Delaware Ruling Reinforces Validity of the Poison Pill

A recent decision by the Delaware Court of Chancery strongly reinforces both the continued relevance of the shareholder rights plan and the primacy of boards’ business judgment. Selectica Inc. v. Versata Inc.,¹ decided by Vice Chancellor Noble last month, concludes the saga of the first triggering of a modern poison pill—and represents the first judicial scrutiny of a pill designed to protect a company’s net operating losses (“NOLs”). The opinion makes several important points: first, that a poison pill can be an appropriate mechanism for protecting a company’s NOLs, despite the NOLs’ uncertain value; second, that lowering a rights plan’s triggering threshold to 4.99 percent in order to convert a traditional poison pill to a NOL pill in response to a competitor’s accumulation of shares is permissible under Unocal and its progeny; third, that directors have broad latitude to draw reasonable conclusions about the value of a company’s NOLs, the severity of the threat posed by a particular shareholder, and the appropriate defensive response under the circumstances; and finally, that even after a pill has been triggered and the acquirer diluted, a board is permitted to implement a new pill (i.e., “reload”) to deter further acquisitions that could jeopardize the company’s NOLs. Recent takeover trends and the widely publicized Cadbury-Kraft deal highlight the importance of takeover defenses in the current environment.

The ‘Selectica’ Decision

The events leading up to the Selectica decision, as well as the opinion itself, provide useful insights into the workings of the modern poison pill, in both the NOL context and the market for corporate control generally. A bit of background: Selectica had struggled since going public in 2000 and, by failing to achieve positive net income in any year, had generated $165 million in NOLs for federal tax purposes by 2008.² Between 2005 and 2008, Selectica rejected several acquisition offers by its competitor Trilogy Inc. (of which Versata is a subsidiary).³ At the end of 2008, Trilogy and Versata acquired more than 5 percent of Selectica’s outstanding stock and continued to acquire shares.⁴ In response, the Selectica board reviewed the effect of Trilogy’s acquisitions on Selectica’s NOLs and, after thorough discussion and with the advice of outside experts, determined to amend Selectica’s existing shareholder rights plan to reduce the threshold from a typical 15 percent trigger to the 4.99 percent necessary to protect the value of Selectica’s NOLs.⁵ (Existing 5 percent shareholders were grandfathered in and permitted to acquire up to an additional 0.5 percent without triggering the distribution of rights.)⁶ The board also established a committee of independent directors to review the rights plan periodically to ensure that it continued to be in the best interests of shareholders and to review the trigger threshold to ensure that it remained appropriate. Shortly thereafter, Trilogy intentionally triggered Selectica’s poison pill by increasing its stockholdings to 6.7 percent and refused repeated requests by Selectica to enter into a standstill agreement to give the board time to evaluate the situation. The Selectica board then determined to allow the exchange feature of the pill to trigger, which diluted Trilogy’s holdings to 3.3 percent. The board also amended the rights plan to “reload” the poison pill.⁷