Selectica v. Versata: 5% Poison Pills

In Selectica, Inc. v. Versata Enter., Inc., No. 4241-VCN, 2010 WL 703062 (Del. Ch. Feb. 26, 2010), Selectica, Inc. (“Selectica”) sued Versata Enter., Inc. (“Versata”) and Trilogy, Inc. (“Trilogy”)  seeking declaratory relief.  The Chancery Court applied the Unocal test and held Selectica’s Board of Directors acted reasonably and that adopting the “NOL Pill,” “Reloaded Pill,” and “Exchange” were proportionate responses to Trilogy’s threatened takeover.

 Selectica and Trilogy are competitors that sell “enterprise software solutions.”  Versata is a subsidiary of Trilogy; both were “beneficial common stock” owners in Selectica.  Selectica is a public company that has not earned a profit since the year 2000, and has generated net operating losses (“NOLs”) of approximately $160 million.  Trilogy offered to buy Selectica twice in 2005 and won two lawsuits (by an affiliate of Trilogy and later Trilogy itself in 2007) against Selectica.

 In 2008, Trilogy began buying Selectica’s outstanding stock while Selectica was searching for a buyer.  Shareholders owned 40% of Selectica’s stock.  Selectica’s advisors determined under IRS §382 that if existing or new 5% shareholders bought 10% more of the floating stock, the company’s NOL value would be permanently impaired.  Additionally, the NOLs’ full value would not be regained though a hostile takeover.  This was important because NOLs were one of Selectica’s main assets.  Without them, buyers could lose interest in the company.

 The Board met to discuss its options and decided to amend the shareholder rights plan: the “poison pill” trigger was changed from 15% to 4.99%.  Five percent owners were grandfathered in, and could buy .5% more stock without activating the amended “NOL Pill.”  The Board also created the Independent Director Evaluation Committee (“Committee”) to review the stock ownership rights agreement and “poison pill” as future developments occurred.

 In response, Trilogy increased its ownership stake to 6.7%, and thus, triggered the “NOL Pill,” which made them an “Acquiring Person.”  The Committee determined during meetings with financial and legal counsel that Trilogy’s recent stock purchases were not exempt from the “NOL Pill,” and the NOLs were still a valuable company asset that required protection.  Selectica’s Committee adopted a “Reloaded Pill” with similar terms to the “NOL Pill,” and, “an exchange of rights for shares of common stock,” (“Exchange”) to protect NOLs’s value.  The Exchange doubled every other investor’s common stock ownership, effectively diluting Trilogy’s ownership to 3.3%.

 The Chancery Court applied Unocal’s test and held that the Board showed it “had reasonable grounds for believing that a danger to corporate policy and effectiveness existed.”  The Unocal test requires the Board be reasonable in its belief that there is a “danger to corporate policy and effectiveness” and that the Boards’ reactions to the outside danger are also reasonable “in relation to the threat posed.”  The court held the Board’s actions were in good faith and were reasonably investigated.  Specifically, under the second prong of the test, the court found the Board’s response was reasonable compared to the threat’s seriousness.  The court also applied Unitrin’s rule: a Board’s defensive reactions are unreasonable if they are “either coersive or preclusive.”  It held that the Board’s response was not preclusive to future takeovers or coercive in forcing the Board’s chosen action on shareholders.

 The court recognized that poison pills are traditionally used to defend against hostile takeovers, not for NOL protection.  It found, however, that a company can use a 5% poison pill to protect its assets from threats.  The court reasoned the Board properly relied on expert advice regarding the NOLs’ values as assets under Delaware General Corporation Law §141(e).  It also found that Trilogy endangered the NOLs, and the Board mounted a reasonable response to Trilogy’s actions.

 The court granted declaratory relief to Selectica.  It concluded that adopting the “NOL Pill”, “Reloaded Pill” and Exchange were proportionate responses to the threatened takeover.

 The primary materials for this post are available on the DU Corporate Governance website.