Implied terms read into post-LIBOR dividends mechanism

The High Court highlighted that point in a case (34-page / 400KB PDF) in which it determined it was “necessary to give business efficacy to the contract” to imply terms into a shareholder agreement to enable continued payment of dividends in the post-LIBOR world.

Experts at Pinsent Masons said the ruling reflects market expectations and practice and that it demonstrates the “world-class” flexibility, pragmatism and commercial sense of UK courts.

LIBOR was a methodology for setting benchmark interest rates that were widely used internationally as the pricing basis for various financial instruments and for setting interest rates in loan agreements. LIBOR rates were set based on data submitted by LIBOR banks representing the inter-bank market cost of borrowing different currencies for different durations.

When it was uncovered that financial traders had manipulated the LIBOR process, the regulation of LIBOR was tightened before the methodology was eventually phased out. In the phase out period “synthetic” LIBOR rates were temporarily operated, which parties could use pending agreeing how to transition their contracts to the new reference rates.

In the case before the High Court, dividend payments were to be calculated with reference to three-month US dollar LIBOR on an issuance of preference shares that Standard Chartered had issued in 2006 to raise $750 million of capital.

Under the offering circular for the shares, dividends were payable twice a year, subject to conditions. Initially, dividends were payable at a fixed rate of 6.409%, but after 30 January 2017 this changed – from that point, the rate of dividends payable was determined with reference to three-month US dollar LIBOR, with the share agreement specifying how the precise rate should be calculated.

However, while the offering circular provided for fallback options for determining the dividend rate payable if three-month US dollar LIBOR was not available, none of these directly accounted for the possibility that the LIBOR reference rate would cease to be published.

In 2022, Standard Chartered tried to obtain shareholder agreement to change the reference rate that dividend payments would be calculated against, but its resolution was not approved by a sufficient proportion of shareholders. For the 31 July 2023 dividends payment, Standard Chartered decided unilaterally to calculate the payments with reference to the three-month synthetic LIBOR, but it then raised legal proceedings seeking the court’s judgment on how dividend payments from 30 October 2024 should be calculated.

Standard Chartered put forward two separate arguments to the court – both of which, it claimed, would entitle it to apply an alternative reference rate to three-month US dollar LIBOR for the purposes of calculating the dividend payments it had to make under the contract.

First, Standard Chartered argued that that entitlement could be read from the way the words ‘three-month US dollar LIBOR in effect’, provided for under one of the fallback options in the contract, should be interpreted.

In this regard, Standard Chartered claimed the words ‘in effect on the second business day in London prior to the first day of the relevant Dividend Period’ entitled it to use whatever reference rate existed that effectively replicates or replaces three-month US dollar LIBOR, should that LIBOR cease to be published.

On this point, the court determined that the words did not mean what Standard Chartered had argued – instead, it said the wording “contemplates a situation when no LIBOR rate is published on the relevant date, but a LIBOR rate first published on a prior date is treated as the effective LIBOR rate by the market (and so is ‘in effect’ or operative) on the later date”.

That interpretation, the court said, is supported by the natural meaning of the words ‘in effect’ “when used in the specific context of an identified point in time”; the way ‘three-month LIBOR’ had been defined in the contract; and by the use of similar wording in the circular issued by Standard Chartered when the preference shares were originally offered.

With its alternative argument, Standard Chartered claimed that an implied term should be added to that, “where the express definition fails, SC should use a reasonable alternative rate to three month USD LIBOR”.

Some shareholders eligible for dividend payments argued that a different implied term should be read into the contract. That implied term provided for automatic redemption of the shares when legal and regulatory conditions allow in the first instance, and, if that was not possible, essentially required Standard Chartered to revert to paying dividends calculated at the fixed rate of 6.409% that previously applied. This was more than Standard Chartered considered that it was obliged to pay.

The court highlighted that case law in England and Wales provides for circumstances in which a contract is required to be performed in circumstances that the parties did not foresee nor provide for. In such cases, the purpose or structure of the relevant aspects of the bargain the parties struck in their contract should be ascertained, with a view to adopting “an interpretation which best serves or is most consistent with that purpose in the changed circumstances”, the court said.

This approach, the court added, “gives effect to an important policy of English contract law which is reluctant to contemplate the failure of partly executed contracts merely because they do not address a particular circumstance or eventuality which has come to pass”.

In this case, it was Standard Chartered’s proposed implied terms that the court considered were “necessary to give business efficacy to the contract”, albeit with some of its own modifications.

In favour of that view, the court said that a flexible approach to the share agreement’s construction “best matches the reasonable expectations of the parties” given the long-term nature of the contract. It also said that it was clear from the contract that provisions referring LIBOR were “non-essential ‘machinery’ for the purpose of determining what happens when LIBOR ceases to be published” and that it is open to the courts in such circumstances to “imply an obligation by reference to what is reasonable to enable the contract to be carried out”. The court said its view was also supported by the fact “the parties did not intend issues with the availability of LIBOR to prevent the continued performance of the contract”, given the terms on which the preference shares were issued.

The court said the arguments it cited in favour of its judgment in this case are “likely to be similarly persuasive when considering the effect of the cessation of LIBOR on debt instruments which use LIBOR as a reference rate but do not expressly provide for what is to happen if publication of LIBOR ceases”.

“This decision is in line with market expectations and practice where parties have almost invariably agreed to new reference rates being used in place of LIBOR,” said Mike Hawthorne of Pinsent Masons.

“Around the time when financial institutions were transitioning their contracts from LIBOR reference rates to alternative reference rates there was quite a lot of talk in the market about potential claims if the alternative rates were less beneficial to one party or another. In fact, the LIBOR transition project has generated remarkably few disputes. This is partly because market participants have generally taken the pragmatic view that the English courts would generally uphold the actions of parties who had done their best to give effect to the change that was being forced onto them. This decision supports that analysis,” he added.

Stuart McNeill, also of Pinsent Masons, said: “The decision is also good example of the Financial Markets Test Case Scheme, a mechanism to allow parties access to judicial determination on a point of importance in financial market before a dispute crystalises. While the expert evidence in the case was hard fought, ultimately the experts were largely agreed that the rate proposed by the court was the closest match to former LIBOR rate. The fact that it was not a perfect match, but was used by nearly 80% of debt issuances, clearly helped, and its sensitivity to volatility did not mean it was outside of the scope of an implied term.”

Caroline Hearn of Pinsent Masons said: “This result is not a surprise but demonstrates the financial savviness of the Financial List in taking a pragmatic approach. It is unlikely that this case will be appealed and will ultimately allow other parties dealing with this point to cut through this issue sensibly going forwards; another reason why the Financial List is world-recognised at understanding the core concerns or issues of parties within the financial services industry.”