Article courtesy of Maggie Parker-Yavuz (Akin Gump) and Jake Gawlak (Akin Gump)
Citibank, N.A. v. Brigade Capital Mgmt., LP, 49 F.4th 42 (2d Cir. 2022)
Overview:
The U.S. Court of Appeals for the Second Circuit considered whether, under New York law, lenders to Revlon were entitled to keep an erroneous payment of approximately $500 million transmitted by Citibank, as administrative agent under the credit agreement. Citibank brought an action for restitution against the lenders following their refusal to return the payment. In a 2021 decision, the District Court for the Southern District of New York, relying on the “discharge-for-value” rule set forth in Banque Worms, held that the lenders were not obligated to return the funds. On appeal, the Second Circuit vacated the district court’s decision, holding that the “discharge-for-value” rule did not apply because the lenders were on notice of a mistake and the debt at issue was not presently payable.
Full Summary:
Citibank N.A. (“Citibank”) was administrative agent under a $1.8 billion syndicated seven-year loan to Revlon, Inc. (“Revlon”), with responsibility to collect and transmit interest and principal payments from Revlon to the lenders. Citibank made a ministerial error in processing an interest payment through its loan processing software, which caused the unintended transfer of Citibank’s own funds in the full amount of the loan’s outstanding principal balance of $894 million to the lenders, three years before the maturity date of the loan. At the time, Revlon was not yet in bankruptcy but was assumed to be deeply insolvent and participations in the loan were trading at 20-30 cents on the dollar. Upon discovery of the error the next day, Citibank notified the lenders and requested return of the payment. Certain of the lenders, holding approximately $500 million of the loan, refused. Citibank brought an action seeking restitution. The District Court for the Southern District of New York held that the lenders were not obligated to return the money, relying on Banque Worms v. BankAmerica International, 77 N.Y.2d 362 (N.Y. 1991). On appeal, the U.S. Court of Appeals for the Second Circuit concluded that the case did not fall within the scope of the Banque Worms ruling and vacated the district court’s judgment.
In arriving at its decision, the Second Circuit first considered New York law’s traditional rule governing mistaken payments, which generally calls for restitution of the mistaken payment unless the recipient has detrimentally relied on the mistake such that it would be unjust to require repayment. The court then considered the Banque Worms “discharge-for-value” exception to the traditional rule. In Banque Worms, the New York Court of Appeals endorsed this exception based on the First Restatement’s discharge-for-value principle. The Banque Worms court had reasoned that “when a beneficiary receives money to which it is entitled and has no knowledge that the money was erroneously wired…such a beneficiary should be able to consider the transfer of funds as a final and complete transaction, not subject to revocation.” Banque Worms, 77 N.Y.2d 362, 373 (N.Y. 1991). In its analysis in the present case, the Second Circuit focused on the Banque Worms holding’s requirements that (1) the beneficiary must have no knowledge of the mistake, and (2) the beneficiary must be entitled to the money.
With respect to the requirement that the recipient have no knowledge of the mistake, the court stated that, under New York law, a recipient of a mistaken payment who has constructive notice of the mistake is not entitled to benefit from the “discharge-for-value” exception. In evaluating what constitutes constructive notice, the court adopted the inquiry notice standard as the applicable standard in adjudicating a “discharge-for-value” defense. Under New York law, “one who has reasonable grounds for suspecting or inquiring ought to suspect, ought to inquire, and the law charges him with knowledge which the proper inquiry would disclose….” Fidelity & Deposit Co. of Maryland v. Queens County Trust Company, 226 N.Y. 225, 123 (N.Y. 1919). The court explained that the inquiry notice test is “whether a prudent person, who faced some likelihood of avoidable loss if receipt of funds proved illusory, would have seen fit in light of the warning signs to make reasonable inquiry in the interest of avoiding that risk of loss.” The court reasoned that, under the circumstances of this case, a hypothetical application of the inquiry notice standard required considering not only a reasonably prudent person but rather a reasonably prudent person with an incentive to make an inquiry. The lenders ignored numerous “red warning flags” suggesting that the payment was a mistake, including that (1) they were not notified by Citibank prior to the payment, (2) Revlon was insolvent, (3) participations in the loan were trading at 20-30 cents on the dollar, and (4) Revlon was currently attempting to avoid acceleration of the loan through a “roll-up” transaction which would not be necessary if Revlon planned to prepay. The court concluded that these “red warning flags” would have caused a reasonably prudent person to make reasonable inquiry as to whether the transfer resulted from a mistake. Having failed to inquire of Citibank, the lenders were chargeable with what they would have learned by doing so. The court concluded that the lenders were on constructive notice of Citibank’s mistake and were thus ineligible to claim the “discharge-for-value” defense.
The court held further that the lenders were not protected by the Banque Worms ruling because the loan was not yet due. The court noted that none of the New York precedents on which the Banque Worms decision relied involved a debt that was not yet due. Under the court’s interpretation of Banque Worms, its rule only operated in favor of a recipient of a mistaken payment who was “entitled” to the funds. In the present case, repayment of the loan was not due for another three years, and the lenders therefore were not entitled to the payment.
The Second Circuit concluded that Citibank was entitled to the return of the funds under the Banque Worms rule because (1) the lenders had constructive notice of the error, and (2) the defendants were not entitled to the money at the time of Citibank’s accidental payment since the debt was not presently due and owing.
