In this en banc opinion affirming the Court of Chancery’s post-trial decision, the Supreme Court of Delaware held that the lower court did not err in applying the Unocal test to a low-trigger shareholder rights plan, or poison pill, designed to protect the corporation’s net operating losses (“NOL”), or in holding that the company’s two NOL poison pills did not have a preclusive effect on the shareholders’ ability to pursue a successful proxy contest.
NOLs are tax losses realized and accrued by corporations that can be used to shelter future or immediate past income from taxation. Under Internal Revenue Code Section 382, the amount of prior NOLs that can be used is limited in periods following an “ownership change,” which occurs when more than 50% of a firm’s stock ownership changes over a three-year period. Most importantly for purposes of this case, the only shareholders considered when calculating an ownership change under Section 382 are those who hold, or have held during the relevant period, 5% or more of the company’s outstanding shares. Over the past few years, Selectica had generated an estimated $160 million in NOLs.
After making two unsuccessful proposals to purchase Selectica in mid 2008, defendant Trilogy, Inc. (“Trilogy”), the parent company of Versata Enterprise, Inc. and a competitor of Selectica, began to purchase Selectica stock on the open market. On November 10, 2008, Trilogy contacted Selectica’s co-chairman to inform her that Trilogy had purchased more than 5% of Selectica’s outstanding stock and would file a Schedule 13D shortly.
In the wake of Trilogy’s share purchases, Selectica’s board learned from its advisors that the cumulative acquisition of stock by shareholders over the past three years was 40%, and that additional acquisitions of roughly 10% of the company’s stock by new or existing 5% holders would “result in a permanent limitation on use of the Company’s [NOLs].” Under the circumstances, including evidence that the cumulative ownership change was not likely to decline in the near term and thus that the company was at risk of losing the ability to use its NOLs, the board amended its existing rights plan by decreasing the beneficial ownership trigger from 15% to 4.99%, while grandfathering in existing 5% shareholders and permitting them to acquire up to an additional 0.5% without triggering the NOL pill.
Trilogy subsequently purchased additional shares of Selectica stock, bringing its holdings to 6.7% and thereby deliberately becoming an “acquiring person” under the company’s NOL pill. The board offered to consider Trilogy’s purchases “exempt” under the NOL pill in exchange for a standstill, but Trilogy refused. After meeting six times since it learned of Trilogy’s purchases, the board met again on January 2, 2009, and reiterated its delegation of authority to an Independent Director Evaluation Committee (consisting of two Selectica directors) to make recommendations regarding implementation of the NOL pill. The same day, after meeting with legal and financial advisors, the committee decided to effect an exchange of rights for common stock under the NOL pill (effectively diluting Trilogy’s beneficial holdings from 6.7% to 3.3%) and to adopt a reloaded NOL pill substantially similar to the original NOL pill.
After a one-week trial, the Court of Chancery granted Selectica’s motion for a declaratory judgment that its NOL pills were valid and that the board had properly effected the exchange of rights. On Trilogy’s appeal from that judgment, the Supreme Court first addressed whether the lower court had correctly applied the Unocal standard. As an initial matter, the Supreme Court held that because the NOL pill was an antitakeover defense, Unocal was the proper standard. Applying the first part of Unocal’s two-part test, the Supreme Court found that the Selectica board had reasonably determined that the NOLs were an asset worth protecting, and that Trilogy’s actions in acquiring additional stock threatened Selectica’s ability to preserve them.
Second, the court concluded that the NOL pill’s relatively low 4.99% trigger did not render it preclusive where a successful proxy contest was not “realistically unattainable.” In reaching this conclusion, the court relied on empirical evidence that rights plans with similar triggers in similar situations had not precluded successful proxy contests, and on its finding that the concentration of a large portion of Selectica’s stock in the hands of a few holders made it logistically easy to wage a proxy contest. Citing the Court of Chancery’s decision in Carmody v. Toll Bros., Inc., 723 A.2d 1180, 1186 n. 17 (Del. Ch. 1998) and the Supreme Court’s decision in Moran v. Household Int’l, Inc., 500 A.2d 1346, 1357 (Del. 1985), the court further reasoned that the combination of the NOL pill with Selectica’s staggered board was not preclusive: as in Carmody, the staggered board would “delay – but not prevent” a proxy contest, and as in Moran, a rights plan would not preclude all hostile acquisitions.
Finally, having held that the NOL pills were neither preclusive nor coercive, the Supreme Court concluded that the Selectica board’s decisions to implement the NOL pill, to exchange rights for shares of common stock and to adopt the reloaded NOL pill were within a range of reasonable responses to the threat identified. First, the board had reasonably concluded it had no other option than to adopt the NOL pill. Second, the exchange employed by the board was a more moderate response than the traditional “flip-in” mechanism it could have applied, and Trilogy experienced less dilution of its position than a traditional rights plan would have achieved. Third, while the original NOL pill had successfully neutralized the threat posed by Trilogy, the reloaded NOL pill was necessary to address the general threat of a Section 382 change-in-control.
In conclusion, the court noted that its decision — that Selectica’s NOL pill was valid and had been appropriately applied in this context — should not be construed as generally approving the reasonableness of a 4.99% rights plan trigger; rather, the court stressed that the validity of such a rights plan will be evaluated on a case-by-case basis, and indeed any future use of the Selectica rights plan must be evaluated if and when it occurs.
The full opinion is available here.