Unocal Union Oil Company of California, and its holding company Unocal Corporation, together known as Unocal was a major petroleum explorer and marketer in the late 19th century, through the 20th century, and into the early 21st century. It was headqu ...

v. Mesa Petroleum Co.'', 493 A.2d 946 (Del. 1985) is a

landmark decision Landmark court decisions, in present-day common law legal systems, establish precedents that determine a significant new legal principle or concept, or otherwise substantially affect the interpretation of existing law. "Leading case" is commonly u ...

of the

Delaware Supreme Court The Delaware Supreme Court is the sole appellate court in the United States state of Delaware. Because Delaware is a popular haven for corporations, the Court has developed a worldwide reputation as a respected source of corporate law decisions, ...

on corporate defensive tactics against take-over bids. Until the ''Unocal'' decision in 1985, the Delaware courts had applied the

business judgment rule The business judgment rule is a case law-derived doctrine in corporations law that courts defer to the business judgment of corporate executives. It is rooted in the principle that the "directors of a corporation... are clothed with hepresumptio ...

, when appropriate, to takeover defenses, mergers, and sales. In ''Unocal'', the Court held that a board of directors may only try to prevent a take-over where it can be shown that there was a threat to corporate policy and the defensive measure adopted was proportional and reasonable given the nature of the threat. This requirement has become known as the ''Unocal'' test for board of directors (as later modified in '' Unitrin, Inc. v. American General Corp.'', which required the tactics to be "coercive" or "preclusive" before the court would step in).

Background

Facts

Mesa Petroleum had made a front-end loaded two-tiered hostile bid for

Unocal Corporation Union Oil Company of California, and its holding company Unocal Corporation, together known as Unocal was a major petroleum explorer and marketer in the late 19th century, through the 20th century, and into the early 21st century. It was headqu ...

in which the front end was $54 in cash, and the back end of the deal was $54 in

junk bonds In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit events ...

. Because most shareholders would prefer to receive the cash instead of the bonds, shareholders were expected to tender their shares into the deal, even if they did not think $54 was a fair price. If a shareholder declined to tender, that shareholder risked being cashed-out for $54 in risky debt instruments instead of cash. In response to the Mesa tender offer, Unocal made a self-tender at $72 for all but the Mesa shares. The Unocal board attempted to launch a self-tender offer to combat an unsolicited tender offer by Mesa Petroleum (Mesa). The self-tender offer would be triggered upon Mesa acquiring sixty-four million shares of Unocal, and would mean that Unocal itself would buy-back 49% of the outstanding shares of Unocal - but none of the shares to be bought-back could be shares held by Mesa.

Court of chancery

The trial court found that this selective exchange offer was not legally permissible, and issued a preliminary injunction against the use of the self-tender offer defense.

Judgment

The Delaware Supreme Court reversed the trial court. It found that the Unocal's board of directors had reasonable grounds for believing that a danger to corporate policy or effectiveness existed and that the response was reasonable in relation to the threat posed. This reasonable relation analysis permitted an analysis of the price, nature, and timing of the offer as well as the impact on shareholders, creditors, customers, employees, and the community. Note that this permission to consider other constituencies besides the shareholders was curtailed in ''

Revlon v. MacAndrews ''Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.'', 506 A.2d 173 (Del. 1986), was a landmark decision of the Delaware Supreme Court on hostile takeovers. The Court declared that, in certain limited circumstances indicating that the "sale" or ...

''. ''The Unocal'' test the court established in this case to determine whether directors may try to prevent a take-over is a two pronged test. The two prongs include: * First, did the directors reasonably perceive a threat? And, * Second, was the directors' defensive measure reasonable in relation to the threat posed? Note that whereas ''

Cheff v. Mathes ''Cheff v. Mathes'', 199 A.2d 548 (Del. 1964), was a case in which the Delaware Supreme Court first addressed the issue of director conflict of interest in a corporate change of control setting. This case is the predecessor to future seminal c ...

'' had sanctioned

greenmail Greenmail or greenmailing is the action of purchasing enough shares in a firm to challenge a firm's leadership with the threat of a hostile takeover to force the target company to buy the purchased shares back at a premium in order to prevent the ...

, or payment to the raider to go away, in Unocal the court sanctioned reverse greenmail, or payment to shareholders excluding the raider.

Analysis

The significance of the opinion flows from the court's premise that, due to the inherent conflict of interest involved, takeover defenses pose a significant danger to shareholders. In essence, the Unocal court feared that a board may use takeover defenses to impermissibly prevent threats to corporate policy or to the board's control over the corporation. As a result, there was a need for "an enhanced duty" on the board, so as to ensure that their decisions in this area were meant only to further the welfare of the corporation and its shareholders. Therefore, the court ruled that in order for the board to be allotted the protection of the business judgment rule, the board must demonstrate that it was responding to a legitimate threat to corporate policy and effectiveness, and that its actions were "reasonable in relation to the threat posed."Id. at 955.

Notes