amended to incorporate a new reference rate to replace LIBOR, as well as spread and other adjustments to account for differences between LIBOR and the new reference rate. In selecting the new reference rate and any adjustments, due consideration is expected to be given to recommendations made by the Federal Reserve Board or other applicable governing bodies, and/or to evolving or then prevailing market conventions for determining a replacement rate.
The Alternative Reference Rates Committee (ARRC), a financial industry group including a mix of banks, accounting firms, law firms and other industry stakeholders, was convened by the Federal Reserve Board and the New York Fed specifically to help facilitate the U.S. transition away from LIBOR. To aid in that transition, the ARRC has recommended using the Secured Overnight Financing Rate (SOFR) to replace LIBOR and has suggested standardized forms of fallback language for use in loan documentation applicable to cash products such as loans and mortgages. Unless the documentation for an existing loan includes a prime rate-based option in addition to a LIBOR-based rate component and the borrower is comfortable utilizing that prime-based rate when LIBOR permanently ceases to be available, it is likely that loan documents will need to be amended to incorporate LIBOR “fallback” language, whether in the form suggested by the ARRC or otherwise, to replace LIBOR and related terms and conventions with terms and conventions related to an alternative interest rate, such as SOFR.
The International Swaps and Derivatives Association (ISDA), the leading industry group for the derivatives market, has recently announced publication of documentation and an ISDA protocol to address the transition away from LIBOR in derivatives transactions, both of which become effective on January 25, 2021. All new derivatives contracts entered into on or after this date will apply the new fallback language for replacing LIBOR irrespective of protocol adherence, and all then-existing contracts (“legacy derivatives contracts”) will incorporate such new fallback language if both counterparties have adhered to the protocol. Similar to the ARRC, ISDA also recommends using SOFR to replace LIBOR for swaps, and ISDA’s recommended LIBOR replacement terms are intended to align with the ARRC’s.
Alternatively, for legacy derivatives contracts parties may bilaterally agree to equivalent or different fallback terms to reflect an agreed replacement rate.