Oh No! I Just Wired $900MM by Mistake!: The Story of Citibank N.A. vs. Brigade Capital Management
Steven N. Kurtz dives into the recently decided Citibank N.A. vs. Brigade Capital Management case, which focused on a $900 million mistaken wire transfer. In the exploration of the case and its decision, Kurtz pulls out important lessons in dealing with electronic payments.
BY STEVEN N. KURTZ, ESQ., LEVINSON ARSHONSKY & KURTZ, LLP
Every so often, a mega commercial finance disaster case comes along that, like a train wreck, you just have to watch, or, in my case, report on. The recently decided Citibank vs. Brigade Capital Management case is one of those disasters.
The Citibank case arose out of a nearly $900 million mistaken wire transfer made to multiple parties in a large, syndicated loan. The sender only intended to wire the regularly scheduled monthly payment but instead, erroneously ended up paying off the entire loan.
The factoring and asset-based lending industry lives by wire transfers. Electronic financial transactions are the new normal and involve nearly every aspect of a business, including, but not limited to, funding deals, getting funded by capital sources, participations, paying vendors, payoff deals, early payment platforms and more.
What Happened?
In the Citibank case, the facts are complicated and detailed. Citibank was the agent for a $1.8 billion syndicated loan to Revlon which was entered into in 2016. In 2020, Revlon had paid down part of the loan, but needed to borrow more. A vote was taken by members of the loan syndication group and the majority, over some heated objections, agreed to lend more money to Revlon, and the lenders who participated in the new loan transaction “rolled up” the 2016 loan into the 2020 loan.
Payments of interest and principal were made electronically and the payment computations, software and management of the electronic payment system were handled by a company based in India. There were some major complexities in managing the payment to members of the loan syndicate. During the Citibank case, the court went into substantial detail explaining the issues and what went wrong. In order to make all the required loan payments to the parties, there had to be phantom payments of the entire principal along with the interest. The phantom principal payoff payments were supposed to be made to a “wash account” at Citibank. Because of the major complexities inherent in managing and accounting for everyone’s interest, the interest payments and principal payments were entered into the system as if the loan was being paid in full that day. When things worked, only the regular monthly payment was made to the syndicate members and the remaining loan payoff payment was paid over to the wash account at Citibank and retained by the bank. There were systems in place to make sure that three sets of people looked at the transaction before any money was wired. However, a mistake was made and only one of the three required system entries were made and it was not clear to the people watching the program that they had to make the same entry as person No. 1 because, on “paper,” it looked like everything was going to work as planned.
Of course, things went wrong and members of the loan-syndication group received payments of principal and interest, calculated to the penny as of the day of the transaction, which paid the loan in full instead of the regular monthly payment. In a world when funds are deployed and redeployed quickly, many of the syndicate members thought Revlon paid off the loan early. The next day, Citibank realized its mistake and sent repayment demands to each of syndicate members who received the complete loan repayment. Some syndicate members returned the money, but nearly $500 million was not returned by members who decided to accept the early Revlon loan payoff.
Citibank then filed suit in the U.S. Federal Court for the Southern District of New York, seeking to get back its mistaken payments. Of note to litigators, or to those businesspeople who have spent some time in court, the case is really a state law issue to get back $500 million of mistaken wire transfers. The law at issue is Article 4A of the Uniform Commercial Code as well as other state-based laws centered in mistake and keeping money which, at first glance, does not get you into federal court unless you have a federal question (a case based in federal law) or diversity jurisdiction.
Diversity Jurisdiction
Diversity jurisdiction requires that you have a complete diversity of citizenship on both sides of the case and more than $75,000 at issue. If any of the plaintiffs or defendants are citizens of the same state, you don’t get into federal court. In cases where you have an LLC or general partnership organized in a particular state, to keep diversity jurisdiction, you have to drill down to the individual members of the LLC or general partnership. That means the plaintiff on the one side must be completely diverse in state citizenship than the parties on the other side, including the individuals who are the ultimate owners of the LLC or general partnership. Many factoring and asset-based lending cases get into federal court on diversity jurisdiction and that’s just where most experienced commercial litigators handling a financial case prefer to be.
Citibank, whose lead counsel was a former solicitor general, based federal court jurisdiction on a piece of banking legislation known as The Edge Act, 12 U.S.C. Sec. 632. The Edge Act gives federal courts jurisdiction to hear civil cases involving international or foreign banking, or international or foreign financial operations, so long as one of the parties is a corporation organized under the laws of the United States. This may be a tool for some International Factoring Association members that have operations in multiple countries or deals that involve some international component to get into federal court when jurisdiction is otherwise not available.
Discharge for Value Defense
The starting point for law at issue before the court in the Citibank case was Article 4A of the UCC, entitled Funds Transfers. This UCC article governs electronic transfers of money. Generally, Article 4 is meant to be the exclusive body of law that governs electronic funds transfers. In fact, the official comment to Article 4A Sec. 102 recognizes that funds transfers involve competing interests of the banks that provide the fund transfer services and the commercial entities that use the services. The official comments go on to state that these competing interests have been thoroughly considered and that resorting “to principles of law or equity outside of Article 4A is not appropriate to create rights, duties and liabilities inconsistent with those stated in this article.” This official comment is important and in stark contrast to UCC Sec. 1-103(b), which, in certain instances, allows the parties to examine state law in addition to the UCC. However, UCC 4A Sec 303, which governs payment by mistake, specifies that a bank that mistakenly wires more money than ordered by the sender is entitled to recover from the beneficiary of the erroneous order the excess payments received to the extent allowed by the law governing mistake and restitution. Therefore, the law governing mistakes and receipt of a mistaken payment applied. The court looked to The Restatement (First) of Restitution Sec. 14(1), which is the “discharge for value defense,” and provides: “A creditor of another or one having a lien on another’s property who has received from a third person any benefit in discharge of the debt or lien is under no duty to make restitution therefor, although the discharge was given by mistake of the transferor as to his interest or duties, if the transferee made no misrepresentation and did not have notice of the transferor’s mistake.” This is a complete defense to relieving a mistaken wire transfer.
The court in the Citibank case ruled that the defendants who received the mistaken payments were protected by the discharge for value defense. The court ruled that the notice of mistake applies at the time the payment was received and not after notice of the mistake was given. At the time the mistaken payment was received, again with payments calculated to the penny, the recipients had no knowledge that the payment was made by mistake. The court noted that although there were provisions in the applicable loan agreements that governed early loan payoffs, Citibank had deviated from its written procedures before.
Although the court ruled that the defendants did not have to repay the mistaken payments, it issued a temporary restraining order (TRO) preventing the defendants from moving the mistakenly paid funds until the case was decided on appeal. This kind of TRO is rare since the person whom the TRO favors normally has to prove a likelihood of success on the merits. In this case, the judgment was against Citibank. The court was careful to show that the TRO was issued because this is a case of first impression and involved important public policy considerations. The judge also noted that there are very few industry rules or procedures that govern mistaken payments, which is true and surprising. The case then immediately went into the appellate court and has been fast tracked due to its importance to the financial community. The case has been fully briefed and it is expected that oral arguments will take place in August or September.
Protection in an Electronic Payment World
Electronic funds transfers are a way of life, both for businesses and consumers. We pay for things using apps on our phones with links to our bank accounts and credit cards. Most businesspeople find it easier to pay via electronic transfers. Industries are being built around commercial and business transactions using electronic payments. As we move into a block chain system, all payments will be electronic. As for what you can do now to protect yourself, my suggestion is to assess and evaluate. What protections and procedures are in place in your business when making electronic payments? Are there backups and/or approvals? This is even more important for smaller factoring shops that are tech savvy but have fewer workers. Contracts should be evaluated to see if these issues are protected. Guaranties should be examined to make sure that you have the right waivers, similar to the waivers that allow you to make mistakes and not take actions or fail to perfect your lien. Believe it or not, those are the types of waivers many of you have in your guaranties. Insurance coverage should be assessed as well.
If something like what happens in the Citibank case happens to you, the first thing you should do is recall the wire or ACH. Of course, you need to examine your security procedures to prevent hackings and/or spoofing. Also, although this is off topic, if you are the victim of a client misappropriating a factored account, do a reverse wire or ACH immediately and then call counsel.
The Citibank case is very interesting. It will be closely watched and will have ramifications on how the electronic payment business is done and what protections are available for the person who initiates a mistaken wire transfer and then immediately seeks to correct the error. This open issue may have to be fixed by legislature. This likely will require an amendment to Article 4A of the UCC or something at the federal level because wire transfers are part of interstate commerce. My preference is a fix to Article 4A so we keep it in the UCC.
For another case about a large commercial mistake, see the article “In re Motors Liquidation - A Clerical Error on Steroids” in the May/June 2015 issue.