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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