The Delaware Chancery Court has upheld a board of directors’ decision to implement a shareholder-rights plan (or “poison pill”) with a 4.99-percent stock ownership threshold trigger in order to protect the company’s net operating loss carryforwards (NOLs). Although Delaware courts have repeatedly upheld the adoption of poison pills as consistent with a board’s fiduciary duty and business judgment,1 this is the first time the Delaware courts have reviewed a board’s decision to adopt a pill intended to protect a valuable corporate asset as opposed to protecting against abusive takeover attempts — and also the first time a stockholder has ever intentionally triggered a poison pill.
In Selectica, Inc. v. Versata, Inc., C.A. No. 4241-VCN (Feb. 26, 2010), the Court ruled in favor of the directors of Selectica, Inc. and concluded the adoption of the pill and the directors’ subsequent actions in allowing the pill to dilute the ownership of the stockholder who deliberately bought through the 4.99-percent stock ownership threshold trigger, were valid exercises of the board’s business judgment based on:
- The Selectica board’s desire to protect the company’s $160-million NOLs, which would be impaired and therefore lose a substantial portion of their value upon an “ownership change” under Section 382 of the Internal Revenue Code
- The board’s multiple meetings to consider whether to adopt the pill and whether to exempt the actions of the acquiring stockholder from triggering the pill
- The directors’ reliance on financial, tax, and legal advisors
- The board’s offer to enter into a standstill agreement with the acquiring stockholder as an alternative to allowing the pill to dilute the acquiring stockholder’s ownership
- The board’s previous decision to hire an investment banker to explore strategic options, including the potential sale of the company
- The absence of any conflict of interest
Under the Unocal standard,2 the reviewing court applies enhanced scrutiny to the board’s adoption of anti-takeover measures such as the adoption of a poison pill, because of the risk that the board may be acting primarily to protect its own interests, rather than those of the corporation and its stockholders. Under Unocal, the directors must show they had reasonable grounds for believing that a danger to the corporation existed and that the defensive response was reasonable to the threat posed. The Court found the Selectica board satisfied this standard, and therefore the board’s decision to adopt the pill, and allow the acquiring stockholder’s stock ownership to be diluted by 50 percent after it acquired shares in excess of the 4.99-percent threshold, was entitled to deference under the business judgment rule.
The facts of the Selectica case were very favorable to the Court sustaining the board’s decisions. The directors appeared to be independent. The board had previously taken steps to put the company up for sale and actively solicit bids. The interest sought to be protected — the $160-million NOL — was the company’s most valuable asset. The Selectica board relied on the opinions of outside experts and considered the issues over many meetings. The acquiring stockholder, a long-time competitor, appeared to be using the threat of impairing Selectica’s NOL as the basis to coerce Selectica into making a variety of business concessions.
Selectica should not be interpreted as support for the proposition that a board can safely adopt a poison pill with a 4.99-percent ownership trigger in every circumstance. The Court acknowledged as much, stating that “[t]here is, of course, the risk that accumulated net operating losses could provide a convenient pretext for perpetuating a board-preferred shareholder structure. For this reason, shareholder rights plans, such as the ones adopted by Selectica, must be subject to careful review.”3 The Court in Selectica examined the totality of the facts and circumstances in reaching its conclusions, and companies and their advisors should carefully consider their own unique facts and circumstances, informed by the reasoning of the Selectica Court, in connection with the adoption of any shareholder rights plan.