Pub. 6 2018 Issue 2

Issue 2. 2018 15 ture. If LIBOR is discontinued, however, these loans may convert to a fixed interest rate at the last quoted LIBOR rate and stay that way until maturity. Lenders have options when considering fallback language. Fall- back provisions can state that the loan will transition to another benchmark rate such as the prime rate or the federal funds rate. Alternative benchmark rates to LIBOR are being developed but it is unclear which rate will supplant LIBOR as the industry standard. Popular with lenders is fallback language giving the lender discretion to select an alternative rate. In exercising this discre- tion, lenders will be subject, under the laws of most states, to the implied covenant of good faith and fair dealing, meaning that a lender cannot act arbitrarily or unreasonably in choosing a rate that is more expensive for the borrower. Less popular is fallback language that requires the parties to mutually agree on an alter- native rate. Provisions allowing the lender to select the alternative rate and provisions requiring the parties to come to a consensus are useful if the parties want to wait and see what alternative rates the market adopts. The parties will choose a rate at a later day when they have more time to watch market trends. If the fallback language contemplates that an alternative rate will be selected at a later date, either by the lender or by mutual agree- ment, the language should be flexible enough to consider multiple possible rates but specific enough to apply the terms of the provi- sion without dispute. This language will clearly state who selects the new rate and what rights, if any, the other party has to dispute the selection. These provisions may prescribe certain methodol- ogies that the deciding party will use in selecting a new rate. The parties may have the option to select between certain specified rates, such as the prime rate, or choose the rate that is identified as the market’s widely accepted replacement for LIBOR. The fallback language should have a clear trigger. Will the new rate come into effect when LIBOR ceases to be published or at some other event or date? The trigger may give the parties discre- tion to choose when the rate will change, such as when the lender or parties agree that LIBOR no longer adequately reflects the cost to lenders to make and maintain loans or when LIBOR is no longer widely recognized as a benchmark rate for newly originat- ed loans. The fallback language should account for other contingencies such as what happens if the new rate is not available for a time or if the new rate ever dips below zero. The fallback language will need to be flexible enough to account for the difference in magnitude between LIBOR and the new rate. The parties should be allowed to make adjustments in case the new rate is higher or lower than LIBOR. Parties could be permitted to adjust margin levels or how they are calculated. It is important for lenders to be aware that the phase-out of LI- BOR is approaching when entering into new loans or modifying existing ones. If lenders continue to use LIBOR in new loans, the agreements should clearly state what will happen to the interest rate when LIBOR is no longer available. Lenders should seek opportunities to add fallback language or adjust the fallback language in existing loans when needed. Bailey makes clear that “the transition away from LIBOR will take time, but will be less risky and less expensive if it is planned and orderly rather than unexpected and rushed.” Lenders have time before the end of LIBOR, but Bailey counsels that “the planning and the transi- tion must now begin.” n Braden Parker is an attorney at Holland & Hart with significant experience in banking, commercial finance, and secured transactions. Through his expertise in the field, Braden has represented both lenders and borrowers in cases related to acquisition loans, working capital lines of credit, asset-based loans, commercial real estate loans, public finance transactions, mezzanine loans, and preferred equity transactions. Braden earned his Juris Doctor degree (J.D.) from University of Chicago Law School in 2016. Prior to his legal career at Holland & Hart, Braden worked in investment banking at Goldman Sachs.