A federal judge has ruled that Citibank is not entitled to the $ 500 million proceeds it sent to various creditors last August. Kludgey software and a poorly designed user interface contributed to the massive screwing.
Citibank was an agent for Revlon, which owed hundreds of millions of dollars to various creditors. On August 11, Citibank was supposed to send out interest payments totaling $ 7.8 million to these creditors.
However, Revlon was refinancing its debt – by paying off some creditors while the rest of its debt was put into a new loan. And that, coupled with the confusing interface of financial software called Flexcube, led to the bank accidentally repaying the principal on the entire loan – most of which was only payable in 2023.
Here is how Judge Jesse Furman describes the situation:
On Flexcube, the easiest (or perhaps only) way to execute the transaction – to pay Angelo Gordon borrowers their share of the principal and interim interest on August 11, 2020, and then to repay the 2016 term loan with the remaining borrowers to recover. – had to enter it into the system as if the loan were to be repaid in full and thus cause accrued interest payments to all borrowers, but to send the bulk of the payment to a “washing account” – an internal Citibank account .. to helps ensure that money does not leave the bank. ‘
The work to enter into this transaction in Flexcube falls on a subcontractor in India named Arokia Raj. He gets a Flexcube screen that looks like this:
Judge Jesse Furman
Raj thought that ticking the ‘main’ check mark and entering the number of a Citibank laundry account would ensure that the main payment would remain with Citibank. He was wrong. To avoid payment of the principal, Raj actually had to set up the ‘before’ and ‘fund’ fields on the washing 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 official in Delaware named Vincent Fratta. All three believed that paying the principal would occur if you set the ‘principal’ field to an internal washing account number. When approving the deal, Fratta writes: “looks good, please continue. Principal is going to wash.”
Revlon’s creditors were delighted
But the principal is not going to wash. When Raj did a routine check the next morning, he noticed that the figures from the previous day were drastic. Citibank actually sent out almost $ 900 million, not the $ 7.8 million it was trying to send.
Citibank scrambles to get the funds back and notifies each creditor that the principal payments were made by accident. Some of the creditors returned the money. But others refused, leaving Citibank with $ 500 million.
Usually, it would not be a big deal to repay a loan early, as the parties would simply be able to negotiate a new loan on similar terms. But in this case, some of the lenders were not on good terms with Revlon and Citibank.
Earlier this year, when the pandemic accelerated, Revlon experienced financial difficulties and tried to borrow more money. In doing so, Revlon persuaded a majority of its previous creditors to allow him to transfer guarantees from his old loan to a new loan.
The strong poor tactic angered the other creditors, who felt that the reduced collateral could keep them in the pocket if there was no more money at Revlon. This is more than a theoretical matter: Matt Levine of Bloomberg reports that Revlon’s debt “traded at about 42 cents on the dollar.” But under the terms of the loan, the minority providers had no way of enforcing early repayment.
Citibank’s turmoil has thus enabled Revlon’s creditors to withdraw cash that would otherwise never have been recovered. And this could leave Revlon in a precarious financial situation if the company is unable to recover the money from the old lenders and cannot find new lenders willing to replace the funds. Although Citibank has been fixed, it could potentially become Revlon’s new creditor.
The judge rules against Citibank
Citibank has sued, arguing that it was entitled to get the money back as the cash was accidentally sent out. Usually the law here would be on Citibank’s side. Under New York law, anyone who sends out an erroneous bank transfer – for example, the payment to the wrong account – is entitled to a refund.
But the law makes an exception when a debtor accidentally transfers money to a creditor. In that case, if the creditor does not have prior knowledge, the payment is an error, it is free to regard it as a repayment of the loan. Judge Furman ruled that this principle applies here, although Citibank notified its creditors the next day. The defendants noted that the amounts they received corresponded with the amounts that Revlon owed to the cent, making it reasonable for them to assume that it was an early repayment of the loan.
Furman also argued that it is reasonable for the creditors to accept that a bank as sophisticated as Citibank would not accidentally send out such a large amount of money.
“To believe that Citibank, one of the most sophisticated financial institutions in the world, made a mistake that has never happened before, up to almost $ 1 billion – would have been irrational on the border,” he wrote.
However, the case is not over. Furman ordered the creditors to keep the funds in custody to give Citibank time to appeal against its ruling.
“We do not fully agree with this decision and intend to appeal,” Citibank said in a statement. “We believe we are entitled to the funds and will continue to bring about a full recovery.