By Jonathan Soble
TOKYO (Reuters) - Japan's Supreme Court ruled on Monday that troubled bank UFJ Holdings Inc. can pull out of a deal to sell its trust business to a smaller rival, clearing the way for a full takeover of UFJ by larger Mitsubishi Tokyo Financial Group (MTFG).
The court rejected an appeal by Sumitomo Trust & Banking Co., which had agreed in May to buy the trust unit from UFJ. The ruling also comes as a blow to Sumitomo Mitsui Financial Group (SMFG), which is seeking to take over UFJ for itself and has launched an unsolicited bid for the bank.
The ruling allows UFJ to include its trust business in the proposed merger with MTFG, a union that would create the world's biggest bank with $1.7 trillion in assets.
But while the decision gives UFJ a free hand to deal with MTFG, its preferred merger parter, SMFG showed no sign of giving up its fight for the smaller bank. Following the ruling, SMFG issued details of a proposal to inject some 700 billion yen ($6.38 billion) in capital into UFJ.
SMFG said it would inject the capital by the end of September in the form of preferred shares. MTFG has proposed a similar-sized capital injection for UFJ, but has not said how it would provide the funds.
SMFG's open pursuit of UFJ has put MTFG under pressure to come up with a generous takeover offer. Earlier this month SMFG said it was prepared to swap one of its shares for each UFJ share, valuing UFJ at an unexpectedly pricey $29 billion.
SMFG has been keen to shoulder out MTFG and acquire UFJ because a UFJ-MTFG union would leave SMFG a distant third among Japanese banks, behind the new entity and currently top-ranked Mizuho Financial Group.
STILL OBSTACLES TO UFJ-MTFG UNION
The Supreme Court's decision ends a month-long legal battle that began when UFJ, the weakest of Japan's mega-lenders and a laggard in cleaning up its vast pile of bad loans, said it would cancel its deal with Sumitomo Trust and seek a merger with MTFG.
Sumitomo Trust, which belongs to the Sumitomo group of companies but is separate from Sumitomo Mitsui Financial Group, objected to the cancellation, saying the May agreement gave it exclusive negotiating rights to UFJ's trust bank unit.
In its ruling, the Supreme Court noted relations between UFJ and Sumitomo Trust had broken down and said the chances of the two banks successfully concluding a deal were "very low."
It added that while Sumitomo Trust may seek compensation from UFJ, UFJ could not be forced to pursue a deal against its will.
Sumitomo Trust said in a statement that it would consider its next move following the decision, leaving open the possibility that it will seek damages from UFJ.
The court's ruling "means the UFJ-MTFG camp scored a success in removing one of the major obstacles to their planned merger," said BNP Paribas banking analyst Nozomu Kunishige.
"But there are still some uncertainties, as Sumitomo Trust could switch its tactics to seek compensation from UFJ. There are also other uncertainties such as how to deal with UFJ's big, troubled borrowers and how to strengthen UFJ's capital base."
UFJ, which is more than 30 percent owned by foreign investors, has lagged other banks in cleaning up its loan book and getting back on its feet.
UFJ and MTFG said in separate statements that the court decision was appropriate.
Sumitomo Trust initially won an injunction from a Tokyo court prohibiting UFJ from negotiating with MTFG, but that injunction was overturned by the Tokyo High Court.
Monday's Supreme Court ruling affirmed the High Court's decision.
Analysts said the unprecedented public tug-of-war over UFJ marked a shift toward more aggressive competition between banking giants.
Bankers until now have kept their rivalries out of the public arena, with previous bank mergers arranged behind closed doors under the guidance of Japan's powerful bureaucracy.
Japan's top financial regulator declined to comment on the court ruling.
"It is basically up to the parties involved to discuss the matter thoroughly in court," Financial Services Agency (FSA) Commissioner Hirofumi Gomi told a news conference. "It's not something for the regulator to comment on."
The FSA on Monday began its planned special inspections into major banks, including SMFG, to check whether large-scale borrowers had appropriate rehabilitation plans in place.
Prior to the announcement, shares in UFJ ended the Monday session up 1.12 percent at 541,000 yen, while MTFG shares firmed 0.5 percent to 997,000 yen. This compared with a 1.22 percent rise in the Tokyo Stock Exchange's banking sector sub-index.
Sumitomo Trust ended the day up 0.15 percent at 664 yen and SMFG rose 1.38 percent to 663,000 yen. ($1=109.70 yen) (Additional reporting by Toru Suzuki, Miki Shimogori, Yoko Nishikawa and Chisa Fujioka) ((Reporting by Jonathan Soble, editing by Dale Hudson; Reuters messaging: jonathan.soble.reuters.com@reuters.net;
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