Selectica, Inc. v. Versata Enterprises, Inc.: Delaware Chancery Court Upholds Trigger of Poison Pill

This case has already gotten lots of attention, as the first instance of the triggering of a poison pill. In his decision of February 26, 2010, 2010 WL 703062, Vice Chancellor Noble concluded that Selectica’s board acted reasonably in adopting a low-threshold (4.99%) poison pill to protect the company’s NOL. His careful decision illustrates why participants in contests for control should always ask themselves “how will this look before the Delaware Chancery Court?”

A. Bad Blood Between Selectica and Trilogy, Inc.

Both Selectica and Trilogy, Inc. provide enterprise software solutions for contract management and sales configuration systems, whatever that means. Trilogy, a private company, is controlled by Joseph Liemandt, its founder and over 85% stockholder. Trilogy had been successful in two patent infringement lawsuits against Selectica, securing a judgment in one of $7.5 million and a settlement in the other of up to $17.5 million, of which some $7.5 million was deferred. Trilogy had also made several unsuccessful runs at acquiring Selectica, which Selectica’s board rebuffed. By the end of 2006, Trilogy had disposed of its Selectica shares.

B. Selectica’s NOL

Since Selectica went public in March 2000, it had never turned a profit. By the time of the dispute before Vice Chancellor Noble in the spring of 2009, it was trading below $1 per share, and it had incurred operating losses of some $160 million. Fewer than 25 investors held some two-thirds of its outstanding stock.

Selectica’s NOL drew the attention of Steel Partners, a private equity fund specializing in smaller cap companies. Steel Partners saw an opportunity in marrying Selectica with a profitable company to exploit Selectica’s NOL. As a result of pressure from Steel Partners, Selectica retained specialists to analyze its NOL and the complicated provisions governing the loss of NOLs if a company undergoes an “ownership change” as defined in IRC Code §382, generally defined as an ownership change of more than 50 percentage points by one or more 5% shareholders within a period of three years. If such an ownership change occurs, then a substantial portion of the NOL is lost.

C. Exploration of Strategic Alternatives

By July of 2008 Selectica concluded it had to explore strategic alternatives. It retained Needham & Company to evaluate its alternatives. The evaluation included reaching out to potential buyers. By February 2009, at least half a dozen parties were seriously interested in Selectica. By April 2009, Selectica had signed a letter of intent and entered into exclusive negotiations with a potential buyer.

D. Trilogy Butts In

Trilogy resumed its interest in Selectica in the summer of 2008. Trilogy made a couple of lowball offers for Selectica, which were rejected by its board. It was invited to engage in the sale process being overseen by Needham, but it declined, apparently out of unwillingness to sign a non-disclosure agreement. Trilogy and its founder, Liemandt, commenced buying Selectica’s stock in the open market. The buying crossed the 5% threshold in November 2008, prompting Trilogy to file a Schedule 13D, in which it stated that it had acquired the Selectica shares “for investment purposes.”

E. Selectica’s Adoption of the NOL Pill

The Selectica board, concerned about the effect of Trilogy’s purchases on its NOL, arguably Selectica’s major asset, engaged its accounting and tax advisors to evaluate its NOL and its potential loss through an “ownership change.” They concluded, after extensive analysis and consultation with the board, that the NOL was valuable and that Trilogy’s actions in acquiring Selectica shares threatened it. On November 16, 2008, the board amended its previous shareholder rights plan, adopted in February 2003, with a view to protecting its NOL. The trigger was dropped from 15% to 4.99%, with existing 5% stockholders grandfathered to permit them to acquire up to an additional 0.5% of Selectica’s shares (subject to the original 15% cap) without triggering the pill. The board established a committee of independent directors to periodically review the pill to determine whether it would continue to be in the best interest of Selectica and its stockholders.

F. Trilogy Buys Through the Trigger

Adoption of the NOL poison pill apparently outraged Trilogy and its controlling stockholder, Liemandt. Liemandt promptly inquired of two of Trilogy’s officers how many shares of Selectica Trilogy and Liemandt would need to purchase “to ruin the tax attributes” of the NOL. Slip Opinion at 20. Trilogy then promptly notified Selectica that a contract it had known about for some four months between Selectica and Sun Microsystems breached the terms of the prior patent infringement settlement between Selectica and Trilogy.

By December 19, 2008, Trilogy had blown through the NOL trigger, attaining 6.7% ownership of Selectica’s outstanding common stock. Selectica then had 10 days, under the terms of the plan, to determine whether Trilogy would qualify as an “exempt person” under the plan, thus avoiding triggering the pill. What was Liemandt’s motive in blowing through the trigger?

“Liemandt testified that the rationale behind triggering the pill was to ‘bring accountability’ to the Board and ‘expose’ what Liemandt characterized as ‘illegal behavior’ by the Board in adopting a pill with such a low trigger.”

Slip Opinion at 21 (footnote omitted).

And what was Trilogy’s proposal to Selectica?

“He [an officer of Trilogy] then proposed that Selectica agree to purchase Trilogy’s shares back, accelerate the payment of its [$7 million] debt, terminate its license with Sun, and make a payment to Trilogy of $5 million ‘for settlement of basically all outstanding issues between our companies.’”

Slip Opinion at 22 (footnote omitted).

This is what one might term an “unvarnished” proposal. One suspects it was not vetted with experienced counsel.

Needless to say, the Selectica board rejected Trilogy’s settlement demands as “highly unreasonable” and “lacking any reasonable basis in fact.” No kidding.

G. After Trilogy Repeatedly Rejects Requests for a Standstill, Selectica Triggers the Pill

Selectica repeatedly requested that Trilogy agree to a standstill and not purchase any additional shares of Selectica stock. Trilogy rejected the demands. Accordingly, after extensive consultation with its tax and legal advisors, the board, on January 2, 2009, implemented the pill and authorized an exchange of rights of common stock and a reloading of the pill. As a result of the exchange, the number of outstanding shares of Selectica’s common stock was doubled, other than for Trilogy and its affiliates, whose ownership of Selectica stock dropped from 6.7% to 3.3%.

H. The Court’s View of Trilogy’s Conduct

Vice Chancellor Noble’s discussion of poison pills, Selectica’s NOL poison pill, and the standards governing the adoption and exercise of a poison pill are important and deserve attention, but not in this post. What I want to focus on is how Trilogy’s ill-advised and, frankly, off the wall conduct in negotiations (or the lack thereof) with Selectica influenced the Vice Chancellor.

At trial and in post-trial argument, Trilogy and its counsel mounted an impressive challenge to all aspects of Selectica’s board’s conduct, including the justification for any NOL pill, the processes followed by the Selectica board in adopting and implementing the pill, the board’s reliance upon experts, and the failure of the Selectica board to meet the Unocal tests for application of the business judgment rule to the adoption of a defensive measure such as a poison pill. All of these objections were carefully rejected by Vice Chancellor Noble. Trilogy’s arguments have a distinct ex post flavor. One cannot escape the conclusion that this case was decided by Trilogy’s opportunistic behavior in making a run at Selectica to coerce it into meeting demands of Trilogy that had nothing to do with Selectica’s governance or its control. As the Vice Chancellor notes at the end of his extensive opinion:

“Here, the record demonstrates that a longtime competitor sought to employ the shareholder franchise intentionally to impair corporate assets [of Selectica], or else to coerce the Company into meeting certain business demands under the threat of such impairment.”

. . . .

In this instance, Trilogy, a competitor with a contentious history, recognized that harm would befall its rival if it purchased sufficient shares of Selectica stock, and Trilogy proceeded to act accordingly.”

Slip Opinion at 65, 69.
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Kudos to the Selectica directors. They served on the board of a small company that had never made money and had been pushed around by an aggressive competitor. They did something no other board had ever done, trigger a poison pill. In a risk averse world, that took courage. Their judgment and determination have been rewarded by Vice Chancellor Noble’s decision in this case.