Ehrenhaus v. Baker, 2008 NCBC 20 (N.C. Super. Ct. Dec. 5, 2008)

The North Carolina Business Court has denied Plaintiff’s Motion for a Preliminary Injunction with regard to the pending merger between Wachovia and Wells Fargo.

The opinion of Judge Diaz was issued early Friday evening, after the close of business.  The principal holdings of the 28 page opinion, briefly, were that (1) the Wachovia Board of Directors, in approving the merger deal, satisfied its obligations under the Business Judgment Rule in light of the dire economic circumstances and lack of alternatives faced by the Board, (2) the Board complied with North Carolina law in the issuance of new shares of stock to Wells Fargo which gave it 39.9% of the voting control over Wachovia, and (3) the grant of this voting bloc was not coercive to Wachovia’s shareholders. 

Judge Diaz also found, however, that the continuation of Wells Fargo’s right to vote these shares for an 18 month period if the Wachovia shareholders reject the merger was invalid.  That narrow victory for the Plaintiff won’t, however, have any effect on the transaction.

The Court’s holdings, in more detail, were as follows:

Business Judgment Rule 

The Board satisfied its responsibilities under the Business Judgment Rule. The Court held that:

this case does not fit neatly into conventional business judgment rule jurisprudence, which assumes the presence of a free and competitive market to assess the value and merits of a transaction. But other than insisting that he would have stood firm in the eye of what can only be described as a cataclysmic financial storm, Plaintiff offers nothing to suggest that the Board’s response to the Hobson’s choice before it was unreasonable.

Op. at ¶¶124-25. As the Court put it:

The stark reality is that the Board (1) recognized that Wachovia was on the brink of failure because of an unprecedented financial tsunami, (2) understood the very real and immediate threat of a forced liquidation of the Company by government regulators in the absence of a completed merger transaction with someone, and (3) possessed little (if any) leverage in its negotiations with Wells Fargo because of the absence of any superior merger proposals.

Against that backdrop, the Board had two options: (1) accept a merger proposal that, although partially circumscribing the shareholders’ ability to vote on its merits, nevertheless still gave the shareholders a voice in the transaction and also provided substantial value; or (2) reject the Merger Agreement and face the very real prospect that Wachovia shareholders would receive nothing.

Pared to its essence, Plaintiff’s argument is that he would have voted to reject the Merger Agreement and take his chances with the government had he been sitting on the Board on 2 October 2008. But it is precisely this sort of post hoc second-guessing that the business judgment rule prohibits, even where the transaction involves a merger or sale of control.

Op. at ¶¶131-33.

The Share Issuance Was Valid

The Wachovia Board complied with North Carolina law in issuing new shares to Wells Fargo which represented 39.9% of the voting stock of Wachovia. Op. ¶¶107-11.  Shareholder approval was not required for the exchange of those shares for Wells Fargo shares, because shareholder approval for a share exchange is required only when the shares exchanged are "already outstanding" shares.  These were not.

The Share Issuance Was Not Coercive

The grant of 40% voting control to Wells Fargo was not coercive, because a majority of Wachovia shareholders were still free to accept — or reject — the proposed merger.  As Judge Diaz observed:

while it is certainly true that slightly over 40% of the total votes to be cast on the Merger Agreement have been spoken for, and that Plaintiff and those in his camp face a substantial hurdle in defeating this transaction, a majority of Wachovia shareholders (owning nearly 60% of all Wachovia shares) “may still freely vote for or against the merger, based on their own perceived best interests, and ultimately defeat the merger, if they desire.” In re IXC Commc’ns. S’holders Litig., 1999 Del. Ch. LEXIS 210, at *23 (concluding that a vote-buying transaction did not disenfranchise the remaining shareholders where a numerical majority of shareholders were still in position to independently vote against the merger).

Op. at ¶142.  Judge Diaz further observed, with regard to Plaintiff’s contention that the Share Exchange had deterred other potential bidders: "the sobering reality is that there are few (if any) entities in a position to make a credible bid for Wachovia that would be superior to the Merger Agreement."  Op. at ¶151.  If Wachovia’s Board had not taken the Wells Fargo deal, it faced "the obliteration of most, if not all, of the shareholder equity."  Op. at ¶152.

18 Month "Tail" Held Invalid

In a small, but meaningless victory for the Plaintiff, the Court found invalid the provision of the Merger Agreement providing that Wells Fargo would retain its 40% stake for at least 18 months after the vote of the shareholders.  It entered an injunction against that particular portion of the Merger Agreement.  

This looks like the end of the road for the venerable North Carolina institution known as Wachovia. It seems very unlikely that the merger won’t receive the 50% plus 1 vote of the outstanding shares required under North Carolina law for the approval of a merger.

Brief in Support of Motion for Preliminary Injunction

Wachovia Brief in Opposition to Motion for Preliminary Injunction

Wells Fargo Brief in Opposition to Motion for Preliminary Injunction

Reply Brief in Support of Motion for Preliminary Injunction

Wachovia Sur-Reply in Opposition fo Motion for Preliminary Injunction