The global phase-out of LIBOR has gained much coverage in financial and legal community since UK FCA’s 2017 statement that it would no longer persuade or compel banks to submit to LIBOR, which marked the gradual wind down of LIBOR’s role as a pivotal benchmark rate for global financial markets.
Although the news of LIBOR’s impending discontinuation was out in the public for quite a long time, there still remains a great deal of uncertainty as to how LIBOR’s phase-out will be completed. The most troubling challenge for global regulators and the markets is handling the smooth transition for so-called “tough legacy” contracts that do not contain any fallback provisions in anticipation of the upcoming global benchmark rate reform. In the face of this uncertainty the major effort of financial regulators is focused on tackling the risks of LIBOR reform for the legacy financial documentation, derivative instruments, securities and commercial contracts that are tied to LIBOR and do not contain robust fallback provisions for alternative benchmark rates in case of LIBOR’s discontinuance.
Yet, there is another substantial category of documents, that is oftentimes overlooked by the professional community that also heavily depends on LIBOR’s future – the arbitral awards.
Arbitral awards oftentimes contain obligations for award debtors to pay interest to the creditor that is tied to various reference rates. For instance, this could be an interest compensating the creditor’s opportunity costs, accruing from the moment of the breach until the date of the arbitral award. Such interest is widely used by arbitrators in damages awards, as well as in investor-state disputes where it pursues the goal of wiping out the consequences of unlawful expropriation or other violations of investor’s rights.
In addition, many arbitral awards contain an obligation for the award debtor to pay the creditor post-award interest until the payment obligations stated in the award are fully met by the debtor. The interest here serves as additional security for the creditor against bad faith debtors who would otherwise have little financial incentive to comply with the awards in a timely manner. It goes without saying that the risk of accrual of such interest is a strong motivator for the debtor to comply with the award as soon as possible in order to avoid extra financial liabilities due to the delay.
Oftentimes, as the result of compounding and respondent’s delay in timely performance of the award the interest builds up to a significant portion of the total award debt, sometimes reaching close to the principal amount.
The interest in arbitral awards is usually expressed as a margin over some benchmark rate. In stark resemblance to financial instruments, LIBOR has historically been one of the most widely used benchmark rates referenced in arbitral awards for the purpose of calculating award interest (with few exceptions where tribunals hesitated to use LIBOR following the heat of 2012 banking scandal). As the result, as of this date, there is a significant volume of yet unperformed arbitral awards that rely on LIBOR (usually EUR or USD, with 6 or 12 months maturity), without any fallback reference rates that could give effect to the accrual of interest once LIBOR is gone.
Risks for award creditors
In December 2020 ICE Benchmark Administration (LIBOR’s administrator) announced its intention to cease publication of a number of LIBOR settings, most importantly all EUR, GBP and some short-term USD settings as of 31 December 2021 and any remaining USD rates as of 30 June 2023, unless compelled by FCA to go on with publications beyond those dates. The finality of these dates was later confirmed by FCA when in March 2021 it announced that it will not require ICE Benchmark Administration or panel banks to publish/submit to LIBOR beyond the contemplated termination dates.
That is, once the above cut-off dates are reached no LIBOR quotes will likely be available. This technically means that the accrual of LIBOR-based post-award interest will cease and creditors would not be able to recover such interest in the course of enforcement, unless the award includes a fallback provision envisaging an alternative benchmark rate (which, in practice seems rather uncommon).
The number of arbitral awards affected by these risks is truly enormous since even after 2017 announcement of LIBOR’s gradual wind down many arbitral tribunals continued to rely on LIBOR when setting out the post-award interest (apparently in absence of any alternative submissions by counsels). As unlikely as it sounds, there are more than plenty of arbitral awards dated 2020-2021 (!) that still reference LIBOR as the benchmark rate for post-award interest.
The financial ramifications for the award creditors will likely be dire, since they will lose a significant portion of what they are entitled to under arbitral awards. Even more so, award debtors will be able to enjoy a certain degree of financial impunity for refusing to comply with awards beyond LIBOR termination dates.
Can creditors do anything about already rendered awards through post-award remedies?
In short, there are no particularly strong options. Theoretically, award creditors could try to squeeze their attempts to rectify LIBOR references in arbitral awards through existing mechanisms for post-award remedies.
Request for correction of the award seems to be the first logical pick among available options, however, this option usually offers very limited redress under the majority of the most popular arbitration rules. It is usually reserved for revising awards in respect of clerical or computational errors (UNCITRAL, LCIA, ICC rules, etc.) and is subject to a very strict time limit of 20-30 days (depending on the rules). Although some parties may try to present a plea to change the applicable benchmark rate as revising a “computational” defect of the award, it is yet to be seen if any tribunal would buy into such an esoteric argument. The most serious challenge to this argument is that usually the choice of a specific benchmark rate is based on a quite sophisticated assessment of creditor’s damages, or in other words, goes to the substance of the award. Accordingly, many tribunals will likely see such a request for an attempt to revisit the merits of the award, which, of course, is not in line with the purpose of the award correction mechanism.
No doubt, most parties will also have a difficult time explaining to the tribunal compliance with the strict deadline for a correction request, especially considering that the news of LIBOR’s wind down was circulating in public since 2017. For the same reason an alternative option – request for revision of award due to “newly discovered circumstances”, which is available in some jurisdictions, does not appear to be an appropriate route either unless the award in question was rendered before the news of LIBOR’s fate was made public.
Neither do the requests for interpretation of the award (SCC, ICC Rules) or additional award seem particularly promising. The former is generally aimed at clarifying unclear or ambiguous parts of the awards and would be at odds with an attempt to effectively revise that part of the award. In turn, the latter option, is also unlikely to be successful, since additional awards are normally issued with respect to claims that were submitted by parties in the arbitration but for some reason were not dealt with by the tribunal in the original award.
Last but not least, for arbitrations seated in certain jurisdictions, creditors will most likely face the need to establish exceptions to the common law doctrines of the finality of the award and cessation of tribunal’s powers after arbitration is concluded in order to submit any additional requests to the tribunal in connection with change of the benchmark rate.
One more straw that we may see the creditors grab at is seeking an order from the competent court for the remission of the award to the tribunal for reconsideration, such as the serious irregularity challenge under 1996 Arbitration Act. In particular, some creditors may attempt to portray the need to rectify arbitral awards with respect to a reference to LIBOR as a factor that would otherwise cause them substantial injustice due to the uncertainty or ambiguity as to the effect of the award (as required under S.68 of the Act).
However, it is yet to be seen if any such request would be successful since in most arbitration-friendly jurisdictions courts are overwhelmingly reluctant to interfere with the tribunals’ authority and conclusions, especially on substantive matters, not to mention extremely high thresholds for such requests.
One more potential option could be to start another set of proceedings, specifically with the purpose of collecting the damages the creditor suffered due to the debtor’s delay in performing the award after LIBOR termination dates. However, due to its “synthetic” nature, this option would need to be carefully explored in each individual case since depending on the applicable law different positions may exist as to whether a failure to promptly pay award debt could per se give rise to a justifiable (or for that matter, justiciable) damages claim.
Will the “legislative fix” be of any help?
Financial market participants in many jurisdictions fearing for the future of their LIBOR-dependent contracts with no fallback language have for a long time sought interference from their governments and regulators to introduce so-called “legislative fix” that would automatically substitute references to LIBOR in such contracts to another appropriate rate by operation of law.
Many regulators were at first very cautious to promise swift adoption of such measures and instead called upon market participants to individually negotiate amendments to relevant instruments with their counterparties. However, apparently, the astronomical value of such “tough legacy” contracts estimated at USD 73.1 trillion and the complicated nature of many contracts, including the number of counterparties that must be brought to the table for renegotiation, have urged the governments to start taking action on that front. The major fear of regulators and markets is that the absence of respective legislative fix would inevitably result in countless litigation/arbitration claims between the counterparties, creating a legal mess that New York Federal Reserve Bank’s general counsel Michael Held coined as “DEFCON 1 litigation event if I’ve ever seen one”.
In response to the markets’ concerns, New York, the UK and the EU passed legislation providing for LIBOR replacement for certain “tough legacy” contracts.
In particular, in March 2021 New York State Legislature passed bill signed into law by New York’s governor on 6 April 2021, which paved the way for LIBOR replacement in contracts that contain no adequate fallback provisions upon LIBOR’s termination. The replacement rate will be selected by the Federal Reserve, New York’s Federal Reserve Bank, or Alternative Reference Rate Committee based on the Secured Overnight Financing Rate.
Yet, the tricky question is whether this “legislative fix” extends to interest-bearing arbitral awards, given that it essentially applies to “contracts, securities or instruments”. The definition is quite broad:
“Contract, security, or instrument” shall include, without limitation, any contract, agreement, mortgage, deed of trust, lease, security (whether representing debt or equity, and including any interest in a corporation, a partnership or a limited liability company), instrument, or other obligation.
There could potentially be an argument that interest-bearing arbitral awards can be viewed under the rubric of “instrument or other obligation”. Yet, one cannot just fail to note that despite its breadth, the list mainly speaks of contract-like arrangements, which makes it quite questionable if arbitral awards can fit into such a company as per the applicable rules of statutory interpretation. One way or another, the applicability of that legislation to arbitral awards will likely be heavily debated in case of a dispute.
EU’s legislative fix is largely similar to New York’s one, as it vests the Commission with the authority to designate a replacement risk-free rate for LIBOR and extends to LIBOR-dependent contracts and financial instruments with no adequate fallback provisions that are governed by laws of the EU Member States, as well as contracts between EU parties governed by law of a third state if that law does not offer replacement mechanism for wind down of LIBOR. That is, the predominantly “contractual” scope of EU’s legislative fix also makes it quite questionable if interest-bearing arbitral awards would fall within its ambit.
The approach adopted by the UK is slightly different. On 29 April 2021 the Financial Services Act 2021 received royal assent, paving way for FCA to exercise powers to smoothen transition from LIBOR for certain “tough legacy” contracts. The Financial Services Act among other things, introduced amendments to the UK Benchmarks Regulation that give FCA authority to designate “critical benchmarks”, such as LIBOR as Article 23A benchmarks. This would mean that the benchmark will be officially considered as no longer representative, however it will continue to be published by the administrator (potentially based on a changed methodology). The use of such a benchmark will generally be prohibited, however FCA by publication of a notice may permit use of such benchmark for certain “tough legacy” contracts.
In common terms, if FCA elects to exercise its powers and designate LIBOR as Article 23A benchmark, LIBOR will survive, albeit in a “synthetic” (or some may ironically call it – “zombified”) form.
Potentially, the key issue for accrual of post-award interest under arbitral awards would be whether such “synthetic” LIBOR could be validly relied on by award creditor when recovering award interest in enforcement proceedings against the debtor, with a plethora of potential arguments revolving around:
– consequences of LIBOR’s loss or representativeness stemming from designation under Article 23A;
– consequences of the general prohibition on the use of LIBOR under Article 23A, especially where the award creditor/debtor is a “supervised entity” under Benchmarks Regulation;
– whether exceptions for use of LIBOR for “tough legacy” contracts made by FCA (if any) will extend to interest-bearing arbitral awards.
Law applicable to post-award interest
Yet, the intricacies of the “legislative fix” in different jurisdictions are not the only headache that arbitration lawyers will likely have to deal with. Before these matters can even start being analysed there still remains a sort of a gateway question – which law would govern the issues of accrual of post-award interest, or in other words, whether award creditors can benefit from a “legislative fix” at all and if yes, which one.
As one might imagine, there could be different approaches to this issue, each with its pros and cons.
Firstly, an argument can be made that the issues related to accrual and calculation of post-award interest are governed by the law applicable to the substance of the dispute (e.g., governing law of the underlying contract), or put differently, that the award creditor’s right to post-award interest is the function of their substantive claims asserted in arbitration.
Some support for this argument can be drawn from the fact that many arbitral tribunals do not distinguish in the awards between pre-award and post-award interest and instead order the award debtor to pay interest on the original amount of damages until the full satisfaction of the award.
Following this argument, if the contract in question is governed by let’s say English or New York law, the creditors would argue that the respective “legislative fix” applies to the post-award interest as well (subject to the issues with the applicability of LIBOR legislation vis-à-vis arbitral awards outlined above) and that such interest should be recovered based on respective LIBOR replacement.
That argument, though, is not bullet-proof for a variety of reasons, not least because not all tribunals choose to merge pre- and post-award interest together in the text of the award. Further, this argument would require further substantiation if the dispute in question was resolved based on a mixture of different applicable laws or if the applicable law does not per se offer any solution for LIBOR phase-out.
An alternative approach would be to resolve matters related to the accrual of post-award interest based on the law of the seat of arbitration.
Again, inspiration for this argument may follow from the fact that arbitration statutes in some jurisdictions deal expressly in their provisions with the matter of tribunal-ordered interest (e.g., S.49 of 1996 Arbitration Act). The same logic would apply here – if the applicable law of arbitration’s seat offers legislative tools for LIBOR transition, then the award creditor could try arguing that post-award interest should be recovered by applying that legislation.
Still, this argument is not entirely pristine either. Firstly, rather few jurisdictions have statutory provisions about the authority of tribunals to award interest and thus award debtors may argue that this practice falls short of a universal approach for determining which law governs the accrual of post-award interest. Secondly, respective statutory provisions mostly focus on tribunals’ power to grant interest, or in other words, prescribe rules for tribunals’ competence to grant interest in the absence of the parties’ agreement. Hence, award debtors may argue that the presence of such statutory rules does not imply that the substantive matters of the accrual and calculation of the interest themselves should too be governed by the law of the seat of arbitration.
Lastly, other potential candidates in terms of the governing law could include the governing law of the arbitration agreement (to the extent it does not coincide with the governing law of the contract and/or the law of the seat) or the law of the enforcing state.
Conclusion
LIBOR transition will likely generate a myriad of legal issues for arbitration lawyers in the context of post-award interest. For the award creditors facing “difficult” respondents, which make every effort to delay timely enforcement of the award and thus generate significant post-award interest liabilities, the issue of interest’s recoverability will, no doubt, be of critical importance. That will bring award creditors and debtors face-to-face with the legal intricacies of recovering LIBOR-based post-award interest accrued after LIBOR’s discontinuance. In turn, lack of legal certainty on these matters gives carte blanche to the most creative arbitration lawyers willing to test bold, innovative legal arguments in front of the enforcement courts to achieve their clients’ goals.
Still, despite the overall legal complexity of the topic, there are some steps that creditors and their counsels may take to reduce the exposure to potential legal risks over post-award interest in the context of LIBOR’s discontinuance:
– Raise the issue of applicable alternatives to LIBOR for the purpose of post-award interest early in arbitration (for ongoing arbitrations);
– Make sure your submissions reference an alternative benchmark rate for the purpose of calculation of post-award interest (for ongoing arbitrations);
– Avoid unnecessary delays in enforcement of already rendered awards, where such awards contain post-award interest before LIBOR discontinuation dates.
Vladyslav Kurylko, arbitration lawyer, Ukraine
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