Dive Brief:

• Revlon’s creditors must return the $504 million Citi errantly paid on the cosmetics firm’s behalf, a federal appeals court ruled Thursday.
• In a 3-0 decision, the 2nd U.S. Circuit Court of Appeals in Manhattan vacated a lower court’s ruling that allowed Revlon’s creditors to retain the “huge windfall” they were mistakenly sent in 2020.
• The ruling is a major victory for the New York City-based bank, whose August 2020 transaction, which it claims it made in error, represented a full payoff of the makeup giant’s $900 million loan that wasn’t due until 2023. The error, Citi claimed in a court filing, “unjustly enriched” Revlon.

Dive Insight:

A trio of circuit judges ruled Thursday that Revlon’s creditors, which include Brigade Capital Management, HP Investment Partners and Symphony Asset Management, should not be allowed to benefit from Citi’s mistake. 

The judges disagreed with the lower court judge’s use of the “discharge for value" defense in his February 2021 decision to allow the creditors to retain the funds. 

The defense, established by a 1991 New York court ruling, allows creditors to keep money that was wired to them in error if they didn't realize the payment was a mistake.

The appellate court judges ruled, however, that the defendants cannot claim the benefit of the rule “because they were on notice of a mistake.”

“[T]he discharge-for-value rule does not shield the beneficiary of a mistaken transfer from claims for restitution if the beneficiary is on inquiry notice of the mistake,” the judges wrote. “The facts were sufficiently troublesome that a reasonably prudent investor would have made reasonable inquiry, and reasonable inquiry would have revealed that the payment was made in error.”

In a separate opinion, Circuit Judge Michael Park called the lawsuit a “straightforward case that many smart people have grossly overcomplicated and that we should have decided many months ago.”

“Put simply, you don’t get to keep money sent to you by mistake unless you’re entitled to it anyway,” Park wrote, according to Bloomberg.

Judge Pierre Leval, in an addendum, took “sole responsibility” for a decision that he said took “a long time to produce.”

Leval and Judge Robert Sack had originally decided to ask the New York Court of Appeals for a ruling, he said, but later reconsidered on the strength of the bank’s arguments. Involving the Court of Appeals may have delayed proceedings by more than a year, Leval wrote.

“We have not found the answers to be as straightforward, obvious, and easy as Judge Park does,” he wrote. "Finding the best accommodation between the objectives of speed and legal soundness is not always easy."

Citi said Thursday’s ruling “reaffirms our long-held belief that these mistakenly transferred funds should be returned as a matter of law, as well as ethics.”

“While Citi has taken steps to reduce the likelihood of such an error in the future, today’s decision provides welcome stability and upholds the concept of cooperation needed for a well-functioning syndicated lending market,” a bank spokesperson told The Wall Street Journal.

So far, Citi has managed to recoup roughly $385 million of the mistakenly sent funds from several lenders who have complied with the bank’s requests, the Journal reported.

Revlon filed for Chapter 11 bankruptcy protection in June, owing more than $3.5 billion in debt. The company has said a decision in Citi’s appeal may help identify who is and is not a creditor — in turn, advancing restructuring talks.

Neal Katyal, a lawyer for Citi, told the appeals court that Revlon’s creditors should have been skeptical of the early loan payoff because they never received formal notice about it, according to Bloomberg.

“This was a mistake. Humans make mistakes,” he said Thursday, according to the wire service. “The idea that a mistake would lead to a finders-keepers rule would be destabilizing for the financial markets.”

A lawyer for the investment firms declined to comment to The Wall Street Journal.

Citi CEO Jane Fraser has called the matter a “massive unforced error,” adding that the bank has told regulators it has put “significant, additional controls in place.”

The blunder occurred after an employee who was manually adjusting the amount of the loan the lenders still own selected the incorrect system options in Citi’s software, allowing the loan to be paid in full with interest years ahead of schedule, the bank said, adding that colleagues who were supposed to act as a safeguard failed to catch the error.