Commercial loans when there is no more LIBOR

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The London Inter-Bank Offered Rate is likely to die out soon. For decades, LIBOR indices have been one of the main sources used by commercial lenders in floating rate loan transactions, but in 2017 the LIBOR regulator announced that the release of these indices could be suspended after December 2021. Since then, banks have grappled with the best way to handle outstanding loans on their books, using LIBOR to determine the interest rate, and how to price and document new loan transactions when both bankers and borrowers are used to LIBOR-based rates.

Until the announcement in 2017, the prospect of LIBOR disappearing was practically unthinkable. While most traditional commercial loan documents addressed the potential unavailability of LIBOR, this was rarely, if ever, negotiated. This formulation often provides that in the unlikely event that LIBOR cannot be determined, the lender would unilaterally replace a new interest rate or index to determine the interest rate, which may also contain some “guard rails” for this process, such as that the lender must be “reasonable” in determining it and / or that the replacement index must be similar to LIBOR. Since such “lender choice” rules in existing loan documents signed prior to the 2017 announcement could now be fertile ground for disputes and potentially strained borrower-lender relationships, in most cases it is advisable that the parties begin to discuss how the interest rate will be set long before the end of LIBOR and may be set in a written amendment with more definitive terms.

Although LIBOR is known to be unlikely to last long, partly due to notoriety and habit, commercial lenders nonetheless continue to compete for new lending business by adding LIBOR-based interest rates to their loan proposals to prospective borrowers. The latter, too, can cope with an index and terminology that has been known for years. Since the LIBOR disappearance is not purely theoretical, commercial loan documentation usually includes more detailed and refined provisions to remedy this disappearance. Unsurprisingly, these provisions are negotiated much more frequently than they were before 2017.

This wording generally falls into three categories: (1) a more robust form of the lender discretion provision discussed above, with clearer “guard rails” governing lender selection for an alternative index and the resulting interest rate; (2) a predetermined substitute index that will automatically replace the discontinued LIBOR, which will most likely be the index known as “SOFR” (Secured Overnight Financing Rate); or (3) where a borrower’s bargaining power is particularly strong, terms that require the borrower and lender to agree on the replacement index and / or rate.

Careful attention to the LIBOR language in existing and future credit transactions by both commercial lenders and borrowers will be especially important over the next 18 months as the industry turns away from this long-running index.

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