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Federal Law to the Rescue? (The Senate Version)

LIBOR Relief Included In Appropriations Bill

New York Law Concerns[1]

The New York law enacted in April 2021 provides the ‘Get Out of Jail’ card[2] for banks from litigation relating to the LIBOR (London InterBank Offered Rate) transition, whether or not the recommended benchmark and spread adjustments are utilized.

Parallel legislation was adopted by:

  • Alabama

  • Florida 

  • Georgia House of Representatives

  • Indiana 

  • Nebraska Legislature

  • Tennessee

US House of Representatives Legislation

In December 2021, by a vote of 415 to 9, the US House of Representatives adopted legislation (HR 4616) sponsored by Congressman Brad Sherman (D-CA). This legislation was generally fair and reasonable to both banks and borrowers in connection with the LIBOR transition, though not without some concerns about mandating the International Swaps and Derivatives Association's spread adjustments.[3]

US Senate Legislation/Enacted Federal Law

On March 8, 2022, related LIBOR legislation was first introduced in the US Senate. However, this legislation, which was enacted on March 15th as part of the Consolidated Appropriations Act, has considerable issues.

Appropriations

Typically, an appropriations bill would address – you guessed it, appropriations:[4]

  • Agricultural, Rural Development and FDA (Division A)

  • Commerce, Justice, and Science (Division B)

  • Defense (Division C)

  • Energy and Water Development (Division D)

  • Financial Services and General Government (Division E)

  • Homeland Security (Division F)

  • Interior and Environment (Division G)

  • Labor, Health and Human Services, and Education (Division H)

  • Legislative Branch (Division I)

  • Military Construction and Veterans Affairs (Divisions J & S)

  • Foreign Operations and Intelligence (Divisions K & X)

  • Transportation and HUD (Division L)

Special Appropriations

It was essential that certain special appropriations be included in the Consolidated Appropriations Act to address the following recent significant events:

  • COVID (Division M)

  • Ukraine (Division N)

  • Haiti (Division V)

Miscellaneous Legislation

Outside of appropriations and the last bullet, the following made minor or contemplated changes to existing law:

  • Health (Division P – Telehealth)

  • Consumer Protection (Division Q)

  • Credit Union Governance (Division T)

  • EB-5 Reform (Division BB)

  • Adjustable Interest Rate (LIBOR) Act (Division U) 

Division U

Generally, the appropriations relating to each Division were finalized in the House of Representatives in July 2021 and taken up in the Senate on or before October 2021. This excludes the Ukrainian relief and COVID-related provisions, which were considered recently given worldwide events.

The only significant exception to the foregoing was Division U which was enacted in the House in December, introduced on the same day that the Ukrainian relief package was introduced in the Senate, but completely different than the generally fair and reasonable HR 4616 and more akin to the New York LIBOR law.

Purposes

Enumerated in Division U are valid reasons for its enactment in connection with the LIBOR transition:

  • establishment of a clear and uniform process

  • preclusion of unnecessary litigation

However, there is no provision anywhere in Division U which provides that the effective interest rate both immediately before and after the LIBOR transition be ‘substantially equivalent’ as required by the Internal Revenue Service (IRS) so as to ensure a fair and reasonable LIBOR transition. See ‘IRS LIBOR Transition Rules’ below.  

Parallel regulatory guidance had been provided by US bank regulators though that will now be prohibited by Division U.  See ‘Prohibition of Regulatory Actions’ below.

Inapplicability to Non-Bank Loans

Division U does not cover loans made by non-banking institutions. Some examples of non-banks include FinTech lenders, hedge funds, and certain student loan lenders.

No Negative Presumption

Division U specifically precludes any negative inference or negative presumption if a Federal Reserve-approved benchmark is not utilized in the LIBOR transition. Presumably, this is meant to protect a financial institution from challenges if a regulator-approved benchmark is not utilized as part of the LIBOR transition but may not protect against alternative benchmarks that are not commercially reasonable.  

It should be noted that regulators have expressed concerns that alternatives may be subject to the same manipulation as LIBOR.

Consumer Loans

During the first year of the LIBOR transition, under Division U, the benchmark rate is determined on June 29, 2023, the day before the scheduled LIBOR end date. There will likely be significant escalations of LIBOR rates one month before the scheduled end date, much less one day beforehand.  

This is particularly relevant if a benchmark not approved by the Federal Reserve is selected, as benchmark spread adjustments will not be predetermined but will instead be determined at the lender's discretion on the date of rate lock-in.

Student Loans

With respect to special allowances for student loans, Division U permits the permanent waiver of all contractual, statutory, and other legal rights with respect to such special allowances.

Trust Indentures

Division U provides that the rights of bondholders, where the related indenture is subject to the Trust Indenture Act of 1939, are not impaired or affected by Division U. This is contrary to the general requirement that each bondholder’s consent be obtained for a change in interest rates on a financing. 

This would be an understandable change if the interest rate immediately before and after the LIBOR transition were to be substantially equivalent, though, that is specifically not a requirement of Division U as outlined above.

Query how tax-exempt bondholders, where the indenture is not subject to the Trust Indenture Act, will be impacted in light of Division U.

Prohibition of Regulatory Actions

Pursuant to the provisions of Division U, Federal and State regulators cannot take any enforcement actions, provide regulatory guidance or even initiate any ‘matter requiring attention’ if a Secured Overnight Financing Rate (SOFR) were not utilized as a benchmark.

These alternatives include Bloomberg Short-Term Bank Yield (BSBY) Index, Ameribor, and any other alternative benchmarks developed by the financial industry, including, but not limited to, LIBOR.

These alternative indices, except for Term SOFR, have not been approved by Federal regulators as there are concerns that alternatives may be subject to similar manipulation as LIBOR.

The following regulators are specifically prohibited from taking any such action:

  • Treasury

  • Commodity Futures Trading Commission (CFTC)

  • Consumer Financial Protection Bureau (CFPB)

  • Federal Deposit Insurance Corporation (FDIC)

  • National Credit Union Administration (NCUA)

  • Office of the Comptroller of the Currency (OCC)

  • Securities and Exchange Commission (SEC)

  • State banking/securities departments and agencies

  • Federal Reserve

Interestingly, the Federal Reserve is tasked with promulgating regulations to carry out Division U.

IRS LIBOR Transition Rules

On January 4, 2022, the IRS issued final regulations, along with amendments to the Internal Revenue Code and related guidance (the “IRS LIBOR Transition Rules”).

The IRS LIBOR Transition Rules were issued so as to avoid (i) the triggering of a tax event as a result of the LIBOR transition for either the borrower or the lender, (ii) costly transition expenses (e.g., contract breaches, bankruptcies, litigation) and (iii) significant US financial market disruptions.

Among other things, the IRS LIBOR Transition Rules provide safe harbors if:

  • the fair market value of the contract immediately before and after the modification is ‘substantially equivalent’ (within 25 basis points)

  • SOFR or Term SOFR is utilized

  • other Federal Reserve endorsed or ARRC recommended benchmarks are used (currently, no other benchmarks are so endorsed or recommended)

  • arms’-length negotiations between the parties in the transition

The IRS LIBOR Transition Rules became effective for benchmark transition modifications entered into on or after March 7, 2022.[5]

Next Steps

To the extent a party believes it is disadvantaged by the passage of Division U, the only alternatives are:

  • passage of ameliorating Federal legislation

  • modification of industry-standard contracts to address the adverse impacts of Division U

FOOTNOTES

[1] See the section entitled ‘Material Adverse Impacts of Proposed New York Legislation’ in ‘The End of LIBOR: The Twilight ZoneTM Edition’ Client Alert, dated March 11, 2021.

[2] See Monopoly Board Games, Card & Online Games – Hasbro MonopolyTM board game from Hasbro, Inc., an American-Canadian multinational conglomerate.

[3] See the section entitled ‘But – Significant Spread Adjustments Concerns’ in the Client Alert entitled ‘Federal Law to the Rescue?’ dated November 3, 2021, with Michael Lengel.

[4] Division references are to the enacted Federal legislation but did not parse through to confirm that the legislation specifically dealt only with appropriations.

[5] It should be noted that a proposed version of Division U was introduced in the Senate on March 2nd, shortly before the effectiveness of the IRS LIBOR Transition Rules. This proposed version included language scaling down or eliminating the effectiveness of the IRS LIBOR Transition Rules. Fortunately, when adopted by the Senate the following week, these provisions were stricken and not included in Division U.

© 2022 ArentFox Schiff LLPNational Law Review, Volume XII, Number 104
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About this Author

Les Jacobowitz Partner ArentFox Schiff LLP
Partner

Les has over 30 years of experience representing issuers, borrowers (including not-for-profits), governmental entities, underwriters, and financial institutions in domestic and international transactions.

Les has provided counsel on deals involving $25 billion or more, as well as restructurings and workouts of an additional $48 billion. He has worked with governmental entities, private companies, banks, investment banks and funds in all aspects of financing, including the lending, securitization, real estate, public finance, not-for-profit,...

212-492-3315
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