LIBOR provides answers, safe harbor for lenders Finance & Banking

On March 15, 2022, the Consolidated Appropriation Act of 2022 has been enacted. Section U, Adjustable Interest Rate Act (LIBOR), resolves what had otherwise been an outstanding issue with variable interest rate loan agreements that use LIBOR as an index.

LIBOR, which was historically used as a floating rate index in many commercial and consumer loan contracts, is set to expire on June 30, 2023. While commercial and consumer lenders have now largely abandoned drafting new contracts in using LIBOR, there are $200 trillion of LIBOR-based legacy contracts. Many of these contracts do not clearly provide for a specific replacement for LIBOR, raising the question of what would happen to these contracts when LIBOR is discontinued. LIBOR now provides a legislative answer to this question and a safe harbor for lenders who comply with its provisions.

LIBOR provides that the replacement benchmark rate selected by the Federal Reserve Board (FRB) will replace LIBOR as the floating rate index in all affected loan agreements. It is widely expected that the FRB will designate the Secured Overnight Funding Rate (SOFR) as the benchmark replacement rate. LIBOR also provides that the use of the designated benchmark replacement constitutes the use of a “comparable” or “commercially reasonable replacement rate”, according to language commonly used in the terms of variable interest rate contracts. In addition, LIBOR provides that the use of the designated benchmark replacement provides a safe harbor that protects the creditor from legal liability.

Specifically aimed at variable rate consumer loans, the LIBOR Act authorizes the FRB to adjust the replacement of the benchmark over a period of one year from June 30, 2023. The purpose of these adjustments is to “transition linearly from the difference between” the LIBOR term specified in the consumer loan documents to the benchmark replacement over that period. At the end of this period, the FRB will publish the replacement benchmark incorporating the “duration gap adjustments” specified in LIBOR. Presumably, this gradual introduction of consumer loans will lessen the impact of the transition away from LIBOR on consumer borrowers.

Finally, the LIBOR Act directs the FRB to promulgate regulations to implement the LIBOR Act within 180 days of its enactment, which means that these regulations are expected in September. LIBOR and its future regulations, combined with amendments to Regulation Z and its official comments, which address disclosure issues related to the transition from LIBOR and which come into effect on April 1, 2022, appear to resolve the contractual and consumer protection issues arising from the demise of LIBOR.

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