Banking Law

As the litigation between Citigroup, Wachovia and Wells Fargo drones on, it has become clear that Section 126(c) of the recently passed Emergency Economic Stabilization Act of 2008 is going to present a substantial obstacle to Citigroup's recovering jack squat, much less $60 billion, from either Wachovia or Wells Fargo. Here's the section in question:

(c) Unenforceability of  Certain Agreements- Section 13(c) of  the Federal Deposit Insurance Act  (12 U.S.C. 1823(c)) is amended by adding at the end the following new paragraph:

(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 Corporation 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.

That certainly seems to cover the "exclusivity agreement" that Citigroup is attempting to use as the basis for its claims for damages for breach and for tortious interference. If such agreements are not only unenforceable, but incapable of imposing liability on any acquirer, then as a matter of public policy neither Wachovia nor Wells Fargo would seem to have any liability arising out of a breach of or interference with the exclusivity agreement. That, apparently, is the position of Wells Fargo, which filed a suit in federal district court in Manhattan today for a declaratory judgment that the exclusivity agreement is unenforceable and that no claim can be made against Wells Fargo for tortiously interfering with it. Thus, despite our initial reaction that the exclusivity agreement appeared to be, on its face, enforceable, it appears that Section 126(c) of the bailout bill trumps the pre-existing agreement and that that Wells Fargo will be the winner of this dispute. Of course, as Dennis Miller would say, that's just my opinion, I could be wrong.

According to last Friday's Law Blog (paid subscription required), Tulane Law Professor Elizabeth Nowicki, referring to Section 126(c), had this to say: "I believe it???s fairly clear," she says. "I doubt Wells will have tortious-interference liability because of it."

It led us to ask why such a section ??? called a ???deal-jumper ???provision??? by Nowicki ??? was needed. ???It has the fingerprints of an extremely smart banking lawyer,??? she says. ???In a distressed atmosphere, we want to encourage bidders to come forward.??? Nowicki says Wells???s takeover removes potential liability from the FDIC, which had agreed to backstop the Citigroup/Wachovia deal.

According to a post in today's Law Blog, Citigroup is arguing in litigation against Wachovia that while Wells Fargo may be off the hook, Wachovia is not. While the lietral wording of the section expressly shields only the acquirer and not the target (the seller), I think that it would thwart the public policy purpose of section 126(c), which is to encourage as many bids as possible for failing banks, if the exclusivity agreement is held to be enforceable against the target/seller. Admittedly, the section should have been more expansively drafted, but, then, this is the slop you get when you draft in a series of all-nighters. As it is, there's enough uncertainty that Citigroup might be able to hang in there and squeeze more money out of Wachovia. Ultimately, however, I think Citigroup will either take some cash and walk away or simply lose in court.

So, let's see if we've got this straight: Wells Fargo backs out of the bidding. Citigroup steps up and agrees to buy the banking business of Wachovia based upon the FDIC's agreement to share in losses above a negotiated threshold. Citigroup then advances money to keep Wachovia going, in return for Wachovia executing an exclusivity agreement with a term ending on October 6. Next, Wells Fargo reenters the picture, signs a deal with Wachovia to buy the "Full Monty" with no FDIC assistance. While the FDIC publicly pays lip service to standing behind its deal with Citigroup, the FDIC knows that the bailout bill, which is signed into law on October 3, contains an "out" that voids the exclusivity agreement. The FDIC comes out smelling like a rose, with no obligation to cover any losses, and Citigroup takes it in the solar plexus. That's a nice finish for the FDIC.

I wonder who the "extremely smart banking lawyer" might have been who is responsible for Section 126(c)? Logic would lead you to the FDIC, which is the beneficiary of the provision. However, perhaps it was Wachovia's counsel, H. Rodgin Cohen, the subject of a feature story in last Thursday's Wall Street Journal, and on whom the authors of this blog have a decided "man crush"? According to the WSJ story, Cohen considers Wachovia a "prized client" and "Rodge" has had his nimble fingers in all sorts of pies related to the this financial crisis. Contrary to earlier speculation, he didn't gloss over the exclusivity agreement as "small stuff." He apparently advised Wachovia's directors to approve the agreement with Wells Fargo notwithstanding the exclusivity agreement with Citigroup because "their duty to shareholders superseded the agreement with Citigroup." Perhaps he was also "aware" at that time of the existence of Section 126(c) and the fact that it negated the exclusivity agreement because he had a hand in drafting it. It's pure speculation, but that's our purpose in blogging: to tee up unfounded rumor-mongering and baseless bloviating and drive them into the far reaches of cyberspace.

I was amused by comments on the Law Blog and elsewhere that the use of Section 126(c) to negate the exclusivity agreement and the FDIC's backdoor "hosing" of Citigroup would scare away future bidders for distressed banks because they wouldn't be able to rely on their agreements with the government. Those readers who've been following this blog for a bit know that we've discussed the breach by the government of many, if not most, of the agreements arising out of the S&L failures of the 1980s, and the long and protracted, and losing, litigation war waged by the US government against the those who acquired failed thrifts and who are seeking damages from the government for those breached agreements. The latest episode was reported last week by The American Banker (paid subscription required), although it seems to have escaped the notice of a main stream media more concerned with the current crisis.

A federal appeals court has affirmed a lower court's ruling awarding SunTrust Banks Inc. $30.6 million of damages from the U.S. government in a case dating to the height of the savings and loan crisis.

More than 100 thrifts filed a lawsuit in 1995 arguing that the government had reneged on a pledge to allow healthy thrifts that bought failing ones during the crisis to count goodwill as regulatory capital. The plaintiffs included American Federal Bank of Greenville, S.C., which, through a series of mergers and acquisitions, eventually became part of SunTrust.

American Federal and the other plaintiffs filed their suit after Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, which prohibited acquiring banks and thrifts from applying goodwill toward capital.

In 2004 the U.S. Court of Federal Claims agreed with American Federal that the United States had breached a contract that had allowed the thrift to count as capital goodwill it inherited when it bought four failing thrifts. A second decision in 2006 set monetary damages but was appealed by the federal government.

On Oct. 1 the U.S. Court of Appeals for the Federal Circuit in Washington affirmed the 2006 decision.

Arnold & Porter LLP in Washington, who represented SunTrust in the matter, said there are roughly a dozen cases relating to the original suit still pending.

"The courts are still dealing with the thrift bailout legislation of more than 19 years ago," Mr. Cayne said.

If you step up and enter into a "deal" with the US Government, just remember to forget all you've heard about the phrase "a deal's a deal." No, it's not, not when you're dealing with Uncle Sam. Your favorite uncle is capable of doing things that would have made Tony Soprano blush.

To people like Sheila Bair, Citigroup is just collateral damage.