The Practical Effects of LIBOR’s Phase Out

Trillions of dollars’ worth of financial documents use the London Interbank Offered Rate, or LIBOR, to set the interest rate of a transaction. The ICE Benchmark Administration currently maintains a reference for LIBOR by averaging banks’ estimates of how much it costs to borrow from another bank for term periods of one day up to a few months. But the rate that has served as a global benchmark for nearly half a century is now on its way out.

At the end of 2021, the U.K. Financial Conduct Authority (FCA) will no longer require banks to submit their quotes for LIBOR rates. The question – “What will replace LIBOR?” – allows for much speculation at this point, though work has been done to pick a replacement. In the United States, the Alternative Reference Rates Committee (ARRC) has chosen a broad Treasuries repo financing rate as its preferred LIBOR alternative, which is tied to the cost of overnight borrowing collateralized by U.S. Treasury securities. In the U.K., the Risk-Free Rate Working Group (RFRWG) has chosen the Sterling Overnight Index Average (SONIA) as its preferred alternative to LIBOR, which is based on actual transactions in the U.K. overnight unsecured lending and borrowing market.

As a result, interest rates using LIBOR as an index will likely become deficient after 2021. Understanding the practical reality of a transition away from LIBOR involves reviewing every contract that uses LIBOR as an index to determine the potential impact. New contracts – or renewals, forbearance agreements, or extensions traditionally using LIBOR – will need to consider alternative indexes and the addition of protective fallback provisions.

No Alternative or Fallback Provisions

Where a contract contains no alternative provision to LIBOR, parties should renegotiate the interest rate provision or risk the contract having a missing term.

Generally, it appears likely that courts will be willing to substitute a rate of interest where the interest rate is essential to the determination of rights and duties and LIBOR is no longer available. The court may also supply the interest rate from its own understanding of the intentions of the parties.

In FDIC. v. Cage, a receiver of a failed bank sued borrowers to recover on a promissory note. The note relied on the “rate which shall be One and One Half percent above the prevailing commercial prime rate of AmBank.” AmBank (American Bank) failed, however, and there was no governing body to set the prime rate of AmBank. The court held it had inadequate information upon which to determine the appropriate interest rate based on the terms of the contract and the termination of AmBank’s prime rate. The parties were given the opportunity to agree to an appropriate interest rate, or the court would compute an amount of interest due. As the parties could not agree, the court found it was able to substitute the New York prime rate for the AmBank interest rate based on affidavits from an FDIC liquidation assistant:

“The question presented to this Court is whether the defunct status of AmBank precludes calculation of an appropriate rate of contractual interest on the Defendants’ promissory note and thereby destroys the negotiability of the note. Defendants base their claim that interest on the note is uncollectible on the fact that the note specifically states that interest will be calculated according to the prime rate of AmBank. Defendants argue that there is no legal authority supporting substitution of the New York prime rate for the prime rate of AmBank, but Defendants cite no authority establishing that the use of the New York prime rate would be unreasonable in this case.”

The court relied on the opinion of two other district court decisions (FDIC v. Condo Group Apartments and FDIC v. Rogers Park I) finding that where the interest rate on a note is determined by reference to the prime rate of a failed institution, it is reasonable to compute the interest rate based on an alternative prime rate selected by FDIC.

In Murr v. Midland Nat. Life Ins. Co., an annuity contract had an initial interest rate of 3.4 percent and a guaranteed minimum interest whose adjustment formula was dependent on the interest rate of newly offered annuities. The missing variable resulted from Midland’s discontinuation of certain types of annuities such that there was no new interest rate to substitute into the formula. The court found that it was bound to enforce terms as written and that it could not substitute a different meaning than the one for which the parties intended and embodied in unambiguous terms. However, because the missing term created ambiguity and there was nothing in the contract to provide for the replacement of the term, the court was able to use extrinsic evidence to supply a term.

For contracts or financial documents governed by the Uniform Commercial Code, the UCC provides a fallback provision for determining interest rates where the instrument provides for one “but the amount of interest payable cannot be ascertained.” In such a situation, the interest rate is the judgment rate in effect at the place of payment of the interest, at the time interest first accrues.

It is possible that LIBOR will continue to be published in some form. Given that LIBOR covers many types of currencies and suggested alternatives have been identified by particular regulatory bodies within each country, there may be a rationale to continue publishing LIBOR past 2021, but it is likely that many fewer banks would submit their individual LIBOR estimates and the rate would be significantly less reliable. If LIBOR continues to be published, it is likely loan documents referencing LIBOR would still be valid. Again that largely depends on the language of each document.

Alternative or Fallback Provisions

Most LIBOR fallback provisions in current contracts were written as a result of issues from 2007 to 2012. As a result, the provisions contemplate temporary disruptions of LIBOR instead of its end. One example is where the methodology of LIBOR changes or becomes unreliable but the index is still being published. Another example is a provision that allows a bank to temporarily determine another rate where the governing body changes interpretation or administration of an interest rate, or the legality of the rate is called into question, but not necessarily the publishing of such a rate. Litigation could arise in such a case as to whether the bank had the ability per the contract language to substitute a completely new interest rate or index indefinitely, or whether the bank was only authorized by the terms of the contract to find a suitable temporary alternative until another rate could be negotiated or established.

Another concern is whether the alternative rate provided in the contract can also withstand confusion and potential litigation. The International Swaps and Derivatives Association (ISDA) is working on creating fallback rates to use if LIBOR is permanently discontinued, but that will likely only be useful to over-the-counter derivatives market participants. However, many commercial loan documents that rely on LIBOR are used in conjunction with over-the-counter derivatives market documents, and changes in one market will need to consider all the documentation supporting a transaction.

Issues in the chosen alternative will likely also pose problems. While the ARRC is currently working on implementation of its preferred alternative rate to replace LIBOR, problems stemming from the methodology and practical use of those rates in conjunction with rates chosen by other advisory boards should be anticipated through language in loan documents.

Although disputes and possibly litigation may arise as to when an alternative rate may be used and the actual effect of the alternative provisions, any dispute will likely not affect their legal validity or enforceability, based on past LIBOR reform litigation.

Additional Provisions to Consider

Although fallback provisions are already contained in many LIBOR-dependent documents, additional provisions should be considered that avoid foreseeable issues with future indexes or the triggering event of fallback provisions. For example, express language could provide that changes in the methodology by which a reference rate is calculated will not be grounds for terminating a contract. Another provision, based upon the inherent reliability of any chosen index, could provide that parties agree to negotiate in good faith should a reference rate be eliminated completely.

Recommended Steps

The best course of action in preparing for the LIBOR phase out is to review any financial documents that mature after 2021 and assess which rely on the LIBOR interest rate. An attorney can assess the viability of fallback provisions, if any, and update the documents to include new fallback provisions relevant to potential problems associated with the phase out of LIBOR and new indexes referenced in the future. Based on the specific provisions of each contract, an attorney can formulate methods of renegotiating loan documents that will require updated provisions. Now is the time to consider the impact.

Brian Darer

Catherine Clodfelter

Faulty Foreclosure Service Results in Lienholder Having to Pay Property Owner

When a lienholder starts a foreclosure, it usually is focused on getting money into its pocket. Yet a recent opinion from the North Carolina Court of Appeals (In re: Ackah – Sept. 5, 2017) should provide a warning to all lienholders – make sure you get proper service in the foreclosure or you may end up with significant money going out of your pocket instead. And if you have an email address for the property owner, make sure to use it to send notice of the foreclosure.

The Facts

Gina Ackah owned residential property in an HOA community near Raleigh. Ms. Ackah moved to Africa and leased the residential property to a tenant while she was gone but did not tell the HOA of her move. Her mail was forwarded to her uncle in South Carolina. In 2014, Ms. Ackah failed to pay her HOA dues and the HOA commenced a foreclosure. The HOA made numerous attempts to send certified mail notices of the foreclosure to Ms. Ackah at her mother’s and uncle’s addresses, but these notices were all unclaimed. The HOA then posted the foreclosure notice on the front door of the property. Even though the HOA had Ms. Ackah’s email address, it never sent the foreclosure notice to her via email. Continue Reading

CFPB’s New Arbitration Rule and How It’ll Likely Be Challenged

On July 10, 2017, the Consumer Financial Protection Bureau (CFPB) announced a new rule that may have significant ramifications for the financial industry. The rule aims to stop a now common feature in financial services contracts: provisions directing customers to private, individual arbitration rather than the courts to settle disputes.

The sweeping rule would ban many financial service companies from using mandatory arbitration clauses in contracts with consumers. The rule does not prohibit such clauses outright, but instead will prevent companies from relying on any arbitration agreement to block a consumer from joining or initiating a class action. The result would be to open the door to class action lawsuits against the vast majority of businesses that extend credit to consumers, including banks, mortgage lenders and servicers, and credit card companies.

In addition, companies will face reporting requirements under the rule for any arbitrations that still happen, either under agreements entered into before the rule becomes effective or for non-class disputes. Parties may then lose the benefit of confidentiality that arbitration can provide. Under the rule, the CFPB would begin posting arbitration data to its public website, starting in July 2019. Continue Reading

The Debt Buying Industry Breathes a Sigh of Relief: Supreme Court Rules for Debt Buyer on FDCPA Claim

Here we are nearing the end of another U.S. Supreme Court term, and it has been a busy one in the creditors’ rights arena – and a particularly good one for debt buyers. Yesterday (June 12, 2017), the Supreme Court issued its second Fair Debt Collection Practices Act (FDCPA) decision of the term: Henson v. Santander Consumer USA Inc. (See our previous blog post about this case after the Fourth Circuit ruled on it in 2016.)

The Supreme Court’s opinion is noteworthy as the first opinion from the newest member of the court, Justice Neil Gorsuch, and for its opening alliterative lines:

“Disruptive dinnertime calls, downright deceit, and more besides drew Congress’s eye to the debt collection industry. From that scrutiny emerged the Fair Debt Collection Practices Act …”

But most memorable for debt buyers is the ruling that the FDCPA does not apply to companies that purchase debt from others and then collect that debt on their own behalf.  Continue Reading

Late Charges on Balloon Payments: How Big Can They Be?

Getting charged extra for a late payment is standard protocol in lending practices. Judges, lawmakers and regulators have long agreed there’s an administrative hassle lenders should be compensated for when having to recover money past its due date. But in the commercial real estate industry, there’s a new question related to maturing loans originated before the financial crisis: Can a lender charge a late fee on the full amount of a balloon payment due at maturity?

In the world of commercial real estate finance, the answer to that question can mean a six or seven figure swing in your loan payoff depending on how the loan documents are interpreted. But so far, courts in New York, Michigan, Arizona and elsewhere have split on what the answer is.  Continue Reading

U.S. Supreme Court Weighs in on Bankruptcy Claims, Fair Debt Collection Practices Act

The United States Supreme Court issued a ruling Monday resolving the question of whether filing a proof of claim for a debt that is time-barred by the statute of limitations is a violation of the Fair Debt Collection Practices Act (FDCPA). In Midland Funding, LLC v. Johnson, Justice Stephen Breyer, writing for the majority, held that filing a proof of claim for a debt that is barred by the applicable state statute of limitations is NOT a violation of the FDCPA.

The case arose out of a Chapter 13 bankruptcy case in which Midland filed a proof of claim for a credit card debt that, on its face, showed that the credit card had not been used in more than 10 years. Such a claim was barred by the six-year statute of limitations in Alabama. After successfully objecting to the claim, the debtor then sued Midland, claiming that the filing of the proof of claim on an obviously time-barred debt was “false,” “deceptive,” “misleading,” “unconscionable” and “unfair” under the FDCPA. The district court held that the FDCPA did not apply and dismissed the lawsuit. The Eleventh Circuit reversed.

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Lenders Welcome Cinco de Mayo Ruling From NC Supreme Court on Deficiency Judgments

Readers of my case alerts may remember a July 2015 alert about the troubling North Carolina Court of Appeals decision in United Community Bank v. Wolfe, which made it a lot harder for lenders to obtain a post-foreclosure deficiency judgment. (For a refresher, you can read that old case alert here.)

Well, the wheels of justice have slowly turned and on May 5, 2017 (almost two years after the Court of Appeals’ ruling), the North Carolina Supreme Court issued its opinion and unanimously reversed the Court of Appeals. Those cheers you hear are lenders celebrating this Cinco de Mayo present.

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Foreclosures in North Carolina – Say Goodbye to Discovery and Res Judicata

Late December is a time of family, mistletoe and “presents under the tree.” It’s not usually the time when minds switch to the specifics of foreclosure procedure. Yet just before they retired for their Christmas break, the justices of the North Carolina Supreme Court dropped off a December 21, 2016 holiday present called In re Lucks which radically changes foreclosure procedure in North Carolina as we know it. Was it a timely present, a lump of coal, or maybe a little of each? You decide.

The Facts

The facts involved in Lucks are pretty dry. In 2006, Borrower executed a 30-year, $225,000 promissory note which was secured by a deed of trust on property in Buncombe County. At some later date, the note went into default. In 2013, a law firm claiming to be the substitute trustee under the deed of trust started a non-judicial foreclose. That foreclosure was dismissed by the clerk based on the failure of the law firm to present evidence that the firm had actually been appointed as the substitute trustee. Continue Reading

Need To Fix That Accidental Release of a Deed of Trust?

N.C. Gen. Stat. § 45-36.6(b) provides that if a secured party erroneously records a release or satisfaction of a security instrument, then the secured party can file a document of rescission that will effectively rescind the release or satisfaction and reinstate the erroneously released instrument. The Court of Appeals of North Carolina recently issued an opinion outlining which mistakes will permit the filing of a document of rescission.


In 1999, husband and wife borrowers obtained financing to purchase a home in Burlington. The loan was secured by a purchase money deed of trust on their house. In March 2004, the borrowers obtained a home equity line of credit from a predecessor of American National Bank that was secured by a second priority deed of trust on their house. In August 2004, the borrowers refinanced their original purchase loan with a loan from Wells Fargo. This loan was secured by a deed of trust. Wells Fargo subsequently entered into a subordination agreement with American National Bank that provided the Wells Fargo deed of trust had priority over the earlier-filed American National Bank equity line deed of trust. Continue Reading

Don’t Forget About Those Aging Judgments!

Has it really been 8 years since the Great Recession? It doesn’t seem all that long ago when the world economy faced the worst recession in a generation. Bankruptcy filings shot up and it seemed as if no borrower could pay back any loan, particularly those real estate development loans that only a few years earlier seemed like “no lose” loans. As a result of the record number of loan defaults, lenders throughout North Carolina obtained thousands of judgments against borrowers and guarantors. These judgments, obtained in 2008-2010, were dismissed by lenders as “uncollectible” and quickly put on a shelf to gather dust.

Those judgments, which are now 6-8 years old, will expire soon, and a lender must take affirmative action to keep their judgments alive. In North Carolina, a judgment (and the lien on real property created by the judgment) expire ten years from the date of the judgment. The statutes provide that no execution may be issued after the judgment, and its corresponding lien, expire. N.C. Gen. Stat. §§ 1-234, 1-306. It is not enough for the execution to have been commenced prior to the ten year expiration; in North Carolina the execution must be completed before the ten year expiration. Once the judgment expires, so does any pending execution. Continue Reading