Citibank gets its money back – Financial Services

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A February 16, 2021 decision of the United States District Court for the Southern District of New York found, in In re Citibank August 11, 2020 Bank transfers, 520 F. Sup. 3d 390, that lenders who received nearly $900 million in error wired by Citibank (the administrative agent of a $1.8 billion seven-year syndicated term loan to Revlon [2016 Loan]) had the right to keep the money. See our newsletter A One-in-a-Billion (-Dollar) Mistake, in which we describe the decision. The United States Court of Appeals for the Second Circuit has now reversed that decision.

The district court’s decision

The district court had ruled that the lenders were protected by a doctrine known as the “release for value” defence. Under New York law, a creditor is not required to return funds paid in error that discharged a debt owed to him if the creditor (i) was unaware of and was not advised (which may include implied notice as well as actual notice) of the error at the time it received payment, and (ii) did not misrepresent to the debtor that it was obligated to ‘make a payment. The district court relied on the landmark New York case for this defense, Bank Worms vs. Bank America Int’l, 570 NE2d 189 (NY 1991). In that case, the New York Court of Appeals (the highest court of appeals in the state of New York) said, at 196:

“When a beneficiary has received money to which they are entitled and they do not know that the money was transferred in error, they should not have to wonder whether they can keep funds; on the contrary , such a beneficiary should be able to regard the transfer of funds as a final and complete transaction, not subject to revocation.”

The district court found that under New York law, the lenders did not receive implied notice of Citibank’s error for a variety of reasons, including the following:

  • The transferred amounts were the exact amounts that would have been due had Revlon decided to prepay all of the loans in full.

  • Given that Revlon had entered into negotiations to restructure its debt, it was not unreasonable for the lenders to believe that it must have decided to prepay this facility.

  • While the credit agreement required Revlon to provide three days’ written notice of prepayment to Citibank, which Citibank in turn was to provide to each lender “promptly” after receipt, it was not uncommon for such notices not being received by the lenders before the prepayment itself, or never being sent at all.

  • The calculation statements provided to the lenders indicated that the interest payments were “due”, and since the payment was not made on a scheduled interest payment date, there was only one way the interest would have been due, that is to say with the early repayment of the entire capital. . Separate statements were often sent for the principal component, so the reference to interest alone did not warn lenders of a likely error.

The decision of the United States Court of Appeals

The U.S. Court of Appeals made different findings of fact than the district court, finding that the lenders had received implied notice of Citibank’s error, applying the “investigative notice standard” in under New York law (as opposed to the “knew or ought to have known” standard): “The facts were sufficiently inconvenient that a reasonably prudent investor would have made a reasonable inquiry, and a reasonable inquiry would have disclosed that the payment had been made in error.” The Court of Appeal found that the lenders “were aware of four red warning flags consisting of facts suggestive of accident or error” – namely,

  • “the absence of notice of an early repayment, to which the Lenders were contractually entitled”;

  • “the apparent inability of insolvent Revlon to repay nearly $1 billion”;

  • “considering that the 2016 loan was trading at 20-30 cents on the dollar, it could have been repaid for much less than paying its full value”;

  • “Revlon’s elaborate scheme just four days earlier to avoid the 2016 loan acceleration made no sense if Revlon was planning to repay that debt days later.”

The Court of Appeal noted that the standard for notice of inquiry is objective: “The test is not whether the recipient of the erroneous payment reasonably believed that the payment was genuine and not the result of mistake. The test is whether a prudent person, who faced with some likelihood of avoidable loss if receipt of the funds proved illusory, would have seen fit, in light of the warning signs, to make a reasonable investigation into the interest in avoiding that risk of loss.” Although the Court of Appeals does not explicitly suggest that the lenders engaged in willful blindness, the Court’s repeated references to the lenders’ failure to call Citibank for inquiring about the accuracy of payments suggest such suspicion.

The Court of Appeal further held that the To Bankprinciple did not apply because the lenders were not “entitled” to the funds, since the loan was not due for three years. This requirement reflects the fact that the release for value defense is a specific application of a bona fide purchaser’s protection for value without notice. The Court noted that it is generally contrary to the principles of restitution to allow the recipient of an erroneous payment to retain a windfall when he has not adversely altered his position by relying on the payment. Since Revlon filed for Chapter 11 bankruptcy on June 5, 2022, the exceptionality of lenders receiving full prepayment of their loans is rather evident.

Canadian repercussions

In our previous newsletter, we noted that the defense based on the New York release has not been recognized under Canadian law, and it is unclear how a Canadian court would deal with facts similar to those in the Citibank decision. Nor has Canadian law developed a clear standard comparable to New York’s notice of inquiry standard for what constitutes implied notice that a payment was made in error. However, on similar facts, a Canadian court could very well come to the same result as the New York Court of Appeals on the grounds that no debt was owed and that due to the lenders in respect of the principal of the loan, the lenders did not count to their detriment on the erroneous payments, and the suspicion that the lenders deliberately refrained from asking questions to Citibank.

“Revlon recovery” clauses

As we suggested in our previous newsletter, in both the United States and Canada, it is now common for credit agreements to include “Revlon Clawback” clauses. In the agency provisions of a credit agreement, lenders usually expressly promise to return to the agent payments made in error and waive any defense to the agent’s claim for reimbursement. The Borrower agrees that such erroneous payments do not discharge its obligations and that the Agent is subrogated to the rights of the Lenders to the extent that the Agent does not recover any such payments.

The reversal of the Citibank The decision is unlikely to change the practice of including such provisions in loan documents. Their effectiveness has not been tested in any court cases to date, and since errors of the magnitude committed by Citibank are presumably rare, they may never be.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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