- Consider modifying policies to require broader internal review of payments over established amounts, potentially including IT personnel or outside software vendors to avoid human error.
- If you believe that there is a heightened risk of error, notify the payee, before initiating payment, of the amount expected to be paid, and that any additional amount is paid in error.
- Ensure that key personnel are adequately trained on software systems used to process payments.
- Encourage personnel to elevate non-ordinary situations or requests to superiors within your institution before processing. Situations that personnel do not see on a day-to-day basis may be more likely to present risk.
- Inform personnel that any payments made on behalf of someone who is a creditor of your institution, which the payor later claims were made in error, should be reviewed with management before any amount is repaid. Your institution may be able to assert the Discharge for Value rule, and should consider that before returning payments allegedly made in error.
- Review any participation agreements to provide for claw-back provisions in case of a mistake. Your bank should review its participation agreements to ensure that they have appropriate claw-back provisions and obligations on participants to cooperate in returning funds in case of a payment mistake.
Financial institutions should be aware of the recent opinion of a New York federal court, which applied a little known “Discharge for Value” rule to deny Citibank’s recovery of over half a billion dollars in errant payments to participants of a $1.8 billion syndicated loan. Although doctrines like “unjust enrichment” and “mistaken payment” are used to protect parties who make payments to those who are not entitled to them, there is an exception if the Discharge for Value rule applies. Under the rule, which has been adopted in many states including Illinois, an errant payment does not have to be returned if the recipient does not receive prior or contemporaneous notice of the error and if the funds discharge a debt owed to the recipient.
What Happened in In Re Citibank?
In Re Citibank, 20-CV-6539 (JMF) (S.D.N.Y. Feb. 16, 2021), involved an early payment of the remaining principal on a $1.8 billion syndicated loan to Revlon, Inc. The payment was made by Citibank, the administrator on the loan, to the syndicated loan participants. Citibank intended to make the early principal payments to only certain participants, those being bought out of their positions, but errantly paid back principal to all of the loan participants.
Citibank administered the principal payments on the syndicated loan using an Oracle software program called Flexcube. It was apparently not possible to schedule payment of only a portion of the outstanding principal using Flexcube, so, to work around that limitation, Citibank personnel intended to make selections on the Flexcube program to cause the selling participants to receive their principal, with all other principal payments being paid to a “wash” account (i.e., the payment would go to an internal Citibank account and would not, as a result, leave the bank). Citibank followed its “six eye” review process (three-person review) in establishing the scheduled payments, but its personnel failed to make the entries necessary to send the bulk of the principal payments to the internal wash account. Instead, almost $900 million in errant early principal payments went to the loan participants.
It was undisputed that the principal payments to most loan participants were not yet due under the terms of the loan agreements and that Citibank notified the loan participants of the error within a day. Notwithstanding these facts, several loan participants refused to return the errant payments. Citibank sued the loan participants who it did not intend to make principal payments to, but the court found that Citibank was not entitled to return of the funds. In reaching its decision, the court found that the Discharge for Value rule applied because the defendants had not been notified of Citibank’s error before or at the moment they received the payments and because the payments discharged a debt owed to the defendants (the debt owed on their share of the loan principal).
When Does the Discharge for Value Apply?
Depending on the facts of a case, the Discharge for Value rule could apply to many kinds of payments made by or to a financial institution. For example, the rule may apply if an institution acts as an escrow agent and errantly pays out of the escrow before the conditions for payment are met.
We Can Help You
BFKN attorneys can review your internal policies and processes, and counsel you on appropriate modifications to policies and processes. We can also advise you on the Discharge for Value rule if questions arise and assist you in determining whether that rule or other rules apply, whether in connection with a payment made by your bank or to your bank.