On February 26, the Delaware Chancery Court issued its long-awaited opinion in the case of Selectica, Inc. v. Versata Enterprises, Inc. The opinion is the culmination of a closely watched legal battle between Selectica’s directors, who sought judicial validation of their use of a poison pill to protect Selectica’s tax assets, and defendants Versata Enterprises, Inc. and Trilogy, Inc., who had deliberately triggered the pill and sought to invalidate its provisions, reverse its effects and recover damages. The court ultimately validated the poison pill, upholding the Selectica directors’ adoption and implementation of a shareholder rights plan, and their subsequent decision to dilute an acquiring person who deliberately crossed the pill’s triggering threshold to effect a takeover.
In order to prevent a takeover by Trilogy, the Selectica directors: (1) amended the company’s poison pill to decrease the beneficial ownership trigger from 15% to 4.99%; (2) implemented an exchange feature in the poison pill that doubled the amount of outstanding common stock held by each stockholder other than Trilogy and Versata; and (3) “reloaded” the pill by declaring a new dividend of purchase rights on similar terms that would become exercisable after another triggering event. Thereafter, Selectica sought a court order validating the amendments to the pill, the exercise of the exchange feature and the decision to “reload” the pill. Trilogy contended that the same conduct was invalid and requested rescission, redemption of the “reloaded” pill and money damages for breach of fiduciary duty.
The court applied the familiar two-pronged Unocal test to determine the validity of the challenged conduct. Under the first prong of the Unocal test, the “directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed.” Under the second prong, the board must demonstrate that “its defensive response was reasonable in relation to the threat posed.” A defensive response will not survive Unocal scrutiny if it is determined to be disproportionate, i.e., coercive or preclusive. A measure is coercive if it is aimed at “cramming down” on shareholders management’s preferred course of action; a measure is preclusive if it renders an alternative transaction “mathematically impossible” or “realistically unobtainable.”
Under the first prong of Unocal, the court found that the board had reasonable grounds to conclude that Trilogy and Versata presented a threat to a valid corporate objective—the preservation of the company’s net operating loss carryforwards (NOLs). The court found that “a board may properly conclude that the company’s NOLs are worth protecting where it does so reasonably and in reliance on expert advice”, notwithstanding the fact that there was no certainty, or even a confirmed probability, that Selectica would ever be able to realize the value of its NOLs. Central to the court’s analysis was the board’s reliance on outside financial, tax and legal advisors.
Under the second prong of Unocal, the court found that the amended 4.99% beneficial ownership trigger under the shareholder rights plan was neither “preclusive” nor “coercive,” because the pill did not render a successful proxy contest by Trilogy “a near impossibility or else utterly moot.” The court recognized that a pill triggered at 4.99% was unusual (though not unprecedented), but determined that this low threshold was permissible given the risk that additional share purchases by Trilogy could lead to a “change in control” under IRS regulations that would preclude any possibility of Selectica ever realizing the value of its NOLs. Notably, the court left open the possibility that a 4.99% trigger might be inappropriate in other circumstances—“As a result of its unique objective, a pill designed to protect NOLs necessitates precluding a lesser accumulation of shares than might be appropriate for a pill designed to prevent a hostile acquirer from establishing a control position in the company.”
Finally, the court concluded that the use of the rights plan fell within Unocal’s “range of reasonableness,” finding the board’s response reasonable in response to the conduct of a “longtime competitor” who “sought to employ the shareholder franchise intentionally to impair corporate assets, or else to coerce the company into meeting certain business demands under the threat of such impairment.” Significantly, the opinion indicates that the proportionality analysis required by the second prong of the Unocal test does not require a board’s response to be perfect, or even “narrowly tailored” to correspond to the identified threat. Instead, the response need only be reasonable under the circumstances. (Selectica, Inc. v. Versata Enters., Inc., C.A. No. 4241-VCN, 2010 WL 703062 (Del. Ch. Ct. February 26, 2010))