Two days to save £28bn BAE and EADS merger

Deadline for deal to create defence giant looms but governments cannot agree on terms

The boards of the British defence group BAE Systems and the aerospace giant EADS have effectively just two days to salvage their £28bn proposed merger, which appeared on the verge of collapse over the weekend.

Philip Hammond, the Defence Secretary, yesterday laid bare the tensions surrounding the deal by saying that Germany and France must reduce their stakes in EADS if the UK Government is to give the deal the green light.

Germany also threatened to torpedo the deal on Friday with its insistence that the group's headquarters be located just outside Munich. This left talks on a knife-edge, but they continued over the weekend. Sources close to EADS told The Independent on Sunday that governments, which effectively control the Airbus maker, need to make "significant progress" in negotiations to ensure the merger does not collapse.

The Takeover Panel has set BAE a deadline of 10 October to agree the deal, walk away, or ask for more time. Even if progress is made, BAE and EADS are not expected to hit the deadline of 5pm on Wednesday, making it likely the UK-based firm will ask for more time.

The merger would have huge ramifications for the global defence and aerospace industry, with a combined workforce of 220,000, of whom 50,000 are in Britain. The British, German and French governments all want guarantees on domestic jobs and national security.

A group of 45 Conservative MPs signed a letter to the Prime Minister on Friday urging him to block the deal.

Furthermore, the proposed tie-up could be derailed if the US Pentagon strips BAE of its special status as a trusted supplier.

The demand by the German government for a Munich headquarters for the enlarged group was made at the end of a tripartite conference call on Friday afternoon with the British and French. The Germans also asked for, but did not get, a written understanding from France it would not raise its stake in the combined entity beyond the 9 per cent that the merger would see its 15 per cent stake diluted to.

Advisers are understood to have told Tom Enders, chief executive of EADS, that there is little point in extending the deadline for both companies to agree terms unless politicians start to make concessions.

EADS and BAE broadly agree over the terms of the deal, which would see BAE investors own 40 per cent of the merged entity and EADS shareholders hold the balance. The UK Government – which holds a "golden share" in BAE, allowing it to veto a foreign takeover – believes the deal would save jobs and create a submarines-to-satellites group big enough to take on Boeing.

But speaking to the BBC's Radio 4, Mr Hammond took a hard line with Germany and France. He said: "We have made very clear that we do have red lines around the BAE-EADS merger and that if they can't be satisfied, then we will use our special share to veto the deal. It is not, I think, necessary to have no French or German government interest in the company. It is necessary to reduce that stake below the level at which it can control or direct the way the company acts."