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In 2010, the Delaware courts issued a trio of opinions addressing shareholder rights plans. These cases expand upon important issues of Delaware law that arise when a board of directors enacts a rights plan to neutralize a perceived threat. Together, Versata Enterprises, Inc. v. Selectica, Inc., eBay Domestic Holdings, Inc. v. Newmark, and Yucaipa American Alliance Fund II, L.P. v. Riggio , demonstrate the deference the Delaware courts will give to an independent, well-informed board of directors. In addition, these cases reinforce the flexibility, and continuing viability, of the intermediate standard of review first articulated in the 1985 Delaware Supreme Court decision Unocal Corp. v. Mesa Petroleum Company . Under the " Unocal " standard, the Delaware courts will examine (1) whether a board had reasonable grounds to believe that a threat to corporate policy and effectiveness existed, and (2) whether the board's response to that threat was reasonable and proportional.
Versata Enterprises, Inc. v. Selectica, Inc.
First, Vice Chancellor Noble of the Delaware Court of Chancery approved of the implementation of a rights plan designed to protect the net operating loss carryforwards, or "NOLs," of Selectica, Inc. ("Selectica")--a ruling that represented a "distinct departure" from the traditional use of rights plans in preventing hostile takeovers. Thereafter, in Versata Enterprises, Inc. v. Selectica, Inc. , the Delaware Supreme Court, sitting En Banc, affirmed the Vice Chancellor's ruling.
Selectica, a "profitless corporation," had accumulated an estimated $160 million in NOLs by the end of 2009, and considered its accumulated NOLs as one of its primary assets. According to the Court, the use of NOLs is restricted in periods following an "ownership change," as defined under Section 382 of the Internal Revenue Code.
Selectica already had a rights plan with a 15 percent "trigger" in place. However, the emergence of additional 5 percent shareholders could have resulted in a change in control event that would have devalued the NOLs under federal tax law. As Trilogy, Inc. ("Trilogy"), a competitor interested in acquiring Selectica, announced accumulations of Selectica's shares in amounts that threatened to cause a "change in control event," as defined under Section 382, the Selectica board amended its existing rights plan, setting its trigger at 4.99 percent in order to protect the NOLs (the "NOL Rights Plan"). Shortly thereafter, Trilogy purchased nearly 160,000 additional Selectica shares, "buying through" the NOL Rights Plan, and bringing its ownership stake in Selectica to 6.7 percent. As a result, the NOL Rights Plan was triggered, and Trilogy's holdings were diluted from 6.7 percent to 3.3 percent.
Selectica sued in the Delaware Court of Chancery, seeking a declaration that the NOL Rights Plan was valid and enforceable. Trilogy counterclaimed, arguing, among other things, that the NOL Rights Plan was impermissibly preclusive of a successful proxy contest for board control, particularly when combined with Selectica's classified board.
Despite the novel purpose of the NOL Rights Plan--to protect a company's NOLs--the Delaware Supreme Court affirmed the Court of Chancery's decision applying the Unocal standard of review, explaining that " any Shareholder Rights Plan, by its nature, operates as an antitakeover device. Consequently, notwithstanding its primary purpose, a NOL poison pill must also be analyzed under Unocal because of its effect and its direct implications for hostile takeovers." The Supreme Court pointed out that Delaware corporation law is not static, and "'must grow and develop in response to, indeed in anticipation of, evolving concepts and needs.'"
The Supreme Court agreed that Trilogy's rapid accumulations provided the Selectica board reasonable grounds from which to conclude that "a threat to the corporate enterprise existed," as required under the first prong of Unocal . In addition, the Supreme Court found Selectica's response in the form of the NOL Rights Plan to be reasonable under Unocal's second prong, in part because the board had eschewed more dilutive options. The Delaware Supreme Court also credited the Selectica board's reliance on its outside legal counsel and financial advisors in concluding its NOLs were assets worth protecting. The Supreme Court reminded that good faith reliance on outside advisors is expressly authorized by 8 Del. C. 141(e).
eBay Domestic Holdings, Inc. v. Newmark
In eBay Domestic Holdings, Inc. v. Newmark , Chancellor William B. Chandler III of the Delaware Court of Chancery, rescinded craigslist, Inc.'s ("craigslist") rights plan because its adoption constituted a breach of fiduciary duty. The genesis of the controversy between the parties traced to eBay's entrance into the online classified marketplace with a website called "Kijiji" in 2007 that directly competed with craigslist. At the time of Kijiji's launch, eBay owned 28.4 percent of craigslist, a privately held company, and was one of only three craigslist stockholders. A shareholders agreement permitted eBay to engage in direct competitive activity, provided that eBay forfeit certain contractual consent rights in the process. However, craigslist's founder, Craig Newmark, and its CEO and president, Jim Buckmaster, were "not enthusiastic about eBay's foray into online classifieds."
In response to Kijiji's launch, Newmark and Buckmaster, who together owned 71.6 percent of craigslist and held two of craigslist's three director seats, enacted (among other defense measures) a rights plan "that restricted eBay from purchasing additional craigslist shares and hampered eBay's ability to freely sell the craigslist shares it owned to third parties."
Unlike in Versata , the novel purpose of the rights plan at issue in eBay was not condoned by the Delaware courts. Newmark and Buckmaster claimed that the rights plan would preserve craigslist's altruistic corporate culture. The court, however, refused to allow the implementation of a rights plan for the protection of a "corporate culture" where no connection between that corporate culture and shareholder value had been demonstrated. The court explained that Newmark and Buckmaster had purposefully chosen to form craigslist "as a for-profit Delaware corporation ," and directors of a for-profit Delaware corporation "cannot deploy a rights plan to defend a business strategy that openly eschews stockholder wealth maximization--at least not consistently with the directors' fiduciary duties under Delaware law." As a result, any "threat" to craigslist's corporate culture could not satisfy the first prong of the Unocal standard. For the same reason, the court found that "the defendants also failed to meet their burden of proof under the second prong of Unocal ."
The court further explained that it was aware of no decision under Delaware law addressing "a challenge to a rights plan adopted by a privately held company with so few stockholders." According to the court, the typical purpose of a rights plan--to "remedy the collective action problems" facing shareholders in large, widely held public companies--was not at issue here because Newmark and Buckmaster were "not dispersed, disempowered, or vulnerable stockholders." Rather, they were the empowered majority. In addition, because they collectively held in excess of 71 percent of craigslist stock (and were protected by a voting agreement between them), concerns that the rights plan might be designed with entrenchment purposes were not present; Newmark and Buckmaster firmly controlled their respective board seats. Nevertheless, the court applied the familiar Unocal standard of review, explaining that Unocal "is not limited to the historic and now classic paradigm. Fiduciary duties apply regardless of whether a corporation is registered and publicly traded, dark and delisted, or closely held."
Yucaipa American Alliance Fund II, L.P v. Riggio
Finally, Vice Chancellor Strine of the Delaware Court of Chancery held that defendant Barnes & Noble, Inc. ("Barnes & Noble"), the nationally known book retailer, and its board of directors had demonstrated that the adoption of a shareholder rights plan was a good faith, reasonable response to a legitimate takeover threat, in Yucaipa American Alliance Fund II, L.P. v. Riggio .
Plaintiff Yucaipa American Alliance Fund II, L.P. ("Yucaipa") approximately doubled its stake in Barnes & Noble over a four-day period, bringing its holdings to 17 percent of Barnes & Noble's outstanding stock. In response, the Barnes & Noble board enacted a rights plan designed to be triggered either if a shareholder acquired over 20 percent of Barnes & Noble's outstanding stock, or if two or more shareholders who combined owned over 20 percent entered into an "agreement, arrangement or understanding . . . for the purpose of acquiring, holding, voting. . .or disposing of any voting securities" of Barnes & Noble. The trigger did not apply to defendant Riggio (Barnes & Noble's founder) or his family, who collectively held approximately 30 percent of Barnes & Noble's outstanding shares. The rights plan did, however, limit Riggio from further increasing his holdings in Barnes & Noble. Yucaipa filed suit, arguing that the adoption of the rights plan was a breach of the board's fiduciary duty, seeking to compel the amendment of the plan's trigger to allow it to increase its share to equal that of Riggio, and to allow the formation of a coalition with other investors in order to run a joint slate in an upcoming proxy contest.
The court held that the board did not breach its fiduciary duties in the adoption of the rights plan. As in Selectica and eBay , the court determined that Unocal was the proper standard of review. First, the court found Yucaipa's rapid accumulation of shares constituted a sufficient threat under Unocal 's first prong. As for Unocal 's second prong, the court found that the adoption of the rights plan was a reasonable, non-preclusive response, noting that the "key issue" was whether the plan unreasonably inhibited Yucaipa's ability to run an effective proxy contest. The court relied on the approval of similar rights plans in Moran v. Household International, Inc. and Stahl v. Apple Bancorp, Inc. , to determine that the Barnes & Noble plan's restriction on the formation of collations aggregating in excess of 20 percent of outstanding shares did not prohibit a successful proxy contest. Indeed, the court noted the fact that the Barnes & Noble rights plan permitted the solicitation of revocable proxies as well as other activities that would aid in a successful proxy contest. The court explained that the question turned on whether the rights plan "fundamentally restricts" a successful proxy contest. In approving the Barnes & Noble rights plan, the court found that record reflected that "if Yucaipa makes a good merits case," it was not precluded from waging a successful proxy contest.
Lessons From the Three Opinions
Several important lessons can be drawn from these three opinions. First, the Delaware courts applied Unocal review to rights plans at issue in each of the three cases. Indeed, the Delaware Supreme Court appears to have committed all rights plans to a Unocal review by applying Unocal in Versata , and explaining that "any Shareholder Rights Plan, by its nature, operates as an antitakeover device."
Second, the three cases demonstrate the Delaware judiciary's willingness to consider the implementation of shareholder rights plans in a variety of novel settings and factual circumstances. In Versata , the Delaware Supreme Court affirmed a Court of Chancery decision approving a rights plan with a particularly low trigger, finding that its unique purpose (of protecting a company's NOLs) justified its departure from the more traditional rights plan triggers of 15 percent. In Yucaipa , the Court of Chancery approved a rights plan implementing a 20 percent trigger applicable to shareholders acting in concert, and the decision to grandfather a family's substantial holdings under the rights plan, thereby solidifying its status as the company's dominant stakeholder (given that the family was prohibited from attaining majority control of the company by the rights plan). In eBay , though the Court invalidated the rights plan at issue, the Court expressed no reluctance from a general standpoint that a shareholder rights plan could properly be deployed in a privately held Delaware corporation, despite no prior case law to that effect.
Third, these cases additionally explicate the permissible purposes for which a board can deploy a rights plan. In eBay , the Court of Chancery appeared to conclude that interests disconnected from shareholder value, such as craigslist's altruistic corporate culture, cannot be protected by a rights plan. However, the courts did not appear reluctant to uphold rights plans when shareholder value was the driving force behind their enactment, such as the NOL Rights Plan at issue in Selectica .
In the end, the Delaware courts approached the questions presented by these cases with familiar standards and principles, and with deference to the well-informed decisions of disinterested boards. The Delaware courts continue to apply a stable body of law to new questions arising in an ever-changing corporate world. Together, these decisions underscore for M&A practitioners the reasons why Delaware corporate law, and the Delaware judiciary, continue to maintain their preeminent position as the nation's preeminent corporate forum.
Ed Micheletti is a partner in the Wilmington, Delaware office of Skadden, Arps, Slate, Meagher & Flom LLP. His practice involves corporate, securities and complex commercial litigation with an emphasis on disputes involving mergers, acquisitions and issues of corporate governance. Cliff Gardner is an associate in Skadden's Wilmington, Delaware office.
1. 5 A.3d 586 (Del. 2010).
2. C.A. No. 3705-CC, 2010 WL 3516473 (Del. Ch. Sept. 9, 2010).
3. 1 A.3d 310 (Del. Ch. 2010).
4. 493 A.2d 946 (Del. 1985).
5. Selectica, Inc. v. Versata Enters., Inc., C.A. No. 4241-VCN, 2010 WL 703062, at *15 (Del. Ch. Feb. 26, 2010), aff'd, 5 A.3d 586 (Del. 2010).
6. The Supreme Court explained that "NOLs are tax losses, realized and accumulated by a corporation, that can be used to shelter future (or immediate past) income from taxation." 5 A.3d at 589. NOLs, however, are considered a contingent asset because realizing any value from them requires a corporation to report a future profit or having an immediate past profit during the 20-year lifespan of the NOLs. Id.
7. Selectica, Inc., 2010 WL 703062, at *1.
8. 5 A.3d at 590.
9. Id. at 594.
10. At the time the board of directors amended Selectica's rights plan, the Internal Revenue Code provided that an "ownership change" occurred when more than 50 percent of a firm's stock ownership changes over a three-year testing period. Selectica, Inc., 2010 WL 703062, at *1. Only those shareholders who held, or obtained during the testing period, a 5 percent or greater block of a company's shares were considered in the context of calculating an ownership change. Id. The cumulative acquisition of stock by Selectica's five-percent shareholders for purposes of Section 382 over the past three years stood at 40 percent. Versata, Inc., 5 A.3d at 594.
11. This "NOL Poison Pill" grandfathered existing 5 percent shareholders, allowing them to accumulate an additional .05 percent, subject to the original 15 percent cap. Versata, Inc., 5 A.3d at 595.
12. Id. at 596. Trilogy thereby became an "Acquiring Person" under the NOL Poison Pill. Id. This provided the Selectica board ten days to determine whether to deem Trilogy an "Exempt Person" under the NOL Poison Pill. Id. Exempt Person status was not conferred on Trilogy. Id.
13. Id. at 599.
14. Trilogy's subsidiary, Versata Enterprises, Inc., also counterclaimed. The two entities are collectively referred to as "Trilogy" for simplicity.
15. 493 A.2d 946. The two-part test of Unocal is well-known: "[t]he first part of Unocal review requires a board to show that it had reasonable grounds for concluding that a threat to the corporate enterprise existed." Versata, Inc., 5 A.3d at 599. "The second part of the Unocal test requires an initial evaluation of whether a board's defensive response to the threat was preclusive or coercive and, if neither, whether the response was 'reasonable in relation to the threat' identified." Id. at 601.
16. Versata, Inc., 5 A.3d at 599 (emphasis added).
17. Id. at 599 (quoting Unocal, 493 A.2d at 957).
19. Id. at 600. The Court of Chancery explained that a challenge to a board's reliance on an expert's advice "must establish such facts as would make reliance on the expert opinion unreasonable." Selectica, Inc., 2010 WL 703062, at *17.
20. 2010 WL 3516473.
21. Id. at *1.
22. Id. In response to Kijiji's launch, Newmark and Buckmaster, who together owned 71.6 percent of craigslist and held two of craigslist's three director seats: (i) enacted a rights plan; (ii) implemented a staggered board (thereby eliminating eBay's ability to unilaterally elect a director); and (iii) sought to obtain a right of first refusal in craigslist's favor over the shares held by eBay ("Right of First Refusal Issuance"). When eBay refused to participate in the Right of First Refusal Issuance, its ownership stake was diluted from 28.4 percent to 24.9 percent. The court applied entire fairness review to the Right of First Refusal Issuance because both Newmark and Buckmaster stood on both sides of the transaction. Id. at *19. As to the implementation of a staggered board, the court explained that business judgment review was warranted because Newmark and Buckmaster did not realize a financial benefit from the decision. Further, the Delaware General Corporate Law expressly authorizes a staggered board. Id. at *26.
23. Id. at *22.
24. Id. at *23 (emphasis in original).
25. Id. at *24.
26. Id. at *20.
28. Id. at *21 (quoting Kurz v. Holbrook, 989 A.2d 140, 183 (Del. Ch. 2010), aff'd in part, rev'd in part sub nom. Crown EMAK Partners, LLC v. Kurz, 992 A.2d 337 (Del. 2010)).
29. 1 A.3d 310.
30. Id. at 312-13.
31. 500 A.2d 1346 (Del. 1985).
32. C.A. No. 11510, 1990 WL 114222 (Del. Ch. Aug. 9, 1990).
33. Yucaipa, 1 A.3d at 334.
34. Id. at 339.
35. Id. at 359.
37. Versata, Inc., 5 A.3d at 599.