Citigroup v Brigade Capital Management

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+++UPDATE+++ UPDATE+++The decision was reversed on appeal on September 8 2022+++

A judgment that surely struck terror into earnest hearts in the global trust and agency community, the US District Court’s stonking 105-page judgment in the Citigroup v Brigade Capital Management addresses a perfect storm of unexpected factors to come to quite the eye-catching — well, eye-watering, at any rate — conclusion.

Headline: Citigroup, who as the lenders’ adminstrative agent, accidentally paid half a billion dollars of principal to lenders when it only meant to pay $8m of interest, was told that due to an obscure defence to an unusual common law action, it couldn’t have its money back.

Happily — and in the JC’s entirely inconsequential opinion, rightly — the New York Appeals Circuit overturned Mr. Justice Furman’s first-instance decision on 8 September 2022. The next section is the JC’s (again, entirely inconsequential but, dammit, correct) assessment of the first instance decision:

First Instance decision of Furman J

This case has everything: it is as if all the ghastly phantoms of commercial legal practice converged in some mountain eyrie for a satanic feast on the bones of a poor, harmless, well-meaning global banking conglomerate. The JC liked it so much he has formulated a new equitable principle: durum caseum per magnos canibus: “hard cheese for big dogs”: a sort of dark inversion of the JC’s anus matronae parvae malas leges faciunt principle.

Facts

Revlon — you know, that Revlon: lippy, perfume, nail polish; a struggling “heritage” brand — borrowed a ton of money in 2016 to acquire Elizabeth Arden. The financing was complex but the thing to know was that Citi acted as the lenders’ administrative agent.

An administrative agent functions rather like a paying agent on a bond, only it is agent of the lenders, not the borrower. It keeps a register of lenders, records who is owed what, and handles interest and principal payments to the lenders on the borrower’s behalf, when the borrower pays them. So the administrative agent has a bank account for the borrower, too.

But Citi had no responsibility for Revlon’s obligations: Revlon would pre-fund all the payments it needed to make to the lenders. If — as seemed increasingly likely — Revlon could not meet its obligations, this was always the lenders’ problem, not Citi’s. Citi was, like all corporate service providers, providing an administrative service, for which it received a nugatory fee and — so it thought — took nugatory risk.

You can just imagine the indemnities, disclaimers, waivers and exclusions of liability littered through Citi’s standard agency legal documents, can’t you. If they were bad before, just imagine what they look like now.

Revlon’s decline

Things aren’t quite as rosy for Revlon as they were when Charlie and Tweed strode globe. By the spring of 2020, its “liquidity position” was “extremely tight”. Revlon was short of the readies. It had become a “distressed” name. Some of its debt has found its way onto the books of hedge funds, who did not appreciate Revlon’s cute attempts to raise further finance against their collateral. They launched all kinds of litigation, which turned out not to matter.

Distressed debt

Though syndicated loans are private contracts, they are actively traded by means of novations, participation agreements, derivatives and the like. When a borrower is distressed its loans trade at a discount to their “face value”, reflecting the diminished likelihood that they will be repaid.

Activist investors were in the Revlon deal and they had acquired their interests for a lot less than “par”. This is what rapacious event-driven hedge funds do. Sometimes Mother Nature is cruel.

Now, short of Revlon agreeing a debt-for-equity swap and giving the company up to the lenders altogether, it unexpectedly repaying the loan in full would be, like, Christmas for these rapacious lenders paragons of the free market. Better than Christmas, in fact: at least you do expect a Christmas every now and then. Distressed borrowers never prepay their loans in full. They can’t.

If an administrative agent did suddenly repay a whole distressed loan in full without warning, every lender would — sorry, on the evidence, I should say, should — know immediately that it was a ghastly mistake and something had gone badly wrong.

The repayment

It came time, in August 2020, for Revlon to pay about $8m in interest on its loan. Owing to the restructuring, this payment was only going to some of the lenders, who were restructuring into a new loan. Remaining lenders were unhappy about that, and were suing Revlon, but that’s beside the point, except insofar as it illustrates the fog of war.

Revlon put Citi in funds for the $8m interest payment, as it was obliged to.

Then someone at Citi made what, on hindsight, we might regard as a “bit of a bish.” Instead of instructing the interest payment, the operations team instructed a full repayment of principal. Eight-hundred and ninety-three million dollars of the stuff. Nearly, as the bankers like to call it, a “yard”. Principal that was not, according to the loan, due to be repaid until 2023. Principal that was not in Revlon’s account with Citi, because Revlon didn’t have it.

Citi had funded a nearly a billion dollars of its own money to pay a sum that was not due by a borrower with no money to lenders it was already in an argument with.

Awkward, right?

“Ok, look, an innocent mistake, okay — would you mind awfully wiring that money back?”

Some complied. Those who rather liked the idea of being repaid early, in full, a loan from a crappy credit that they had bought at a discount, did not.

Citi sued the hold-outs. Its rationale, essentially, was “this cannot be right”. But the jurisprudence of gut instinct can only find its voice through the detailed articulations of common law, equity and restitution as those have been developed by New York courts.

Issues

Because Citi sort of was — and, at the same time, was nominally not — Revlon’s agent, there is quite the four-dimensional chess game going on here. It is one thing to work out where the money should end up, in an equitable resolution; tracing that through the tangled skein of interrelations is something else again.

Citi vs lenders

As principal: If Citi acted as a principal, then no debt was due, no contract existed, and we would look at common law principles of unjust enrichment and restitution to return money had and received. An alternative action might lie in the tort of conversion. But, as against the lenders, Citi was acting, and holding itself out as acting, as agent.

As agent: If Citi acted as agent — and on the narrow view of the contracts, it did not: it was the lenders’ agent — then we look through Citi to its principal, Revlon. That Revlon didn’t, itself, ask anyone to pay anything to anyone, and didn’t itself pay anything to anyone, doesn’t matter. Citi’s actions, ostensibly on its behalf, are attributable to it. Here there is a conflict, in English law, between agency principles from the eye of the third party (in particular ostensible authority) and bank mandate principles, which are viewed from the perspective of the customer. In light of the formal agency relationship with the lenders, this tension was resolved differently, as we shall see.

Revlon v lenders

Revlon might try to claim under a mistake, though that would be difficult as any mistake was not mutual, and unilateral mistakes are not compensable under the ancient doctrine of durum caseum. It might also claim that as the debt was not then due the lenders should be obliged to return the money under some kind of constructive trust (or even money had and received). But — since it wasn’t out of pocket and wasn’t being sued, Revlon might be forgiven for just sitting quietly and keeping its powder dry in case it needed it against Citi.

The discharge-for-value defense

We struggle to agree with the court’s conclusion, and the heart of the matter is its application of the discharge-for-value defense.

The discharge-for-value defense defeats a claim for unjustified enrichment under New York law where a recipient, without notice of mistake and not having induced the payment, receives funds that discharge a valid debt:

“When a beneficiary receives money to which it is entitled and has no knowledge that the money was erroneously wired, the beneficiary should not have to wonder whether it may retain the funds; rather, such a beneficiary should be able to consider the transfer of funds as a final and complete transaction, not subject to revocation.” Banque Worms v Bank America (1991) 570 N.E. 2d 189

This is the crux of the decision: the payment, though mistaken, discharged a debt, was made without inducement and received without notice of the mistake.

Ouch. The “discharge-for-value defense”, generally, has been criticised by some US authorities and has no equivalent in English law, where courts have reached the opposite conclusion (see: Barclays Bank Ltd v WJ Simms [1980] QB 677) but even if the principle is valid, its application here seems rather to have the quality of hard cheese one feeds to big dogs.

No notice of the mistake? Seriously?

It is not at all clear that prepaying a loan when the loan is not due does discharge the debt, nor is it remotely credible that any lender laboured for an instant under the misapprehension that the payment was anything but a howling clanger: it is axiomatic that distressed lenders can’t repay their loans at all, let alone ahead of time. The judge agreed with Citi that, to defeat the discharge-for-value defense it need show only the Lenders had constructive, and not actual, notice of the mistake. Citi must have been encouraged by this finding.

You might, therefore, be surprised to hear the lenders’ evidence about their own states of mind on receiving the funds was strikingly consistent: not one of them thought it could possibly be an error. The transcript catalogs their testimony: “Not in my wildest imagination ... [did I suspect that the payments could have resulted from an error] ... That just — the thought literally never crossed my mind.”

Now you might think the loan service personnel in the New York lender community to have demonstrated themselves to be an uncommonly unimaginative and credulous bunch, therefore — the JC couldn’t possibly comment — but happily, their extraordinary lack of curiosity as to how, or why, a distressed debtor was suddenly paying down a massive loan with money it didn't have, worked to their great advantage. This is a finding of fact which it will be hard to overturn on appeal. On the other hand the judge seemed greatly impressed that it did not occur to the lenders that there might be a mistake. That is not the test for constructive notice. The test is should it have occurred to them.

Must the debt be “due”?

A way out occurred to Citi: at the time of the payment, Revlon’s debt to the lenders was not, then, due and payable. It would not mature for another three years. This seems strikingly sensible, but the Judge could find nothing in the American Law Institute’s 1937 Restatement (First) of Restitution, on which Banque Worms v Bank of America relied, or any of the common law precedents, that required a “present entitlement”.

Section 14 of the Restatement 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 interests or duties, if the transferee made no misrepresentation and did not have notice of the transferor’s mistake.

One might take the court to task for being a little too literal there. Nor does the court seem to have considered what “in discharge of the debt” means, but assumes it means that, mathematically, “has the effect of discharging the debt”. One could apply a reductio ad absurdum here: any payment made by a debtor to a creditor, apropos anything, would have the effect of retiring debt. If I have a mortgage which, for good consideration, I have borrowed money for thirty years, the bank could treat my employer’s payment of my monthly wage to retirement of the debt, notwithstanding our carefully worked out thirty year long amortisation schedule. This surely cannot be right. My employer’s factual paymentr surely cannot unilaterally amend that contract.

The finding that it can, in the JC’s (literally) unqualified view, rather mounts the pavements — sidewalks, sorry — and runs down peaceable pedestrians perambulating the common law of contract. This is something which the law of restitution, being really no more than a life-hack to cover the parts of commercial life that tort and contract somehow contrive to miss — really ought not to be able to do.

Surely a contract, being an explicit, detailed, construction of rights and obligations between consenting parties must displace general common law principles like those of tort and restitution that the law has developed to mediate relationships between strangers. The contract must prevail. It cannot be right that an action that was neither requested, supported by consideration nor accompanied by any representation, let alone one on which the beneficiary has relied to its detriment, can unilaterally amend a contract. Nor, to our reading, does the Restatement require it to. The Restatement is silent on the matter, and leading case Banque Worms concerned a payment that was due on the day.

There is a question as to whether this was a prepayment of principal per the terms of the contract. The contract allowed this, upon the Borrower delivering prior written notice to Citi, about which Citi must “promptly” notify lenders on receipt. Not only did the lenders not receive such a notification — since it wasn’t given, but nor did Citi. That notice seems to be a condition precedent to prepayment under the contract, and was not delivered. Without it, Revlon would not be entitled to pay down the loan, even if it wanted to. To be sure, it is a low hurdle to cross, but Citi’s appeal team may feel it is a significant one all the same.

When it comes down to it, this is why the “Banque Worms” precedent, as interpreted here, cannot be right, at least insofar as it is supposed to overwrite the terms of a contract: it would mean that a bank, as mortgagee, would be entitled to treat any payment into a mortgagor customer’s account, as a partial discharge in of that mortgage. All salary payments. That is plainly absurd.

Redux: Citi and Revlon

This all leaves things rather delicately poised between Citi and Revlon. Forgetting for a moment that Revlon might not be able to pay Citi back, does it have to? A rather odd artefact of agency law comes into play here.

As against a third party without notice, an agent with the ostensible authority to bind a principal, in fact, does so: this is part of the legal case for the lenders. Here Citi had been explicitly appointed by Revlon as agent and, for all the lenders knew or cared (let’s park constructive knowledge for now) is acting on instructions, within the scope of authority, and binds the principal. Hence — if such a payment would operate to automatically discharge the debt, and the court concluded it did — the debt is discharged. To the rest of the world, Citi was an agent.

But to Revlon, in making that payment, Citi was not an agent. It was acting in excess of its mandate. Revlon might say, “I did not ask you to make that payment. I did not want my debt discharged. I was rather enjoying not having to discharge it for the time being. So this one, Citi, is on you.” This might, indeed seem fair, if Citi can then proceed against the lenders in an action for money had and received, as it would be able to under English law. But, as long as this judgment remains the law, it can’t. Citi is in a paradoxical position: as regards the lenders it is an agent; as against the principal, it is not. This is one more reason that Justice Furman’s decision seems to be wrong. Citi is left without a remedy.

We might suppose that Citi has somehow assumed the lenders’ claims, then. But has it? This does not seem to be what it has done at all. It has repaid those loans, unasked, on Revlon’s behalf. Revlon neither agreed to it doing this, nor provided any consideration for it.

The Appeal

The appeals court interpreted the Banque Worms case narrowly, along the lines we suggested:

We conclude that Citibank is entitled to prevail under the New York rule expressed in Banque Worms because (i) under the standards of New York law, the Defendants had constructive notice of Citibank’s error, and (ii) the Defendants were not entitled to the money at the time of Citibank’s accidental payment, as required by the Banque Worms ruling.

Constructive knowledge

We are fond of the constructive quality of this adjective. It has helped many an importuned old lady to justice. It is a magnificent tool of equity. It the appeals court stated it thus:

“If a person has knowledge of such facts as would lead a fair and prudent man, using ordinary thoughtfulness and care, to make further accessible inquiries, and he avoids the inquiry, he is chargeable with the knowledge which by ordinary diligence he would have acquired.”

As we have seen the recipients, serially, swore blind it dawned on none of them them the payment might be mistaken.

The appeals court stroked its proverbial chin, muttered a proverbial “Jimmy Hill” and without needing to call these witnesses liars implied they were wilfully blind: at the very least, more delinquent in interior monologue than a prudent lender would be.

The test in any case was not whether the recipients ought to have known the payment was mistaken, but simply whether there were enough warning flags over to the payment to justify making an enquiry about it:

The test is not whether the recipient of the mistaken payment reasonably believed that the payment was genuine and not the result of mistake. The test is whether a prudent person, who faced some likelihood of avoidable loss if the 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.

Real world effects

Leaving the legal conundrums aside, this cleaves to a few interesting management observations, and themes dear to the JC’s heart:

• Operator error
• Design
• Subject matter expertise
• Don’t take a piece of paper to a knife fight

See also

• Stupid banker cases
• Judgment transcript
• Operator error
• Sidney Dekker’s The Field Guide to Human Error Investigations