Wachovia Corp. v. Citigroup; Where's This Headed?

By my post of October 10 I discussed the state court action filed by Citigroup against Wachovia in New York State Supreme Court. On that day Citigroup announced that it will now pursue the action for damages and not seek to enjoin the Wells Fargo/Wachovia merger.

It turns out that Wachovia got the jump on Citigroup by its complaint filed October 4, the day after Wachovia entered into its merger agreement with Wells Fargo, in the U.S. District Court for the Southern District of New York, drawing Judge Lewis Kaplan. Wachovia seeks a declaratory judgment that the Wells Fargo merger agreement is valid and proper and not prohibited by the Wachovia/Citigroup Exclusivity Agreement of September 29, 2008. Wachovia also sought injunctive relief, prohibiting Citigroup from interfering with the Wells Fargo transaction or from invoking the Exclusivity Agreement to require Wachovia to negotiate any transaction that is less favorable to its shareholders than the Wells Fargo transaction. Wachovia’s request for injunctive relief has been rendered moot by Citigroup’s announcement on October 10 that it is withdrawing its pursuit of an injunction preventing Wells Fargo from acquiring Wachovia.

There has been a flood of filings in the district court case, addressing a host of procedural issues that could supply several bar exam questions. The parties have also focused considerable attention on the application of Section 126(c) of the Emergency Economic Stabilization Act of 2008 (“EESA”) to the Exclusivity Agreement, and to the exercise by the board of directors of Wachovia of their fiduciary obligations in approving the Wells Fargo merger agreement and jettisoning negotiations with Citigroup, notwithstanding the terms of the Exclusivity Agreement.

A. EESA § 126(c)

In my post of October 10, I raised a question concerning EESA that has been extensively briefed by Citigroup and Wachovia in the district court action, namely, whether Section 126(c) only protects third parties such as Wells Fargo and not Wachovia, a party to the Exclusivity Agreement.

Here it is helpful to have Section 126(c) in front of us:

“(11) UNENFORCEABILITY OF CERTAIN AGREEMENTS — No provision contained in any existing or future standstill, confidentiality, or other agreement that, directly or indirectly —

“(A) affects, restricts, or limits the ability of any person to offer to acquire or acquire,

“(B) prohibits any person from offering to acquire or acquiring, or

“(C) prohibits any person from using any previously disclosed information in connection with any such offer to acquire or acquisition of,

all or part of any insured depository institution, including any liabilities, assets, or interest therein, in connection with any transaction in which the [FDIC] exercises its authority under section 11 or 13, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy.”

The briefing on the scope of 126(c) has been hot and heavy, between Greg Joseph’s offices and Wilmer Cutler, representing Citigroup, and Boies Schiller, representing Wachovia. On balance, I think Wachovia has the better argument, namely, that Section 126(c) protects both Wells Fargo and Wachovia.

The language of Section 126(c) does not directly extend to Wachovia, as a party to the Exclusivity Agreement. The focus is clearly on protecting third parties who would butt into a deal involving a bank in which the FDIC has exercised its authority under Section 11 or 13 of the Federal Deposit Insurance Act. If a no-shop is not enforceable against a third party, such as Wells Fargo, because enforcement of a no-shop as to a third party would be “contrary to public policy,” then it is only sensible that the no-shop also not be enforceable against the party who agreed to the no-shop provision, in this case, Wachovia. Given that Wachovia will become a wholly-owned subsidiary of Wells Fargo, Wells Fargo will, in effect, be responsible for any contract damages imposed upon Wachovia for its breach of the Exclusivity Agreement. That makes no sense, even if the language of the statute inartfully applies only to third parties. As Wachovia argues in its reply memorandum of October 9:

“However, this [Citigroup’s argument that Section 126(c) only extends to third parties] would read the phrase ‘directly or indirectly’ out of the statute. Generally, if a party remains bound not to accept an offer, then there is no point in freeing another party to make offers to the bound party. The direct limitation on the bound party operates as an indirect limitation on the party the statute aimed to make free. Indeed, as a practical matter, if the party to be acquired may yet be liable for accepting an acquirer’s offer, then post-acquisition the acquirer may ‘indirectly’ [be] liable for the acquired party’s breach anyway.”

Reply Memorandum at 7 (footnote omitted).

Or, as stated more emphatically in Wachovia’s response to Citigroup’s motion to file a sur-reply:

“It is inconceivable that Congress, while expressly declaring an agreement ‘contrary to public policy,’ would nevertheless permit its enforcement as long as suit is brought against the acquiree and not the acquirer. Because the statute aims to protect acquirers both ‘directly’ and ‘indirectly’ - and the acquirer is poised to inherit the liabilities of the acquiree - Citigroup’s reading necessarily countenances harm to the acquirer in violation of Section 126(c).”
Wachovia’s Proposed Supplemental Memorandum re EESA at 2-3.

B. Wachovia’s Board’s Exercise of Fiduciary Duties

The parties also devote considerable effort on the question of whether the fiduciary obligations of the Wachovia board compelled them to jettison the Exclusivity Agreement with Citigroup and enter into the Wells Fargo merger agreement. Citigroup claims there remains a factual question of whether the Wells Fargo deal is superior to Citigroup’s, but that argument is a stretch. The interesting question to this observer is why, in the midst of the negotiations with Citigroup, when it received and reviewed the Wells Fargo merger proposal, Wachovia did not present it to Citigroup with a demand that Citigroup best it?

Of course, the background is dramatic, with all-nighters and decisions having to be made in short order. While the Citigroup Exclusivity Agreement extended to October 6, 2008, apparently Citigroup insisted that a definitive deal had to be completed by Friday, October 3. Wachovia first received the Wells Fargo merger proposal, in the form of an executed and board approved merger agreement, at 9:04 p.m. on the prior evening, Thursday, October 2. The Wachovia board convened to review the proposal at 11:00 p.m. that evening. After receiving advice from Goldman Sachs and Perella Weinberg Partners that the Wells Fargo proposal was fair from a financial point of view, the Wachovia board accepted it.

Why not then have given Citigroup one last shot?

The answer is apparent from the affidavits of Robert Steel, Wachovia’s CEO, and David Carroll, its Senior Executive Vice President:

• Citigroup’s proposal was to acquire only Wachovia’s banking subsidiaries and not other key businesses of Wachovia.

• The form of the Citigroup proposal thus necessitated negotiations over the separation of business units.

• The negotiations with Citigroup, according to Steel, “proved extremely complicated and difficult.”

• Citigroup repeatedly refused to restructure the acquisition as an acquisition of the whole of Wachovia.

• Wachovia and its board concluded that the Wells Fargo proposal was superior to the Citigroup proposal.

• Given Citigroup’s deadline for executing definitive documentation of October 3, only hours after receipt of Wells Fargo’s superior proposal, it was unrealistic to expect Citigroup to match or exceed Wells’ proposal.

As they say, $15.1 billion in hand is worth more than $2.1 billion in the bush.

C. The Wachovia/Citigroup Agreement-In-Principle

In my post of October 10, I speculated that one possible measure of damages for Citigroup, were it to establish liability against Wachovia for breach of contract (the Exclusivity Agreement) or in tort against Wells Fargo (for interference with contract) would be the putative termination fee Citigroup would be entitled to under a standard fiduciary-out set of provisions in any putative Citigroup/Wachovia acquisition agreement. But the Agreement-In-Principle (“AIP”) entered into by Citigroup and Wachovia on September 29, 2008 appears to remove that template of damages. The AIP is attached as Exhibit A to Steel’s affidavit of October 5, 2008, filed in the district court action. The AIP sets forth stringent “adhesion” covenants binding Wachovia (referred to in the AIP as “Wednesday”) to the deal: Wachovia was to seek shareholder approval for up to six months following any first meeting of Wachovia at which the shareholders voted against the transaction, and Wachovia could not terminate the deal, even in the face of any such shareholder rejection, for the six-month period. And Wachovia could only change its recommendation to approve the Citigroup deal to its shareholders “if required by its fiduciary duties.” No termination fee is specified in the AIP.

The AIP does include a crown jewel feature for Citigroup: If the acquisition is not consummated (other than due to Citigroup’s willful breach), then Citigroup would “have an irrevocable option to purchase any or all of [Wachovia’s ] branches, deposits, and corresponding assets selected by [Citigroup] in NJ, CA and FL for their fair market value exercisable at any time through 12 months following deal termination …”

Since this option is priced at “fair market value” of the underlying assets, Citigroup would have a tough time pointing to it as a basis for termination-fee type damages against Wachovia or Wells Fargo.

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So where is this case headed? All in all, it doesn’t look promising for Citigroup. The story line on this one is likely to be that Citigroup overplayed its hand, and that Wells Fargo’s Chairman Kovacevich, capping a sterling career, played a brilliant hand.