Greenmail

Quick facts

• What it is: a targeted buyback of a hostile holder's shares at a premium
• The name: "greenback" plus "blackmail"
• Tax treatment: 50% excise tax on the recipient, under 26 U.S.C. § 5881
• Statutory trigger: stock held under two years, plus a takeover offer
• Status: effectively obsolete

Greenmail is a company buying back a hostile shareholder's stake at above the market price, on the understanding that the shareholder will go away. Everyone else's shares stay where they are, at the price they were already worth.

It was a defining tactic of the 1980s takeover era, and it is now largely a historical term, because Congress taxed it out of existence.

In plain English

An investor accumulates a large position and makes it clear they intend to pursue the company. Management would rather not fight. So the company uses its own cash to buy that investor out at a premium, and the investor leaves with a profit.

The company is poorer. The threat is gone. The other shareholders received nothing and paid for all of it.

Why a company could do this at all

Delaware gives a corporation broad power to deal in its own shares, including the power to purchase and hold them.¹ Nothing in the statute requires a buyback to be offered to everyone, which is precisely the gap greenmail occupied. A company could single out one shareholder.

Note the contrast with a public tender offer, where the all-holders and best-price rules force equal treatment. Greenmail worked because a privately negotiated repurchase is not a tender offer.

What it looked like in practice

Unocal Corp. v. Mesa Petroleum Co. records the pattern in a court's own words. Mesa, "the owner of approximately 13% of Unocal's stock, commenced a two-tier 'front loaded' cash tender offer for 64 million shares, or approximately 37%, of Unocal's outstanding stock at a price of $54 per share," with a back-end designed to eliminate the remaining public shares by exchanging securities "purportedly worth $54 per share."²

The Unocal board's assessment was explicit. The threat was "a grossly inadequate two-tier coercive tender offer coupled with the threat of greenmail."²

Unocal's response was not to pay. It ran its own self-tender that excluded Mesa, which the Delaware Supreme Court described as "an issue of first impression in Delaware, the validity of a corporation's self-tender for its own shares which excludes from participation a stockholder making a hostile tender offer."²

The court upheld it, concluding "the device Unocal adopted is reasonable in relation to the threat posed, and that the board acted in the proper exercise of sound business judgment."²

That is the useful lesson. Faced with a greenmail demand, the board had an alternative to paying, and the alternative was the one that survived review.

What killed it

Section 5881 of the Internal Revenue Code: "There is hereby imposed on any person who receives greenmail a tax equal to 50 percent of gain or other income of such person by reason of such receipt."³

The statute defines the target carefully. Greenmail means consideration transferred by a corporation to acquire its own stock from a shareholder where that shareholder held the stock for less than two years before the agreement, and where during the preceding two-year period the shareholder or a related party made or threatened a tender offer.³

Fifty percent of the gain is not a deterrent at the margin. It removes the profit that made the trade worth doing, and it falls on the raider rather than the company, so the party being paid loses the reason to accept.

What replaced it

The defensive toolkit moved on. A poison pill prevents the accumulation in the first place rather than paying to unwind it. A standstill agreement achieves a negotiated truce without a premium changing hands. And activists themselves changed tactics, pursuing board seats through a proxy fight rather than seeking to be bought out.

The modern activist wants influence over the company. The greenmailer wanted a cheque.

What this means for a founder

The exact mechanic will never reach a private company, but the underlying dynamic does: an uncomfortable shareholder asking to be bought out at a premium.

That conversation happens regularly at private companies, usually with a departing co-founder or an early investor who wants liquidity. The considerations are the same ones that made greenmail objectionable. Company cash is being used for one holder's benefit. The price is not available to anyone else. And the board approving it may not be disinterested.

If you find yourself in that negotiation, the questions worth asking are whether the repurchase price can be justified against a defensible valuation, whether disinterested directors approved it, and whether other holders have a contractual right to participate. A repurchase is not wrong. An undocumented one is a problem waiting for a later dispute.

Related reading

• Poison Pill covers the defence that made greenmail unnecessary
• Standstill Agreement covers the negotiated version of making someone go away
• White Knight covers finding a friendlier buyer instead
• Tender Offer covers the equal-treatment rules greenmail avoided

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Sources

1. 1
   Delaware General Corporation Law § 160: Corporation's powers respecting ownership of its own shares
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2. 2
   Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985)
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3. 3
   26 U.S.C. § 5881: Greenmail, 50 percent excise tax
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