Delaware's Top Five Worst Shareholder Decisions for 2010 (#2: Versata Enterprises v. Selectica)

Our second most anti-shareholder case for the year is Versata Enterprises v. Selectica, 5 A.3d 586 (Del. 2010).  We did a series of posts on this case, both at the Chancery Court and the Supreme Court. 

The case has historical significance.  It represents the first time a poison pill was triggered in a manner that resulted in dilution of the acquirer's interest (one was also triggered back in the 1980s in connection with the acquisition of Crown Zellerbach but resulted in no dilution).  For that, it will be cited often ("No poison pill has ever been triggered except . . . ").   

The case, however, has far greater practical significance and amounts to an important salvo in the relationship between the Delaware courts and the Securities and Exchange Commission.  The case demonstrates that the courts have no intention of sitting by idly as federal preempts state law in the area of corporate governance. 

Selectica upheld a poison pill with a 5% trigger.  Plaintiffs argued, among other things, that the low threshold violated Unocal (really Unitrin) because it rendered a proxy contest preclusive.  By setting the triggering percentage at 5%, insurgents could not buy a block sufficient to make a proxy contest viable.  Nor could they negotiate any meaningful alliance with other shareholders in connection with a proxy contest since agreements also triggered the pill.  The low threshold applied even though the Company had a staggered board, making it impossible for the insurgents to acquire control in one election.

The Chancery Court and the Supreme Court found that a 5% pill did not render a proxy contest preclusive.  The Supreme Court held that to be preclusive, a pill had to "render a successful proxy contest realistically unattainable given the specific factual context" and summarily concluded that the pill did not meet that standard.  The Chancery Court was a bit more overt, holding that a pill was not preclusive unless it "render[ed] a successful proxy contest a near impossibility or else utterly moot, given the specific facts at hand." 

Effectively, therefore, the courts have reduced the concept of preclusion with respect to the application of poison pills to proxy contests to one of impossibility.  The effect is to read the preclusion element out of the test.  As a result, poison pills with very low triggering thresholds will be unchallengeable based upon the preclusion element.  The fact that the Company also had a staggered board, something that doubly discouraged a putative insurgent, was deemed irrelevant to the analysis.

The decision will have two additional and significant effects.  First, the decision validated the use of poison pills with very low thresholds, encouraging companies to adopt pills with similar triggers.  Until now, pills have typically had triggers of 15 or 20%.  That will change.  The result will significantly tilt the playing field in management's favor.  More importantly, however, it will discourage insurgents from engaging in proxy contests in the first instance. 

Second and more interesting will be the effect of the decision on efforts by shareholders to elect a short slate of directors.  The SEC's shareholder access rule (Rule 14a-11) allows shareholders owning more than 3% of the voting shares (individually or in a group) for at least three years to submit a short slate of nominees for inclusion in the company's proxy statement.  In many companies, this will require shareholders to organize to put together a 3% block of shares.  Yet to the extent the size of the shareholder block exceeds 5%, it may trigger a poison pill, with the members of the group seeing their shares suffering immediate dilution. 

It is more than a mere possibility.  While the threshold is only 3%, it would be logical for larger groups of shareholders to form.  The poison pill will make this impossible.  Moreover, to the extent competing groups of shareholders emerge, each seeking to submit nominees, a low threshold pill will prevent them from reaching agreement on a common slate or the sharing of expenses. 

Finally, the requirement of a three year holding period means that not all shares will be eligible to be counted toward the access ownership threshold.  Thus, a group of shareholders may barely meet the 3%/3 year requirement yet when the shares owned for less than three years are included have, collectively, more than 5%, triggering the poison pill.

No institution will agree to even discuss a short slate if there is any risk that in doing so the poison pill will be triggered.  Individual institutions will not always know of the insurgent has reached agreement with other shareholders, potentially triggering the poison pill.  Moreover, even if there is room for challenging the legality of the pill, Selectica demonstrates the risks.  The plaintiff in that case triggered the pill, challenged it, and lost, seeing its ownership diluted in percentage and value.  Institutions will not incur this risk even if they have a significant chance of invalidating the pill in post-hoc litigation. 

Nor is there anything in Selectica that bars the possibility of a poison pill with a lower threshold, say 2%, essentially eliminating any possibility of the formation of a group formed in order to avail itself to the rights provided in Rule 14a-11. 

Selectica shows that the Delaware courts will not sit back and accept federal intervention into the governance process, at least where the intervention is disadvantageous to management.  The real issue is whether the federal government, in this case the SEC, will allow this to occur.