Forgiving or Taking Advantage of Mistakes—the Citibank Case
A federal judge ruled this week that when Citibank made a $900 million error in paying interest to holders of loans to Revlon, Inc., the recipients of the wire transfers could keep the money. This decision, to me, establishes an ethically destructive precedent and I hope it is overturned on appeal. By this logic, if you dropped your wallet on the street, the person behind you to keep it. He might even be incented to tip the wallet out of your pocket to create your “mistake.”
In this case, some of the recipients of the payments, such as Carlyle Group and Octagon Credit Investors, immediately sent the money back. All the recipients were notified of the error the next day after the overnight transfers. There are a number of celebrated cases in the past of obvious commercial mistakes and the courts have held that those who received the payments must return them. In one case I long taught in my graduate case, several zeroes were added to a check by an electronic glitch. And the courts have repeatedly held that depositors whose bank accounts receive misdirected deposits must return them.
But in this case, a significant part of the erroneous payment went to a hedge fund/investment manager, Brigade Capital Management, which was sore at Citibank for helping Revlon restructure the Revlon debt in a way to Brigade felt watered down the value of the Revlon debt they held. One analyst estimated the value of the debt held by Brigade had been reduced from 70 cents on the dollar to just 32. But the accidental payment paid off Brigade at 100 cents on the dollar, from Citibank’s funds. Brigade and ten other investment firms were delighted and saw a change to stick it to Citi. They refused to return the money, arguing that arcane and unique aspects of the payments did not qualify them for the commercial mistake doctrine. “Finders keepers,” they argued.
The judge in this case ruled that even though they were notified within one day, the transaction was complete the instant the wire transfer was made. Further, he ruled that because the amount paid exactly matched the value of interest and principal, the recipients could assume their loans had been paid off at 100%. Further, because Citibank is such a highly professional organization Brigade is justified in concluding the payment was deliberate, despite Citibank’s notice of the error the next day. To permit a firm to withdraw a transaction (i.e. redeeming a debt) would encourage one of the parties to claim something is an error if any subsequent economic change makes a transaction less favorable for either party.
The judge’s argument has some logic. Allowing a company to claim “mistake” at any time after a transaction was concluded would create a real moral hazard. But by not reversing a genuine mistake, the judge creates an even greater moral hazard that companies may encourage or create the conditions for errors and then take advantage of them. If I can confuse you to make an error, I am entitled to keep the money? Remember the quick-change artist who preyed on the least experienced retail clerk?
The law plays a significant role in creating the conditions for ethical behavior. This is a case where I think the judge has created more incentives for unethical behavior, and rewarded sharp and unjust misconduct.