A Crazy Debt Repayment Rule Just Cost Revlon $900 Million

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Federal district court judge Jesse Furman has issued his ruling in the Citigroup-Revlon lawsuit involving a $900 million mistake. Due to human error, Citigroup employees made debt payments to Revlon’s creditors that Revlon didn’t intend for them to make. Remarkably, Furman ruled in favor of the creditors, who won’t have to give back the money it received in error. Citigroup and Revlon will now have to eat the costs of the bank’s mistake.

The outcome is fascinating as an instance of strict judicial rule following. As Furman framed his opinion, the legal rule was clear: Under New York law, a creditor can keep a mistaken payment as long as he has “no knowledge” that it was sent in error.

The case then came down to a question of fact: whether the creditors knew they were getting paid by mistake at the moment they got the payment. After hearing witness testimony, Furman concluded they did not. From there, it followed that they could keep the money.

Seen from the perspective of common sense, the result is (I think) absurd. But the fault lies not in the judge’s application of the binding legal rule. It lies in the rule itself, at least as applied to sophisticated financial institutions. It makes almost no sense to focus on the magic moment of receipt of funds in deciding whether the courts should be able to rectify a mistake. The New York State courts, who adopted the rule, should re-think it.

As I explained in detail when I wrote about the case in December, the case pitted the so-called “discharge for value” rule — that you can keep the money you received if it was owed to you — against the rule that a mistaken payment is usually repayable to the party who made it.

Here, the core issue was the state of mind of the recipients of the funds. Furman’s opinion emphasized that the recipients got exactly what they were owed, to the penny. It wasn’t a situation where an interest payment was due and then more arrived, which might have led them to suspect an error immediately. Instead, no payment was due — and the amount that came was exactly the amount that would settle the debt. There was also litigation brewing over the payments, which further led the recipients to think that Revlon had simply decided to pay them off.

I was intrigued and surprised to learn that the recipients actually thought they were being paid off. I closed my December column by predicting incorrectly that they must have known the payments were in error. As Sherlock Holmes once put it, “It is a capital error to theorize before one has data.”

Yet the result, while legally correct and (on the facts) unassailable on appeal, shows that the rule makes little sense for sophisticated financial actors, or for an era in which vast sums can be transferred with a keystroke. Between receiving the funds and discovering they had been paid in error, nothing cosmic happened to the recipients. Practically speaking, they would not have been inconvenienced by paying the money back. Morally, they should have done so.

But trial court judges don’t make the law. They apply it. That’s as it should be. Given the law and the facts, the court here reached just about the only decision it could.

Appellate courts, however, can change the rules. New York State’s Court of Appeals, as the highest court in the state is known, should in the future revisit the discharge for value rule, at least as applied to big banks. So much of the industry of payments and clearing takes place in New York that the rules should favor morality and common sense, not formalism.  A revised rule should say that creditors can keep mistaken payments only if they have relied on their belief that the money is theirs, making returning the payment a problem.

Meanwhile, the takeaway is that the rule of law, formally applied, sometimes produces silly results. When that happens, judicial institutions should have the flexibility to change and improve the law. Absurd results can be understood as a price we all pay for having the rule of law in the first place. But such results should not be allowed to remain in place for long. Otherwise the rule of law can discredit the law itself.

Just for appellate law geeks: on appeal in this case, the U.S. Court of Appeals for the Second Circuit could, just conceivably, revise its own precedent interpreting New York State law. But that would take some serious legal creativity.

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

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

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