The Delaware Supreme Court, in Versata Enterprises, Inc v Selectica, Inc, Del No 193, 2010 (October 4, 2010), upheld a shareholder rights plan (or poison pill) with a 4.99-percent stock ownership threshold trigger intended to protect a company's net operating loss carryfowards (NOLs). Although Delaware courts have repeatedly upheld the adoption of poison pills to protect against abusive takeover attempts as consistent with a board's fiduciary duty and business judgment,1 this is the first time the Delaware Supreme Court has reviewed a board's decision to adopt a pill intended to protect NOLs. Versata also involves the first time a pill has actually been used to dilute the acquiror's stock ownership.
Selectica had accumulated $160 million of NOLs that could be carried forward to reduce future taxable income. The Internal Revenue Code significantly limits a company's ability to use its NOLs if the company undergoes a “change of ownership” of more than 50 percent by one or more five-percent shareholders within a three-year period.2
The Selectica board set the poison pill trigger at 4.99 percent to protect against additional persons becoming five-percent shareholders and potentially triggering a “change of ownership” and substantial limits on the use of the NOLs.
Trilogy was a competitor of Selectica in the software business. Trilogy had previously sued Selectica for patent infringement and made several unsuccessful offers to buy the company.
Trilogy deliberately bought through the stock ownership trigger of Selectica's NOL pill. Trilogy management testified it wanted to “force the board to make a decision.”
Selectica responded by distributing additional shares to all shareholders other than Triology, as permitted by the “exchange” provision of the Selectica pill, thereby diluting Trilogy's ownership from six percent to three percent.
The Court ruled Selectica's adoption and implementation of the pill were valid exercises of the board's business judgment based on:
- The Selectica board's desire to protect the company's $160 million NOLs that would be impaired, and therefore lose a substantial portion of their value, upon an “ownership change”
- The board's multiple meetings to consider whether to adopt the pill and whether to exempt Trilogy's actions from triggering the pill
- The directors' reliance on financial, tax, and legal advisors
- The board's offer to enter into a standstill agreement with Trilogy as an alternative to exercising the pill
- 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,3 courts apply enhanced scrutiny to the board's adoption of anti-takeover measures, such as the adoption or exercise of a poison pill, because of the risk the board may be acting primarily to protect its own interests, rather than those of the corporation and the shareholders. 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 in response to the threat posed.
The Court found that the Selectica board carried its burden of proof under both parts of the Unocal test. However, the Court emphasized that the adoption of the poison pill is not absolute, but must be evaluated in relation to the specific defensive circumstances at any given time. The Court cautioned that “the fact that the NOL Poison Pill was reasonable under the specific facts and circumstances of this case, should not be construed as generally approving the reasonableness of a 4.99 percent trigger in a Rights Plan of a corporation with or without NOLs.”4