Recipients of an erroneous $500 million wire transfer that rocked the financial world must return the funds, a panel of the United States Court of Appeals for the Second Circuit ruled on September 8, reversing a decision by the federal district court in New York.
In 2020, Citibank NA mistakenly passed funds to loan servicers at certain lenders on a seven-year, $1.8 billion syndicated loan to Revlon Inc. The $500 million error paid off the principal balance outstanding from Revlon three years prior to the repayment of the company’s loan. Citibank, the lenders’ administrative agent, asked the lenders to return the funds. While a number of lenders participating in the syndicate have returned funds received at Citibank’s request, some have refused. In a lawsuit brought by Citibank seeking reimbursement for the erroneous payments, the district court ruled that the lenders did not need to return the money, a decision that has raised serious concerns in the financial community. As a result, administrative agents and the lawyers representing them began to include express “mispayment” language in credit agreements, which required lenders to return erroneous payments to the administrative agent.
Recently, the Second Circuit determined that the lower court erred in deciding that the loan servicers did not have to return the money. The “discharge for value” rule did not in fact protect loan servicers from Citibank restitution claims because they were on notice of investigation of the error, Judge Pierre N. Leval wrote in a opinion joined by Justices Robert D. Sack and Michael H. . To park. Judge Park also drafted a separate agreement.
The circumstances surrounding the erroneous transfer showed red flags that would have prompted “a reasonably prudent person” faced with an avoidable risk of loss to investigate whether the transfer was the result of an error. Moreover, a reasonable investigation would have revealed the error, the panel said.
How did it happen
During the transmission of accrued interest to the lenders’ loan managers on August 11, 2020, Citibank made an error that caused the accidental wire transfer of $894 million – the full amount of Revlon’s outstanding principal balance – three years before the timing of the repayment of the Revlon loan.
Although three people reviewed and approved the transaction before it was executed, the transmission was sent without certain specific parameters that would have prevented the transfer of the principal balance. The transaction came at a time when, with Revlon insolvent, loan participations were trading at 20% to 30% of face amount. (Revlon then filed for Chapter 11 bankruptcy on June 15, 2022.)
Citibank discovered the erroneous transmission the next day and issued a total of four reminder notices over the next few days, asking loan servicers to return the principal portion. However, some loan managers, representing $500 million in debt, have refused to return the funds.
Discharge rule for value
Citibank sued these loan managers in the United States District Court for the Southern District of New York. Following a bench trial, the district court found that the release-for-value rule shielded loan servicers from Citibank’s disgorgement action, relying on Worms Bank c. Bank America International.
In To Bank, the New York Court of Appeals upheld a lender’s right to withhold a bank’s erroneous repayment to the bank’s customer of a loan that was due and payable. The Court of Appeal based its decision on the American Law Institute’s rule of discharge for value, published in Article 14 of the Restatement (First) of Restitution (Am. Law Inst. 1937). The discharge for value rule describes the circumstances that exempt the beneficiary of a payment made in error in settlement of a debt due, from the obligation to return the erroneous payment.
The district court ruled that loan servicers had the right to keep funds that Citibank paid out in error. She concluded that the defendants had established the elements of the defense of release for value because (1) the lenders were creditors of Revlon on the date of the erroneous payment, (2) each lender was liable in principal and interest for the exact amount of money he received from Citibank, (3) neither the lenders nor the loan servicers made any misrepresentations to induce the erroneous wire transfers, and (4) neither the lenders nor the loan servicers were aware of Citibank’s error.
On appeal to the Second Circuit, Citibank raised several arguments challenging the value discharge rule and the applicability of To Bank to this case.
Citibank argued that the loan servicers could not claim the benefit of the release-for-value rule because they had been advised of an error.
The panel agreed. Under New York law, the value release rule does not protect the beneficiary of an erroneous transfer from restitution claims if the beneficiary is informed of the error. Further, based on the facts available to loan servicers on August 11, the notice of investigation standard was met. “The facts were sufficiently inconvenient that a reasonably prudent investor would have made a reasonable inquiry and a reasonable inquiry would have revealed that the payment was made in error,” the panel wrote.
Loan servicers were aware of four red warning signs suggesting error:
- The absence of notice of an early repayment, to which the lenders were contractually entitled.
- The inability of insolvent Revlon to repay nearly $1 billion.
- The fact that the loan was trading between 20 and 30 cents on the dollar, so it could have been repaid for much less than paying its full value.
- Revlon tried four days earlier to avoid the accelerated maturity of the loan by making an exchange offer to holders of the 2021 notes.
Further, the district court’s decision hinged on its factual findings that the loan servicers had a good faith belief that the payments they received were not in error and its conclusion that those beliefs were reasonable. The panel said the district court’s reasoning represented a misunderstanding of the notice of inquiry test.
“The test is not whether the recipient of the erroneous payment reasonably believed that the payment was genuine and not the result of an error. The test is whether a prudent person, who faced some probability of loss avoidable if receipt of funds proved illusory, would have seen fit in light of the warning signs to make a reasonable investigation in the interest of avoiding this risk of loss,” he explained.
Citibank also challenged the district court’s finding that a reasonable inquiry would not have revealed the error. The panel again sided with Citibank. In this case, calling Citibank would have been an easy and obvious way to confirm any suspicion that the wire transfer payment was in error. A loan servicer who did not call Citibank or Revlon but instead relied on nothing more than confirming that the payment matched the debt failed to conduct a reasonable investigation, the panel said. Having failed to make these calls, loan managers were responsible for advising what they would have learned. Therefore, the panel concluded that the loan servicers had been made aware of Citibank’s error and therefore were not eligible to claim the value discharge defense.
Worms Bank stop
The panel also agreed with Citibank’s assertion that loan servicers were not protected by the To Bank decision because on August 11, they were not entitled to the money they had received from Citibank, since Revlon’s debt was not yet due.
The applicant in To Bank was entitled to the money because the loan in question was due and the defendant demanded payment. The loan in this case was not repayable for three years, the panel explained. The Banque Worms decision highlighted the finality of wire transfers, but it did not value finality above all other values.
On the contrary, the To Bank The court explicitly left in force the basic New York rule requiring the return of erroneous payments, except where identified exceptions apply. It also provided exceptions to denial of restitution based on factors such as when the assignee made the misrepresentations or was notified of the error, the panel said.
Judge Leval wrote an addendum to the opinion, questioning whether an incidental payment of the type made by Citibank falls within the scope of the Restatement Value Release Rule. The restatement rule applies in circumstances where the transferor’s payment results from its “error.” . . as to his interests or duties. Citibank was not mistaken about its interests or its duties. His only mistake was making a bank transfer setting error, Judge Leval said. Therefore, the release for value rule does not apply to the payment made in this case, which was an incidental payment made with no intention to pay, no intention to discharge any debt or lien and without error as to the duties or interests of the grantor, he said.
Judge Park wrote an agreement in which he said he only agreed with the judgment. The district court clearly erred in finding that there were insufficient red flags to warn loan servicers of Citibank’s error. However, the loan managers’ case failed on a more fundamental level, he said.
The recipient of funds transferred in error cannot invoke the defense of release for value “unless and until he has a present right against the debtor”. In other words, the recipient cannot keep the money sent in error unless they are entitled anyway, Judge Park said.