A sigh of relief for agents in syndicated financings

October 5, 2022 | Kenneth R. Rosenstein, David Reynolds, Victor Cornea

Agents in syndicated loan transactions have received some much needed relief in respect of potential erroneous payments made by them to the lenders in their syndicate.

Erroneous payments provisions became commonplace in many credit agreements in 2021 as a by-product of the landmark decision of the United States District Court for the Southern District of New York (the “District Court”) in In re Citibank Aug. 11, 2020 Wire Transfers (2021) 2021 WL 606167 (New York S.D. Dist. Ct. (Citibank).  The recent successful appeal of this decision may call into question the need for such provisions though it is our expectation that they are here to stay.

Case overview – re Citibank Aug. 11, 2020 Wire Transfers

Revlon Inc. (“Revlon”) was a borrower under a US$1.8 billion syndicated loan transaction to which Citibank Inc. (“Citibank”) was the administrative agent for a syndicate of lenders. On August 11, 2020, Citibank received an interest payment of approximately US$7.8 million from Revlon.

Rather than wiring each lender its pro rata share of the US$7.8 million interest payment, Citibank erroneously wired each of the lenders its pro rata share of the full balance owing on the Revlon loans – equating to almost US$900 million of its own funds. Citibank promptly notified the lenders that the payment was made in error and requested that the lenders remit the payments back to Citibank.

Following the recall notices, approximately US$385 million was returned to Citibank, however, lenders holding approximately US$500 million refused to repay Citibank. Citibank sued to recover these funds.

On February 16, 2021, the District Court released its decision, finding that erroneous payments are a form of unjust enrichment and must be repaid – unless the “discharge-for-value” defence can be established, which requires: (i) the payment discharges a valid debt; (ii) the recipient made no misrepresentations to induce the erroneous payment; and (iii) the recipient did not have notice of the mistake.

In this case the District Court found that the lenders had made out all of the elements to establish the discharge-for-value defence, and were therefore entitled to keep the erroneous payment of approximately US$500 million.

The United States Court of Appeals for the Second Circuit (the “Court of Appeals”) has now reversed this decision.

Results of the Citibank Decision

As a result of the initial District Court decision, parties to syndicated credit facilities in both the United States and Canada started including erroneous payment provisions within their loan agreements as a protective measure, with the intention of ensuring that payments made in error are returned, and lenders waive their right to assert the defence of discharge for value or any other similar defence (“Erroneous Payment Provisions”).

Common elements found within Erroneous Payment Provisions, include: (i) language which states that the determination of whether an erroneous payment was made or not is at the administrative agent’s sole discretion; (ii) clawback cut-off dates; (iii) language obligating lenders to return erroneous payments within a given amount of time, usually two (2) business days of receipt of written notice; (iv) the requirement that any payment which is returned accrue interest; (v) where payment amounts do not correspond, a provision that puts the lender on notice that an error has been made and the amount must be returned, usually within one (1) business day; (vi) a provision that each lender waives the “discharge for value” defence used by certain lenders in the Revlon case, and other similar defences; (vii) a subrogation provision whereby the administrative agent is subrogated to the lender in the event an erroneous payment is not recovered; and (viii) a recognition that the provision survives termination of the commitments and/or the repayment of all obligations.

Case overview – Court of Appeals decision

The Court of Appeals came to a different conclusion than the District Court – holding that the present case did not fall within the scope of the discharge-for-value defence, as the rule implies entitlement to payment, and the loan was not due and payable for three years from the time the erroneous payment was made.

The Court of Appeals also maintained that the lenders had constructive notice of Citibank’s error, and therefore required the defendant loan managers to return the erroneous payments to Citibank. The Court applied the “inquiry notice standard” under New York Law, and determined that the lenders were aware of certain indicators suggestive of an error, in particular: (i) the absence of prior notice of a prepayment, to which the lenders were contractually entitled; (ii) the apparent inability of the insolvent Revlon to make a near $1 billion repayment; and (iii) the fact that the loan was trading at 20-30 cents on the dollar and repayment for the full amount would not have been a reasonably expected business outcome. The inquiry notice standard is an objective one, and as this case demonstrated, the courts can impose heightened inquiry obligations upon a party who should have inquired into certain facts, but who failed to do so.

Conclusion

The Court of Appeals’ decision provides welcome relief to many in the syndicated loan industry by establishing that a simple administrative error will likely not result in another party’s unjust enrichment.

While the decision of the Court of Appeals serves to rectify what many viewed as an unjust enrichment, it also reinforces the notion that lenders cannot simply act blindly in accepting repayment, and demonstrates that parties to a financing transaction will have an increased onus placed upon them to make further inquiry where the circumstances surrounding the payment and receipt of funds does not coincide with the business terms of the transaction. Therefore, it is prudent, and even possibly incumbent in certain situations, that parties in receipt of funds take extra precaution to verify the accuracy and timing of such payments.

While the initial Revlon decision was never binding on Canadian courts, and it remains uncertain how Canadian courts would have ruled given similar facts, the Court of Appeals’ decision provides a level of confidence to Canadian institutions that an erroneous payment will likely be required to be returned.

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