Versata Enterprises, Inc. v. Selectica, Inc., No. 193, 2010 (Del. Supr., Oct. 4, 2010), read opinion here. In this 51-page decision, the Delaware Supreme Court affirmed the Court of Chancery’s 71-page decision in Selectica, Inc. v. Versata, Inc., C.A. No. 4241-VCN, 2010 WL 703062 (Feb. 26, 2010), which was summarized on this blog here.
Delaware’s High Court upheld the board’s adoption of a poison pill rights plan with a 4.99% triggering threshold, designed to protect the corporation’s net operating losses ("NOLs"), and a special committee’s subsequent decision to deploy the rights plan to dilute the triggering stockholder. Much more can be, and will be, written about this decision in the days to come.
Supplement: Professor Gordon Smith provides a scholarly review of the decision here.
Kevin F. Brady of Connolly Bove Lodge and Hutz, LLP, provides the following supplemental review of the opinion:
DELAWARE SUPREME COURT AFFIRMS APPROVAL OF POISON PILL INVOLVING NET OPERATING LOSSES
On October 4, 2010, the Delaware Supreme Court affirmed the Court of Chancery’s decision approving Selectica’s use of a unique shareholder rights plan poison pill with a 4.99% trigger. Citing the standard set forth in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (1985), the Supreme Court supported Selectica’s exercising the pill to protect the company’s net operating losses (NOLs) as a proper exercise of business judgment.
Trilogy and Versata Challenge the Use of Unocal Test on Appeal
On appeal, Trilogy and Versata claimed that instead of applying the Unocal test of enhanced scrutiny, the correct question before the Supreme Court was “what are the minimum requirements for a reasonable investigation before the board of a never-profitable company may adopt a [Rights Plan with a 4.99% trigger] for the ostensible purpose of protecting NOLs from an ‘ownership change’ under Section 382 of the Internal Revenue Code?” Second, Trilogy and Versata argued that the Court of Chancery “erred in holding that the two NOL poison pills, either individually or in combination with a charter-based classified Board, did not have a preclusive effect on the shareholders’ ability to pursue a successful proxy contest for control of the Company’s board.” The Supreme Court dismissed both of Trilogy and Versata’s arguments.
Court Affirms Application of Unocal Standard
The Supreme Court agreed with the Court of Chancery’s decision that “the protection of company NOLs may be an appropriate corporate policy that merits a defensive response when they are threatened.” Even though a NOL poison pill was primarily designed to prevent the forfeiture of potentially valuable assets, it also has the effect of acting as an anti-takeover device. Thus, the Unocal test scrutiny was the appropriate test.
Court Finds Threat Reasonably Identified
In considering the first prong of the Unocal standard, the Supreme Court noted that the Selectica Board had concluded that NOLs were important corporate assets, that the appellants’ actions posed a threat to the corporate enterprise, that their protection was an important corporate objective and that the board properly conducted an investigation. The Supreme Court agreed with the Court of Chancery’s finding that the record was “replete with evidence” that the Board acted reasonably. The Board had met for a number of hours, with legal and investment banking experts in attendance to educate the Board. In addition, the Supreme Court pointed to: 1) Trilogy’s status as “a competitor with a contentious history;” 2) the potential harm to Selectica if the requisite amount of shares were purchased; and 3) the fact that the threshold for the pill was driven by Section 382 of the IRC – “an external standard, one created neither by the Board nor by the Court [of Chancery].” Accordingly, the Supreme Court determined that the Court of Chancery’s findings were not clearly erroneous.
Selectica Defenses Not Preclusive
In considering the second prong of the Unocal standard, the Court, citing Unitrin, Inc. v. American General Corp., 651 A.2d 1361, 1383, 1387 (Del. 1995), held that the Selectica Board’s response was not preclusive or coercive. A board’s defensive measure is preclusive when it “makes a bidder’s ability to wage a successful proxy contest and gain control either ‘mathematically impossible’ or ‘realistically unattainable.’” Similarly, a measure is coercive when it “is aimed at ‘cramming down’ on its shareholders a management-sponsored alternative.” Trilogy asserted that the Rights Plan rendered a potential proxy contest “realistically unattainable.”
In this case, the record supported the Court of Chancery’s conclusion that that the NOL Poison Pill and Reloaded NOL Poison Pill were not preclusive. Trilogy’s argument that “the 4.99% pill trigger prevents a potential dissident from signaling its financial commitment to the company so as to establish . . . credibility” was to no avail. Rather, the Supreme Court held that the 5% trigger for a NOL poison pill is necessarily lower than the triggers for rights plans that have traditionally been adopted and upheld as acceptable anti-takeover defenses by the courts because of the objective to protect NOLs. Selectica’s expert corroborated this conclusion – identifying more than fifty publicly held companies with NOL poison pills with similar triggers. Another Selectica expert testified that in 10 of 15 proxy solicitations where a challenger controlled approximately 5% of the shares in micro-cap companies, the challenger was able to get a seat on the board.
The Supreme Court also rejected an argument from Trilogy that preclusivity exists unless a successful proxy contest is both reasonably attainable and will result in gaining control of the board. The Supreme Court disagreed: “[t]he fact that a combination of defensive measures makes it more difficult for an acquirer to obtain control of a board does not make such measures realistically unattainable, i.e., preclusive.”
Range of Reasonableness
The Supreme Court also affirmed the Court of Chancery’s holding that all of the Board’s defenses, taken as a whole, were reasonable in relation to the perceived threat. In particular, the Court noted that the Selectica Board on three separate occasions attempted to negotiate and reach a settlement with Trilogy. On each occasion, Trilogy rebuked the offers leaving the Selecta Board with no choice but to implement the NOL Poison Pill.
Likewise, the implementation of the Reloaded NOL Poison Pill was also reasonable. When implemented, Selectica still faced a potential ownership change under Section 382. Plus, the Rights Plan was no longer in place to deter acquisitions. Given the value with which Selectica viewed the NOLs, its defenses were reasonable.
Context Determines Reasonableness
While the Supreme Court held that the Selectica Board carried its burden under Unocal, that does not mean the poison pills will always satisfy Unocal. As the Court noted, “we have upheld the adoption of Rights Plans in specific defensive circumstances while simultaneously holding that it may be inappropriate for a Rights Plan to remain in place when those specific circumstances change dramatically.” The Supreme Court made clear that it was not generally approving a 4.99% trigger in the rights’ plan of a corporation with or without NOLs. Rather, reasonableness is dependent on the particular circumstances. “If and when the Selectica Board ‘is faced with a tender offer and a request to redeem the [Reloaded NOL Poison Pill], they will not be able to arbitrarily reject the offer. They will be held to the same fiduciary standards any other board of directors would be held to in deciding to adopt a defensive mechanism.’”