October 6, 2008

Citigroup, Wachovia & Wells Fargo: “Deal Jumping” is Alive and Well in the Financial Sector

John Jenkins, Calfee, Halter & Griswold LLP

A fascinating showdown appears to be brewing between Citigroup and Wachovia over the decision by Wachovia’s board to abandon talks with Citigroup and embrace a $15.1 billion takeover proposal from Wells Fargo. Citi has issued a statement accusing Wachovia of a “clear breach” of the parties’ exclusivity agreement. As noted in this WSJ article today, the Fed is trying to resolve the dispute and perhaps “split the baby” – ie. Wachovia would be split among the two suitors. (Also note that Wells Fargo’s offer was made feasible by a new IRS position on losses after an ownership change; memos on this IRS position are posted in the “Tax” Practice Area).

Citi says that “the agreement provides, among other things, that Wachovia will not enter into any transaction with any party other than Citi, and will not participate in any discussions or negotiations with any third party.” Citi has demanded that Wachovia and Wells Fargo terminate their proposed deal, and asserts that it has “substantial legal rights regarding Wachovia and this transaction.”

A generation of M&A case law about directors’ fiduciary duties has made most public companies very reluctant to enter into any kind of an exclusivity agreement with a potential buyer that does not provide them with some ability to respond to competing proposals. But then again, most public companies don’t find themselves with regulators breathing down their necks in quite the way that companies like Bear Stearns and Wachovia have in recent months.

Enforcement of Air-Tight Exclusivity Agreements

The situation involving Wells Fargo’s effort to “deal jump” Citi (and the FDIC) with respect to Wachovia raises all sorts of interesting questions. The first one that comes to mind is whether a court would enforce an air-tight exclusivity agreement under these circumstances, or whether it would instead read a fiduciary out into it.

It seems to me that in order to answer that question, a court may well have to decide the extent to which the authority of a federal regulator influences what a board’s fiduciary duties require of it. That’s a question that courts have managed to avoid so far, but as the government becomes a more active player in attempting to address the financial crisis, it seems likely to be one that will increasingly be at the forefront of M&A litigation.

Wells Fargos’ Potential Exposure to Citi

Another potentially interesting aspect of this situation is what exposure Wells Fargo might have to Citi. After all, Citi does apparently have a contract with Wachovia, and efforts to disrupt that agreement might give rise to a tortuous interference claim. In 2006, the ABA’s Negotiated Acquisitions Committee (which recently recently changed its name to the “Committee on Mergers and Acquisitions”) prepared an indispensable survey on the law of tortious interference with merger agreements, exclusivity agreements and letters of intent. Here is a copy of that survey.

One of the things that the Negotiated Acquisitions Committee’s survey makes clear is that while deal jumping may make the original bidder as mad as a hornet, just lobbing in a better offer generally isn’t enough to expose the deal jumper to a tortuous interference claim. Under the Restatement (Second) of Torts, a third party bidder may be liable if its conduct involves interference with the existing agreement that is both intentional and improper.

In determining whether conduct is improper, the Negotiated Acquisitions Committee’s survey concluded that it frequently boils down to a court’s assessment of whether the third party’s efforts “to pursue its legitimate competitive interest go beyond what is generally held as acceptable or reasonable under the circumstances in the business community and where he violates the rules of fair play.” It will be very interesting to see how this plays out.