A $900 million operational blunder
Citibank might need to accept that its $900 million operational blunder will leave a mark on its balance sheet in the most stunning combination of a bad user interface, ineffective six-eyes control, and the weight of judicial precedent.
As an administrative agent, Citibank wanted to make a $7.8 million interest payment to Revlon lenders but ended up transferring almost $900 million - the full loan amount. They noticed the error the next day and requested the money back. This is the story of the 10 fund managers that Citibank is suing for not returning the funds.
A couple of weeks ago, a New York judge sided with the defendants leaving Citibank holding over $500 million of Revlon debt - the unreturned amount. The expected losses amount to $386 million from bad debt provision and legal expenses.
The backdrop of the story
It all started in 2016 when Revlon acquired Elizabeth Arden to consolidate further its cosmetics, skincare, and fragrance offerings. Citibank helped Revlon raise $1,800 million to fund the operation and act as administrative agent for the loan.
Unsurprisingly, it started to go south with the Covid 19 outbreak. Revlon needed to raise fresh funds to offset the pandemic impact; sales globally had dropped between 20 to 40 per cent across their brands. So in May 2020, Citigroup helped them obtain an extra $800 million in new financing while stripping away access to intellectual property that had previously secured the loans from the Elizabeth Arden acquisition.
This whole situation did not sit well with most of the defendants, and they sued Citibank. As fate would have it, this demand was filed on 12th August 2020. The lawsuit has since been dropped, but it highlights that no amount of foundation would improve the relationship's outlook.
The $900 million blunder
A small group of lenders requested to be reassigned to a different Revlon credit facility. It's not relevant why only five lenders could request this; the relevant part is that the limitations in Citibank's system needed (1) to pay the accrued interests to ALL 315 lenders instead of the 5 that requested it, and (2) to pay the accrued interests, the system needs to PRETEND to pay off the whole loan. Sorry for the caps, but they do spell disaster.
On 11th August 2020, once Citibank had received the Revlon interest funds, the chosen team located in India received the green light to process the payments. At around 5 pm, Arokia Raj directed Santhosh Ravi to input the instructions into Flexcube (a banking software developed by Oracle): (1) Pay interests totalling $7.8 million to all lenders and (2) Pretend to pay the $894 million principal by putting it into a wash account. As most payments in Flexcube are wire transfers, to effectively put the principal to a wash account, the default options must be overridden. However, instead of following the Flexcube manual, both relied on their user interface interpretation.
The manual explains that three components must be overridden to send the principal to a wash account: Front, Funds and Principal. Below are screenshots of what Mr Ravi input and what he should have done.
Under Citibank's six-eyes approval process, Mr Ravi requested Mr Raj to review his work at 5:45 pm. The email indicates that the principal is going to a wash account and the interest to the lenders' account. Two minutes later, at 5:47 pm, Mr Raj emails Vincent "Vinny" Fratta, a Delaware-based Citibank senior manager, for final approval. Again, the email states that the principal is going to a wash account and the interest to the lenders. Below are the literal emails in each case.
- Maker to Checker (Mr Ravi to Mr Raj): "Princip[al] to Wash A[ccount] & Interest to DDA A[ccount]." DDA stands for Demand Deposit Account used to pay lenders.
- Checker to Approver (Mr Raj to Mr Fratta): "NOTE: Principal set to Wash and Interest Notice released to Investors."
- The six-eyes approval process proved a failure when, at 5:54 pm, Mr Fratta replied: "Looks good, please proceed. Principal is going to wash."
Before officially sending out the payments, Flexcube alerted Mr Raj that actual money was leaving the bank and asked whether he wanted to continue. But alas, the message is uninformative: it did not indicate the amount, or whether the amount equalled the interest payment, or the principal, or a total of both. If there ever was a lousy user interface, here you can appreciate a multi-million dollar bad one.
Mr Raj pressed "Yes" and irreversible sent out both the intended interest payment and the unintended outstanding principal. At 6:08 pm, he emailed Mr Fratta and other team colleagues confirming that the transaction had been successfully processed. At 6:10 pm, he left the office. Unknown to everyone, by having paid lenders $894 million using its own money - Citibank became de facto the only bank financing Revlon on the Elizabeth Arden deal.
The immediate aftermath
Early in the next day, Mr Raj started the reconciliation process and noticed the money missing. By noon, Citibank knew this was no technical glitch and started contacting the 315 lenders who had erroneously received funds. Over the next days, the lenders received increasingly explicit recall notices.
The 12-13th August recall notices stated that "the principal amount had been paid erroneously... please return." The 17-18th August recall notices were more explicit:
- Citibank funds were mistakenly remitted to you. To be clear, those funds belong solely to Citibank.
- You are legally obligated to return those funds immediately.
- Citibank is prepared to take legal action to recover its funds.
- We demand that you refrain from any transfer, use or dissemination of those funds.
The reaction from the fund managers and lenders was mixed. Many returned the principal amount as Citibank requested. The 10 non-returning fund managers representing 126 lenders decided to hold on to the $504 million they received.
An overview of the comments and remarks made by the defendants is below. Defendants' personnel made the black-coloured remarks in the early moments after receiving the payments. In general, they noticed that Citibank didn't notify about principal payments; they also noted this amounted to full payment. In some cases, they even offered to return the funds as soon as possible.
However, when Executive committees and legal teams got involved, the tone changed. The blue-coloured remarks and conclusion are theirs. In essence, they didn't view this as an error and directed their operations teams three things: First, not to return any funds to Citibank. Second, not to put the funds in any account where they could be used by mistake. Lastly, get your meanest looking eyeliner and brace for the fight.
The trial and the arguments
It is undisputed that Citibank's payment of principal was a mistake. As such, and as common sense would initially dictate, the defendants should return the funds. It is called the "mistake of fact" doctrine and explains why you can't keep any monies mistakenly received to your bank account —no "finders, keepers; losers, weepers" allowed here.
However, there is an opposing force at play here—the "discharge for value" rule (DFV). It states that when a beneficiary receives money to which it is entitled and has no knowledge that the money was erroneously sent, he should consider the transfer of funds as final and not subject to revocation.
Citibank laid out four arguments to support the funds' return. The first one addresses the fairness and policy implication of the DFV rule. The next three explain why the rule is not applicable in this case or seek to qualify some part of its application.
First, Citibank argues that it is being taken advantage of. If the defendants returned the funds, they would still have the Revlon loan they bargained for. Citibank echoes (from previous similar lawsuits) that if such blatant opportunistic behaviour succeeds, it will cripple New York's reputation as a place for international business. However appealing, the judicial precedents firmly rejects these arguments:
When the security procedures are not followed and a mistaken payment is sent, it is appropriate to impose the loss on the transferor bank.
Over the last 30 years, many banks have made similar assertions when trying to recover their mistakenly transferred funds, and New York continues to be a thriving business centre.
Second, Citibank argues that "to be entitled" as per the DFV rule requires the debt to be due, not only outstanding. As the Revlon loan matured only in 2023, no principal portion was due. Even when using a curler, the judicial precedents are straightforward: "to be entitled" proceeds from the condition of bona fide creditor and not from the payment schedule.
Third, Citibank disputes the appropriate "when" to know about an erroneous payment. Given that Citibank informed the error before the defendants could discharge the debt, it is impossible to use the DFV rule. Again, the judicial precedents clarify that the appropriate time to be aware (of any error) is before the transfer: An interbank payment transaction is irrevocable and final once the transfer takes place.
Fourth, Citibank disputes the appropriate "how" to know about an erroneous payment. Citibank argued, and the court agreed that as long as the recipients didn't themselves view the transfers as an error, the court would uphold the DFV rule. This is where the trial was fought. The defendants had to prove that even if the payments were unexpected, they believed them to be an intentional full payment from Revlon.
The 10 defendants managed to prove they believed the payments to be deliberate. Below are the arguments that swayed the court:
- The transfers matched to the penny the amounts owed;
- There is no record in the history of the loan market of an error of these proportions, let alone one made by a sophisticated financial institution;
- The payment of interests and principal is the hallmark of an intentional early repayment;
- The lack of an industry-standard regarding payment notices renders trivial the fact that Citibank didn't send a principal payment notice with the interest payment notice;
- That although the defendants affirmed in their lawsuit against Citibank (see The backdrop of the story) that Revlon was insolvent and couldn't possibly make a principal payment, they can still believe this was an intentional payment. Revlon's majority owner, billionaire Ronald Perelman, has pulled off similar stunts before.
- The almost total absence of references to "errors" or "mistakes" within the defendants' internal communications (that is, until Citibank sent the recall notices); and finally,
- The defendants conducted inquiries to confirm that this was an intentional payment. None of these inquiries was directed to the source as is standard practice.
In a literal sense, this was a proverbial black swan event. An event so utterly improbable that nobody thought it could happen, but almost everyone holds it as self-evident once it did. With all this in mind, the court invoked the Discharge for Value rule and allowed the defendants to keep the undisputably mistakenly transferred funds.
It was indeed a most stunning combination of a bad user interface, ineffective six-eyes control, and the weight of judicial precedent that we've seen and might ever get to witness. Regardless of the outcome, as Citibank can still appeal, the industry will change for the better. Systems, procedures, and standards will improve to avoid repeating the $900 million blunder.
Note: I originally published this article on my LinkedIn profile.