Corporate Governance

Selectica v. Versata Enterprises: A Poison Pill Triggered (Validating the 5% Threshold)(Part 3)

By J Robert Brown Jr.

Under the traditional Unocal analysis, the court first had to determine whether the board adopted the poison pill in response to a threat.  The need to protect the net operating loss carryforwards (NOL) were considered a sufficient threat.  The next issue was whether the pill was reasonable in response to the threat posed. 

Relying on Unitrin, the court first examined whether the pill was preclusive.  Here, preclusiveness did not depend upon the particular threat at issue.  Instead, it largely turned on whether the pill effectively precluded "effective stockholder action."  More to the point, the real issue was whether the pill rendered a proxy contest for control of the board "realistically unattainable."  The court concluded that a pill with a 5% threhold was not preclusive. 

• Though Trilogy's expert testimony suggests that a poison pill with a less than 5% trigger 'has a substantial preclusive effect,' the Court cannot conclude that the NOL Pill, Exchange, and Reloaded NOL Pill were preclusive, and thereby draconian. Such a high standard operates to exclude only the most egregious defensive responses. As the court in Unitrin noted, 'This Court's choice of the term draconian in Unocal was a recognition that the law affords boards of directors substantial latitude in defending the perimeter of the corporate bastion against perceived threats.'190 The requirement of either the mathematical impossibility or realistic unattainability of a proxy contest reinforces the exactness of the preclusiveness standard. It is not enough that a defensive measure would make proxy contests more difficult—even considerably more difficult. To find a measure preclusive (and avoid the reasonableness inquiry altogether), the measure must render a successful proxy contest a near impossibility or else utterly moot, given the specific facts at hand. The NOL Pill and Reloaded NOL Pill do not meet this standard.

In other words, a pill that stops a bidder's purchases at 5% will make a proxy contest far more difficult, but is not preclusive.  Under this rational, a pill set at 1% could be said to have the same effect:  it would render a proxy contest more difficult, but not impossible.  

Because courts in Delaware will not strike down poison pills, the only way to implement a hostile acquisition is to engage in a proxy contest and change the make-up of the board.  By allowing pills to be set at thresholds of 5% or below, the courts are making proxy contests more difficult and more expensive.  In short, they are reducing the likelihood that a proxy contest will in fact be a realistic avenue for putative acquirors. 

In the aftermath of this decision, companies would be foolish not to set the trigger in their poison pills at 5% (or perhaps lower) in order to reduce significantly the risk of a proxy contest.  We predict this will occur.  

For some of the primary materials on the case, go to the University of Denver Corporate Governance website. 

Full post as published by The Race to the Bottom on April 08, 2010 (boomark / email).