Lloyds bid faces tough new hurdle: Court ruling would exclude many mortgage borrowers from receiving pounds 500 sweetener in merger with C&G

THE PROPOSED pounds 1.8bn merger between the Cheltenham & Gloucester Building Society and Lloyds Bank faced a fresh hurdle yesterday when it emerged that a large, but unknown, number of the C&G's 380,000 mortgage borrowers cannot be paid an incentive to agree the deal.

Lawyers studying Wednesday's judgment by Sir Donald Nicholls, the Vice-Chancellor, said that a closer reading made it clear that only mortgage borrowers who also have share accounts can be paid the pounds 500 incentive.

The borrowers have a vital separate vote from the general share account holders, which must be passed by a majority. C&G was unable to say how many borrowers had share accounts, but there is no requirement for them to have one.

The ban on payment to borrowers is another hurdle for any future takeovers of building societies. Not only does it rule out any lingering hopes that the original deal might have got through, but it also provides a possible basis for an appeal against the Vice-Chancellor's decision on the grounds that it discriminates against borrowers who, unlike depositors, are full members of the society.

However, the deal in its original form was already unlikely to succeed. The Vice-Chancellor's judgment ruled that payments by Lloyds Bank to C&G account holders of less than two years' standing were unlawful. This covers 27 per cent of C&G share account holders, a total of 226,000.

Since 50 per cent of C&G's customers have to vote on the merger, with 75 per cent voting in favour, the original merger scheme stood little chance of success.

Both C&G and Lloyds yesterday reaffirmed their determination to press ahead with the deal despite the ruling.

But gaps were beginning to appear in the perception of the best way forward, thanks largely to the sheer speed of developments. C&G is insisting that when it launched the merger proposals in April it was determined to pay out the pounds 1.8bn from Lloyds to all C&G borrowers and lenders, staff members and pensioners. 'This remains our objective,' a C&G spokeswoman said.

Lloyds' advisers appeared yesterday to be contemplating schemes that might not fulfil this objective, although it was insisting that the decision lay with C&G.

C&G is writing to all 1.4 million customers saying that it is surprised and disappointed at the High Court's decision that some aspects of the original merger scheme do not conform with the 1986 Building Societies Act. C&G is examining the possibility of appealing the decision.

An appeal would take weeks rather than months since the Vice- Chancellor agreed on Wednesday that clearing up any legal dispute on this area is a matter of urgency.

The letter will also stress that the C&G is determined to revamp the deal so that the original aim of paying all members is fulfilled. It will say that the merger of Lloyds and the society is still in the best interests of C&G's customers and its business.

City opinion is far more optimistic that the current obstacles will be overcome, and the merger completed, than most outside observers. Lloyds Bank faced difficulties in its merger with Abbey Life, analysts point out, but because both boards were determined to succeed the deal came through.

Many City corporate finance specialists and financiers are keen to see the deal work, because of the lucrative advisory fees if it provokes a spate of building society takeovers by banks.

Yesterday an unnamed medium-sized building society signed up a team of City advisers to consider strategic issues, including selling to a bank, in the wake of Wednesday's judgment.

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