June 3 (Bloomberg) -- Microsoft Corp. offered $40 a share for Yahoo! Inc. in January 2007 only to have its bid rebuffed, according to court papers unsealed in a lawsuit over the failed buyout.

Lawyers for Yahoo investors said executives ``gave the back of their hand'' to Microsoft's efforts to negotiate a friendly buyout, according to papers unsealed yesterday in Delaware Chancery Court. Some Yahoo shareholders seek to hold Chief Executive Officer Jerry Yang and other directors liable for failing to accept the offer. Yahoo's shares closed yesterday at $26.40.

``Whoever's suing the Yahoo management and board of directors, if they had a $40 offer and didn't take it, they're going to want to cut their throats for being that stupid,'' BP Capital LLC Chairman T. Boone Pickens, a Yahoo shareholder, told Bloomberg television in an interview yesterday. ``Anybody who sued them has got a good lawsuit, I'd say. I'd hate to be on that board of directors right now.''

Microsoft, the world's largest software company, dropped a $33 a share bid for Yahoo, owner of the second-most-popular computer search engine, on May 3 because the two couldn't agree on a price. Microsoft Chief Executive Officer Steve Ballmer was willing to pay $40 a share last year to help the Redmond, Washington-based company compete with top search site Google Inc., according to the complaint.

Yang used his power as CEO ``to delay, to refuse to negotiate in good faith and to erect roadblocks'' to Microsoft's bid, investors said in an amended complaint.

Chancery Judge William B. Chandler III ruled yesterday that Sunnyvale, California-based Yahoo couldn't keep parts of the complaint secret.

Buyout `Coming Together'

A buyout agreement between Microsoft and Yahoo is still ``slowly coming together,'' said Gene Munster, an analyst at Piper Jaffray Cos. in Minneapolis with a neutral rating on Yahoo shares. The investor suit is ``an entertaining sideshow that emphasizes the point that Yahoo could have handled this better.''

Activist investors such as billionaire Carl Icahn have bought Yahoo stock since May 3, when Microsoft scrapped its $47.5 billion bid for the company after the board deemed it too low. Icahn has threatened to oust the directors if they don't make a deal with Microsoft, the world's biggest software maker.

Icahn has proposed his own slate of directors and won support from John Paulson's Paulson & Co., Pickens and investor Daniel Loeb, who have taken stakes in Yahoo. All of Yahoo's directors must stand for re-election at its next shareholder meeting, set for the end of July.

Thwart Microsoft

As part of the Delaware suit, shareholders are seeking to hold directors financially liable for snubbing the Microsoft bid and for setting up an expensive employee-severance plan in case the company is bought out.

Investors contend Yang designed the severance plan to thwart Microsoft's offer by giving employees incentives to quit rather than work for the acquirer and ignored the advice of an executive-compensation expert his company hired.

Yang insisted on a more expensive plan than his human- resources executives originally proposed, the investors claim. Yahoo estimated that the final plan would cost as much as $2.1 billion if Microsoft bought the company for $31 a share and all the employees left, according to unsealed court documents.

Timothy Sparks, a compensation consultant hired by Yahoo, warned executives that structuring the severance plan to allow workers to get payments if there were ``significant adverse alterations'' in their job duties would cause mass defections, according to a brief filed by investors that also was unsealed yesterday.

Consultant Ignored

``Yahoo management ignored Sparks and proposed imposing on Microsoft the incredibly expensive problem of an entire workforce incentivized to walk out and claim severance benefits,'' investors' lawyers said.

He also noted Yahoo's severance plan compensates senior executives ``very aggressively'' by accelerating their stock options and restricted stock rights.

Under the plan, Yahoo's 13,000 employees can get between 24 months and four months worth of pay depending on their positions, according to papers unsealed along with the briefs.

Executives can get two years pay if they leave while lower- level managers and others can get a year or six months, the papers said.

`Good Cause'

Yahoo's executives pushed Chandler to keep details about the severance plan secret when it was originally filed May 16, saying the material may be misused ``in its upcoming proxy contest,'' the judge noted.

``The severance plans we established were part and parcel of the company's plan to maximize shareholder value,'' said Yahoo spokeswoman Diana Wong. ``It was enacted to protect our greatest asset, our people.''

The judge ruled the company couldn't show ``good cause'' to continue keeping the material sealed since it was ``neither privileged nor confidential.'' Bloomberg News was among news services that asked Chandler to unseal the details.

Microsoft fell 52 cents to $27.80 in Nasdaq Stock Market trading yesterday. The shares have fallen 9.1 percent in the past year. Yahoo fell 36 cents, bringing the past year's decline to 8.3 percent.

The case is Police and Fire Retirement System of the City of Detroit v. Yahoo, CA3561, Delaware Chancery Court (Wilmington).

To contact the reporter on this story: Jef Feeley at jfeeley@bloomberg.net.

Last Updated: June 3, 2008 00:01 EDT