Caseflicks

Supreme Court of Delaware • 1985

Unocal Corp. v. Mesa Petroleum Co.

493 A.2d 946 | 1985 Del. LEXIS 482

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Takeaway

In short, this case established the Unocal enhanced-scrutiny standard: a target board may resist a hostile bid if it reasonably identifies a threat after good-faith investigation and adopts a response proportionate to that threat.

Background

Mesa Petroleum, controlled by T. Boone Pickens, owned about 13% of Unocal and launched a two-tier, front-loaded tender offer. Mesa offered $54 cash per share for enough shares to obtain control, then planned a second-step merger in which remaining shareholders would receive highly subordinated debt and preferred securities. Unocal’s board reasonably viewed the back-end securities as worth substantially less than $54 and as creating pressure for shareholders to tender immediately, even at an inadequate price.

After lengthy meetings and advice from independent financial and legal advisers, Unocal’s board—whose majority consisted of independent outside directors—rejected Mesa’s bid as grossly inadequate. It then adopted a self-tender exchange offer: if Mesa obtained control, Unocal would offer the remaining shareholders senior debt securities with a $72 aggregate par value per share. The offer expressly excluded Mesa. The board concluded that allowing Mesa to participate would both finance Mesa’s inadequate bid and reduce the protection available to shareholders facing Mesa’s back-end merger.

The Court of Chancery initially restrained the exchange offer unless Mesa could participate, then granted Mesa a preliminary injunction. Although the Vice Chancellor found that Unocal’s directors acted in good faith in viewing Mesa’s offer as inadequate, the court held that the business-judgment rule did not protect a selective exchange offer and required Unocal to show a valid corporate purpose and fairness to all shareholders, including Mesa. The Delaware Supreme Court accepted an expedited interlocutory appeal, reversed, and vacated the injunction.

Issues

Issue #1

Whether Unocal’s board had authority and a fiduciary duty to resist Mesa’s hostile tender offer through a selective self-tender exchange offer.

Holding

Yes. Unocal’s board had both the power and the duty to protect the corporate enterprise and its shareholders from a takeover threat it reasonably perceived as harmful.

Reasoning

Delaware law gives directors broad authority to manage the corporation’s business and affairs under 8 Del. C. § 141(a), and it authorizes a corporation to acquire and deal in its own shares under § 160(a). Those statutory powers, together with directors’ fiduciary obligation to protect the corporation, permit a board to respond affirmatively to a hostile bid rather than remain passive.

Delaware precedent already permitted selective stock repurchases when directors were not acting solely or primarily to entrench themselves. The Court therefore rejected a categorical rule that a corporation may never exclude a hostile bidder from a self-tender merely because the bidder is also a shareholder.

The board’s duty runs to the corporate enterprise and its shareholders as a whole, even when the perceived threat comes from another shareholder. Mesa retained the right to pursue its own economic interests, but Unocal was not required to confer the benefits of its defensive response on the party whose coercive proposal created the danger being addressed.

Issue #2

What standard governs judicial review of directors’ defensive measures in response to a hostile takeover bid.

Holding

A defensive measure receives business-judgment-rule protection only after directors show reasonable grounds, based on good faith and reasonable investigation, for believing that a threat to corporate policy and effectiveness exists; the response also must be reasonable in relation to the threat posed.

Reasoning

The ordinary business judgment rule presumes that directors acted on an informed basis, in good faith, and in the honest belief that their decision served the corporation’s best interests. But the threat of self-interested entrenchment is especially acute when a board acts to resist a takeover, so judicial review begins with an enhanced threshold inquiry before ordinary deference applies.

Under Cheff v. Mathes, directors must demonstrate reasonable grounds for believing that the bidder’s ownership or offer posed a danger to corporate policy and effectiveness. They meet that burden by showing good faith and reasonable investigation. Approval by a majority of independent outside directors materially strengthens the showing because it reduces the risk that the measure principally served incumbent management.

Even a good-faith response cannot be unlimited or Draconian. The board must show proportionality: its defensive measure must be reasonable in relation to the threat it identified. In evaluating a bid, directors may consider price inadequacy, timing and structure, illegality, risk of nonconsummation, the quality of consideration, effects on constituencies, and the interests of long-term shareholders facing coercive pressure.

Issue #3

Whether Unocal satisfied that standard by excluding Mesa from its $72-per-share exchange offer.

Holding

Yes. Unocal reasonably concluded that Mesa’s inadequate, coercive two-tier offer and apparent greenmail objective posed a threat, and the Mesa exclusion was a proportionate response.

Reasoning

The record supported Unocal’s conclusion that Mesa’s $54 front-end cash offer was materially inadequate. Unocal’s financial advisers valued the company above $60 per share, while the planned back-end consideration consisted of deeply subordinated, highly leveraged securities that the board reasonably viewed as worth far less than the stated $54 value.

Mesa’s two-tier structure was inherently coercive. Shareholders could rationally fear being left with inferior back-end securities if they did not tender into the first-tier cash offer, which could stampede them into accepting an inadequate price. The board also had grounds to infer from Mesa’s history and conduct that Mesa sought greenmail or other selective premium treatment rather than a transaction beneficial to Unocal’s shareholders generally.

Unocal’s exchange offer addressed the threat directly. It gave the shareholders who otherwise could be forced into Mesa’s inferior back-end merger an opportunity to receive senior debt with a $72 aggregate par value. Allowing Mesa to tender would have displaced shares held by those shareholders and would effectively have used Unocal’s assets to subsidize Mesa’s own inadequate acquisition proposal.

The directors’ participation in the exchange offer did not create a disabling personal interest. Once the Mesa exclusion was valid, the directors received the same benefit offered to all shareholders other than Mesa, not a special benefit unavailable to the general shareholder body. On the findings that the board was informed, acted with due care and good faith, and consisted largely of independent directors, its decision was entitled to business-judgment-rule protection.