[February 2021 update: Citi lost their case, but it’s on appeal and not looking good for them. Matt Levine has his normally hilarious take on the ruling. I also learned a new legal doctrine as part of this whole brouhaha. Luckily I learned it from the bleachers.]
Back in August of 2020, so roughly 3 years ago by my calculation, Citi, as Administrative Agent for a loan that was in the midst of restructuring for Revlon, accidentally wired a bunch of the participants $900M. Citi said it meant to pay several months of accrued interest on the loan that totaled ~$9M, but due to a clerical error they wired $900M to the participants instead.
11 of the participants decided not to return the money and chose to view it as a payoff of the full loan balance. This is a convenient stance for these creditors because the loan was trading at ~30 cents on the dollar in the secondary market. It was trading at ~30 cents on the dollar in the secondary market because the full recovery of the debt was in doubt due to how badly Revlon’s financial performance has been.
Needless to say, Citi ultimately sued 11 participants in the loan when they refused to return the money to Citi and the trial is scheduled for November.
You’re probably wondering at this point if this is a set-up for a joke. It’s not – while I can’t promise you it’ll be riveting it may end up being kinda interesting along the same vein as the GM bankruptcy settlement that happened during the Great Financial Recession when a judge monkeyed around with the well-established rules of creditor repayment in order to serve the “Greater Good” or some such thing.
If the judge in Citi’s case doesn’t force the defendants to return the money it changes the common practice and understanding of credit agreements and bond indentures the world over. Which would be a big deal.
So let’s start with some credit agreement basics.
Every multi-billion dollar syndicated term loan, revolving loan, or bond has a bank that acts as an Administrative Agent. The Administrative Agent simplifies the movement of money from the borrower to all the entities, whether individuals, funds, or corporations, that act as a creditor and own a piece of the bond. Instead of the borrower having to deal with dozens or hundreds of people, it sticks to making widgets and lets a bank deal with all those people. The Administrative Agent also acts as the intermediary between the borrower and the creditors during negotiations for any changes in terms of the loan.
In this case, Citi was the Administrative Agent and was responsible for taking money from Revlon and paying the interest and principal owed to the creditors each time it was due.
To make sure there is no misunderstanding as to the obligations of the borrower and the terms and conditions of the loan, it’s all memorialized in a credit and security agreement that is a legal document that is typically 200 to 500 pages long. Since Revlon is in the middle of a restructuring there are a couple often overlooked parts of the credit agreement that comes into play besides the usual ones:
- Payment dates and amounts. This one is obvious – it states on which day the interest is due, which day principal payments from normal amortization are due, and when the remaining balance of the loan is due.
- Acceleration of principal: this section lists the various events that could force the company to make larger than normal payments on its bond principal. The most common ones are sales of assets or business units, proceeds from insurance due to property loss, equity raises, and bankruptcy.
- Application of proceeds: this section is commonly called the Waterfall Provision. It lists out in excruciating detail how any proceeds from #2 are applied. It generally starts with repaying the fees and expenses of the Administrative Agent’s attorneys (gee, wonder who wrote the document…), then repays protective advances (these were advances made by the creditors in an effort to try to preserve their collateral or enhance their recovery even though they weren’t obligated to advance this extra money), swing line advances (in the case of revolving credit facilities – it’s a mechanism to simplify borrowings), accrued but unpaid interest, principal, then any other obligations owing by the borrower to the creditors.
The thing is, when you sign up as part of a syndicated loan like Revlon’s you’re agreeing to be bound by the terms and conditions of the credit and security agreement. You’re agreeing that you will be treated equally among all the other creditors that have signed up with you for that particular tranche of debt based on your pro-rata ownership of the debt.
There’s money to be made by exploiting loopholes in the different tranches of debt and how they’re handled by intercreditor agreements (or the lack thereof). Paul Singer has earned quite the reputation for exploiting the oversights by lawyers and creditors even to the point where he once briefly repoed a naval vessel from the Argentinian government. And if this involved Elliott Capital and different tranches of debt I’d find this less perplexing.
But it’s not. Elliott Capital isn’t involved and there’s only one tranche of debt at issue.
And the dumb part (part un):
Citi is arguing that it was a clerical error. While an $891M overpayment is quite the clerical error, it’s not impossible given the nature of a bank’s syndicated loan system. A human starts the process and is usually the one that introduces the error and then the actual movement of money is completely automated from there.
I’ve seen enough bank errors in my day that I’m sympathetic to a cousin of mine who only invests in physical gold and farmland. Ironically he’s done very well with his strategy.
In this case it’s easy to trace the source of the funds through Citi’s accounts. Did Revlon’s depository account get hit for $900M or $9M to fund the wire? If it didn’t, then it’s not likely they meant to send the $900M wire. Since Revlon only had ~$400M of liquidity prior to the wire it’s going to be pretty obvious that they couldn’t have made that payment.
Dumb part (part deux):
Even if Brigade Capital Management and the other 10 defendants are successful in convincing the court that the wires were not sent in error and it does constitute a full payoff then they will likely still be obligated to return the money because those funds would have to be distributed on a pro-rata basis among the other creditors that are part of the deal because Brigade Capital Management signed a credit and security agreement that stipulated how any repayments of principal and interest would be distributed.
But wait! The funds they received was their share of the payoff! Yes, but only if there was enough money to pay off the loan at par. This loan was trading at 30 cents on the dollar so Citi would have to force Revlon to pony up the rest. Since Revlon can’t pony up the rest, the funds distributed would be kept frozen and this whole thing would go back to a different court. Complicating this is that the intercreditor agreements of the other debt tranches would probably kick in and limit the distribution of funds until whoever has priority to those funds has been paid out. This process would force a restructuring or BK that would have to be sorted out before Brigade would find out how much money they would actually get. It’d be a long, expensive mess for everyone involved.
Dumb part (part trois)
Whether Brigade Capital Management is successful or not, if I’m one of their investors (I’m not), I’d be really nervous. Funds like Brigade need to stay in the good graces of banks that act as administrative agents, otherwise their access to better quality deals will be curtailed. And for something like this, which involves $175M just to Brigade, you’re at serious risk of getting blacklisted.
So you have to sit back and wonder how rough a shape Brigade is in that they’d be willing to risk their future in the credit markets over a case that they probably don’t have a leg to stand on.