Wells Fargo vs. Citigroup: A Legal Analysis

Includes: C, WFC
by: Avery Goodman

Robert Steele, former Undersecretary of the Treasury and now President of the Wachovia Corporation (NASDAQ:WB), states, in an affidavit, filed in the litigation with Citigroup, that his company came very close to failing last week.  It had put itself up for sale, and two major banks were competing to buy it, Citigroup (NYSE:C) and Wells Fargo Corporation (NYSE:WFC). 

Citigroup, as is well known, has its own financial troubles, so the FDIC was initially favoring a buyout by Wells Fargo. However, they dropped out of the bidding, temporarily.  Management at Wells Fargo wanted to do a complete examination of WB’s books, and the FDIC wanted a quick sale. Intense pressure was being placed on Wachovia by the FDIC. Its Board of Directors were faced with two unpleasant options. The choice was 1) an FDIC run insolvency receivership of its subsidiary banking operations, with a bankruptcy filing for the holding company, or 2) accepting a low-ball offer from Citigroup.

Naturally, they chose the low-ball offer. A tentative agreement, including an exclusivity agreement that included a specific performance clause, was signed. Specific performance meant that Citigroup, theoretically, had the right to go to a court and request that the judge require that Wachovia complete the agreement, rather than merely awarding money damages.

Then, something happened. Wachovia went from being a down and out debtor that nobody wanted, to being the coveted prize. The reason is Congressional approval of a bailout bill that will largely place the bad debts of banks, like Wachovia, on the back of the taxpayers, rather than on its shareholders.

Accordingly, Warren Buffett, with an ever-keen eye to a bargain, has put his various financial companies, including Wells Fargo, on the prowl for buying other financial institutions or shares thereof. That Wachovia is weighed down with well over $120 billion worth of Option-ARM mortgage loans, and some $40 billion worth of potential losses on defaulting loans, is no longer a deal killer. The government will be buying most of that up, most likely at prices that are much higher than anyone could hope to obtain in the free market.

Meanwhile, aside from the Option-ARM mortgages, inherited from its foolish purchase of World Bank, a few years ago, Wachovia is a fine institution. It has a huge deposit base of reasonably happy customers, a deep network of branches all over the country, and an extremely profitable full service retail brokerage and clearing house that is the envy of Wall Street. Now that its past mistakes will be bailed out by kindly Uncle Sam, and its defaulting assets socialized, Wachovia is a screaming BUY! 

For competing banks, like Wells Fargo, whose branch network is concentrated mainly in the West, buying Wachovia provides an opportunity to become a national giant, with branches from coast to coast. The huge retail brokerage and clearing house helps Wells Fargo expand its brokerage operations, which is something this particular bank has been trying to do for some time now.

Only one problem remains – Citigroup. Prior to the enactment of the Congressional bailout, Citigroup had been willing to take the risk, with some help from the FDIC, to acquire Wachovia. By the time the bailout passed, they had been supplying liquidity support for a week or so. Citi’s President, Vikram Pandit, had already held a press conference, explaining how the WB purchase would work. Citigroup has filed suit, in New York, per the venue provisions of the preliminary exclusivity agreement, to block the deal between Wells Fargo and Wachovia.

Unfortunately for Citigroup, the specific performance provisions of the exclusivity clause cannot be enforced. At the request of the FDIC, Section 126 (c)(11) was inserted into the new Congressional bailout bill. It invalidates the type of exclusivity clause that is a part of the agreement between Citigroup and Wachovia. It reads, in pertinent part that

…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 Corporation exercises its authority under section 11 or 14, shall be enforceable against or impose any liability on such person, as such enforcement or liability shall be contrary to public policy…

The provisions of the bailout bill are procedural in nature, and, therefore, probably can be applied retroactively. However, even if they were not retroactive, it is a simple fact that only the shareholders of Wachovia could give final approval to the merger. If the court ordered Wachovia to specifically perform the contract for Citigroup’s acquisition, the end result would be a vote of the shareholders?   What would happen? Would they choose the Citigroup deal, knowing that Wells Fargo has already made a much better offer? Not likely. No one would choose $2.1 billion when they can collect $16 billion.   

So, why is Citigroup suing? Well, given that billions of dollars are involved here, the incremental cost of filing a lawsuit and attorney’s fees are comparatively small. Second, Citigroup did provide liquidity support for about a week. That was extremely valuable to Wachovia. Without the support, it probably would have failed. Citigroup’s lawyers know they cannot force the merger, even though they are trying to do that, on the surface. What they are really angling for is 1) some of Wachovia’s branch offices to fill branch gaps in certain limited geographic locations, and 2) most importantly, a nice cash settlement. 

Given its own still shaky financial condition, a few hundred million dollars worth of added capital would be very useful to Citigroup.  That is the price Wells Fargo must pay for the careful manner in which Buffett-controlled firms do business. Ultimately, however, the real price will be paid by the taxpayers, who are likely to end up lifting bad assets out of Wachovia, at premium prices.

WFC waited until Congress passed the bailout bill. They now must pay something to Citigroup because the latter took a risk that the former was not willing to take, and preserved the value of Wachovia by doing so. Citigroup has a legal right to be paid something for that. For Wells Fargo, of course, paying Citigroup is well worth the cost. Wells Fargo will receive a Wachovia in far better condition than it would be under an FDIC receivership or bankruptcy. Let’s hope they pay quickly, so that things can proceed without further disruption, from here forward.