As 2021 comes to an end, many companies will have ceased using the London Interbank Offered Rate, or Libor, in their contracts—though some reports suggest that the one-day, one-month, six-month and one-year Libor rates may continue to be published through June 2023.
The reference rate has long been used to set the value of interest on loans and lines of credit, calculated by averaging the rates that several U.K. banks charge when lending to each other. Unfortunately, during the 2008 financial crisis, it was found that some major banks could manipulate Libor, a move that held serious consequences, so changes were set in motion.
At a quick glance, this scenario could be viewed as a problem solely for the financial sector. However, all types of companies are realizing they have meaningful exposure due to Libor. The rate is used in contracts across functions, internal processes and systems, leases, procurement, funding, pension plans and much more.
Contracts based on Libor will now have to reference other interest rates. The Secured Overnight Financing Rate, or SOFR, has been recommended as a USD replacement, though it’s not the only alternative rate. Still, the question remains, what happens to contracts when the interest rates received, or offered, are based on Libor? It’s important to understand the financial impact on your organization that the Libor sunset will have. While changes to payment terms may be necessary, in some instances entire agreements could be compromised.
Unanticipated macro-scale changes like the Libor transition often present massive challenges to businesses and their legal teams and require that legal teams craft agreements to account for potential changes—especially when it comes to critical provisions involving financial consideration.
Feeling the Pressure
There’s no way around it—legal teams and corporate counsel will need to review every single financial agreement in their contract portfolios and identify any Libor references. Because contracts are frequently dispersed throughout a company, not only may they be tough to find, but performing the analysis to calculate the true exposure is likely to be very challenging. This analysis will require a lot more than just a search for the term “Libor” in documents.
It’s important to understand how contracts handle changes in Libor, as well as any other fallback reference rates. Are there any provisions dictating a replacement rate when a benchmark like Libor sunsets. Does the end of Libor as a reference rate make determining payment impossible, impractical, or otherwise lead to a result that neither party intended? Legal teams are likely to find themselves renegotiating existing contracts that lack fallback language or changes in contracts for new clients.
With a traditional approach, major resources and employee time would be consumed for a Libor review of all contracts. Adding to the pressure, teams have set December 31 as a drop-dead date to get it done. For contracts that extend far beyond the end of 2021, the lessons learned from the Libor sunset should be accounted for when entering into new commitments based on a reference rate or some other floating variable. The point is to identify provisions that may be impacted by actions outside of either party’s control, and attempt to set in place a process in the agreement for managing any impactful changes.
It’s Different With Digital
Until you know where Libor intersects a business, every financial agreement should be subject to review by the legal team. Digitizing contracts can greatly expedite the review process as the legal team zeros in on understanding the Libor exposure and reduce processing costs, while strengthening agreements and negotiating positions. Digitizing contracts helps legal teams to quickly identify Libor issues—and many other similar issues that may arise in the future—and offers additional benefits like unearthing patterns across transactions, improving risk analysis, and facilitating accounting and compliance reviews.
The difference digitizing makes is huge. However, it’s only the first step; you still have a mountain of detail to organize before the information can become helpful. Many legal teams are finding a solution in contract lifecycle management platforms with analysis tools. Capable of harnessing digital information, these provide the speed, nuance, and accuracy necessary to deal with the end of Libor in an efficient manner, both cost-wise and operationally. Technology can quickly analyze and identify key components in your existing contracts, support the writing of better agreements, and centralize resources, all while enabling peers to collaborate at every step. Ideally, platforms should utilize AI to produce more powerful insights, automate tasks, and deliver higher-quality results in less time.
With the right contracting platform, legal teams can quickly identify all legal agreements mentioning Libor, with customized reporting enabling the sorting and categorizing of each. It can distinguish between loans taken and sales contracts offered. Teams can also easily see which contracts include key provisions that can help you spot opportunities and mitigate the risk associated with major, global changes like the Libor transition. Having strong technology that can help you identify key agreements and provisions where you should focus your efforts will save you countless hours and help you drive a more beneficial outcome for the business.
Legal teams need modern contract management capabilities to keep pace in today’s digital world. With talent tight, technology can empower staff to do more than ever. The right contract management platform is a valuable tool to help you spend your time delivering high-value analysis and anticipating potential issues, and will elevate the quality of service that you provide to your organization.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Tim Parilla is the CLO of LinkSquares, the fastest-growing AI-powered contracting platform for legal teams. Named a 2020 Gartner Cool Vendors for contract lifecycle management and advanced contract analytics, LinkSquares is used to move business forward by more than 400 legal teams at mid-to-large companies, including brands such as TGI Fridays, Cogito, and Wayfair.
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