(Sept 9): A federal appeals court saved Citigroup Inc from an epic blunder that became the talk of Wall Street, rejecting a ruling that Revlon Inc creditors could keep more than half a billion dollars the bank accidentally sent them.
After a decision process one expert compared to The Twilight Zone, a trio of judges in Manhattan on Thursday overturned the trial court’s surprise decision early last year that the lenders — which include Brigade Capital Management LP, HPS Investment Partners LLC and Symphony Asset Management — didn’t have to return US$504 million the bank mistakenly wired them in 2020.
The appellate decision is a major victory for Citigroup’s main banking unit in its efforts to redeem the embarrassing lapse, which forced the bank to explain to regulators how such a failure was possible. Chief executive officer Jane Fraser called it a “massive unforced error” and showed examples of manual processes that needed to be automated.
“Today’s ruling reaffirms our long-held belief that these mistakenly transferred funds should be returned as a matter of law, as well as ethics,” a spokesperson for Citigroup said in a statement. “While Citi has taken steps to reduce the likelihood of such an error in the future, today’s decision provides welcome stability and upholds the concept of cooperation needed for a well-functioning syndicated lending market.”
‘A great win’
Bloomberg Intelligence senior analyst Elliott Stein called the reversal “a great win” for the bank but also something of a surprise.
“While we thought it was a very close case, it seemed after oral arguments that the federal appeals court would send the case to New York’s highest state court to clarify the main legal issue concerning the ‘discharge for value’ rule,” he said. He was referring to a defense established by a 1991 New York court ruling that creditors can keep money sent to them in error if they didn’t realize the transfer was an accident.
Instead, in deciding the case on its own, the panel “ruled that promoting finality in transactions, while important, was not to be elevated above returning mistaken payments in this circumstance,” Stein said.
Columbia Law School professor Eric Talley, an expert in corporate law and finance, said the judges “got to the right outcome” but added that “the delay was considerable and costly.”
‘Stuck in limbo’
“It has caused Revlon’s bankruptcy to be stuck in limbo,” Talley said. “This will clarify things going forward, but it really seemed like a Twilight Zone episode, without a peep coming from the court and the parties trying to figure out how to reorganise Revlon’s debts in the interim.”
The creditors had been locked in a bitter battle with Revlon and Ronald Perelman, the billionaire whose holding company controls the cosmetics maker, over its May 2020 restructuring.
Representatives of Brigade, HPS and Symphony declined to comment on Thursday’s decision.
The August 2020 bungle took place as Citigroup was trying to send an interest payment to some Revlon lenders. Instead, the bank accidentally paid all the creditors on the loan — more than US$900 million. It managed to recover almost half the funds, but other lenders refused to give their sums back, saying Revlon had already defaulted and should have repaid them.
In a painful piece of bad timing, the bank was preparing to resign its role as administrative agent on the loan when it wired the huge sum to the lenders.
Windfall for creditors
US district judge Jesse Furman ruled for the creditors in February 2021, saying they shouldn’t have been expected to know the transfer was a mistake. The decision was a windfall for them.
At a hearing last year, Neal Katyal, a lawyer for the bank, told the three-judge appeals panel that the lenders should have been sceptical of the payments because they never received formal notice that the Revlon term loan was being paid off. He noted that the loan was trading as low as 20 cents on the dollar and that some creditors thought Revlon was insolvent, and said six of the 10 lenders didn’t even know about the transfers until Citigroup notified them.
“All of these red flags” should have led them to ask “any one of the million questions that would have led to discovery of the mistake,” Katyal said.
Kathleen Sullivan, representing the lenders, told the panel the decision needs to stand because those who receive funds from a third party “should not have to wonder” if the payments are legitimate.
“It would have been unreasonable to think this was an unprecedented mistake by a bank like Citibank,” she argued. “It would have been borderline irrational.”
Katyal said on Thursday that he was “gratified” by the decision.
“The idea that a mistake would lead to a finders-keepers rule would be destabilizing for the financial markets,” he said. “This was a mistake. Humans make mistakes.”
Well after the payment blunder, Revlon filed for Chapter 11 bankruptcy protection as the global supply chain crunch proved the tipping point for the debt-laden company. The bankruptcy filing capped a tumultuous period for the cosmetics giant, owned by Perelman’s MacAndrews & Forbes, which suffered during the pandemic after years of declining sales and financial controversies.
Revlon and some of its creditors declined to acknowledge the bank’s rights as a secured lender in the company’s bankruptcy financing package. Citigroup sued the company to resolve the nagging legal question of whether, after the accidental US$900 million payment to Revlon lenders, it would become a lender itself.
Thursday’s decision may mean lenders who got paid by Citigroup before the bankruptcy filing will need to return the funds to the bank, resolving the question of who is or isn’t a Revlon creditor.
Rare window on court
The opinions from the three-judge panel provide a rare window on its disagreements over the case.
“In my view, this is a straightforward case that many smart people have grossly overcomplicated and that we should have decided many months ago,” Circuit judge Michael Park said in a separate opinion agreeing with the result. “Put simply, you don’t get to keep money sent to you by mistake unless you’re entitled to it anyway.”
Answering Park’s complaint, judge Pierre Leval acknowledged in an addendum to the main opinion that the decision “has taken a long time to produce” and said, “I take sole responsibility for that.”
Leval said that he and Judge Robert Sack had originally decided to ask the New York Court of Appeals, the state’s highest court, for a ruling. He said they changed course because they became convinced by the bank’s arguments and felt the Court of Appeals route could add more than a year of delay.
“In addition, we have not found the answers to be as straightforward, obvious, and easy as Judge Park does,” Leval wrote. “The arguments advanced for the parties by their exceptionally able counsel, raise complex, subtle questions that required care and study.”
Park, who was appointed to the court by former US president Donald Trump, is the junior member of the panel.
A number of law professors, advocacy groups and industry associations sided with the bank, saying Furman’s decision had already disrupted the way the market works and changed the expectations of its participants.
One of the briefs in support of the bank’s position was filed by the Loan Syndications and Trading Association, a not-for-profit group that represents more than 500 firms involved in the origination, syndication and trading of commercial loans, including both Citigroup and most of the creditors in the case.
LSTA general counsel Elliot Ganz said in a statement on Thursday that the appellate decision conforms with “long-standing market expectations and norms, that when mistaken payments are occasionally made, the money is quickly returned.”
The case is Citibank NA v. Brigade Capital Management LP, 21-487, 2nd US Circuit Court of Appeals (Manhattan).