Versata Enterprises, Inc. v. Selectica, Inc.

Supreme Court of Delaware
5 A.3d 586 (2010)

ELI5:

Rule of Law:

A board of directors may adopt a shareholder rights plan with a low (e.g., 4.99%) trigger threshold to protect a corporation's valuable net operating loss carryforwards (NOLs) from impairment under Section 382 of the Internal Revenue Code, provided the board's actions satisfy the Unocal standard of enhanced judicial scrutiny.

Facts:

Selectica, Inc., a historically unprofitable company, had accumulated approximately $160 million in net operating loss carryforwards (NOLs), a significant corporate tax asset contingent on future profitability.
Selectica had a long-standing, adversarial relationship with a competitor, Trilogy, Inc., which had previously made rejected acquisition offers and engaged in patent litigation.
Trilogy began purchasing Selectica stock, eventually acquiring over 5% and raising concerns about triggering an 'ownership change' under Section 382 of the Internal Revenue Code, which would severely limit the future use of Selectica's NOLs.
At the time, Selectica's cumulative ownership change over the preceding three years was already at 40%, just 10% below the 50% threshold that triggers NOL impairment under Section 382.
Relying on the advice of tax and financial experts, the Selectica board amended its shareholder rights plan on November 16, 2008, lowering the ownership trigger from 15% to 4.99% to protect the NOLs (the 'NOL Poison Pill').
After learning of the new pill, Trilogy's founder, Joseph Liemandt, inquired about the ownership percentage needed to 'ruin the tax attributes' Selectica sought to protect.
On December 19, 2008, Trilogy deliberately purchased additional shares to increase its stake to 6.7%, intentionally triggering the NOL Poison Pill to 'create a sense of urgency' and gain leverage in other disputes with Selectica.
After Trilogy repeatedly refused standstill agreements, Selectica's board on January 2, 2009, implemented the pill's exchange feature, which diluted Trilogy's ownership to 3.3%, and adopted a new 'Reloaded NOL Poison Pill' with the same 4.99% trigger.

Procedural Posture:

Selectica, Inc. filed a lawsuit in the Delaware Court of Chancery against Trilogy, Inc. seeking a declaratory judgment that its recently adopted NOL Poison Pill was valid.
Selectica later amended its complaint to also seek a declaration that its implementation of the pill's exchange provision and its adoption of a 'Reloaded NOL Poison Pill' were valid.
Trilogy filed counterclaims alleging that the board's defensive actions were unlawful and impermissibly preclusive of a proxy contest.
After a trial, the Court of Chancery issued a final judgment in favor of Selectica, holding that all of the challenged defensive measures were valid under Delaware law.
Trilogy appealed the Court of Chancery's decision to the Supreme Court of Delaware, where it is the appellant and Selectica is the appellee.
Selectica filed a cross-appeal challenging the Court of Chancery's denial of its application for attorneys' fees.

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Issue:

Does a board of directors' adoption of a shareholder rights plan with a 4.99% trigger, designed to protect a company's net operating loss carryforwards (NOLs), satisfy the enhanced scrutiny standard of Unocal when faced with a shareholder whose acquisitions threaten to impair the NOLs?

Opinions:

Majority - Holland, J.

Yes, the board's defensive actions satisfy the enhanced scrutiny standard of Unocal. The adoption of a low-trigger shareholder rights plan is a valid defensive measure when reasonably necessary to protect a significant corporate asset like NOLs from a perceived threat. First, under Unocal's first prong, the Selectica board reasonably identified a threat to corporate policy and effectiveness. Relying on expert advice, the board properly concluded the NOLs were a valuable asset and that Trilogy’s stock accumulations posed a legitimate danger of triggering an irreversible 'ownership change' under Section 382. Second, under Unocal's second prong, the board’s response was proportionate and not preclusive. The 4.99% trigger, which was dictated by federal tax law, did not render a proxy contest 'realistically unattainable,' even when combined with a classified board. Given Trilogy’s specific actions—deliberately triggering the pill to gain leverage in unrelated disputes—the board's implementation of the exchange and adoption of a reloaded pill were reasonable defensive measures within the range of reasonableness.

Analysis:

This decision validates the use of low-trigger (sub-5%) poison pills for the specific purpose of preserving a company's Net Operating Losses (NOLs). It establishes that protecting a valuable corporate asset from impairment is a legitimate corporate objective that can justify significant defensive measures under the Unocal standard. The ruling provides a crucial precedent for companies, particularly those in turnaround situations or with large accumulated losses, to shield their tax assets from being jeopardized by shareholder accumulations. However, the court emphasized the context-specific nature of its holding, cautioning that the reasonableness of such a pill would still be subject to judicial review if used to thwart an actual takeover bid in the future.

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