I Can’t Get Any Satisfaction… 2nd Circuit Reverses, Revlon’s Decision Returned | McGuireWoods LLP
On September 8, 2022, a three-judge panel of the 2nd United States Circuit Court of Appeals overturned a decision by the United States District Court for the Southern District of New York regarding lenders who refused to return funds that had been paid in full in error.
The district court’s decision in In re Citibank August 11, 2020 Bank transfers, 20-CV-6539 (JMF), 2021 WL 606167 (SDNY Feb. 16, 2021), dealt with the mispayment by Citibank, the administrative agent, of a $900 million syndicated term loan owed by Revlon. (For more information on the 2021 decision, see the February 23, 2021 alert from McGuireWoods.) In short, instead of making an $8 million interest payment that was due, the Administrative Agent accidentally used his own internal accounts to repay the loan in full. After discovering his error, the agent was able to obtain repayment of the funds from some lenders, but other lenders holding $500 million of the loan (mainly non-institutional lenders) refused to return the erroneous payments (the “recalcitrants”). “).
Citibank sued the recalcitrants for the return of payments. In a 100-page ruling, the district court ruled that holdbacks were permitted to withhold erroneous payments under the “release for value” doctrine against the agent’s claims to recover the payments. At the time the district court issued its decision, it upheld its previously issued restraining order prohibiting any transfer or application by holders of the funds paid in error pending resolution of the officer’s appeal to the 2nd circuit.
Pending the 2nd Circuit’s decision, and following the District Court’s decision, many lenders and administrative agents entering into new credit agreements, or changes to existing credit agreements, have added “blockers Revlon” which contractually required the reimbursement of the sums paid to the lenders in error. However, unless a credit agreement contained such a provision, payments made in error remained at risk.
In a decision that will allay the concerns of administrative and payment officers, a panel of three 2nd Circuit judges reversed the district court’s ruling, finding that lenders could not raise the value release defense. In doing so, the 2nd Circuit disagreed with the district court’s analysis regarding the notice required to render this defense inapplicable; he ruled that if the recalcitrants had a notice of inquiry indicating that the payment may have been in error, they had a duty to inquire further as to whether the payment had been made in error.
The district court had concluded that if the defaulters knew or should have known that the payment was wrong at the time they received the payment, they would be deemed to have received implied notice that the payment was wrong. The 2nd Circuit disagreed with the application of the “knew or ought to have known” standard and concluded that recalcitrants would be deemed to have implied notice if the investigative notice standard was met. The 2nd Circuit further concluded that the inquiry notice standard would be met if a hypothetical prudent investor had reason to question the payment received and, had that investor made such inquiry, the error would have been discovered. .
In that vein, the 2nd Circuit went on to conclude that, given the facts known to the holdouts at the time of payment, a hypothetical prudent investor would have ample factual basis to question repayment of the loan and, if that investor inquired , would have discovered that the payment was wrong. Since a hypothetical prudent investor would have known that the payment could be wrong and would have discovered that the payment was wrong if the investor had inquired, the 2nd Circuit ruled that the value relief defense was not available. for the recalcitrant to protect payment receipts.
The facts that the 2nd Circuit found compelling in determining that the hypothetical prudent investor would have viewed the payment as potentially erroneous included that (i) neither Revlon nor the agent provided the lenders with the contractually required notice of the impending payment; (ii) Revlon was allegedly insolvent at the time of payment and therefore lacked the ability to make such payment; (iii) the loan itself was trading at 20-30 cents on the dollar, so it could have been repaid for much less than full payment; and (iv) there would have been no reason for Revlon to undertake a recent exchange offer, in order to avoid early maturity, if it intended to repay the loan prior to maturity.
As a second ground for overturning the district court’s decision, the 2nd Circuit found that the recalcitrants were not entitled to the funds received because the loan was not currently due and payable, as it had not been accelerated or nor expired. Since the holdouts were then not entitled to repayment of the loan, they could not invoke the defense of release for value.
The 2nd Circuit remanded the case to the District Court for further processing pursuant to its decision.
This ruling limits the ability of a lender who is repaid in error to retain those funds. However, he also points out that any attempt to recover these funds will remain subject to factual investigation into the circumstances surrounding the payment and whether a hypothetical prudent investor would have reason to wonder whether the payment was made in error. It is because of this potentially factual analysis that additional contractual terms governing mispayments (i.e. Revlon blockers) in recent credit agreements should remain in place, in the hope of avoiding a such analysis and to provide greater certainty in the syndicated loan market.