A federal judge ruled that Citibank is not entitled to a $ 500 million refund that it sent to several creditors last August. Kludgey software and a poorly designed user interface contributed to the great confusion.
Citibank was acting as an agent for Revlon, which owed hundreds of millions of dollars to several creditors. On August 11, Citibank was expected to send interest payments totaling $ 7.8 million to these creditors.
However, Revlon was in the process of refinancing its debt – paying off some creditors while rolling over the rest of its debt on a new loan. And this, combined with the confusing interface of a financial software called Flexcube, led the bank to accidentally repay the principal of the entire loan – most of which would not mature until 2023.
See how Judge Jesse Furman describes the situation:
At Flexcube, the easiest (or perhaps only) way to execute the transaction – pay Angelo Gordon Lenders their share of the principal and provisional interest due on August 11, 2020 and then replenish Term Loan 2016 with the remaining creditors —It was to enter it into the system as if it were paying off the loan in full, thereby triggering accrued interest payments to all creditors, but directing the main portion of the payment to a “laundering account” – “an internal Citibank account . to help ensure that money does not come out of the bank. “
The real job of entering into this transaction at Flexcube went to a subcontractor in India called Arokia Raj. He was presented with a Flexcube screen similar to this:
Judge Jesse Furman
Raj thought that checking the “principal” checkbox and entering a washed Citibank account number would ensure that the principal payment would remain with Citibank. He was wrong. To avoid paying the principal, Raj really needed to define the “front” and “fund” fields for the laundering account, as well as “principal”. Raj did not do that.
Citibank’s procedures require three people to sign a transaction of this size. In this case, it was Raj, a colleague of his in India and a senior Citibank employee in Delaware named Vincent Fratta. All three believed that setting the “primary” field to an internal laundering account number would prevent payment of the principal. When approving the transaction, Fratta wrote: “it looks good, please proceed. The director will wash it.”
Revlon creditors were delighted
But the director was not going to wash. When Raj did a routine check-up the next morning, he realized that there was something drastically wrong with the previous day’s figures. Citibank had actually sent almost $ 900 million, not the $ 7.8 million it was trying to send.
Citibank then struggled to recover the funds, sending a notification to each creditor that the principal payments had been made in error. Some of the creditors sent the money back. But others refused, leaving Citibank for $ 500 million.
Normally, paying off a loan in advance would not be a big deal, as the parties could simply negotiate a new loan on similar terms. But in this case, some of the creditors were not on good terms with Revlon and Citibank.
At the beginning of the year, as the pandemic was accelerating, Revlon experienced financial difficulties and sought to borrow more money. To do this, Revlon convinced most of its previous creditors to allow it to transfer the guarantees on its old loan to a new one.
The strong arm tactic infuriated the other creditors, who felt that the reduced guarantee could leave them holding the bag if Revlon ran out of money. This is more than a theoretical concern: Matt Levine of Bloomberg reports that Revlon’s debt is “being traded at around 42 cents on the dollar”. But, under the terms of the loan, minority creditors had no way of forcing early repayment.
Therefore, Citibank’s confusion allowed Revlon’s creditors to recover the money he otherwise would never have received. And that could leave Revlon in a precarious financial position if the company could not get the money back from the old creditors and could not find new creditors willing to replenish the funds. Despite its confusion, Citibank may end up becoming Revlon’s new creditor.
The judge ruled against Citibank
Citibank filed a lawsuit, arguing that it had the right to receive the money back, since the money was sent in error. Normally, the law would be on Citibank’s side here. Under New York law, anyone who sends an incorrect wire transfer – for example, sending a payment to the wrong account – has the right to get the money back.
But the law makes an exception when a debtor accidentally transfers money to a creditor. In that case, if the lender has no prior knowledge that the payment was an error, he can treat it as a loan refund. Judge Furman decided that this principle applies here, although Citibank notified its creditors about the error the next day. The defendants observed that the amounts received corresponded to the amounts owed by Revlon up to the penny, making it reasonable to assume that it was an early repayment of the loan.
Furman also argued that it was reasonable for creditors to assume that a bank as sophisticated as Citibank would not send such a large amount of money by accident.
“To believe that Citibank, one of the most sophisticated financial institutions in the world, made a mistake that had never happened before, on the order of almost $ 1 billion – it would be almost irrational,” he wrote.
The case is not over yet. Furman ordered creditors to keep the funds in custody to give Citibank time to appeal its decision.
“We strongly disagree with that decision and intend to appeal,” said Citibank in a statement. “We believe that we are entitled to the funds and will continue to seek a complete recovery of them.