5 A.3d 586 (Del. 2010)
Selectica, Inc., a Delaware corporation headquartered in California and listed on the NASDAQ Global Market, provides enterprise software solutions for contract management and sales configuration systems.1 Since becoming a public company in March 2000, Selectica has lost substantial sums and failed to achieve an annual profit despite projecting near-term profitability, generating an estimated $160 million in federal NOLs while its market capitalization fell below $23 million.2 Trilogy, Inc., a competitor also specializing in enterprise software, holds over 85% of its stock through founder Joseph Liemandt and, through subsidiary Versata Enterprises, Inc., beneficially owned 6.7% of Selectica before the events at issue; the companies have a five-year history of patent litigation resulting in Selectica paying Trilogy $7.5 million plus up to $7.5 million more, plus two rejected acquisition offers by Trilogy in 2005 at premiums of 16-23%.3
Steel Partners, Selectica's largest shareholder since at least 2006, has advocated selling Selectica's assets to create a NOL shell for merger with a profitable company and lobbied unsuccessfully for a board seat.4 Beginning in 2006 at Steel Partners' urging, Selectica retained tax advisors Alan Chinn and then John Brogan of Burr Pilger & Mayer to analyze its NOLs under Internal Revenue Code Section 382.5 Brogan delivered updated studies in 2007 and 2008 concluding the company had not undergone an ownership change since 1999 and held approximately $165 million in NOLs as of March 31, 2008, with cumulative ownership change by 5% holders reaching roughly 40% by late 2008.6
On November 10, 2008, Trilogy disclosed purchases exceeding 5% of Selectica shares and filed a Schedule 13D on November 13.7 Within four days it acquired an additional 1% of the float.8 On November 16 the Selectica board, after a meeting attended by Brogan, CFO Richard Heaps, and investment banker Jim Reilly of Needham & Company, amended its 2003 Shareholder Rights Plan by reducing the trigger from 15% to 4.99%, grandfathering existing 5% holders to an additional 0.5% increase, and creating an Independent Director Evaluation Committee to review the plan periodically.9 Trilogy then purchased further shares on December 18 and 19, 2008, reaching 6.7% ownership and becoming an "Acquiring Person" under the amended plan.10
Selectica filed suit in the Court of Chancery on December 21, 2008, seeking a declaration that the NOL Poison Pill was valid and enforceable.11 After Trilogy refused multiple standstill requests and demanded a global settlement involving patent disputes and a $5 million payment, the board on January 2, 2009, implemented the dilutive exchange provision that reduced Trilogy's interest to 3.3% and adopted a Reloaded NOL Poison Pill with a 4.99% trigger.12 Trilogy and Versata counterclaimed that the NOL Poison Pill, the Reloaded NOL Poison Pill, and the Exchange were unlawful on the grounds that, before acting, the Board failed to consider that its NOLs were unusable or that the two NOL poison pills were unnecessary given Selectica's unbroken history of losses and doubtful prospects of annual profits. After trial the Court of Chancery upheld all three measures.13 Trilogy and Versata appealed.14 Selectica cross-appealed the denial of attorneys' fees.15
Whether the Court of Chancery erred in applying the Unocal test for enhanced judicial scrutiny when confronting the adoption of a rights plan with a 4.99% trigger by the board of a never-profitable company for the ostensible purpose of protecting NOLs?16
Under Unocal Corp. v. Mesa Petroleum Co., a board adopting defensive measures with antitakeover effects must demonstrate that it had reasonable grounds for believing a danger to corporate policy and effectiveness existed.17 The board must also show that its response was reasonable in relation to the threat.18 This standard applies to NOL poison pills because they function as antitakeover devices even when their primary purpose is asset preservation.19
No. The Court of Chancery correctly applied the Unocal test to the Selectica Board's actions.20 The Board, after more than two and a half hours of deliberation on November 16 attended by tax advisor John Brogan, CFO Richard Heaps, and banker Jim Reilly, received expert advice that the NOLs constituted a significant corporate asset at risk of permanent impairment once the Section 382 ownership change threshold was crossed at roughly 40 percent cumulative acquisition by 5 percent holders.21 Brogan specifically warned that additional acquisitions of roughly 10 percent of the float by new or existing 5 percent holders would result in a permanent limitation on use of the NOLs with no possibility of cure.22 The Board responded by reducing the Rights Plan trigger from 15 percent to 4.99 percent while grandfathering existing holders at an additional 0.5 percent increase.23
This measure was narrowly tailored to the external standard of Internal Revenue Code Section 382 rather than an arbitrary defensive threshold.24 The Court of Chancery's finding that the Board acted in good faith reliance on experts is supported by the record of prior NOL studies dating back to 2006.25 The contemporaneous advice showed that the NOLs remained at significant near-term risk.26
The Court of Chancery did not err in applying the Unocal test.27
Whether the NOL poison pills, either individually or in combination with a charter-based classified board, had a preclusive effect on the shareholders' ability to pursue a successful proxy contest for control of the Company's board?28
Under Unitrin, Inc. v. American General Corp., a defensive measure is preclusive only if it renders a successful proxy contest either mathematically impossible or realistically unattainable.29 The combination of a rights plan and classified board is not preclusive merely because it requires two election cycles to obtain board control.30 This holds provided a challenger starting below the trigger percentage can still realistically win a proxy contest on the merits.31
No. The NOL Poison Pill and Reloaded NOL Poison Pill, whether standing alone or combined with Selectica's classified board, did not render a successful proxy contest realistically unattainable.32 Expert testimony established that in micro-cap companies, challengers holding less than 5.49 percent of shares prevailed in ten of fifteen proxy contests over a three-year period, including five at companies with classified boards.33 Selectica's concentrated shareholder base, with seven holders controlling 55 percent and twenty-two holders controlling 62 percent of the stock, further reduced the logistical and financial barriers to a proxy contest, as only 43.2 percent plus one share was needed to prevail.34 The 4.99 percent trigger, while lower than traditional plans, was dictated by the requirements of Section 382 and did not eliminate the ability of a dissident to signal credibility or communicate with the key institutional holders who could decide the outcome on the merits of the insurgent platform.35
The NOL poison pills did not have a preclusive effect on the shareholders' ability to pursue a successful proxy contest.36
Whether the Court of Chancery erred in denying the application for an award of attorneys' fees under the bad faith exception to the American Rule?37
The bad faith exception to the American Rule permits fee shifting only for bad faith conduct in the commencement or conduct of litigation itself.38 It does not extend to the underlying substantive conduct that gave rise to the claim.39 A trial court's denial of fees under this exception is reviewed for abuse of discretion and will be upheld unless arbitrary or capricious.40
No. The Court of Chancery acted within its discretion in denying Selectica's request for attorneys' fees.41
Trilogy's deliberate decision to purchase shares that triggered the NOL Poison Pill, its refusal to agree to a standstill, and its insistence on a global settlement encompassing separate patent disputes all constituted the substantive conduct underlying Selectica's declaratory judgment claim rather than independent bad faith litigation tactics.42 Although the Court of Chancery found that Trilogy recognized harm would befall Selectica and proceeded accordingly, that finding pertained to the events giving rise to the lawsuit and therefore could not support a fee award under the bad faith exception.43 The denial was neither arbitrary nor capricious given the legal standard limiting the exception to litigation conduct.44
The Court of Chancery did not err in denying the application for an award of attorneys' fees under the bad faith exception to the American Rule.45