You’ve probably been reading about the mistaken USD 900 million payment made by Citibank acting as agent for Revlon.
As as well as the decision by the US District Court, Southern District of New York, that the lenders to Revlon who received Citibank’s erroneous payments of principal were not legally obligated to return the funds.
Let’s take a closer look as I think some details of the story haven’t been highlighter.
Here’s the link to the 105 page decision.
As a starter it's a good introduction.
It’s well worth a read as it explains the background and facts of the erroneous payment and the legal precedent Banque Worms vs Bank of America International (Banque Worms) which “led” the court to its judgment.
Banque Worms establishes the right of creditor who receives funds in error from a debtor or the debtor’s agent to retain the funds and apply them against the debtor’s outstandings as long as the lender had no knowledge of the error when it received the payment.
This precedent thus overrides the concept of equity that typically governs payments received in error: if one receives funds in error, one is obligated to return the funds.
Background and Some Clarifications
The “USD 900 million” payment was actually for approximately USD 902 million: approximately USD 894 million in principal and USD 7.8 million in interest. Citibank received funds from Revlon for the (authorized) interest payment, but used its own funds for the (erroneous) principal payment.
Citibank were able to recover about USD 390 million from the principal payment, reducing its loss to some USD 504 million.
The USD 894 million principal payment was made to two groups of lenders. Allocations are based on my calculations using data in the court decision.
The first group received USD 341 million. They were involved in a non-cash exchange of one Revlon debt for another (a “roll up”). Based on the terms of the exchange, they were not to receive any principal payments. Thus, they would not be able to resort to the Banque Worms precedent cited above. This group returned the full USD 341 million in principal payments they received.
The second group received USD 553 million. This group was not involved in the debt exchange. Therefore, they had no right to any interest or principal. Under Banque Worms they had a legal defense to retaining the funds because they did not “know” the transfer was in error when it was received. An important part of the refusenik lenders’ defense was that they were unaware of the “roll up” involving the first group. Some lenders in this group returned USD 49 million either because they or they agents were unaware of the possible Banque Worms defense or decided to return funds despite such knowledge.
At first blush, this sounds like a case of human error.
A “fat” finger, a misplaced decimal point, or an error in calculation.
But there’s more to the story than that.
Each lender received a principal payment in the exact amount of its principal balance as well as the exact amount of interest due it to the date of the payment – which was not an interest payment date.
The error was due to a combination of factors – human plus limitations in Citibank’s perhaps inaptly-named Flexcube system.
Citi was attempting to perform a complicated and uncommon transaction.
The first “bit” of complexity was that this was a “roll-up” transaction. Some lenders were exchanging existing Revlon debt (positions in the 2016 Revlon loan) for positions in other Revlon debt.
The second “bit” of complexity was that not all of the lenders in the 2016 Revlon debt were participating in the “roll-up”.
The lenders participating in the roll-up—whose positions were managed by Angelo Gordon (the Angelo Gordon Lenders)--were entitled to a cash payment of interest on the existing debt up to the date of the “roll-up”. They were, however, not entitled to any cash payment for principal. Revlon owed this group USD 341 million in principal.
Those lenders not participating in the roll-up were not entitled to any cash payment of either interest or principal. Revlon owed this group USD 553 million in principal.
What were the problems? And what were the “issues” surrounding Citibank’s systems?
Citi’s system could not process an interest payment to just the Angelo Gordon Lenders.
All lenders had to be paid interest.
To get the exchange done, Revlon agreed to pay (cash) interest to all lenders. Some USD 7.8 million.
If my calculations are right, Revlon paid approximately USD 4.9 million in interest to the non Angelo Gordon lenders. Interest that it did not have to pay on that day.
In effect it prepaid this amount of interest.
Small beer perhaps, but perhaps not so small for a company in Revlon's financial position.
As well as, perhaps, opening itself to the charge of creditor preference were the egg to fall off the proverbial spoon.
Further complicating matters, to achieve the “roll up”, the principal balances of the Angelo Gordon Lenders in the 2016 Revlon term loan had to be reduced.
Citi’s system required this be achieved using a principal payment.
To do this without the movement of cash, the principal payment would have to be made using internal Citi “wash accounts” (General Ledger accounts). The amount of the principal payment would be funded by debiting an internal Citi G/L account. Then the principal payments to each roll-up lender would be “paid” into an internal Citi G/L account. Then (presumably) each lender’s principal payment would be be used to purchase an equivalent amount in the other Revlon facility.
But there was the same problem as before.
Citi’s system could not apply this mechanism to only the Angelo Gordon Lenders.
All lenders would have to be “repaid”.
That means that the non participating lenders’ shares of the 2016 loan would have to be "repaid" using the Citibank G/Ls as above. But with a key difference. In the final step instead of “purchasing” shares in another Revlon loan, these lenders would “repurchase” their shares in the 2016 loan.
That wasn’t the only wrinkle.
To ensure that interest payments would be made in cash and that the principal payments would not, Citi’s ABTF (Asset Based and Transitional Finance Team) had to check three boxes on the Flexcube payment system: FUND, FRONT, and PRINCIPAL to override the standard settlement instructions. They also had to input the related G/L account numbers in each of the three fields associated with these boxes
You can see a “screen shot” of Citi’s Flexcube system on page 13 Figure 1.
This seems a rather complicated system. Unnecessarily complicated.
One that is not intuitive. What does FRONT mean? What does FUND? And thus subject to mistake.
Citi’s agents (Wipro) checked the box “override default settlement instructions” next to PRINCIPAL as well they input the internal G/L in the required field.
They did not do the same for FUND and FRONT.
There are two possibilities here.
The first case: If settlement instructions means the details of where Citi was to pay the funds (to the creditors) then it would appear Flexcube “ignored” the two override inputs for PRINCIPAL.
I would have expected it to decline the transaction with a note “incomplete” or “inconsistent instructions”.
Also if the standard settlement instructions for the principal payment were “overridden”, shouldn’t the system have been unable to make the payment as presumably it did not have other settlement instructions?
The second and more likely case: Settlement instructions meant the accounts that Citi should debit (the debtor's), the system processed a payment against an internal Citi G/L account that was it seems (note that caveat) designed for non-cash transactions.
With 10/10 hindsight, it would seem that ideally the system should have been programmed to refuse such a transaction.
Or perhaps more likely programmed to raise a warning -- You are attempting to make an external cash payment against an internal non-cash account.
As well, it would have been ideal if the warning message associated with the final release of funds had been more explicit. For example, “You are about to release an external cash payment of USD 902 million: USD 894 million in principal and USD 7.8 million in interest”.
Somehow the fact that Citibank had not received USD 894 million from Revlon and was “going out of pocket” was not reflected in Flexcube.
Typically agent banks require a borrower to remit funds to a special “loan agent” account to cover loan repayments and only release payments to lenders when receipt of funds is confirmed. Banque Worms is one reason why.
There are of course other reasons. The Agent wants to be certain it has received the funds and that the funds are in an account under its control, not the borrower's account.
As indicated above, and with admitted 20/20 hindsight, it seems there were several steps in the process where a fail safe mechanism in Flexcube could have prevented the payment.
That being said, the human element is not innocent here.
Citi’s Flexcube manual contained detailed instructions.
The three Citi employees charged with input of the payment, checking of details, and authorization (release) apparently assumed that checking the PRINCIPAL box and inputting the G/L number was all that was required.
The fact that this wasn’t a common transaction, that Citi’s mistakenly named Flexcube required workarounds to complete the transaction, that the size of the transaction was "large", and that Revlon’s credit was weak should have prompted additional steps by Citi’s staff.
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