The United States Adopts a Federal LIBOR Transition Solution

With the inclusion of the Adjustable Interest Rate (LIBOR) Act (the “LIBOR Act”) as Division U of H.R. 2471, Consolidated Appropriations Act, 2022 (the “Appropriations Act”), signed into law by President Joseph Biden on March 15, 2022, the United States has adopted a federal solution for legacy LIBOR-linked contracts that contain inadequate fallback provisions or none at all. Indeed, the final version of the legislation provides additional legal certainty with respect to the use of non-SOFR benchmarks not included in the earlier version of the legislation passed by the US House of Representatives.

Background

The search for a legislative solution to the problem of legacy contracts linked to the London Interbank Offered Rate (“LIBOR”) that are impossible, or virtually impossible, to amend, and that lack fallback provisions that implement a replacement rate that is not linked to LIBOR or that does not result in a fixed interest rate, began with the passage by the New York legislature of Senate Bill S297B on March 24, 2021. Shortly thereafter, Alabama passed the LIBOR Discontinuance and Replacement Act of 2021—a virtually identical bill—on April 29, 2021. However, to address conflicts with other federal laws¹—outside the purview of state legislatures—and for reasons of efficiency and uniformity, on December 8, 2021, the US House of Representatives passed H.R. 4616, the Adjustable Interest Rate (LIBOR) Act, in order to provide a federal solution for LIBOR-linked contracts that need to transition away from LIBOR but that lack the mechanics to do so.²

On February 28, 2022, US Senator Jon Tester (D-MT), along with Senate Banking Committee Chair Sherrod Brown (D-OH), Ranking Member Pat Toomey (R-PA) and Senator Thom Tillis (R-NC), announced that they planned to introduce their own LIBOR-transition legislation. This legislation made a number of revisions that tightened the language of the US House bill and offered three substantive changes: new protections for banks that use non-SOFR benchmarks; broader coverage that includes any interbank offered rate, not LIBOR only; and tax provisions that confirm that amendments to a financial contract that implement transition to a replacement benchmark for LIBOR, and nothing more, will not be treated as a taxable sale, exchange or other disposition of property for purposes of section 1001 of the Internal Revenue Code.

As federal legislation has worked its way through the US Congress, seven states now have proposed or adopted LIBOR transition legislation—New York, Alabama, Florida (House and Senate versions), Georgia, Indiana, Nebraska and Tennessee. However, the passage of the LIBOR Act will provide a federal solution to LIBOR transition for legacy contracts, supersede state legislation to date and eliminate the need for additional state-level legislation.

Appropriations Act Version

The LIBOR Act, as incorporated into the Appropriations Act, differs from the original US House version of the bill in several ways. The major differences are as follows:

1. Use of non-SOFR replacement benchmarks – Section 106 of the LIBOR Act includes the so-called Toomey amendment, which limits the ability of bank regulators to take enforcement action against any bank that uses a replacement benchmark other than SOFR in loan transactions. The additional provision represents a legislative response to concerns of various regulatory bodies regarding the adoption by regulated institutions of alternate replacement benchmarks that are not based on SOFR, such as the Bloomberg Short Term Bank Yield Index, or BSBY. Under the LIBOR Act, a bank regulator cannot take enforcement actions against a bank that uses an alternate reference rate other than SOFR “… solely because that benchmark is not SOFR.” The bill sets forth a number of criteria that a bank should use in determining whether to use a non-SOFR reference rate, none of which directly addresses regulators’ concern about using a reference rate that raises “inverse pyramid” concerns or is otherwise not “robust.” While this new provision is helpful, it is our understanding that its intention is to prevent federal regulators from prohibiting the use of non-SOFR loans. However, if a bank engages in poor risk management in connection with the use of a non-SOFR loan, violates existing consumer protection requirements by selling a loan that uses a non-SOFR benchmark or violates any other regulation with a practice or action that involves a loan with a non-SOFR benchmark, the bank would still be subject to enforcement actions by federal banking regulators.
2. Spread adjustments for consumer loans – Section 104(e)(2) of the LIBOR Act includes language that modifies benchmark spread adjustments applicable to consumer loans during the one-year period beginning on the LIBOR replacement date. This one-year “phase in” period prevents consumers from experiencing sudden interest rate shifts and should help moderate the effect of LIBOR replacement.
3. Subsequent Federal Reserve regulations – Section 110 of the LIBOR Act requires the Federal Reserve Board to promulgate regulations to carry out the provisions of the legislation within 180 days after the date of enactment.

Also of note is the fact that, apparently due to jurisdictional considerations,³ the tax provision proposed in the US Senate legislation ultimately was dropped from the final legislation introduced on March 8, 2022, and passed by the US House on March 9, 2022, and then by the Senate on March 10, 2022. Accordingly, US federal income tax implications of the federal legislative solution are governed by recently released final Treasury regulations, which generally provide broad relief from the potential US federal income tax consequences of IBOR replacement.⁴

The signing into law of the Appropriations Act by President Biden has had broad industry support and is being welcomed widely as an effective solution for tough legacy contracts, including by the Alternative Reference Rates Committee, which was convened by the Board of Governors of the Federal Reserve System, which is the entity empowered to identify the benchmark replacement under the LIBOR Act. Adoption of the LIBOR Act, including the contract continuity and safe-harbor provisions, is expected to help avoid the substantial litigation that regulators foresaw if the legislation failed to be enacted.

¹ Including, importantly, the Trust Indenture Act of 1939. See our Legal Update Federal LIBOR Legislation Signed Into Law; Amends Section 316(b) of the Trust Indenture Act of 1939 (March 16, 2022) for a discussion of the solution provided by the LIBOR Act and its specific effect on floating rate notes.

² See our blog post Adjustable Interest Rate (LIBOR) Act of 2021 Is Passed by the U.S. House of Representatives (December 9, 2021).

³ In the Senate, the Senate Finance Committee has jurisdiction over any bill that includes any changes to the Internal Revenue Code. Hence, had the tax provision not been removed, the legislation would have been referred to the Senate Finance Committee, rather than the Senate Banking Committee, on which its sponsor and co-sponsors sit.

⁴ For a detailed discussion of the final Treasury regulations, see our Legal Update US IRS Releases Final Regulations Addressing IBOR Transition (January 7, 2022).