New Dividend Security In Fight for Wachovia

The slugfest for control of Wachovia Corp. has generated at least two tactical developments – one legal, the other in deal structuring – that are being closely watched by the m&a profession at large to test their applicability in other situations. Banking titans First Union Corp. and SunTrust Banks Inc. were waging the bitter duel for the right to win Wachovia, a highly coveted banking organization based in Charlotte, N.C. First Union, which had an agreement to do a friendly acquisition, took an innovative tack to woo Wachovia shareholders by sweetening its bid with a unique preferred stock designed to maintain the dividend they now enjoy. Meanwhile, Atlanta-based SunTrust, the unsolicited bidder, filed suit in federal and state courts in Georgia attacking a stock-purchase option granted by Wachovia to First Union as a breakup fee. SunTrust claimed that although the option had been valued at $780 million, it had a much greater potential value that was not properly disclosed. In what had become a game of one-upmanship, First Union expanded its initial bid of two common shares per Wachovia share with a choice of dividend maintenance provisions. It gave holders of the target bank an option of getting 48 cents a share in cash up front or receiving two preferred shares per Wachovia share (as well as the common). Dividends on the preferred stock were to make up the difference between the current rates paid by Wachovia and First Union and would continue until the new institution’s common dividend equaled or exceeded $1.20 a share (or Wachovia’s current rate of $2.40 a share, adjusted for the 2-for-1 exchange ratio). The question of whether receipt of the preferred stock is taxable often is up in the air. Robert Willens, managing director and tax expert at Lehman Brothers, says that preferred, under federal tax law, usually is taxable if the dividend rate varies in whole or in part with reference to interest rates, commodity prices, or other indices. He says that those conditions seemingly do not apply to the proposed First Union preferred but the issue remains unsettled. Willens adds that the proposal reminds him of a deal, which led to a significant IRS ruling in 1975. The IRS ruled that a preferred stock issued as the primary acquisition currency and containing a dividend maintenance guarantee was not taxable to recipients. But Willens cautions that in the 1975 case, the preferred stock was the only currency paid, while First Union is proposing a separate preferred class as a shirttail to the common stock that is the workhorse of the deal. William Lawlor of the Philadelphia-based law firm of Dechert says that the SunTrust lawsuit could be significant because courts often have a problem with breakup fees that are not considered reasonable or have no limitation provisions. “They like break fees to have a capped amount,” he states. Shortly after the suit was filed, Wachovia’s board amended the agreement to put a $780 million cap on First Union’s take should it lose the deal.