LIBOR was – and still is – the dominant reference rate for CHF-denominated floating rate and other variable interest rate bonds. There is still a significant number of outstanding “legacy bonds” with such variable interest rates that have maturities beyond the end of 2021, the announced time for the discontinuation of LIBOR. This article discusses considerations for issuers and bondholder representatives in dealing with such “legacy bonds”.
By René Bösch / Eduard De Zordi / Benjamin Leisinger / Lee Saladino (Reference: CapLaw-2019-28)
1) Background
In his July 2017 speech on The Future of LIBOR, Andrew Bailey of the UK Financial Conduct Authority (the FCA), which regulates LIBOR, announced that the FCA intends to no longer persuade, or compel, banks to submit to rates for the calculation of LIBOR after 2021. Although it is expected that all the current panel banks would agree voluntarily to sustain LIBOR for a four to five-year period, i.e., until the end of 2021, the speech made it clear that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021.
About two years have passed since Mr. Bailey’s speech, and various participants in the CHF-denominated bond market have invested significant effort in finding a solution to the expected discontinuation of CHF LIBOR. Some bond issuers began to include (increasingly) sophisticated fallback and/or replacement rate provisions in the terms and conditions of their floating rate (or other variable interest rate) CHF-denominated bonds to specifically address how the interest rate will be determined if CHF LIBOR is discontinued. These provisions have been drafted without knowing how and when CHF LIBOR will exactly disappear and what will follow, so there can be no certainty that they will operate as expected if and when the time comes. Notwithstanding this development, there are still a significant number of outstanding CHF-denominated bonds scheduled to mature after 2021 that have interest rates determined by reference to CHF LIBOR and have terms and conditions that do not address the effect of a discontinuation of CHF LIBOR on the determination of the interest rate — be it because they contain no fallback provisions at all or no specific fallback or replacement rate provisions addressing such a discontinuation (such bonds being referred to herein as “legacy bonds”). For issuers of legacy bonds, as well as for bondholder representatives and holders of such legacy bonds, the question arises: what, if anything, they should do at this juncture?
2) Amend the Terms and Conditions?
One possible approach would be to amend the terms and conditions of the legacy bonds. If this is done while there is still uncertainty as to the identity and related mechanics of the industry-accepted successor rate for CHF LIBOR, such an amendment could take the form of a new or additional fallback provision and/or open-ended replacement rate provision. In either case, such a provision would provide for the replacement of CHF LIBOR with a new rate meeting certain parameters and under certain conditions. Once there is an industry-accepted successor rate to CHF LIBOR, this could also be done by adding a provision providing for the replacement of CHF LIBOR with such successor rate.
However, in the case of Swiss issuers of legacy bonds that were public offered, amending the terms and conditions must not only be done in compliance with the terms and conditions of the relevant legacy bonds, but also in compliance with the mandatory rules on bondholder meetings in the Swiss Code of Obligations (CO). This article specifically addresses Swiss issuers and how they may deal with such legacy bonds in compliance with the CO.
a) Swiss Issuers – Application of the Bondholder Meeting Provisions
in the CO
If the relevant legacy bonds were offered directly or indirectly for public subscription by a Swiss issuer, i.e., an issuer whose domicile or commercial office is in Switzerland, then by operation of law the bondholders will form a community of creditors and the mandatory provisions on bondholder meetings of articles 1157 et seq. of the CO apply.
Articles 1157 et seq. CO contain certain high-level provisions on bondholder meetings, with the more detailed provisions governing such meetings being set forth in an implementing ordinance issued by the Swiss Federal Council.
b) Quorum and Majority Requirements
With respect to amendments of the terms and conditions of Swiss law-governed bonds, one has to distinguish between types of amendments that are already specifically provided for in the terms and conditions themselves (and that are, therefore, covered by the parties’ agreement) and other types of amendments. In the case of an amendment foreseen in the terms and conditions, the applicable provision of the terms and conditions will normally also govern how such amendment may be effected. With respect to any other amendment of the terms and conditions, the mandatory Swiss provisions on bondholder meetings will apply. However, not all amendments are treated identically under such provisions. Rather, these provisions differentiate between amendments that are, for bondholders, clearly positive, neutral to positive, negative and specifically set forth in an exhaustive list of measures, and negative and not set forth in such list.
In the context of amending the terms and conditions of legacy bonds in a way that will or may result in the replacement of CHF LIBOR (or the relevant reference rate based on CHF LIBOR) as the reference rate, three provisions of Swiss law are of particular importance:
– Article 1170 CO, which, subject to stricter requirements in the terms and conditions, if any, requires a majority of at least two-thirds of the outstanding aggregate principal amount of the relevant series of bonds to pass a valid resolution approving certain enumerated measures. This exhaustive list includes measures that decrease the interest rate by up to one-half of the rate set by the terms and conditions of the bonds for a period of up to ten years, with the option to extend such period for up to an additional five years.
– Article 1173 CO, which applies to resolutions approving measures not set forth in article 1170 CO, but that still negatively modify the rights of bondholders, and requires unanimous consent. Except for privately placed bonds, this standard of unanimous consent is impossible to achieve in practice.
– Article 1181 CO, which applies to resolutions approving measures that do not limit the rights of the bondholders, and, subject to stricter requirements in the terms and conditions, if any, merely requires more than half of the outstanding aggregate principal amount of the bonds actually represented at the bondholders’ meeting, unless the law stipulates otherwise (cf. article 1170 CO, or the revocation or modification of the authority conferred on a bondholder representative governed by article 1180 CO).
If the issuer’s rights are negatively modified by any amendment to the terms and conditions of the bonds, such amendment will require the consent of the issuer as well.
Applying the above to legacy bonds, if the use of the industry-accepted successor rate to CHF LIBOR in place of CHF LIBOR would be, or if the terms of the fallback or open-ended replacement rate provision are, economically positive to the bondholders, the issuer could take the view that the bondholders will not object to getting more than they bargained for and, consequently, that no bondholders’ consent for amending the terms and conditions to provide for such use or provision is required. Arguably, for Swiss law-governed legacy bonds, the issuer may also rely, by analogy to article 6 CO, on the presumption of consent by all bondholders, so long as such successor rate or fallback or replacement rate provision, as applicable, is clearly beneficial to the bondholders for the remaining term of such legacy bonds. Therefore, the economic effect that replacing CHF LIBOR with the industry-accepted successor rate or that a new or additional fallback or open-ended replacement rate provision, as the case may be, will have on bondholders is of the upmost importance when determining whether such replacement or the introduction of such a provision requires bondholder consent. In our view, such effect would need to be assessed only one time, i.e., prior to first introducing the successor rate or fallback or replacement rate provision and amending the terms and conditions. The economic effect does not need to be measured on an ongoing basis or at any particular time thereafter (e.g., when the interest rate resets or when the fallback or open-ended replacement rate provision is actually triggered).
The analysis described above may be illustrated by reference to an extreme example: if using a new reference rate in place of CHF LIBOR would effectively reduce the interest rate by up to one-half of the rate envisaged in the terms and conditions of the bonds, article 1170 CO would require at least a two-thirds majority consent to do so. If the reduction were more than that, only a unanimous consent could achieve this. It is, however, very unlikely that the bondholders would agree to such an amendment, the terms of which are to their disadvantage.
The crucial question is, therefore, how to achieve a result that is as economically neutral as possible; meaning to ensure the continuation of the economic bargain with respect to the interest rate that would have been in place had CHF LIBOR not been discontinued (and replaced). And how do issuers know whether there is such an economically neutral switch and what to do then? This question calls for an interpretation of the terms and conditions.
3) Interpretation of Terms and Conditions of Swiss Law-Governed Bonds
a) Principles of Interpretation
In Swiss law, when interpreting the terms and conditions of a bond, the primary focus is on an objective interpretation thereof based on the principle of trust. According to the Swiss Federal Supreme Court, in light of the principle of trust, it is relevant “what reasonable and correctly acting parties would have wanted to agree among themselves in the circumstances at the time the contract was concluded” and “how a condition or statement could, and had to be, understood in good faith by the recipient”, whereby “always the context, in which the expression of will was made has to be taken into consideration”.
In the case of the terms and conditions of a bond, doctrine demands that the terms and conditions be interpreted uniformly, rather than based on the relevant individual’s good faith interpretation. Thus, it is not a question of what the individual buyer of the bond understood at the time of purchase. Rather, the decisive factor is how an average professional investor would understand the terms and conditions based on the principle of trust. Some scholars have expressly stated that an interpretation in conformity with the capital market should take precedence over interpretations based on principles of investor protection. However, even with an interpretation in conformity with the capital market, the primary means, and starting point, of interpretation is still the actual wording, with respect to which the understanding of an average professional investor is decisive. Using methods analogous to the rules applied in connection with general terms and conditions (which terms and conditions are not in Swiss law), doctrine requires any unclear terms to be interpreted against the issuer.
Accordingly, when interpreting the interest provision in Swiss law-governed terms and conditions, the question should be “what would the hypothetical average professional investor and the issuer have agreed” and does the wording itself provide any indication as what the parties agreed (e.g., even if there is no explicit fallback provision, does the provision speak of a possible successor rate, screen page or administrator)?
b) Application to Interest Provisions tied to CHF LIBOR in Legacy Bonds
In our view, when analyzing the Swiss law-governed terms and conditions of any legacy bonds, the hypothetical will of the parties – which would also be relevant in the case of a clausula rebus sic stantibus and an amendment of a contract by a Swiss court due to unforeseeable change in circumstances – cannot have been to have a dysfunctional interest rate provision. Furthermore, we believe that a dysfunctional interest rate provision should not result in an extraordinary termination right either because of the general principle of pacta sunt servanda and the economic expectations of the parties at the time of issuance of the legacy bonds.
In the case of Swiss law-governed terms and conditions of legacy bonds that provide for the calculation of interest on the basis of CHF LIBOR without the benefit of any fallback provision whatsoever, the agreement to issue and purchase such legacy bonds may well be interpreted as (i) an agreement to use the industry-accepted and prevailing reference rate for CHF-denominated floating rate bonds generally and (ii) an agreement to be treated economically the same way as if CHF LIBOR had been continued. In other words, an agreement to replace CHF LIBOR (or the reference rate based on CHF LIBOR) with the successor industry-accepted and prevailing reference rate for CHF-denominated floating rate bonds and implement whatever adjustments to such rate as are necessary in order to reduce or eliminate, to the extent reasonably practicable under the circumstances, any economic prejudice or benefit, as applicable, to holders as a result of such replacement of CHF LIBOR.
c) But the Terms and Conditions Prevail…
Notwithstanding the above, if the terms and conditions of the legacy bonds already contain a fallback provision that would provide a way to calculate the interest rate if CHF LIBOR were to be discontinued, we see little room for proceeding as laid out in the previous subsection b). This, unfortunately, holds true even if the interest rate resulting from such fallback provision turns out not to be beneficial for the holders or the issuer – e.g., if the ultimate fallback in the conditions is the continuation of the last interest rate on a fixed-rate basis and the interest rates significantly rise (negative to the issuer) or fall (negative to the holders) thereafter. In this case, the parties have agreed on a specific fallback regime that may only be amended with bondholders’ consent (subject to obtaining requisite defined majority required under the CO to pass such amendment). The introduction of a fallback provision that takes into account the principles set out in subsection b) above should, however, be neutral to the bondholders and, therefore, could be approved by the defined majority required under article 1181 CO, subject to stricter requirements in the terms and conditions, if any.
d) Just Pay the New Interest Rate?
Even if the discontinuation of CHF LIBOR can be addressed by merely interpreting the terms and conditions of the respective legacy bonds (i.e., rather than by amendment), the new reference rate or mechanism for calculating the interest rate will still have to be communicated to the bondholders. Accordingly, the issuer must publish a notice in line with the terms and conditions and – for bonds listed on the SIX Swiss Exchange – publish an official notice in line with the Directive Regular Reporting Obligations of the SIX Swiss Exchange.
4) Importance of the Economic Effect
Whichever approach is chosen, the analysis as to what is permissible and how it should be effected depends largely on the assessment of the economic effect the new interest rate or interest rate mechanism will have on bondholders.
To complete this assessment, as well as to evaluate the risks associated with a particular approach, the relevant terms and conditions should be analyzed as to whether the approach chosen may potentially constitute an event of default thereunder and, in such case, who would be authorized to accelerate the bonds. In the case of Swiss law governed terms and conditions, typically only the bondholders’ representative can accelerate the bonds. For this reason, it is advisable that each issuer coordinates its approach with the applicable bondholders’ representative(s).
5) Time to Act
As the end of 2021 comes closer, it is clear that companies should now take a close look at the terms of any legacy bonds issued or guaranteed by them, particularly at their maturity dates and the interest rate provisions contained therein.
In this context, it is advisable to also review related hedging arrangements and to analyze the consequences an amendment (or adjusted interpretation) of the terms of conditions of the respective legacy bonds may have on such arrangements.
René Bösch (rene.boesch@homburger.ch)
Eduard De Zordi (eduard.dezordi@homburger.ch)
Benjamin Leisinger (benjamin.leisinger@homburger.ch)
Lee Saladino (lee.saladino@homburger.ch)