The Effect of LIBOR Cessation on Bonds – What’s a Trustee to do?
On April 6, 2021, New York Governor Cuomo signed into law legislation aimed to provide legal certainty and curb litigation as LIBOR is discontinued in favor of another fallback benchmark rate. While the most popular tenors of LIBOR (forward-looking 1-month and 3-month rates) may continue to be published up until June 2023, it is estimated that of the $864 billion of bonds referencing LIBOR that are currently outstanding, 43% have a maturity date beyond the end of 2034. It appears inevitable that a replacement benchmark rate must be substituted for outstanding bonds.
As the New York legislation cannot override Federal law that applies to trust indentures governed under New York law, Federal legislation is likely required as described below. As LIBOR fades into the sunset, the crucial question is whether a bond trustee can unilaterally decide to substitute LIBOR for another rate, or whether a bond trustee can obtain a sufficient number of consents to substitute away from LIBOR.
Trust Indenture Act
Under Section 316(b) of the Trust Indenture Act of 1939, as amended, “the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security…shall not be impaired or affected without the consent of such holder.” As a result of this Trust Indenture Act provision, an issuer cannot – outside of bankruptcy – alter its obligation to pay bonds without the consent of each bondholder.
A trust indenture is a contract between a bond issuer and a trustee that represents the bondholder’s interests by highlighting the rules and responsibilities that each party must adhere to while the bonds are outstanding. The trust agreement, like the provisions of the Trust Indenture Act, often requires each holder’s consent for any changes in the key economic terms of the bond – principal, maturity, and interest rate.
The transition from LIBOR represents a potential change in the interest rate on a bond. Even if the trustee were to choose SOFR, embraced by some as a replacement for LIBOR, there is currently no forward-looking SOFR rate for different time periods that would provide an explicit benchmark, even with a benchmark spread adjustment, to equate to LIBOR. Importantly, numerous regulators have stated, from the Federal Reserve to the IRS, that the effective interest rate to the borrower immediately prior to and subsequent from the LIBOR transition should be nearly economically equivalent.
Trust indentures generally permit a trustee to unilaterally change provisions that are merely ministerial or conforming in nature, permitting the trustee to agree to amendments that are not materially adverse to the interests of the bondholders. As the contemplated changes in connection with a LIBOR transition potentially change the economic value of a bond, it is unlikely that a trustee alone would make such a determination.
As a key economic term change, consents will likely be needed from all bondholders. Getting 100% consent from each holder of a bond, however, would prove to be a logistical nightmare. The problem: “[i]ndividual bond issues are very often held by multiple investors, many of whom will hold them anonymously through clearing houses or through trust or other arrangements. There is therefore not a straightforward mechanism for an issuer to obtain the necessary consents to allow amendments to the documentation to address the issues raised by LIBOR discontinuation.” Unanimous consent will be especially difficult for a trustee to obtain from small retail holders who may not be paying full attention to their bond holdings.
With respect to a bond trustee changing a rate, “a party disadvantaged by the replacement rate might argue that the manner in which another person …selected the replaced rate violates the implied covenant of good faith and fair dealing.”
What are the possible options open to bond trustees?
- Governing law possibly to the rescue – this time Federal law. The U.S. House of Representatives held a hearing on April 15, 2021 with respect to the LIBOR transition and the possibility of enacting Federal law to deal with these concerns.
The proposed Federal legislation’s goal is to “(1) establish a clear and uniform process, on a nationwide basis, for replacing LIBOR in existing contracts that do not provide for the use of a clearly defined fallback benchmark rate; (2) preclude litigation related to existing contracts that do not provide for the use of a clearly defined fallback benchmark rate; and (3) allow existing contracts that reference LIBOR but provide for the use of a clearly defined fallback benchmark rate to operate according to the terms of such contracts.”(emphasis added)
- Consent Solicitation – Here, an agreement is reached between the issuer and bondholders to make a critical change like the benchmark interest rate used along with the related spread adjustment, as well as third-party evidence that the interest rate is not materially changing. The issue, as mentioned above, is finding all outstanding bondholders and having them unanimously agree.
To the extent 100% of the outstanding bondholders have not consented, even though proceeding would counter the provisions of the trust indenture and the Trust Indenture Act, and is not a path we recommend, the trustee could accept indemnifications from certain bondholders with a significant financial wherewithal to assure the LIBOR transition and reduce the financial impact of inevitable litigation costs of the trustee.
- Offer Bondholders Alternative Bonds, or Cash in Exchange – “If bonds are trading below par in the market…an issuer may make a tender offer…[or] repurchase the bonds in the private market on a more ad hoc basis …[perhaps] adding an incentive fee.” 
The problem with this option is that many bonds may be locked-out from redemption at the time of the proposed LIBOR transition.
- Let the Bonds Lapse into Fixed Rate Bonds (and expect litigation) – Existing fallback language often states that, in the event LIBOR is not available, the variable rate becomes a fixed rate based upon the last published LIBOR tenor. This is actually meant to be a very short term fix until LIBOR is once again available, and was not intended to be a permanent transition. “Without a solution [to replacing LIBOR], countless floating-rate bonds would effectively convert to fixed-rate notes based on LIBOR’s final [published floating rate], potentially upending the market and leading to a flood of litigation.”
Adding to this potential litigation – interest rate swaps are often tied to variable rate bonds. Fixed borrower counterparty payments might still be required under the swap (as well as on the now converted variable to fixed rate bonds) even though the bank counterparty may only be contractually obligated under the swap to pay a variable rate. In other words, there must be equivalent treatment of variable rate bonds and their related swaps.
- Publish a ‘Zombie’ LIBOR – A rate, perhaps published by a few LIBOR panel banks, for use ONLY by legacy bonds (i.e., those that mature subsequent to June, 2023), calculated as a modified LIBOR based on reference to another benchmark rate (SOFR?) with an adjustment spread determined by these LIBOR panel banks or a government regulator. 
The ramifications to the bond market were made clear by Mark Van Der Weide, General Counsel, Board of Governors of the Federal Reserve System, when he stated that “the end of LIBOR may result in significant litigation…a party disadvantaged by [a] conversion might request that a court reform the contract by substitution of an alternative floating rate for LIBOR…an aggrieved party might cite a variety of common law doctrines including mutual mistake, impracticability, and frustration of purpose.”
Short of Federal legislation or a tender offer, if bonds are trading below par, in light of the expected wave of litigation, what is a bond trustee to do?
 BOKF, N.A. v. Caesars Entertainment Corp., 144 F.Supp.3d 459, 466 (S.D.N.Y.,2015). See In re Board of Directors of Multicanal S.A., 307 B.R. 384, 388–89 (Bankr.S.D.N.Y.2004); and Mark J. Roe, The Voting Prohibition in Bond Workouts, 97 Yale L.J. 232, 251 (1987) (“Only two events should change a company's obligation to pay its bonds. Either each affected bondholder would consent to the alteration of the bond's terms, or a judge would value the company to determine that the firm was insolvent, eliminate the stockholders, and then reduce the express obligation to the bondholders.”) (emphasis in original). BOKF v. Caesars held that in order to prove an impairment under §316(b) of the Trust Indenture Act, plaintiffs must prove either an amendment to a core term of the debt instrument, or an out-of-court debt reorganization. Also see Marblegate Asset Management, LLC v. Education Management Finance Corp., 846 F.3d 1, 17 (C.A.2 (N.Y.), 2017). “Absent changes to the Indenture’s core payment terms,” the court held that a particular out-of-court debt restructuring plan was not a violation of §316(b) of the Trust Indenture Act.
 Ceri Morgan, Esq., et al., LIBOR is Being Overtaken: Will it Be a Car Crash, Journal of International Banking Law and Regulation, 34 J.I.B.L.R., Issue 2, 2019, Page 58.
 Statement by Mark Van Der Weide, General Counsel, Board of Governors of the Federal Reserve System, before the Subcommittee on Investor Protection, Entrepreneurship and Capital Markets of the Committee on Financial Services, U.S. House of Representatives, April 15, 2021, available here last visited May 2, 2021.
 Id. FN 8.
 For more information on Zombie LIBOR, look forward to “Zombie LIBOR for USD Contracts: Navigating the Critical Issues” Live Webcast, Les Jacobowitz, Esq., Partner, Arent Fox LLP, and Paul Noring, Managing Director, Berkeley Research Group, LLC, May 12, 2021, information available here last visited May 4, 2021.
 Id. FN 7. See Canpro Investments Ltd. v. United States, 130 Fed.Cl. 320 (Fed.Cl., 2017). “To prevail on a claim of mutual mistake, a party to a contract must show that (1) both parties were mistaken in their belief regarding a fact existing at the time of contracting, (2) the mistaken belief constituted a basic assumption on which the contract was made, (3) the mistake had a material effect on the bargain, and (4) the contract did not place the risk of mistake on the party seeking relief.” Our cursory legal review found that, upon a court finding of mutual mistake, impracticability or frustration of purpose, the borrower might have legal grounds to have the underlying loan agreement or swap documents either reformed or perhaps declared void or voidable since a material fact at the time of signing of the contract, the continuance of LIBOR, was a mistake – a dire result for the ‘smooth transition’ of LIBOR.
Everything you need to know to be prepared for the LIBOR-SOFR transition.