Banking and Business Monthly – September 2022

On September 8, 2022, the Second Circuit ruled that hedge fund lenders should not be able to keep roughly $500 million that they were mistakenly paid by Citibank on a loan owed by now-bankrupt Revlon, Inc. The U.S. Second Circuit Court of Appeals vacated the lower court’s 2021 ruling, which held that the lenders were not on constructive notice of the mistake and could rely on the discharge-for-value doctrine to retain the funds, and remanded it for further proceedings. Citibank, N.A. v. Brigade Capital Management, LP, 2022 WL 4102227 (2^nd Cir. September 8, 2022).

In this case, Citibank served as Administrative Agent for Brigade and the other lenders of a $1.8 billion syndicated seven-year loan to Revlon, Inc., with the responsibility to collect interest and principal payments from Revlon and transmit them to the lenders. In undertaking to transmit accrued interest to the lenders, Citibank had made a ministerial error in administering a computer program, which caused the unwitting transfer by wire of Citibank’s funds in the full amount of Revlon’s outstanding principal balance, three years before Revlon’s loan repayment was due, and, at a time when, because Revlon was understood to be deeply insolvent, loan participations were trading at 20% to 30% of the face amount. The next day, when Citibank discovered that the accidental transmission had occurred, it demanded the return of the portion representing the principal. While some lenders returned their portion of the principal, others refused to return their shares, totaling approximately $500 million. Citibank then filed suit bringing claims of unjust enrichment, conversion, money had and received, and payment by mistake.

Following a bench trial, the Southern District of New York district court ruled that since the lenders had received the exact amount each was owed, had not made misrepresentations to induce the wire transfer, and were not on notice of the mistake at the time it occurred, they had satisfied New York’s discharge-for-value defense.

The Second Circuit reversed, vacated, and remanded, explaining that under New York law, the elements of the discharge-for-value defense were not satisfied because the lenders had constructive notice and because they were not entitled to the money at the time of the payment. To reach that conclusion, the Second Circuit first determined that the inquiry notice standard was the proper standard for determining constructive notice, not whether the lenders “knew or should have known” of Citibank’s mistake. Here, an unexpected early payment of all of the principal owed from a debtor that was known to be insolvent at the time and who was previously attempting to avoid acceleration of the loan, and without the contractually required notice of prepayment, amounted to “visible red flags” that would have induced “the hypothetical prudent investor” to investigate and call Citibank, at which point, they could have immediately learned that the payment resulted from a mistake.

The Second Circuit next held that because the loan was not due and payable for another three years, the lenders were not entitled to the money at the time it was wired. In so holding, the court interpreted past precedent as requiring a “present entitlement” to New York’s discharge-for-value doctrine. If there is a requirement that the underlying debt be presently payable, then the court determined there would be a “substantial reason in justice” to return the funds to Citibank to prevent a windfall to lenders, so that ordering restitution would then place the lenders back where they contracted to be.

In sum, under New York law, a creditor may not invoke the discharge-for-value rule as a defense to retain a payment unless the creditor satisfies an inquiry notice standard and the debt at issue is presently payable.

For further inquiries or questions about banking or business matters, please contact me at smigala@lavellelaw.com or at (847) 705-7555.