In the Sunday night ruling, the Appellate Division of State Supreme Court threw out an order by Justice Charles Ramos issued late Saturday at the request of Citigroup; the order would have extended the time under which Wachovia and Citigroup had to complete their deal.
Citigroup, which announced on Sept. 29 that it had received federal government backing to acquire the banking assets of Wachovia Corp. for $2.1 billion, or the equivalent of about $1 a share, said it would appeal the decision.
The fight was also waged in federal court, where Wachovia asked U.S. District Judge John Koeltl to declare invalid part of the Citigroup deal that would have restricted Wachovia from considering competing bids.
With both Wells Fargo and Citigroup vowing to press their legal rights to a deal with Charlotte, N.C.-based Wachovia, analysts warned that a prolonged takeover fight carries enormous risk at a time when the nation's financial system is under the worst stress since the Great Depression.
"I would hope there would not be a long battle because that does not bode well for Wachovia's existing business," said Ben Halliburton, chief investment officer at Tradition Capital Management in Summit, N.J. "Any delays in action and uncertainty ... just causes further problems for the operating entity."
It was clear from documents filed in federal court Sunday that Wachovia was in considerable trouble when it agreed to the deal. Wachovia disclosed that it agreed to the deal "with the understanding that a seizure of its banking assets later that day by the Federal Deposit Insurance Corp. would occur" unless it accepted Citigroup's proposal.
Four days later, San Francisco-based Wells Fargo & Co. stunned Citigroup by announcing that Wachovia's board had agreed to its $14.8 billion all-stock offer. Originally, the deal was valued at $15.1 billion, or $7 a share, but Wells Fargo stock declined after it was announced.
Wells Fargo also said it would need no FDIC assistance to complete the takeover, which would be aided by a new IRS rule designed to make it easier for banks to offset losses from loans and other bad debts held by other banks they acquire.
"This deal enables us to keep Wachovia intact and preserve the value of an integrated company, without government support," Robert Steel, Wachovia's president and chief executive, said in a statement Friday.
According to an affidavit filed by Steel in federal court Sunday and obtained by The Associated Press, he was approached by FDIC Chairman Sheila Bair late Thursday; Bair told him that Wells Fargo was prepared to propose a merger transaction "and encouraged me to give serious consideration to that offer."
One of Wachovia's attorneys then advised Bair that unless Wachovia had a signed and board-approved merger agreement from Wells Fargo, it could not consider the proposal, the affidavit said.
The FDIC said Friday it "stands behind its previously announced agreement with Citigroup." It also said it would review all proposals and work with all three institutions to resolve the tug-of-war. An FDIC spokesman did not return calls for comment on Sunday.
In its request to Ramos, Citigroup invoked an exclusivity agreement in the deal that it said barred Wachovia from considering competing bids from other potential buyers before Oct. 6, which is Monday.
Meanwhile, Wachovia asked Judge Koeltl to declare that the Wachovia-Wells Fargo agreement "is valid, proper and not prohibited by a letter agreement between Wachovia and Citigroup." Koetl scheduled another hearing for Tuesday so Citigroup could respond.
Citigroup said in a statement announcing Ramos' ruling late Saturday it "is prepared to continue negotiations with Wachovia on the parties' previously agreed-to transaction."
It was quite possible that litigation among the three banks could go on for some time; any ruling by either judge was likely to be appealed. A protracted court fight raised the possibility that Wachovia, already hurt by billions of dollars in losses from failed mortgages, will further weaken. However, the government, which has closed and then seized failing banks including Washington Mutual Inc., the nation's largest thrift, would likely step in if the bank were in jeopardy.
Wachovia is among the banks whose billions of dollars in losses from bad mortgage bets ultimately led to the government's $700 billion plan to buy bad assets from banks and other institutions to shore up the financial industry.
Wachovia spokeswoman Christy Phillips-Brown said in a statement Sunday the company believes its agreement with San Francisco-based Wells Fargo is "proper, valid and ... in the best interest of shareholders, employees and the American taxpayers."
She said Citigroup is free to make a better offer to Wachovia under that agreement.
Wells Fargo said Sunday it has "a firm, binding merger agreement" with Wachovia.
"That agreement represents a transaction that, in stark contrast to Citigroup's proposal, provides significant and certain value to Wachovia shareholders, keeps Wachovia intact, is better for all of Wachovia's stakeholders including its employees and does not demand financial support from our government," the bank said, adding that it is confident that it will complete the deal.
The legal fight pits two of the largest remaining financial institutions against one another as the ongoing credit crisis leads the federal government to arrange marriages and sales among banking entities.
But not only does a legal battle delay Wachovia's saving, it could also be damaging to Citigroup, Halliburton said.
"I'm quite surprised that Citigroup would be agitating in this fashion, given that they themselves might need some government favors in the near future," Halliburton said, either for recapitalization or potentially to take over some other failed institution with the help of the FDIC.
"I can see why Citigroup wants it. I'm just surprised they don't recognize in all likelihood it's over."
Wachovia was a big originator of what are called option adjustable-rate mortgages, which offered very low introductory payments and let borrowers defer some interest payments until later years. Delinquencies and defaults on these types of mortgages have skyrocketed in recent months.
Wachovia and Citigroup are among the companies that have been forced to take billions of dollars in write-downs because of failed mortgages and mortgage-backed securities that have also plunged in value. The heavy losses led to the failure not only of WaMu and a number of smaller banks, but also the government-brokered sale of Bear Stearns Cos. to JPMorgan Chase & Co. and the bankruptcy filing of Lehman Brothers Holdings Inc.
Despite its escalating loan losses, Wachovia is still worth far more than either Citigroup or Wells Fargo is offering, said Herb Sandler, the former co-chief executive of Golden West Financial Corp. Wachovia picked up about $122 billion in option ARMs when it bought Golden West and its thrift, World Savings in 2006 for $24.3 billion.
Arguing the projected losses on the World Savings loan portfolio have been grossly exaggerated, Sandler believes Wachovia is still worth at least $60 billion. "This is still a viable company," said Sandler, who declined to disclose how many shares he still owns in Wachovia. He and his wife received Wachovia stock worth more than $2 billion at the time the deal closed.
New York-based Citigroup has not turned a profit for three straight quarters, and lost a total of $17.4 billion during that period after writing down its assets by about $46 billion. That's the most write-downs of any U.S. bank.
AP Business Writer Michael Liedtke contributed to this report from San Francisco.