Unocal Corp. v. Mesa Petroleum Co.

Citations: 493 A.2d 946; 1985 Del. LEXIS 482

Court: Supreme Court of Delaware; June 10, 1985; Delaware; State Supreme Court

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The Supreme Court of Delaware addressed the validity of Unocal Corporation's self-tender offer, which excluded Mesa Petroleum Co. and its affiliates, who were making a hostile tender offer for Unocal's shares. The Court of Chancery had issued a preliminary injunction against Unocal's exchange offer, ruling that such a selective offer was legally impermissible. However, the Supreme Court reversed this decision, stating that Unocal's board, comprised mainly of independent directors, acted in good faith after a reasonable investigation. They found Mesa's offer to be inadequate and coercive, justifying their opposition to it.

The Court emphasized that the board's actions were reasonable considering the perceived threat to the corporation, and the decision fell within their sound business judgment as long as it served any rational business purpose. The factual context revealed that Mesa, owning approximately 13% of Unocal, initiated a two-tier cash tender offer for a significant portion of Unocal's stock at a price of $54 per share. However, Mesa's subsequent disclosures indicated the securities offered in the follow-up merger would be inferior, termed 'junk bonds' by Unocal. The board of Unocal, after extensive deliberation with legal and financial advisors, determined that the real value of Unocal's stock was over $60 per share. Thus, the Supreme Court vacated the injunction against Unocal's tender offer.

Mr. Sachs presented valuation techniques and recent business combinations in the oil and gas industry to the Court of Chancery, indicating that the presentation aimed to inform directors about the analysis scope rather than the specific data supporting the conclusion that Mesa's tender offer was inadequate. He outlined defensive strategies for the board, including a self-tender option for Unocal at a price range of $70 to $75 per share, which would incur $6.1-6.5 billion in additional debt, affecting exploratory drilling but still keeping the company viable. The eight outside directors, a majority, later met with financial advisors and unanimously recommended rejecting Mesa's offer and pursuing a self-tender to provide shareholders a fairly priced alternative.

The board reconvened and unanimously rejected Mesa's offer as grossly inadequate, yet no formal decision was made regarding the self-tender during a lengthy meeting. On April 15, a subsequent meeting with four directors present by phone considered terms for an exchange offer, settling on a price of $72 per share. The board, relying on investment bankers' advice, approved the exchange offer contingent upon Mesa acquiring 64 million shares, after which Unocal would buy the remaining shares for debt securities valued at $72 each. The offer would be subject to conditions discussed in the meeting, including excluding Mesa, consistent with the offer's intent.

Unocal's exchange offer began on April 17, 1985, prompting Mesa to file a lawsuit. By April 22, the Unocal board was advised to waive the Mesa Purchase Condition concerning 50 million shares to alleviate shareholder concerns about the tendering process. Additionally, directors were encouraged to tender their Unocal stock as a display of confidence in the exchange offer, while legal counsel emphasized that under Delaware law, Mesa could only be excluded for what the directors reasonably believed to be a valid corporate purpose.

Directors focused on the goal of compensating shareholders effectively at the conclusion of Mesa's proposal, which was to be financed through 'junk bonds.' Allowing Mesa to participate would undermine this goal, as accepting Mesa shares would displace shares held by other shareholders due to the 49% proration in the exchange offer. If Mesa were allowed to tender, Unocal would essentially be funding Mesa’s inadequate proposal. On April 24, 1985, Unocal issued a supplemental notice regarding a partial waiver of the Mesa Purchase Condition, and on May 1, it extended the dates for withdrawal and proration of its exchange offer to May 17, 1985. Concurrently, Mesa amended its complaint on April 22, challenging its exclusion, and sought a temporary restraining order after Unocal's announcement of a partial waiver. The Court of Chancery held a hearing on April 26, ultimately issuing a temporary restraining order on April 29, forbidding Unocal from proceeding without including Mesa. The Vice Chancellor acknowledged that directors can oppose hostile takeovers they view as detrimental to the corporation but stated that in selective stock purchases, the corporation must demonstrate both a valid purpose and fairness to all shareholders. Unocal sought an interlocutory appeal certification, which was initially denied, but on May 2, the higher court ruled the temporary restraining order was appealable due to its significance. The court deferred action on the appeal pending a preliminary injunction hearing set for May 8, noting that certain issues needed consideration, including the extent of directors' duty to protect the corporation, potential selective treatment by plaintiffs, and whether Unocal's directors acted in good faith.

On May 13, 1985, following a hearing on May 8, the Vice Chancellor issued an unreported opinion granting Mesa a preliminary injunction. The trial court acknowledged a consensus that directors must protect the corporation from perceived harm from both third parties and shareholders. It inferred that while evidence was insufficient to prove Mesa’s primary goal was to secure a buyout at a premium, reasonable inferences supported this notion. The court raised fundamental issues regarding whether directors owe fiduciary duties to shareholders perceived to be acting against the corporation's best interests. It determined that the board's opposition to Mesa's tender offer was based on a good faith belief that the offer was inadequate; however, the business judgment rule did not apply to selective exchange offers.

The Court of Chancery certified this interlocutory appeal, accepted on May 14, raising essential questions about the Unocal board's power and duty to oppose a perceived harmful takeover threat and whether their actions were protected under the business judgment rule. Mesa argued that Unocal's discriminatory exchange offer violated its fiduciary duties, claiming that the exclusion of Mesa from the offer undermined fairness and that Unocal could not demonstrate the offer's equity to all shareholders. Unocal countered that it owed no duty of fairness to Mesa, asserting that its board reasonably believed Mesa’s two-tier offer was coercive and inadequate, and that the board acted in good faith and informed judgment to protect the company.

The crux of the matter involves the authority of a Delaware corporation's board to adopt defensive measures. The board's powers derive from 8 Del.C. 141(a) and 8 Del.C. 160(a), which grant broad management and stock transaction authority, respectively. It is established that Delaware corporations may selectively deal with shareholders in stock acquisitions, provided the directors do not act primarily to entrench themselves.

In Bennett v. Propp and other cited cases, it is established that a corporate board's authority stems from its duty to safeguard the corporation and its shareholders from potential harm, regardless of the source of that harm. This duty implies that the board is an active entity in corporate governance, especially in the context of significant corporate changes. The business judgment rule applies to director actions during takeovers, presuming directors act on an informed basis, in good faith, and with the belief that their decisions serve the company's best interests. Courts typically do not interfere unless the board's decisions lack any rational business purpose. When evaluating a takeover bid, the board must assess whether the offer benefits the corporation and its shareholders, which is consistent with their broader responsibilities. However, due to the potential for conflicts of interest, there is an increased scrutiny on boards to demonstrate that their decisions are made with reasonable grounds and good faith, particularly when the board's actions may be influenced by self-interest. This scrutiny is heightened when corporate funds are used to counter threats to control, necessitating that directors show evidence of reasonable investigation and the backing of independent directors. Ultimately, corporate directors are bound by a fiduciary duty to prioritize the interests of shareholders while recognizing that their powers are not unfettered.

A corporation's discretion to counter perceived threats through stock repurchases is limited; directors must not act primarily to maintain their positions. Legal precedents, such as *Cheff v. Mathes* and *Schnell v. Chris-Craft Industries, Inc.*, emphasize that defensive actions must be motivated by genuine concerns for the corporation and shareholders, free from fraud or misconduct. Additionally, any defensive measures must be reasonable in relation to the identified threat, requiring directors to analyze the takeover bid's nature and implications on the corporation and its broader stakeholders, including creditors and employees. 

In the case of Unocal, the board deemed a two-tier tender offer from Mesa as grossly inadequate and coercive, believing Unocal's true value exceeded the proposed $54 per share. They recognized the subordinated securities offered in the back-end merger as having significantly less value. The board's selective exchange offer aimed either to counter the inadequate offer or to protect shareholders from receiving inferior securities, demonstrating valid purposes. The board found that allowing Mesa to participate in the exchange would undermine these efforts, as it would effectively subsidize Mesa's buyout at an inadequate price. Ultimately, the selective exchange offer was deemed reasonably related to the threats faced by Unocal, upholding the principle that minority shareholders should receive substantial equivalent value.

The legal principle of fairness in mergers extends to tender offers, where a corporation’s board can reasonably determine and offer fair value to 49% of its shareholders to prevent them from being forced to accept inferior 'junk bonds.' V. Mesa argues that discriminating against any shareholder is unlawful, a position supported by the trial court. However, Delaware corporate law does allow selective stock repurchases, evidenced by previous cases. Historically, such selective treatment was associated with 'greenmail' payments to raiders, and Mesa’s claims are seen as ironic given its own history with such practices. The evolution of corporate law accommodates new threats and tactics, including various defensive measures against hostile takeovers, which have received judicial approval. The board's decision to engage in a selective exchange offer is deemed lawful and reasonable, provided the directors are disinterested and act in good faith. Mesa contends that the board cannot be disinterested due to personal benefits from the tender offer, but it concedes that if the exclusion of certain shareholders is valid, the board's interests align with those of all stockholders. Ultimately, the exclusion is upheld as valid, and the directors' participation does not constitute a disqualifying interest.

The excerpt clarifies that the status of certain board members as large stockholders does not automatically qualify their transactions as 'interested' under the business judgment rule, as established in Cheff v. Mathes. The board retains its fiduciary duties of due care and loyalty to Mesa, but must also protect the corporation and its shareholders from perceived threats, such as Mesa's tender offer. Mesa argues that the board's actions are punitive and infringe on its rights, but the board, with a majority of independent directors, determined that Mesa's actions were contrary to the interests of Unocal and its shareholders. Delaware law does not require a corporation to ensure benefits to a stockholder that is perceived to be creating danger. The Court of Chancery found the board's opposition to the tender offer to be in good faith and reasonable. The board's selective stock repurchase plan was deemed reasonable in light of the threat posed by Mesa's offer and is protected under the business judgment rule unless evidence shows that the directors acted to perpetuate their positions or engaged in other fiduciary breaches. The validity of the Mesa exclusion confirms that directors, although they tendered shares, are receiving a benefit shared with other stockholders, excluding Mesa. Stockholders unhappy with board actions can exercise corporate democracy to remove directors, as stipulated in Aronson v. Lewis and Delaware corporate law.

The Court of Chancery found that the Unocal board acted in good faith, believing the Mesa offer was inadequate, and that their decision was informed and careful. The court noted Mesa's previous actions suggested a motive of greenmail, yet deemed the offer's substance reasonable for Unocal and its stockholders if Mesa were involved. Consequently, the appellate court reversed the Chancery's decision and vacated the preliminary injunction. The context of the appeal was expedited due to overlapping tender offer deadlines, with the decision announced orally on May 17, 1985. Additionally, Mesa's proxy statement outlined plans for a merger that would significantly increase Unocal's leverage and alter its capital structure. Delaware law allows directors to participate in meetings via telephone, facilitating the board's decision-making process.

Provisions in a corporation's certificate of incorporation dictate how the board of directors exercises its powers and duties, as authorized under 8 Del.C. 160(a). Corporations possess broad authority regarding their shares, including the ability to acquire, sell, and manage them. Director action is essential for significant corporate changes, such as charter amendments, mergers, asset sales, and dissolutions, as established in various Delaware code sections and reinforced by legal precedent.

Debate exists among legal scholars regarding the proper response of a board to takeover threats, with some advocating for a passive approach. However, Delaware law does not support this passivity, and empirical studies indicate that companies resisting hostile takeovers often see their stock prices rise after rejecting offers, suggesting that boards should apply the business judgment rule in such situations.

The term "greenmail" describes the strategy of repurchasing a bidder's shares at a premium to prevent a takeover. The Chancery Court recognized that actions taken by the Unocal board were in good faith to counter inadequate tender offers and avoid greenmail. A referenced case, Fisher v. Moltz, involved different circumstances where the corporation's actions lacked a rational corporate purpose, illustrating the need for a legitimate threat to justify defensive measures against takeovers.