I Can’t Get No Satisfaction … 2nd Circuit Reverses, Remands Revlon Decision

September 14, 2022

A three-judge panel of the 2nd U.S Circuit Court of Appeals on Sept. 8, 2022, reversed a decision of the U.S. District Court for the Southern District of New York regarding lenders who refused to return funds that were mistakenly paid in full.

The District Court’s decision in In re Citibank Aug. 11, 2020 Wire Transfers, 20-CV-6539 (JMF), 2021 WL 606167 (S.D.N.Y. Feb. 16, 2021), addressed the erroneous payoff by Citibank, the administrative agent, of a $900 million syndicated term loan owed by Revlon. (For background on the 2021 decision, see McGuireWoods’ Feb. 23, 2021, alert.) In short, instead of making an $8 million interest payment that was due, the administrative agent accidentally used its own house accounts to pay off the loan in full. Upon discovering its error, the agent was able to obtain return of the funds from certain lenders, but other lenders holding $500 million of the loan (mostly non-institutional lenders) refused to return the erroneous payments (the “holdouts”).

Citibank sued the holdouts for return of the payments. In a 100-page decision, the District Court held that the holdouts were permitted to retain the erroneous payments under the doctrine of “discharge for value” against the agent’s claims to recover the payments. At the time the District Court issued its decision, it continued its previously issued restraining order prohibiting any transfer or application by the holdouts of the erroneously paid funds pending resolution of the agent’s appeal to the 2nd Circuit.

Pending the 2nd Circuit’s decision, and as a result of the District Court’s ruling, many lenders and administrative agents entering into new credit agreements, or amendments to existing credit agreements, added “Revlon blockers” that contractually required the repayment of amounts paid to lenders in error. However, unless a credit agreement included such a provision, payments made in error remained at risk.

In a decision that will ease the concerns of administrative and payment agents, a three-judge panel of the 2nd Circuit reversed the District Court’s decision, finding that the lenders could not rely on the discharge-for-value defense. In doing so, the 2nd Circuit disagreed with the District Court’s analysis of the notice necessary to render this defense inapplicable; it held that if the holdouts had inquiry notice that the payment may have been erroneous, they had a duty to inquire further as to whether the payment was made by mistake.

The District Court had found that, if the holdouts knew or should have known that the payment was erroneous at the time they received payment, they would be deemed to have constructive notice that the payment was erroneous. The 2nd Circuit disagreed with the application of the “knew or should have known” standard and found that the holdouts would be deemed to have constructive notice if the standard of inquiry notice was met. The 2nd Circuit further found that the inquiry notice standard would be satisfied if a hypothetical prudent investor would have reason to question the payment received and, if that investor made such inquiry, the mistake would have been uncovered.

In that vein, the 2nd Circuit went on to find that, under the facts known to the holdouts at the time of the payment, a hypothetical prudent investor would have ample factual bases to question the payoff of the loan and, if such investor inquired, would have discovered the payment was in error. Because a hypothetical prudent investor would have known that the payment could be erroneous and would have discovered the payment was erroneous if the investor had inquired, the 2nd Circuit held that the discharge-for-value defense was not available to the holdouts to protect the erroneously received payments.                         

The facts the 2nd Circuit found persuasive in determining that the hypothetical prudent investor would have considered the payment potentially erroneous included that (i) neither Revlon nor the agent provided the lenders with the contractually required notice of the impending payoff; (ii) Revlon was purportedly insolvent at the time of the payoff and, therefore, had no ability to make such payment; (iii) the loan itself was trading at 20-30 cents on the dollar, so it could have been retired for far less than payment in full; and (iv) there would have been no reason for Revlon to undertake a recent exchange offer, to avoid a springing maturity, if it intended to repay the loan prior to maturity.

As a second basis for vacating the District Court’s ruling, the 2nd Circuit found that the holdouts were not entitled to the funds received because the loan was not currently due and payable, as it had neither been accelerated nor matured. Because the holdouts were not then entitled to the payoff of the loan, they could not use the discharge-for-value defense.

The 2nd Circuit remanded the case to the District Court for further proceedings consistent with its ruling.

This decision limits the ability of a lender who is erroneously repaid to retain such funds. However, it also underscores that any attempt to recover those funds will remain subject to a fact-intensive inquiry regarding the circumstances surrounding the payment and whether a hypothetical prudent investor would have reason to question whether the payment was made in error. It is because of this potentially fact-intensive analysis that the additional contractual terms governing erroneous payments (i.e., Revlon blockers) in recent credit agreements should remain in place, in hopes of avoiding such analysis and providing greater certainty in the syndicated loan market.