Fascinating case about paying off a $900 million debt by mistake

(Bloomberg Opinion) – The $900 million Citi-Revlon lawsuit that began Wednesday is a law professor’s dream. The case, which is being heard by Judge Jesse Furman in federal district court in New York, pits two perfectly logical and reasonable principles against each other. On the one hand, there is the idea that if someone gives you money by mistake, you have to give it back. On the other, the intuition that if someone owes you money and transfers it to you – whether through Venmo or direct bank transfer – you should be able to keep what is owed to you.

But what if someone owes you a lot of money, and while they intend to transfer only the interest payment to you, they accidentally pay off the entire debt?

That’s pretty much what happened in this case. Citi was responsible for sending interest payments to Revlon’s creditors. But through what the bank says was human error, Citi sent creditors not the interest payments, but exactly the total they were ultimately due to receive — down to the penny, more or less.

It’s as if, instead of paying your monthly mortgage payment online, you accidentally send all of the outstanding principal to the bank. Could you ask for your money on the assumption that you obviously had no intention of paying off your mortgage? Or could the bank keep your payment, on the theory that you actually owe them money and hey, some people pay off their mortgage early?

You won’t be surprised to learn that the lawyers have technical names for the rules that would lead to the two alternative results. One rule is called the “mistake of fact” doctrine. It says that, generally speaking, sums paid on the basis of a factual error can be recovered “unless the payment caused such a change in the position of the other party that it would be unfair to ask him to reimburse”.

This rule is based on the moral notion that no one deserves to be unjustly enriched. If out of the blue I get a $1,000 payout in my PayPal account from someone I’ve never heard of, I should pay it back. (Unless it is a Nigerian prince. In which case, all bets are off.) The caveat built into this rule is that there may be circumstances in which the person receiving the payment was based on the belief that the money really belongs to him, and that it might be unfair to make him pay it back. However, the purpose of this rule is to be guided by principles of justice.

Citi, of course, wants the current case to be decided on the basis of the “error of fact” rule. The payment was in error and the money should be returned.

On the other side, however, there is a rule known as the “discharge for value” rule. This rule states that when a creditor receives a payment from a third party (such as Citi) “in discharge” of a debt, the creditor does not have to repay it even if “the discharge was given in error”, as long as that the creditor “was not aware of the assignor’s error”. The idea here is, basically, that if someone owes you money and it gets paid back, you should be able to assume that the payment is yours, even if it came to you at an unexpected time. After all, in a sense, it is your money, since it was yours.

In 1991, the New York Court of Appeals, the highest court in the state, directly considered the question of which rule should prevail in a case involving electronic transfers. (The case was called Bank Worms v. Bankamerica – a case name for the ages, if you ask me.) The application of this precedent to the Citi-Revlon case will likely determine the outcome.

The court in the Banque Worms case explained that there was a particularly good reason to apply the discharge-for-value rule when it came to wire transfers, which at the time were still a relatively financial technology. news. His logic was that people should rely on the finality of these transfers – once they are made, the thing is done. The court even added a self-serving and pro-New York argument that “that state is considered the national and international center for wholesale wire transfers.” Enforcing the law would therefore be good for business.

The court therefore adopted the discharge-for-value rule because it was “consistent with and promotes the policy objective of finality in commercial transactions.” He framed the rule this way:

When a beneficiary receives money to which they are entitled and they do not know that the money was transferred in error, the beneficiary should not have to wonder whether they can keep the funds; on the contrary, such a beneficiary should be able to regard the transfer of funds as a final and complete transaction, not subject to revocation.

That sounds good to Revlon’s creditors; but not so fast. Creditors will only be able to keep the money under the Banque Worms precedent if they had “no knowledge” that the money had been transferred to them in error. This leaves the question whether sophisticated financial actors like creditors knew that the money they were receiving had been received in error.

Technically, it’s a question of fact: did the creditors know it was a blunder? The reality is that they must have known almost instantly. No creditor expects to get all of the principal from a sophisticated borrower when only interest is due. Creditors were already angry with Revlon for allegedly eroding the value of their collateral. It seems almost unimaginable that they thought Revlon was somehow making their dreams come true.

Furman, the judge assigned to the case, is one of the Southern District’s intellectual stars. He knows how to be wary of parties that describe their motives in summary terms. His lengthy opinion on the Trump administration’s outrageous efforts to add a citizenship question to the census convinced the Supreme Court, particularly swing voter Chief Justice John Roberts, to rule against the government.

It seems extremely likely that Furman will conclude that the creditors knew – knowledge based on their common sense – that the payments were wrong. I expect them to have to refund the money. The basic moral intuition against unjust enrichment will trump the more abstract interest in finality.

In a world where apps allow us to split checks using wire transfers, the decision will set an important precedent beyond the rarefied world of corporate finance.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Noah Feldman is a Bloomberg Opinion columnist and host of the “Deep Background” podcast. He is a professor of law at Harvard University and clerked for United States Supreme Court Justice David Souter. His books include “The Three Lives of James Madison: Genius, Partisan, President”.

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