Coauthored by Stephen B. Brauerman
In Versata Enterprises, Inc., et. al. v. Selectica, Inc., C.A. No. 193, 2010 (Del. Oct. 4, 2010), the Delaware Supreme Court affirmed a final judgment order entered by Vice Chancellor Noble, that upheld a series of shareholder rights plans followed by a dilutive exchange (the “Exchange”) adopted by the Board of Directors (the “Board”) of Selectica, Inc. (“Selectica”) to preserve the value of the corporation’s net operating loss carryforwards (“NOLs”)1 as valid under Delaware law. The Supreme Court emphasized that the propriety of a defensive measure is context specific and did not “generally approv[e] the reasonableness of a 4.99% trigger in the Rights Plan of a corporation with or without NOLs.” Versata Enterprises, Inc., et. al. v. Selectica, Inc., C.A. No. 193, 2010, slip op. at 49-50 (Del. Oct. 4, 2010).
To protect the value of its NOLS, the Board adopted a rights plan reducing the trigger of its existing rights plan from 15% to 4.99% and prohibiting existing shareholders with a 5% or greater equity position from increasing their positions by more than 0.5% of Selectica’s issued and outstanding stock (the “NOL Poison Pill”). The 4.99% trigger restricted the number of stockholders who could threaten the NOLs by acquiring more than 5% of the company’s stock and the 0.5% limitation ensured that Selectica’s existing 5% shareholders would not reach the 50% threshold causing a change of control that would impair NOLs.
Trilogy, Inc. (“Trilogy”), a shareholder, creditor and competitor of Selectica, intentionally triggered the NOL Poison Pill to leverage a global settlement of various, on-going disputes with Selectica. Following Trilogy’s refusal to agree to a standstill in exchange for an exemption from the NOL Poison Pill, Selectica implemented the Exchange of the NOL Poison Pill, which reduced Trilogy’s interest from 6.7% to 3.3%, and adopted another Rights Plan with a 4.99% trigger (the “Reloaded NOL Poison Pill”). The Exchange diluted Trilogy’s holdings, but to a lesser extent than would have occurred if the Board had allowed the default, “flip-in” provisions of the NOL Poison Pill to take effect.
The Supreme Court noted that, “notwithstanding its primary purpose [to prevent the inadvertent forfeiture of potentially valuable assets], a NOL poison pill must also be analyzed under Unocal2 because of its effect and its direct implications for hostile takeovers.” Id. at 31. Applying Unocal, the Supreme Court upheld the Board’s decision that NOLs were a valuable corporate asset worth protecting and perception of threat caused by Trilogy’s decision intentionally to trigger the NOL poison pill Id. at 35. Although the 5% trigger necessary to make the NOL Poison Pill effective is a lower threshold than other rights plans, the Supreme Court found the NOL Poison Pill reasonable because it tied to objective criteria (the 5% Section 382 threshold for change of control) and proportionally responded to Trilogy’s threat and refusal to negotiate an exemption that would preserve the NOLs while minimizing the effects of the pill.
Beyond its primary approval of the use of rights plans to preserve NOLs, the Supreme Court also clarified the preclusivity prong of the Unocal test, holding that “Because the ‘mathematically impossible’ formulation in Unitrin is subsumed within the category of preclusivity described as ‘realistically unattainable,’ there is, analytically speaking, only one test of preclusivity: ‘realistically unattainable.’” Id. at 36. This clarification is noteworthy because, earlier this year in Yucaipa American Alliance Fund II, L.P., et. al v. Riggio, et. al., C.A. No. 5465-VCS, slip op. at 87 (Del. Ch. Aug. 11, 2010), Vice Chancellor Strine suggested that the “mathematically impossible” test for preclusivity under Unocal was impermissibly narrow and argued that a rights plan could still be preclusive even if it did not render a proxy contest mathematically impossible. While the Supreme Court did not address this concern directly, its formulation of preclusivity as “realistically unattainable” is consistent with Vice Chancellor Strine’s views.
A copy of the opinion may be found here.
1 NOLs permit a company to offset taxable income earned during the preceding two or succeeding twenty years. To prevent one company from using the NOLs of another, NOLs become substantially impaired upon a change of control as measured by a change in more than fifty percent (50%) of a company’s stock held by those with greater than five percent (5%).
2 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 957 (Del. 1985). Unocal requires a two-step analysis during which the Court must consider whether a corporate board reasonably identified a threat to the corporate enterprise and if so, whether the board’s response to the perceived threat was preclusive, coercive, or reasonable.