JC Flowers in court over bid to pull out of Sallie Mae buyout

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A private equity firm's attempts to wriggle out of one of the most audacious deals of the buy-out boom looks set to be decided by the courts.

The $25bn (£12.3bn) acquisition of Sallie Mae, the American student loans company, announced in April, is the biggest deal to have hit the rocks after the debt market crisis of the summer made it much more expensive for the private equity industry to finance takeovers.

But the company is refusing to let a consortium led by the New York firm JC Flowers walk away from the $60-a-share deal, which came at a juicy 50 per cent premium to the share price at the time. It has launched a lawsuit claiming that JC Flowers – and its partners Friedman Fleischer & Lowe, JP Morgan Chase and Bank of America – must go through with their takeover.

"Sallie Mae has honoured its obligations under the merger agreement," said its chairman, Albert Lord. "We ask only that the buyer group do the same."

Sallie Mae, formally known as SLM Corp, runs a secondary market for student loans, having been set up in 1972 as a "government-sponsored enterprise" with the aim of stimulating the finance industry to provide cheap debt for college educations. It has been fully privatised since 2005, and has become a substantial direct lender to students, as well as a provider of other services such as debt collection.

The takeover announcement in April marked a high point in the buy-out boom. It was the largest ever in the finance industry, signalling that few areas of corporate America were off-limits to private equity, which was raising money at low interest rates to make its investments. That availability of cheap funding has collapsed and acquirors are trying to renegotiate deals. The buyers of the wholesale arm of DIY chain Home Depot, for example, shaved $2bn off the original $10.3bn price tag.

Other firms are examining whether it is cheaper to pay a break fee to walk away from deals altogether. In the case of Sallie Mae, though, Christopher Flowers says his firm is not liable to pay the $900m break fee because of a "material adverse change" in the company's business since April. He says new US laws cutting subsidies to student loan companies have undermined the business, but Sallie Mae's lawsuit insists that the laws were in the works when the price was agreed and JC Flowers was happy to take the risk.