SDNY Judge Rules Lenders Can Retain Mistakenly Paid Funds

February 23, 2021

In a decision issued Feb. 16, 2021, Judge Furman of the U.S. District Court for the Southern District of New York held that lenders who were mistakenly paid in full by Citibank (the “Agent”) could retain those funds because they had an absolute defense of discharge and satisfaction.

On Aug. 11, 2020, the Agent mistakenly paid all outstanding principal and interest due on $900 million of debt issued by Revlon Inc. A day following that mistaken payment, the Agent sought the return of those funds from the lenders (and their agents). Some of those lenders returned the funds, but many chose to retain the money, citing discharge and satisfaction as a defense. The Agent filed suit in the Southern District of New York to recover the funds. A bench trial was held in December 2020 and Judge Furman recently issued his 100-page ruling.

The Agent asserted four claims against the defendants who did not return the funds: conversion, unjust enrichment, money had and received, and payment by mistake.

In its ruling, the court implied the Agent was generally able to establish that these causes of action would be valid against the defendants but found that each of the lenders was able to assert an absolute defense of discharge and satisfaction to each of these causes of action.

The discharge and satisfaction defense provides as follows:

A creditor of another [] who has received from a third person any benefit in discharge of the debt [] 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.

RESTATEMENT (FIRST) OF RESTITUTION § 14(1) (Am. Law Inst. 1937).

The Agent acknowledged that the defense of discharge and satisfaction was available to the lenders, but disagreed as to its application. Specifically, the Agent argued that (1) the defense applies only when a debt is actually due; (2) notice of the mistaken payment is determined at the moment the payment is credited, not when it is received by a creditor; and (3) the notice did not have to be an actual notice, so constructive notice that the payment should not have been received was sufficient to bar use of the defense.

As discussed below, the court ruled against the Agent on points one and two. The court agreed with the Agent on the final point that actual notice was not necessary to overcome the discharge defense, but further held that the lenders to Revlon did not have constructive notice that the payment was made in error when it was received and, therefore, the discharge defense still applied.

The court found that whether the debt was then due when the money was received was irrelevant to the discharge defense. The recipient need only be a bona fide creditor when the funds were received to invoke the defense. Here, there was no assertion that the lenders were not bona fide creditors of Revlon at the time the lenders received the mistaken payment.

In regard to notice, the court found that the relevant point in time for evaluating whether the recipient of funds sent by mistake is on notice of the mistake is the moment the payment is received — to hold otherwise creates too much ambiguity into when discharge actually occurs.

The final issue revolved around whether actual or constructive notice that the payments were mistakenly made was needed. Initially, the court adopted Agent’s contention that the notice need only be constructive. However, the court then found that the lenders did not have constructive notice that the payments received were mistakenly made.

In a fact-intensive analysis, the court found that it was common for debt to be properly prepaid — in this case, the mistaken transfers received were the exact amounts of all principal plus accrued interest — and that any other explanation for the payment was less probable (despite the fact in this case it was true). He therefore found that there was no reason the lenders would have expected the payment to be anything other than a prepayment. The court found unpersuasive the Agent ’s assertion that the lack of prepayment statements, payoff notices, the overall size of the transaction, and Revlon’s financial health should have provided sufficient notice to the lenders.

Because the defense of discharge and satisfaction applied, the court found the Agent could not recover the funds.

Observers expect an appeal to the 2nd U.S. Circuit Court of Appeals. Due in part to the likelihood of such an appeal, the court left the temporary restraining orders (regarding the further transfer/application of the mistaken payments) in place pending appeals and/or further argument.

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