A 30-year legal precedent that essentially writes “guards of finders” in some financial transactions will make it difficult for Citigroup to roll back the transaction.
The bank said it would appeal a court decision – given this week by a federal judge in New York – that rejected an attempt to recover the $ 504 million it mistakenly sent to asset managers last summer for Revlon lenders.
Citigroup had transferred to fulfill Revlon’s “loan agent” role. However, instead of the due interest amount, the entire loan amount was transferred as a result of a back office error. Among the recipients of this generosity is Brigade. Capital Management, HPS Investment Partners and Symphony Asset Management.
Judge Jesse Furman in the southern district of New York said the transfer, totaling more than $ 900 million, should not be expected for buyers to know that it was a mistake before some lenders returned their shares.
“It would be unreasonable to believe that Citibank, one of the most advanced financial institutions in the world, made a mistake that had never been done before, on the border of nearly $ 1 billion,” wrote Furman, who heads in Manhattan.
The result is fascinating as an example of abiding by strict judicial rules. As Furman pointed out his opinion, the legal rule was clear: Under New York law, a creditor can keep an erroneous payment unless he “knows” that it was sent in error.
The decision was the final blow to Citigroup, who was in the midst of an effort to update its underlying controls and technology, after regulators fined $ 400 million for shortcomings in both areas last year. The New York-based company is also undergoing a leadership change, and incoming CEO Jane Fraser is preparing to take over the reins on March 1.
For the lucky recipients of the multi-million dollar transfer, this decision is a blessing. Asset executives went to war over billionaire investor Ronald Perelman’s restructuring with formidable cosmetics company Revlon in May 2020. They argued that one of the biggest banking mistakes in recent memory, the August 11, 2020 payment, Revlon closed its debt to them under a 2016 maturity loan and did not seem like a mistake when it arrived. So, it was theirs to keep it. The judge said they could get the money until the appeal, but not spend it.
Eric Talley, professor of corporate law and finance at Columbia Law School, said it would not be easy to appeal the court decision. “Citi has a reasonable chance of appealing, but that result will create some strong winds,” Talley said.
Citigroup’s shares slashed earnings in the resolution and closed below 1% Tuesday. The stock gained 4% this year.
Not the fairest result
Furman said in his 101-page verdict that the outcome of the case was surprisingly simple, even if it did not appear to be the fairest result.
“Transfers matched the outstanding principal and interest amount of the loan with penny,” wrote Furman. “The attached statements were that the interest was ‘due’, and the only way this was true was if Revlon was doing a major upfront payment.”
The key precedent is an interesting 1991 New York state case called Banque Worms v BankAmerica International. In this case, New York’s highest court ruled that if a third party mistakenly sent money from a debtor to a creditor, the creditor could withhold the payment if he did not realize that the payment was sent in error. He did not make any false statements.
Rather than paying interest as an administrative agent for the Revlon loan, Citibank paid the full $ 900 million outstanding from its own pocket. Some of the buyers returned the money, but about $ 504 million was stuck.
Applying the statement in the Citibank case to the law stated in the Banque Worms verdict, Furman said the main problem in question was whether the lenders were all “open” around 18:00 – at the time of the wrong transfer – on 11 August 2020. He constructively announced Citibank’s mistake. “By examining the evidence, he saw that they were not.
It’s a challenge for Citibank, said Talley, a Columbia professor. He could claim that Furman misinterpreted the facts when he realized that lenders had no reason to believe the payment was wrong, he said. But they tend to show much more respect for court judges’ interpretation of the facts, as the appellate courts are a step out of the trial, Talley said.
The bank may have more chances when it realizes that Furman has misunderstood the law, that the lenders reasonably expected Citibank to pay off the loan as they had received the full amount owed – despite not having full debt yet due.
“To take the most likely example, Citi can claim that the eviction for value defense is not valid unless the debt is due and payable, which is not here,” Talley said. “And that’s why the court judge misunderstood the context of the claim. This kind of claim is probably his best chance on appeal, because it requires little respect from the appellate court.”
Citigroup said on Tuesday that Furman got it wrong.
Bank spokesman Danielle Romero-Apsilos said after the verdict, “We strongly disagree with this decision and we plan to appeal.” “We believe we have the right to the funds, and we will continue to get the money back completely.” The bank had no additional comment.
Furman dismissed Citibank’s claim that the size of the transfer alone warned the lenders of the error, saying that each lender’s representatives have expressed reasonably believe that the payments are upfront payments of the 2016 loan deliberately made.
“It was almost unthinkable for any reasonable investor in the (lenders) position that Citibank had accidentally paid $ 900 million,” Furman said, given that banks have security procedures to ensure that such errors do not occur.
“Citigroup has a tough challenge that succeeds in appealing,” said Braden Perry, a partner of Kennyhertz Perry and an expert on legal and regulatory issues. “It broke down after a contractor checked the wrong box on the digital payment form,” the judge ruled on the bank’s “six eyes” system, where three people must confirm a transaction.
Under the six-eye protocol, an employee designated “producer” manually puts the payment information into the bank’s Flexcube loan processing program. In most cases, Citigroup trusts external tech firm Wipro Ltd for this step. The second step also typically includes a Wipro employee acting as a “supervisor” in the producer’s job.
In the last step is a team of Citigroup employees who “approve” and serve as final control of the payment. For the $ 900 million flawed Revlon transfer, Vinny Fratta was the one who approved it.
Fratta, a senior manager in Citigroup’s global credit operations group, joined the bank in 2006.
After a series of promotions, he was selected to lead the asset-backed transition finance group in 2012 and led a bank-only team of six Delaware-based Citi employees and nine Wipro employees in India.
Fratta said in a statement to the court that the bank can process hundreds of bank transfers per day using the Flexcube system. It has a default mode to send a bank transfer unless the manufacturer in the six-eye system overrides this option. This box is ticked for some of the Revlon payments, but not for all.
Fratta at first thought the error was due to a technical malfunction.
But during court proceedings, “day by day,” he said, “I admitted that the error was caused by human error and not by any glitch, and that I am one of the people responsible for the error.”
“Confirming” the transfer, Fratta said in a statement that it was “shocked” to discover the error. “My first reaction was reflected in a conversation with Mr. Raj at 9:51,” he said, referring to a contractor in India who was a “controller” in payments.
“‘Oh my God,” he told Fratta Raj, “Do we have evidence that the wires went to the specific lender listed in their email? Did they go to all lenders? How much was the overpayment?”
Fratta said his intention was to transfer approximately $ 8 million in interest payments to Revlon lenders.
The judge pushed aside some of Citigroup’s other arguments, including allegations that it was unfair to let the transfer proceed and that New York state rule was bad law. Furman said these arguments were “directly blocked” by the decision in Banque Worms.
“The problem for Citibank is that the court doesn’t write on a blank board,” he wrote.
This does not mean that the law has not changed. The federal appeals court in Manhattan will hear the bank’s appeal, although it does not have the power to change state law, New York’s highest court can reconsider its decision. If he realizes, as Talley did, that Tuesday’s verdict “is probably not a good development for the most logical evolution of the law”, he may do so.
Undoubtedly, the bank seemed to be getting its share of points at the December 2020 hearing, when Citibank argued that the transfers were a clear mistake and firms had no right to them.
A senior loan operations employee at Symphony, who was questioned by a lawyer of the bank, stated that his standard practice is to look at fund transfers made without prior notice and return the money if it was sent in error. He said that he had seen the money sent to his firm or other parties by mistake before.
“We were going to examine the telegram and confirm it was a mistake,” and he testified, “If we don’t owe money, we’ll send it back.” He was asked whether false interest payments were common, he said so.
Although Citibank manages to win or lose its ultimate appeal, the accidental payment may have a lasting impact on the syndicated loan market of more than $ 1 trillion, as it will require a review of internal controls in the industry.
“It could be a pioneering and transformational case in terms of agents’ responsibilities and their potential liability for errors in the credit process,” said Kennyhertz Perry partner Braden Perry. This case “will be rectified by a court of weak internal controls and major mistakes of this species”.
Citibank’s controls over the payment – part of a squeaky system that was on its way out when the error occurred – were perhaps particularly weak. During the trial, however, Furman went outside the courtroom to issue a more comprehensive warning.
“The industry must find a way to deal with them, even if this is a black swan thing,” he said at the hearing via videoconferencing. “Whatever my decision in this case, I hope the world, the market., Takes into account what is happening here and the resulting uncertainties.”
While it’s still too early to tell exactly what kind of changes will happen, the case is a celebrity and a signal for bankers to make sure their homes are tidy.