Have you ever given someone extra money by mistake? What if it's not possible for you to get that money back now? It's a horrible feeling, right? Now, imagine if you gave someone $900 million extra by mistake. Even the thought of such a blunder feels like a void in our stomach. This is exactly what happened with Citibank- well of course if we set aside the confusing financial terms. Let us get to know the backstory first.
In 2016, Citibank acted as an administrative agent to facilitate a deal between two cosmetic giants. In this deal, Revlon were to acquire Elizabeth Arden. Now, this deal was so expensive that a $1.8 billion loan had to be procured. Many companies were involved in this arrangement- Brigade Capital (a hedge fund), Allstate (an Investment Management Company) etc. It was Citibank's duty to collect money from Revlon and transfer it to the lenders whenever interest was due.
Now, for a long time Citibank did an efficient job of handling the payments. However, in August 2020 when they were supposed to pay $7.8 million as interest due, Citibank paid the whole outstanding amount of the loan ($900 million) out of their own pockets. When the fact that Revlon had paid back their whole debt hit the markets, everyone was shocked as Revlon's loan fund was trading at less than 30 cents on the dollar when the clerical error occurred. Also, their already deteriorating financial situation had hit a major snag due to Covid-19 and everyone was expecting them to default on their payments.
Once Citibank identified their mistake, they asked the lenders to return the money, which many of them did. But some big hedge funds flat out refused to consider Citibank's request, leaving a $500 million hole in their pockets. Let's move on to how this mistake really happened.
Citibank uses 'Flexcube' to carry out these complicated and large transactions. Flexcube is a third party application system from Oracle, which is used by many commercial banks to perform tasks such as a wire transfer. So basically to perform a transaction using flexcube, one has to enter the transaction information in the flexcube database. This initiates the transfer process. The simplest way to do such a transaction is to enter the ‘principal’ amount in the database. Now, the principal amount is transferred to a ‘wash account’ within the bank and this transfer triggers the automatic payment of interest to the lender. Now, this system sounds simple enough. However, it has an ancient interface, lacks clear instructions and does not use human friendly language. So, unless you are a robot or have ample experience, you are going to have a hard time, navigating through the ‘Flexcube’.
This is why such transactions also undergo Citibank's 'Six eye approval procedure'. Under this procedure, three Citibank employees verify and confirm the payment. Leaves a very small margin for error, right? Now, Citibank only had to pay the interest. The rest of the principal was supposed to be transferred to their 'wash account'. In the flexcube system, you have to select three boxes to suppress the principal payment- 'Front, Fund and Principal'. However, they selected only the 'principal' option and all three of the Citibank employees failed to notice this error. So much for 'six eye verification'.
Citibank took this matter to court to retrieve their remaining funds. They cited the rule of 'unjust enrichment' under contract law. This rule states that the recipient has to return the money if enrichment happens of one party on the expense of the other, in a situation the law deems unjust.
However, there is an exception to this rule under the New York court of appeals. This exception states that the recipient is not liable to return the money if he was entitled to it and had no knowledge that the funds were erroneously transferred.
Citibank's initial attempt to retrieve their funds was rejected in Federal Court by Judge Furman. “To believe that Citibank, one of the most sophisticated financial institutions in the world, had made a mistake that had never happened before, to the tune of nearly $1 billion would have been borderline irrational," wrote Furman.
It was later found out that Citi was in the process of resigning as the agent in this deal in April, 2020, because many hedge funds were not happy with their refinancing plans. If this were to have happened, some other bank would have undertaken the 'Cursed Transfer of August, 2020'.
Now, whether Citibank manages to prevail or not is an entirely different story because whatever the result may be, it will send ripples through the banking sector. Judge Furman even mentioned that, "The industry should figure out a way of dealing with these things even if this was a black swan event. Whatever my ruling is in this case, I hope the world, the market, takes notice of what’s happened here and the uncertainties that have resulted." There will be lots of changes as every bank rushes to make sure that their own house is in order. Till then, finders keepers I guess.