In this framework, LIBOR transition amendments are a bit tricky. Neither borrowers nor lenders asked for the phaseout of LIBOR to occur—it was largely imposed by regulatory authorities.
In a consensual lending world, a commercial borrower is usually obligated to pay for a lender’s expenses relating to a loan. Depending on the loan agreement, the borrower might agree to pay closing costs, enforcement costs if the loan goes bad, and fees and expenses for amending the loan agreement. Even if a loan agreement is silent, a borrower may find that the lender is unwilling to amend the agreement unless the borrower pays the costs. Regardless of the language or lack thereof, whether a lender can and should impose such costs may be an open question.
If the borrower is asking for an amendment, then it only seems fair that the borrower pay for the lender’s amendment costs if requested. In a committed loan, it is unusual for a lender to ask for an amendment that the borrower doesn’t also want―but if it does, it doesn’t seem fair for the borrower to have to pay the lender’s costs.
In this framework, LIBOR transition amendments are a bit tricky. Neither borrowers nor lenders asked for the phaseout of LIBOR to occur—it was largely imposed by regulatory authorities. Nonetheless, both parties should want to amend their loan agreements. Technically, many U.S. loan agreements do not need to be amended since they already have a fallback rate, albeit an unattractive one for borrowers in the form of the prime rate or other base rate. Astute borrowers should be asking their lenders how they plan to address the transition from LIBOR and be actively involved in reviewing and understanding the replacement rate. However, many borrowers are likely not in this position quite yet due to the strain of operating their businesses while the COVID-19 pandemic continues and the fact that many significant details of the replacement rate remain to be determined by the finance industry. Conversely, it’s easy for a lender with base-rate fallback language to suggest that it does not need to amend the loan agreement unless the borrower insists, but realistically the lender may find that it is no longer competitive in a market that has generally determined to switch to the Secured Overnight Financing Rate (SOFR).
Assuming that both parties want the amendment and the borrower is willing to pay some or all of the lender’s amendment costs, what costs should the borrower pay? The direct costs of drafting, negotiating and executing each amendment seem like fair items. Conversely, a borrower would probably object if a lender tried to impose costs that are viewed as part of the lender’s ongoing business operations, such as developing a new SOFR interest rate model, upgrading IT systems and complying with regulatory requirements.
Where do contract due diligence and generating amendment forms fall within this spectrum? Many sources are advising lenders to do detailed due diligence on each loan agreement in their portfolios so that they can understand precisely the LIBOR language in their documents and tailor customized amendments for each of their borrowers. Lenders are spending millions of dollars to review their loan agreements and will likely spend millions more to generate amendments. It is no small task―even organizing thousands of agreements across business units and database systems for review can be a challenge.
In one sense, reviewing the loan agreement provisions is a quintessential part of the amendment process. However, if the cost is more than a nominal amount, a borrower might argue that the lender should already know what its loan agreements say and that large portfolio review projects are a cost of being in business. Similarly, if an amendment is viewed as too complicated to understand and negotiate, a borrower may balk at a high price tag for a custom amendment.
There is no simple answer for all loans. Regardless of what a loan agreement says, a lender that rigidly expects its borrowers to pay all LIBOR amendment costs may find that some of them are not happy with the arrangement. From a business relationship standpoint, a lender may determine that it benefits from not imposing such costs, especially if the loan was drafted at a time when a SOFR fallback was contemplated but not included in the loan documentation. Conversely, a borrower probably should not automatically expect a lender to bear the full cost just because this is a finance industry issue that is not the borrower’s fault. As in any consensual arrangement, there may be give and take. A lender that seeks to manage the LIBOR transition effectively should consider keeping the process simple, and the question of allocating costs between lender and borrower may follow.
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As the end of LIBOR draws closer, Duane Morris’ LIBOR Transition Team will continue to monitor developments and issue additional Alerts.
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If you have any questions about this Alert, please contact Roger S. Chari, Joel N. Ephross, Amelia (Amy) H. Huskins, Phuong (Michelle) Ngo, Han Wang, any of the attorneys in our Banking and Finance Group or the attorney in the firm with whom you are regularly in contact.
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