Corporate Governance

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (The Import of the Poison Pill)

By J Robert Brown Jr.

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger. 

Selectica put in place a poison pill with a 5% threshold in order to prevent the loss of NOLs (net operating loss carryforwards).  The board understood that the NOLs could be lost should ownership of the company change during any three year period.  As the Court described:

• At its most basic, an ownership change occurs when more than 50% of a firm's stock ownership changes over a three-year period.  Specific provisions in Section 382 define the precise manner by which this determination is made. Most importantly for purposes of this case, the only shareholders considered when calculating an ownership change under Section 382 are those who hold, or have obtained during the testing period, a 5% or greater block of the corporation's shares outstanding.

Given that only 5% shareholders could cause an ownership change that would result in the loss of the NOLs, the pill's attempt to prevent the creation of additional 5% thresholds more than met the standard in Unocal that imposed on management a prima facie case of establishing a threat to the company.  Indeed, as the Court noted:  "The Court of Chancery found the record 'replete with evidence' that, based upon the expert advice it received, the Board was reasonable in concluding that Selectica's NOLs were worth preserving and that Trilogy's actions presented a serious threat of their impairment."

But the poison pill did more than restrict purchases.  It also prevented shareholders in a proxy contest from reaching agreement on a common slate of directors and a sharing of expenses.  The threat to the NOLs may have justified a 5% threshold on purchases but it did not justify a restriction on agreements in proxy contests.  Moreover, given the existence of a staggered board, it was difficult to see how the insurgents could pose any threat to the company.  Moreover, the pill could have preserved the 5% threshold for purchases but put in place a higher one applicable to proxy contests. 

The decision suggests that a low trigger, if justified for any reason, will be allowed to remain in place during a proxy contest, even where the poxy contest poses no threat to the company.  

For materials from the lower court proceeding, access the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on October 22, 2010 (boomark / email).