Revlon Lenders required to return unintended payoff to Citibank
In February 2021, WurstCaseScenario discussed the $894 million mistake made when Citibank erroneously paid off a Revlon syndicated loan including paying some $500 million to disgruntled syndicate members in full. While many of the syndicate lenders returned the erroneous payments to Citibank, a large group of lenders who felt mistreated in the syndicate retained the payments. Citibank brought an action seeking restitution by requiring the lenders to return the payments. The U.S. District Court for the Southern District of New York (SDNY), relying on precedent from the New York Court of Appeals in its 1991 Banque Worms case, ruled that they could keep the payments. Citibank appealed. On Sept. 8, 2022, the Court of Appeals for the Second Circuit reversed the SDNY ruling that Citibank was entitled to be repaid about $500 million from the co-lenders.
To recap, Citibank, in its capacity as agent, intended to wire $7.8 million in interest to Revlon’s lenders. However, user error and failed safeguards allowed Citibank to wire $894 million of its own money to the Revlon lenders. The payments totaled the exact amount owed to each lender. Once Citibank realized the error, they sent notices to each lender demanding the funds be returned. After the notices, some lenders returned funds, but $501 million remained unpaid. The SDNY determined that Citibank could not recover the $501 million because the “discharge-for-value” defense applied.
The discharge-for-value rule allows a creditor to escape restitution where they have mistakenly received funds that discharged a debt owed to them so long as they were unaware of the transferor’s error.
In reversing the SDNY, the Second Circuit ruled that the elements of the “discharge-for-value” defense had not been met. According to the Court, the lenders had constructive notice and “were not entitled to the money at the time of Citibank’s accidental payment, as required by the Banque Worms ruling.”
The Second Circuit determined the “discharge-for-value” defense is not applicable because the lenders were on notice of mistake. The Court stated that a “reasonably prudent investor would have made reasonable inquiry, and reasonable inquiry would have revealed that the payment was made in error.”
The Circuit Court discussed that New York courts and the Restatement of Restitution and Unjust Enrichment (a scholarly treatise covering numerous legal topics and regularly relied upon by judges and litigators in considering questions of first impression) require inquiry in such situations. Relating to the erroneous $894 million payment, the Court identified four red flags that existed and created a duty for the lenders to inquire about the payment error:
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- The credit agreement required prior written notice of prepayment. No prior notice was provided.
- Revlon’s distressed financial condition should have caused doubts as to the almost $1 billion payoff.
- The loan was trading with a 70-80% discount and therefore it would be improbable that Revlon could or would pay off debt at full value.
- Four days prior, Revlon had an elaborate scheme to avoid acceleration, and it would be illogical if they were planning to retire the debt.
The Court determined these red flags should have caused the Revlon lenders to inquire of Citibank about the payment, and that inquiry would have exposed the error. The Court stated the SDNY misunderstood the inquiry notice test.
Additionally, the Court said Banque Worms does not apply because the debt was not payable on Aug. 11, 2020. According to the Court, a debt is payable if 1) demand is made or 2) the debt has matured. On Aug. 11, 2020, demand had not been made and the Revlon debt’s maturity was in three years.
This is not the first time the Second Circuit was faced with an agent’s error. You must recall the error made when the agent inadvertently terminated the Unsecured Creditor’s Committee (UCC) financing statements securing a $1.5 billion loan to General Motors. In GM, there were two facilities with the same agent. When the first was paid off, the agent unwittingly released all UCCs instead of just the one that secured the synthetic lease that had been paid. Delaware UCC law applied, so the Second Circuit certified Delaware law questions to the Delaware Supreme Court, and held the agent liable for its error saying that “…no creditor could ever be sure that a UCC-3 filing is truly effective, even where the secured party itself authorized the filing.” The big winners here were GM’s creditors who were able to benefit from some unexpected, unencumbered assets.
But the Revlon/Citibank case did not concern the erroneous filing of a UCC-3 – it was about an error by paying off the syndicated lenders. The lenders knew or should have known that they were not about to receive payments; to the contrary, they knew that their loans were seriously impaired. They knew that Revlon was at risk of having to file for bankruptcy protection – something it ultimately did in June 2022, nearly two years later.
The apparent lesson here is that while some mistakes cannot be corrected, others can. However, the better lesson is to exercise care whether in releasing UCCs, making payments or taking any action affecting your rights.