Texaco's Star Falls

By Janice Castro

Never have the stakes in a corporate battle been higher. After losing a crucial decision in the U.S. Supreme Court last week, Texaco faced the disastrous prospect of having to post a $10 billion bond in its epic legal fight with Pennzoil. As its stock plummeted and its credit began to dry up, the company was thrown into a financial crisis. Over the weekend, Texaco's board of directors gathered for an emergency meeting at the firm's White Plains, N.Y., headquarters. Following a marathon discussion, the directors chose a stunning course: the eighth largest U.S. industrial corporation (1986 sales: $32.6 billion) and the third-ranking oil firm filed for Chapter 11 protection on Sunday. Texaco suddenly became the biggest company in American history to go into bankruptcy.

Texaco made that dismal choice only after frantic, repeated efforts to reach a settlement with Pennzoil produced no results. Within hours following the Supreme Court's ruling, Texaco Chairman Alfred DeCrane, 55, and Chief Executive James Kinnear, 59, flew with a battery of lawyers from White Plains to Pennzoil's home city of Houston. But Pennzoil's combative chairman, J. Hugh Liedtke, 65, who has stayed on past retirement age to fight the case, steadfastly refused at least ten settlement offers from Texaco. At the start of the talks, Texaco apparently had a figure of $500 million in mind, but Pennzoil was believed to have held out for at least $3 billion.

The dispute had taken on historic proportions in November 1985, when a Texas jury issued a $10.5 billion judgment against Texaco for inducing Getty Oil to break a merger agreement with Pennzoil. After more than 17 months of intricate legal maneuvers, the battle came down to a test of strength and nerve between resolute executives at two powerful corporations. In the end, neither side was willing to move far enough from its initial negotiating stance to reach an agreement.

Texaco left itself an escape hatch. Officials said that if a settlement was reached soon or a large reduction of the bond granted, then the company could withdraw or suspend the bankruptcy filing. In other words, Texaco could be using its bankruptcy as the ultimate pressure tactic against Pennzoil. Liedtke flew to New York City on Sunday.

Under Chapter 11 of the federal bankruptcy law, Texaco will be allowed to continue normal business operations. Its cash flow could actually improve because it will still receive sales revenue and yet be afforded relief from interest payments on its $9.1 billion in debts. But it could also lose a great deal of business because of uncertainty surrounding the Pennzoil case. Many of the jobs held by the company's 52,000 employees could be threatened. Moreover, Texaco will be under the strict supervision of a federal court. It will, for example, be forbidden to buy major oil reserves or other substantial assets without the approval of Texaco's creditors, or failing that, of the judge. Such restraints could hamstring the planning and undermine the future of a once mighty corporation.

The bankruptcy filing is a supreme irony since Texaco would be in robust financial health if it had never tangled with Pennzoil. In the U.S. alone, Texaco has 1.7 billion bbl. of oil reserves, worth $9.6 billion, and 5.l trillion cu. ft. of natural gas with a value of $3.l billion. Before last week, Wall Street analysts had projected Texaco's profits to be more than $650 million for this year and nearly $790 million in 1988.

With Texaco in Chapter 11, Pennzoil could be a loser as well. Instead of having a priority claim to Texaco's riches, the smaller company will have to get in line with all the other creditors of the bankrupt firm. Any payment to Pennzoil will not only be delayed, but might be far less than $10 billion.

When the Texas jury first pronounced the verdict against Texaco, the sum was so enormous that it seemed absurd. The award appeared certain to be reduced drastically on appeal. Almost no one believed that Pennzoil, the 200th largest U.S. industrial corporation (1986 sales: $1.78 billion) and the 20th biggest oil company, would be allowed to topple a titan about 18 times its size. But Texaco soon learned that it was dangerously vulnerable to an unusual provision of Texas law. In this case, it required Texaco to post a bond for roughly the full amount of the judgment while the company pursued appeals.

To avoid an immediate crisis, Texaco's lawyers quickly sought relief in a federal court in White Plains, N.Y. The judge ruled in January 1986 that Texaco's bond must be reduced to a more reasonable $1 billion. That gave the company some breathing space to file appeals, and the scene of battle returned to Houston, where much of the public was rooting for the hometown company against New York-based Texaco. Pennzoil Attorney Joseph Jamail was already becoming a folk hero there for jousting with the giant firm.

Last February a Texas appeals court reduced the penalty against Texaco -- but only to $8.5 billion. By that time the addition of 15 months' worth of interest and court costs to the $8.5 billion meant that Texaco still owed $10.2 billion. Under a court order, Texaco has been paying $2.5 million a day, $104,000 an hour, $1,736 a minute into an escrow account to cover interest on the judgment.

Last week's drama started unfolding early Monday in Washington, where the Supreme Court ruled 9 to 0 that the federal judge had acted improperly in reducing the size of Texaco's bond. The Justices said that the amount of the bond was a matter for the Texas courts to decide. For Texaco, a stable situation had suddenly become a crisis.

Texaco's DeCrane immediately called a press conference in White Plains to say that unless the company got new legal relief from having to post a $10 billion bond, it might be forced into bankruptcy proceedings. The company's legal team, led by David Boies of Manhattan-based Cravath, Swaine & Moore, obtained a temporary restraining order in Texas that barred Pennzoil from making any moves to seize Texaco's assets. Meanwhile, Kinnear called Pennzoil's Liedtke and asked for a face-to-face meeting in Houston. Liedtke agreed.

Kinnear knew that many of Texaco's creditors and suppliers were getting jumpy and that the Supreme Court decision might cause the whole situation to spiral out of control. In an affidavit filed in a Texas appeals court, Texaco outlined in detail the pressures it was under. Chase Manhattan had demanded that Texaco maintain new minimum balances in its accounts before the bank would transfer funds to satisfy commercial obligations. Worse, Manufacturers Hanover Trust had canceled a $750 million line of credit.

At the same time, some of Texaco's suppliers were refusing to do business, or setting tougher terms. According to the Texaco affidavit, Venezuela's state-owned oil companies had at least temporarily stopped pumping oil for Texaco. (Venezuela denies that it has cut Texaco off.) Southern California Edison started requiring Texaco, its largest customer, to pay its electric bill every week.

As the walls seemed to be closing in on their firm, Texaco's DeCrane and Kinnear, along with Lead Attorney Boies and a legion of advisers and secretaries, arrived in Houston on Monday night for their confrontation with Pennzoil. They settled into Lamar Towers, a posh condominium development. On Tuesday afternoon at 1, Liedtke arrived with his corporate and legal staff, including former Pennzoil President Baine Kerr and Lead Attorney Jamail.

Kinnear brought out a typewritten note that outlined what Texaco would be willing to put up for a bond while the case remained on appeal. After two hours of discussion, Liedtke declined the offer. The sides agreed to meet again the following afternoon in a Houston condominium owned by Pennzoil.

That next meeting was limited to Kinnear, DeCrane, Liedtke and Kerr. Kinnear arrived with a new proposal in hand to resolve the bond question. As the four men argued the matter over coffee and soft drinks, they began to discuss the possibility of a comprehensive settlement that would end the legal battle altogether, according to sources close to Texaco. After the meeting broke up, Kinnear sent another proposal to Liedtke. His response: No deal. In the meantime, Jamail was telling the press that no discussions about a final settlement were being held. Texaco accused Jamail of making misleading statements about the talks, perhaps to spook Texaco's creditors and put a squeeze on the company.

The negotiations continued through Thursday. Between meetings with Pennzoil, DeCrane and Kinnear were huddling with their team of advisers, including Boies, Investment Banker Donald Brennan of Morgan Stanley, and Gibson Gayle, a lawyer with the Houston firm of Fulbright & Jaworski. Several members of Texaco's board of directors hastily flew to Houston, among them Robert Beck, former chairman of Prudential Insurance, and Frank Cary, former IBM chairman. Other directors, including Thomas Murphy, chairman of Capital Cities/ABC, went to Texaco's White Plains headquarters to join the talks via conference calls. All week long board members debated whether or not the company should file for Chapter 11. Some directors feared that creditors might force Texaco into involuntary bankruptcy.

A source close to the negotiations said that by Thursday night Texaco had presented Pennzoil with four proposals regarding the bond dispute and five possible final settlements. "Pennzoil rejected each offer," he recalled. "But they refused to make any counteroffers." Pennzoil's attorneys argued that Texaco's offers were all similar and grossly inadequate.

Liedtke and Kinnear talked twice by phone on Friday. Kinnear sent over one last proposal, and Liedtke rejected it. That evening Kinnear and DeCrane gave up and flew back to New York. Texaco's lawyers then filed an affidavit with the Texas appeals court in which the company swore that it could not afford to put up more than $500 million in additional assets for a bond. The maneuver seemed designed to put extra pressure on Pennzoil to accept a settlement. In response, Pennzoil proposed to the court that Texaco could set aside assets worth about $5 billion for a bond without being forced into Chapter 11. Said Pennzoil Attorney Irvin Terrell: "Everyone has a constitutional right to file for bankruptcy, but it would be absolutely irresponsible for them to do so."

Now that Texaco has chosen that route, its battle with Pennzoil will go on. Under the protection and supervision of a bankruptcy judge, Texaco will undoubtedly keep fighting the most gargantuan legal judgment in history. If it exhausts all appeals in the Texas courts, the company's survival could once again wind up in the hands of the nine Justices of the U.S. Supreme Court.

With reporting by B. Russell Leavitt/Atlanta and Thomas McCarroll/New York