Oct. 9 (Bloomberg) -- An investor group led by J.C. Flowers & Co. said the reduced buyout proposal it made last week to SLM Corp. expired without negotiations, setting up a legal battle over the acquisition of the student-loan provider.

``We regret that our offer to amend the terms of the Sallie Mae transaction was allowed to expire without discussion,'' the investors said today in an e-mailed statement, using SLM's nickname. ``Instead, Sallie Mae filed what we firmly believe is a meritless lawsuit. We now look forward to having this matter resolved'' in court.

The Flowers group agreed in April to buy Reston, Virginia- based Sallie Mae for $60 a share, or $25.3 billion. It lowered the offer to $50 a share and additional warrants, saying cuts to federal subsidies for education lenders, signed into law last month, were a ``material adverse effect'' that nullified the original deal. Sallie Mae, the largest U.S. student lender, sued yesterday to force Flowers to make the purchase or pay a $900 million breakup fee.

``There's a lot of posturing going on here, but hopefully Flowers and Sallie Mae know there is a middle point between their two positions,'' said Sameer Gokhale, an analyst with Keefe, Bruyette & Woods in New York. ``They just need to get there.''

J.C. Flowers, the New York-based private-equity firm founded by former Goldman Sachs Group Inc. managing director J. Christopher Flowers, said its reduced offer was fair because the warrants would increase in value depending on Sallie Mae's earnings. Members of the group also include New York-based JPMorgan Chase & Co. and Bank of America Corp. of Charlotte, North Carolina.

Shares Dip

Sallie Mae shares fell 71 cents, or 1.4 percent, to $48.50 at 4:30 p.m. in New York Stock Exchange composite trading. The stock is trading 19 percent below the original offer.

``We would hope that the parties would honor their contract and we are prepared to close under the contact we signed in April -- and the other parties signed too,'' SLM spokesman Tom Joyce said today.

At the center of the dispute is the impact of the smaller subsidies on Sallie Mae's business. The company claimed last month the reductions would cut so-called core earnings by 1.8 percent to 2.1 percent annually over five years.

The Flowers group, in an Oct. 2 letter, countered that the impact of the subsidy cuts and upheaval in the credit markets would slash core earnings by more than 14 percent in 2009. That figure would swell to 20 percent in 2012.

LBO Freeze

After announcing a record $616 billion in deals during the first half of the year, private-equity firms saw transactions screech to a halt during July. Investors, skittish about losses tied to subprime mortgages, balked at buying the high-yield loans and bonds that fund leveraged buyouts. Investment banks have more than $300 billion of LBO debt on their books and are hesitant to finance new transactions until they can sell it.

The banks sought to renegotiate terms to make the debt more palatable, and some buyers cited declining prospects in the housing market and broader economy as reasons to rework deals.

Banks, buyers and sellers successfully retooled deals including the sale of Home Depot Inc.'s contractor-supply division to a consortium of private-equity firms. Other deals, such as the $8 billion purchase of Harman International Industries Inc. by Kohlberg Kravis Roberts & Co. and Goldman Sachs's buyout arm, fell apart.

To contact the reporters on this story: William McQuillen in Washington at bmcquillen@bloomberg.net; Jason Kelly in New York at jkelly14@bloomberg.net

Last Updated: October 9, 2007 17:30 EDT