David Colan, and Unocal Corporation v. Mesa Petroleum Co., David Colan, and Unocal Corporation v. Mesa Petroleum Co.

Citations: 951 F.2d 1512; 91 Daily Journal DAR 15800; 123 A.L.R. Fed. 715; 1991 U.S. App. LEXIS 29608Docket: 90-55641, 90-55643

Court: Court of Appeals for the Ninth Circuit; December 23, 1991; Federal Appellate Court

SummaryOriginalCytator Case TreatmentBackward CitatorAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

In the case of Colan v. Mesa Petroleum Co., the Ninth Circuit addressed an appeal from Unocal Corporation regarding a summary judgment favoring Mesa Petroleum and associated entities concerning alleged short-swing profits under Section 16(b) of the Securities Exchange Act of 1934. The central issue was whether an exchange of common stock for non-convertible debt securities in a self-tender offer qualifies as a "sale" under the statute. The court determined that such an exchange does constitute a "sale," thus reversing the district court's ruling. Unocal argued that the district court improperly assessed evidence and credibility in its summary judgment decision and incorrectly labeled the transaction as "unorthodox," which exempted the Mesa Defendants from disgorgement of profits. Pertinent facts include the formation of Mesa Partners II, which began acquiring Unocal stock in 1984, escalating to ownership of 9.7% by February 1985. In response to this accumulation, Unocal enacted defensive measures, including bylaw amendments and legal actions against Mesa and its affiliates for various grievances, including breach of fiduciary duty.

On March 27, 1985, Mesa Partners II purchased 6.7 million shares of Unocal stock at $48.10 each, raising its total holdings to 23.7 million shares (13.6% ownership). The following day, Mesa Partners II amended its Schedule 13D, indicating intentions to seek control of Unocal and to solicit proxies to postpone the annual shareholders meeting set for April 29, 1985. In response, on April 1, 1985, Unocal filed a complaint in the U.S. District Court for the Central District of California against T. Boone Pickens, Jr. and others for alleged violations of section 13(d) of the Securities Exchange Act, claiming misleading representations in Mesa's Schedule 13D. Defendants counterclaimed on April 12, alleging violations of proxy solicitation rules.

On April 8, 1985, Mesa Partners II made a tender offer for 64 million shares at $54 per share, which Unocal's Board recommended shareholders reject as inadequate. On April 16, Unocal proposed an exchange offer for up to 87.2 million shares in exchange for debt securities, initially conditioned on Mesa's acceptance of its tender offer. This was modified on April 23 to allow for purchasing up to 50 million shares for $72 per share in notes, explicitly excluding Mesa Partners II from participation. Mesa Partners II challenged this exclusion in Delaware state court on April 22, leading to a temporary restraining order against Unocal on April 29. However, the Delaware Supreme Court reversed this order on May 17, allowing Unocal to exclude Mesa Partners II. Subsequent negotiations between the parties occurred without resolution until an agreement was finally reached on May 20, 1985.

The Mesa Entities were permitted to participate in Unocal's self-tender offer under an agreement that included several key stipulations. Mesa Partners II agreed to terminate its own tender offer and abstain from any proxy solicitation or acquiring additional Unocal shares for twenty-five years. Additionally, for ten years, it committed to voting its Unocal shares aligned with the votes of other shareholders, excluding the Mesa Entities. Mesa Partners II also accepted strict limitations on selling its Unocal stock.

On the same day, Mesa Partners II exchanged approximately 7.8 million shares of Unocal for negotiable debt securities with set maturity dates and periodic interest payments. Mesa Asset Company later sold these securities for about $589 million on July 3, 1985.

In a legal context, on June 3, 1986, shareholder David Colan initiated a derivative action against the Mesa Defendants for violations of section 16(b), seeking recovery of short-swing profits. Initially, Unocal was a defendant but was realigned as a plaintiff in 1989. The Mesa Defendants moved for summary judgment, claiming their stock exchange for debt securities did not constitute a sale under section 16(b), invoking the "unorthodox transaction" defense from the Supreme Court's Kern County Land Co. case. The district court denied this motion on October 23, 1989, citing genuine issues of material fact.

On December 1, 1989, Unocal sought a ruling to exclude the "unorthodox transaction" defense as a matter of law and requested an evidentiary hearing if any facts were disputed. The Mesa Defendants opposed this and renewed their summary judgment request, asserting that the case was ready for a court decision. During a January 4, 1990 hearing, counsel debated the appropriateness of a motion in limine versus summary judgment, leading to an agreement to treat the issue as a cross-summary judgment motion for the court's consideration.

The court addressed Unocal's motion in limine, categorizing it as a cross motion for summary judgment and agreeing to reconsider Mesa's earlier summary judgment motion, supplemented by a book authored by T. Boone Pickens. The court declined oral arguments on the "unorthodox transaction" defense. On January 22, 1990, the court ordered a grant of the defendants' motion for summary judgment while denying the plaintiffs' cross-motion. A hearing on January 26, 1990, discussed whether the case would proceed to trial, with Unocal asserting the necessity of a trial regardless of the classification of the stock-debt exchange as "unorthodox." The court reminded Unocal's counsel of prior representations that all necessary facts were in the record. Unocal reaffirmed its position to rely on the existing factual record. On February 9, 1990, Mesa submitted a "Supplemental Motion for Summary Judgment," and on April 10, 1990, the court vacated the January 19, 1990, order, ruling that while the stock exchange constituted a "sale," the unorthodox transaction exception exempted it from Section 16(b) liability. The court again granted the Mesa defendants' motion for summary judgment and denied Unocal's cross motion. Unocal filed a timely appeal regarding the judgment that resolved this Section 16(b) action.

Unocal claims the district court infringed on its right to a jury trial by improperly weighing evidence, drawing inferences from conflicting circumstantial evidence, resolving factual disputes, and assessing the credibility of T. Boone Pickens' testimony while ruling on cross motions for summary judgment. The Mesa Defendants acknowledge that the court did not consider evidence favorably to Unocal but assert that the court effectively conducted a bench trial rather than a hearing on summary judgment. They argue for a "clearly erroneous" review standard, but the record does not support their claim that the parties consented to a bench trial. Instead, the Mesa Defendants requested the court to reconsider their summary judgment motion rather than address Unocal's motion in limine, while they had previously prepared an order to grant their summary judgment and dismiss Unocal’s case. The reliance on Wolfe v. United States and other cases by the Mesa Defendants is deemed misplaced, as those cases involved explicit agreements to waive jury trials. In contrast, the current case involved a mutual understanding that the court would decide on the "unorthodox transaction" defense through cross motions for summary judgment. The court confirmed this understanding during discussions about trial timing and jury procedures. The Mesa Defendants’ later claim of an agreed bench trial is viewed as overzealous advocacy, lacking support from the record, which shows their request for the court to rule on the "unorthodox transaction" defense and their participation in jury selection. Thus, the argument for a clear error review is rejected based on the established record.

Review of an order granting summary judgment is conducted de novo, requiring all evidence to be viewed favorably for the non-moving party and an independent assessment of the district court's legal application. Unocal contends that the district court incorrectly applied the "unorthodox transaction" defense regarding a disgorgement action for short-swing profits related to the Mesa Defendants. Unocal argues for a summary judgment in its favor, asserting that the Mesa Defendants' exchange of common stock for debt securities constitutes a "sale" under section 16(b) of the Securities Exchange Act of 1934. This section allows issuers to recover profits from beneficial owners—defined as shareholders owning over ten percent of any equity class—who sell securities within a six-month window. The Act aims to maintain fair markets and prevent insider manipulation for personal gain. Section 16(b) imposes strict liability on transactions within this timeframe, regardless of the insider's intent. A "sale" is broadly defined to include any contract to sell or dispose of securities. The district court acknowledged that the exchange could be considered a "sale" but found that the "unorthodox transaction" exception applied, thus exempting it from section 16(b) liability.

The Mesa Defendants acknowledged that their exchange of Unocal equity stock for debt securities was a "sale" under a literal interpretation of section 16(b). They argue that this exchange falls under the "unorthodox transaction" defense established by the Supreme Court in Kern County, which held that certain exchanges are not considered "sales" if they are involuntary and devoid of speculative abuse of insider information. In Kern County, the Supreme Court ruled that the involuntary exchange of stock as part of a merger did not trigger section 16(b) liability, emphasizing the lack of choice in such transactions.

In contrast, the Mesa Defendants' exchange on May 20, 1985, was voluntary; they were not compelled to participate in Unocal's tender offer, which expressly excluded them. They filed a lawsuit in Delaware seeking to be included in the tender offer, indicating they had the option to either participate or retain their shares. Anticipating that Unocal's stock would drop to $30 per share post-exchange, the Mesa Defendants aimed to negotiate their participation in the tender offer to avoid significant financial loss. The negotiations reflected a concern from Unocal about the Mesa Defendants potentially buying devalued shares and gaining control of the corporation, as highlighted by statements from T. Boone Pickens regarding the stakes involved for both parties.

The ruling was unprecedented, presenting a choice between negotiating with Unocal or making a full cash offer following their tender offer. Drexel contacted the team, offering to secure additional funds for a 100 percent offer, which boosted morale despite the inherent risks. Concerns lingered from a prior $300 million setback, leading to caution against reckless financial commitments. If Mesa pursued Unocal aggressively, they could face exclusionary tactics again, prompting a potential return to court.

Hartley expressed willingness to negotiate but imposed a condition: Mesa would cover Unocal's expenses, a request deemed trivial yet significant to Hartley. Mesa retained a strategic advantage, potentially netting $80 million after taxes if included in Unocal's offer while holding stock for a year, necessitating discretion to avoid Unocal's awareness.

After concluding the deal, Hartley claimed victory over Mesa, asserting a $100 million loss for them, while in reality, Mesa was positioned to profit significantly. The final profit, confirmed two months later, amounted to $83 million after taxes, surpassing previous earnings from another deal. The document clarified that the Mesa Defendants willingly exchanged stock for negotiable securities, distinguishing their situation from involuntary exchanges seen in cases like Kern County. Courts have noted that the absence of involuntariness is crucial in determining whether a transaction constitutes a "sale" or "purchase" under section 16(b), reaffirmed by precedent in Provident Sec. Co. v. Foremost-McKesson, Inc.

The Mesa Defendants contend that transactions deemed "otherwise volitional" under section 16(b) are atypical if a beneficial owner is economically coerced into selling common stock to avoid financial loss. In Oliff v. Exchange Int'l Corp., the Seventh Circuit ruled that a significant tax payment did not constitute a reasonable alternative to repurchasing shares, yet the acquisition was not involuntary enough to exclude it from the definition of "purchase" under section 16(b). Similarly, in Tyco Laboratories, Inc. v. Cutler-Hammer, Inc., the court dismissed the notion that coercion exempted the sale from section 16(b) liability, emphasizing that the plaintiffs chose to sell their stock for perceived financial benefits, which did not render the transaction involuntary. 

The document argues against an "economic coercion" standard, asserting that it would enable insiders to evade section 16(b) liability by citing unfavorable circumstances leading to stock sales. Section 16(b) was designed with objective criteria to eliminate the need for assessing an insider's subjective intent. The excerpt rejects applying the "unorthodox transaction" defense from Kern County broadly, clarifying that the Supreme Court approved a very limited exception for transactions resulting from mergers, which do not fall under section 16(b). Most cases referencing "unorthodox" transactions relate to stock exchanges in mergers, reinforcing that section 16(b) does not apply to involuntary exchanges stemming from such events.

In National Westminster Bancorp v. Leone, the court examined the application of Section 16(b) concerning mergers and tender offers, characterizing mergers as "unorthodox transactions" that necessitate specific analysis under this statute. It was determined that a forced exchange of securities in a merger does not constitute a "sale" under Section 16(b). Courts that have addressed Section 16(b) liability in the context of tender offers or hostile takeovers generally concluded that share dispositions during these scenarios are not "unorthodox transactions." The Eleventh Circuit affirmed that the Kern County case did not exempt corporate officers and directors from short-swing profit prohibitions when voluntarily tendering shares during a tender offer. Similarly, in T-Bar, Inc. v. Chatterjee, the court ruled that a defeated tender offeror's conversion of debentures into common stock and subsequent tendering of those shares did not qualify as "unorthodox." The Fifth Circuit also clarified that Kern County did not apply when a defeated tender offeror sold shares to a company involved in a merger with the target. In Tyco Laboratories, the court dismissed claims that a control contest rendered a stock sale "unorthodox." In Lane Bryant, Inc. v. Hatleigh Corp., a ten-percent shareholder facing a proxy contest was found to have engaged in a standard stock sale for cash, diverging from the "unorthodox" classifications seen in previous cases. The only cited case supporting the notion of a tender offer as "unorthodox" was Pier 1 Imports, where the court recognized tender offers as distinct from typical Section 16(b) claims.

The excerpt examines the applicability of Section 16(b) of the Securities Exchange Act within the context of various cases, particularly focusing on whether certain transactions qualify as "unorthodox transactions." It argues that the cases of *Makofsky* and *Texas International* do not support the ruling in *Pier 1 Imports*, as *Makofsky* did not involve a tender offer but rather an insider action regarding option shares, and the court affirmed that Section 16(b) applied. The language cited from *Makofsky* regarding tender offers is deemed dictum and not relevant to tender offers given its basis on earlier cases that did not involve stock exchanges under such offers.

In *Texas International*, the court addressed a claim by the SEC under Section 14(b) of the Williams Act without making Section 16(b) the focal point of the discussion. The excerpt agrees with findings from the Eleventh Circuit in *Super Stores* and a district court in *T-Bar Inc.* that transactions under tender offers do not fall under the classification of "unorthodox transactions."

The Mesa Defendants argue that their stock-for-debt exchange resulting from Unocal's recapitalization should be considered an "unorthodox transaction," citing a footnote from *Kern County*. However, this footnote is described as non-essential to the *Kern County* opinion and does not directly address recapitalization. The excerpt suggests that the Supreme Court did not endorse the notion of recapitalization as "unorthodox" and that the defendants' reliance on two district court decisions to support their claim is unsubstantiated as neither case supports the conclusion they wish to draw. Specific findings from *Rothenberg* and *Hayes* are mentioned, indicating that changes in investment character or market risk are necessary for a violation under Section 16(b) to be established.

The district court ruled, based on precedent from Rothenberg, that exchanging old debentures for new ones by corporate directors did not constitute a sale under Section 16(b), as there was no change in investment amount or ownership percentage within the six-month period. However, the court clarified that a recapitalization that alters the nature of an owner’s investment and market risk qualifies as a sale under Section 16(b). In this case, the Mesa Defendants changed their investment from common stock, which was subject to market volatility, to negotiable debt securities that had a higher market value and guaranteed fixed payments.

The Mesa Defendants voluntarily opted to participate in Unocal's self-tender offer, exchanging common stock for these higher-value debt securities. This strategic decision, influenced by potential undisclosed tax benefits, indicated a clear change in both investment nature and market risk. The court determined that this exchange fell within the ambit of a sale per Section 16(b) and deemed it not an "unorthodox transaction," hence negating the need to investigate potential insider trading abuses.

Consequently, the court reversed the summary judgment in favor of the Mesa Defendants and directed the entry of an order granting Unocal's motion for summary judgment. Additionally, it was noted that Section 13(d) of the Securities Exchange Act mandates that anyone becoming a beneficial owner of more than 5% of any equity security must file a statement with the SEC within ten days of reaching that threshold. The document also referenced the Mesa Entities involved in the tender offer and provided context for the legal definitions and implications of the transactions discussed.