5 A.3d 586 (2010)

VERSATA ENTERPRISES, INC. and Trilogy, Inc., Defendants/Counter-claim Plaintiffs Below, Appellants/Cross Appellees,
v.
SELECTICA, INC., Plaintiff Below, Appellee/Cross Appellant, and
Selectica, Inc., James Arnold, Alan B. Howe, Lloyd Sems, Jim Thanos, and Brenda Zawatski, Counterclaim Defendants Below, Appellees/Cross Appellants.

No. 193, 2010.

Supreme Court of Delaware.

Submitted: July 7, 2010. Decided: October 4, 2010.

*588 Megan Ward Cascio, Esquire, Leslie A. Polizoti, Esquire and Ryan D. Stottmann, Esquire, Morris, Nichols Arsht & Tunnell, LLP, Wilmington, Delaware, and Nicholas Even, Esquire (argued) and Daniel Gold, Esquire, Haynes and Boone, LLP, Dallas, Texas, for appellants.

Gregory V. Varallo, Esquire (argued), Lisa A. Schmidt, Esquire, John D. Hendershot, Esquire, Ethan A. Shaner, Esquire, Scott W. Perkins, Esquire and Jillian G. Remming, Esquire, Richards, Layton & Finger, P.A., Wilmington, Delaware, and Jonathan S. Kitchen, Esquire and Christian H. Cebrian, Esquire, Cox, Castle & Nicholson, LLP, San Francisco, California, for Selectica, Inc., James Arnold, Alan B. Howe, Lloyd Sems, James Thanos and Brenda Zawatski.

Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS and RIDGELY, Justices, constituting the Court en Banc.

HOLLAND, Justice:

This is an appeal from a final judgment entered by the Court of Chancery. On November 16, 2008 the Board of Directors of Selectica, Inc. ("Selectica") reduced the trigger of its "poison pill" Shareholder Rights Plan from 15% to 4.99% of Selectica's outstanding shares and capped existing shareholders who held a 5% or more interest to a further increase of only 0.5% (the "NOL Poison Pill"). Selectica's reason for taking such action was to protect the company's net operating loss carryforwards ("NOLs"). When Trilogy, Inc. ("Trilogy") subsequently purchased shares above this cap, Selectica filed suit in the Court of Chancery on December 21, 2008, seeking a declaration that the NOL Poison Pill was valid and enforceable. On January 2, 2009, Selectica implemented the dilutive exchange provision (the "Exchange") of the NOL Poison Pill, which reduced Trilogy's interest from 6.7% to 3.3%, and adopted another Rights Plan with a 4.99% trigger (the "Reloaded NOL Poison Pill"). Selectica then amended its complaint to seek a declaration that the Exchange and the Reloaded NOL Poison Pill were valid.

Trilogy and its subsidiary Versata Enterprises, Inc. ("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. Trilogy and Versata also asserted that the NOL Poison Pill and the Reloaded NOL Poison Pill were impermissibly preclusive of a successful proxy contest for Board control, particularly when combined with Selectica's staggered director terms. After trial, the Court of Chancery held that the NOL Poison Pill, the Reloaded NOL Poison Pill, and the Exchange were all valid under Delaware law.

Trilogy and Versata now appeal and assert two claims of error. First, they contend that the Court of Chancery erred in applying the Unocal test for enhanced judicial scrutiny when confronting what they frame as a question of first impression. The issue (as framed by them) is: "what are the minimum requirements for a reasonable investigation before the board of a never-profitable company may adopt a [Rights Plan with a 4.99% trigger] for the ostensible purpose of protecting NOLs from an `ownership change' under Section 382 of the Internal Revenue Code?" Second, *589 they submit that the Court of Chancery erred in holding that the two NOL poison pills, either individually or in combination with a charter-based classified Board, did not have a preclusive effect on the shareholders' ability to pursue a successful proxy contest for control of the Company's board. We conclude that both arguments are without merit.

In its cross-appeal, the Selectica related parties argue that the Court of Chancery erred in denying their application for an award of attorneys' fees under the bad faith exception to the American Rule. We conclude that argument is also without merit.

Facts^[1]

The Court of Chancery described this as a case about the value of net operating loss carryforwards ("NOLs") to a currently profitless corporation, and the extent to which such a corporation may fight to preserve those NOLs. The Court of Chancery also provided a helpful overview of the concepts surrounding NOLs, their calculation, and possible impairment.

NOLs are tax losses, realized and accumulated by a corporation, that can be used to shelter future (or immediate past) income from taxation.^[2] If taxable profit has been realized, the NOLs operate either to provide a refund of prior taxes paid or to reduce the amount of future income tax owed. Thus, NOLs can be a valuable asset, as a means of lowering tax payments and producing positive cash flow. NOLs are considered a contingent asset, their value being contingent upon the firm's reporting a future profit or having an immediate past profit.

Should the firm fail to realize a profit during the lifetime of the NOL (twenty years), the NOL expires. The precise value of a given NOL is usually impossible to determine since its ultimate use is subject to the timing and amount of recognized profit at the firm. If the firm never realizes taxable income, at dissolution its NOLs, regardless of their amount, would have zero value.

In order to prevent corporate taxpayers from benefiting from NOLs generated by other entities, Internal Revenue Code Section 382 establishes limitations on the use of NOLs in periods following an "ownership change." If Section 382 is triggered, the law restricts the amount of prior NOLs that can be used in subsequent years to reduce the firm's tax obligations.^[3] Once NOLs are so impaired, a substantial portion of their value is lost.

The precise definition of an "ownership change" under Section 382 is rather complex. 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.

The Parties

Selectica, Inc. ("Selectica" or the "Company") is a Delaware corporation, head-quartered *590 in California and listed on the NASDAQ Global Market. It provides enterprise software solutions for contract management and sales configuration systems. Selectica is a micro-cap company with a concentrated shareholder base: the Company's seven largest investors own a majority of the stock, while fewer than twenty-five investors hold nearly two-thirds of the stock.^[4]

Trilogy, Inc. ("Trilogy") is a Delaware corporation also specializing in enterprise software solutions. Trilogy stock is not publicly traded, and its founder, Joseph Liemandt, holds over 85% of the stock. Versata Enterprises, Inc. ("Versata"), a Delaware corporation and a subsidiary of Trilogy, provides technology powered business services to clients.

Before the events giving rise to this action, Versata and Trilogy beneficially owned 6.7% of Selectica's common stock. After they intentionally triggered Selectica's Shareholder Rights Plan through the purchase of additional shares, Versata's and Trilogy's joint beneficial ownership was diluted from 6.7% to approximately 3.3%.

James Arnold, Alan B. Howe, Lloyd Sems, Jim Thanos, and Brenda Zawatski are members of the Selectica Board of Directors (the "Board").^[5] Zawatski and Thanos also served as Co-Chairs of the Board during the events at issue in the case.^[6] In this role, they handled the day-to-day operations of the Company, as Selectica had been without a Chief Executive Officer since June 30, 2008.

Selectica's Historical Operating Difficulties

Since it became a public company in March 2000, Selectica has lost a substantial amount of money and failed to turn an annual profit, despite routinely projecting near-term profitability. Its IPO price of $30 per share has steadily fallen and now languishes below $1 per share, placing Selectica's market capitalization at roughly $23 million as of the end of March 2009. By Selectica's own admission, its value today "consists primarily in its cash reserves, its intellectual property portfolio, its customer and revenue base, and its accumulated NOLs." By consistently failing to achieve positive net income, Selectica has generated an estimated $160 million in NOLs for federal tax purposes over the past several years.

Selectica's Relationship with Trilogy

Selectica has had a complicated and often adversarial relationship with Trilogy, stretching back at least five years. Both companies compete in the relatively narrow market space of contract management and sales configuration. In April 2004, a Trilogy affiliate sued Selectica for patent infringement and secured a judgment that required Selectica, among other things, to pay Trilogy $7.5 million. While their suit was pending, in January 2005 Trilogy made an offer to buy Selectica for $4 per share in cash—a 20% premium above the then-trading price—which Selectica's Board rejected. Nevertheless, during *591 March and April of that year, a Trilogy affiliate acquired nearly 7% of Selectica's common stock through open market trades. In early fall 2005, Trilogy made another offer for Selectica's shares at a 16%-23% premium, which was also rejected.

In September 2006, a Trilogy-affiliated holder of Selectica stock sent a letter to the Board questioning whether certain stock option grants had been backdated.^[7] The following month, Trilogy filed another patent infringement lawsuit against Selectica. That action was settled in October 2007, when Selectica agreed to a one-time payment of $10 million, plus an additional amount of not more than $7.5 million in subsequent payments to be made quarterly. In late fall 2006, Trilogy sold down its holdings in Selectica.

Steel Partners

Steel Partners is a private equity fund that has been a Selectica shareholder since at least 2006 and is currently its largest shareholder. One of Steel Partners' apparent investment strategies is to invest in small companies with large NOLs with the intent to pair the failing company with a profitable business in order to reap the tax benefits of the NOLs. Steel Partners has actively worked with Selectica to calculate and monitor the Company's NOLs since the time of its original investment.

By early 2008, Steel Partners was advocating a quick sale of Selectica's assets, leaving a NOL shell that could be merged with a profitable operating company in order to shelter the profits of the operating company. In October 2008, Steel Partners informed members of Selectica's Board that it planned to increase its ownership position to 14.9% just below the 15% trigger of the 2003 Rights Plan, which it later did. Jack Howard, President of Steel Partners, lobbied for a Board seat twice in 2008, citing his experience dealing with NOLs, but was rebuffed.

Selectica Investigates Its NOLs

In 2006, at the urging of Steel Partners, Selectica directed Alan Chinn, its outside tax adviser, to perform a high-level analysis into whether its NOLs were subject to any limitations under Section 382 of the Internal Revenue Code. Chinn concluded that five prior changes in ownership had caused the forfeiture of approximately $24.6 million in NOLs. Selectica provided the results of this study to Steel Partners, although not to any other Selectica shareholder.

In March 2007, again at Steel Partner's recommendation, Selectica retained a second accountant who specialized in NOL calculations, John Brogan of Burr Pilger & Mayer, LLP, to analyze the Company's NOLs more carefully and report on Chinn's Section 382 analysis. Brogan had previously analyzed the NOLs at other Steel Partners ventures. Brogan ultimately determined that Chinn's conclusions were erroneous.

The Company engaged Brogan to perform additional work on the topic of NOLs in June 2007. One of Steel Partners's employees, Avi Goodman, worked closely with Brogan on the matter, although Brogan *592 was working for and being paid by Selectica and received no compensation from Steel Partners. Brogan's draft letter opinion, concluding that the Company had not undergone an "ownership change" for Section 382 purposes since 1999, was shared with Steel Partners, although again not with any other outside investors.

In the fall of 2007, Brogan proposed a third, more detailed, Section 382 study, which Selectica's then-CEO, Robert Jurkowski, opposed. In February 2008, the Board voted against spending $40,000-$50,000 to fund this Section 382 study. By July, however, the Board asked Brogan to update his study. Brogan delivered the draft opinion that, as of March 31, 2008, the Company had approximately $165 million in NOLs. Brogan was later asked to advise the Board in the fall of 2008 on the updated status of its NOLs when the Board moved to amend its Rights Plan.

Lloyd Sems Elected Director

In April 2008, the Board began interviewing candidates for an open board seat, giving preference to the Company's large stockholders. Selectica investor Lloyd Sems had previously expressed interest in joining the Board and had sought support from certain shareholders, including Steel Partners, through Howard, and Lloyd Miller, another large Selectica shareholder not affiliated with Steel Partners. Both Miller and Howard wrote to the Board in support of Sems's appointment, although Sems was already favored by the Board by that time. In June 2008, Sems was appointed to the Board.

As large shareholders, Sems, Howard, and Miller had periodically discussed Selectica as early as October 2007. At that time, Sems had e-mailed Howard, stating, "I wanted to get your opinion of how or if you would like me to proceed with [Selectica]." Howard replied, "Lloyd [Miller] said he would call you about [Selectica]." Both before and after his appointment to the Board, Sems discussed with Howard and Miller a number of the proposals that Sems ultimately advocated as a director, including that Selectica should buy back its stock, that Selectica should consider selling its businesses, that the NOLs were important and should be preserved through the adoption of a Rights Plan with a 5% trigger, and that Jurkowski should be removed as CEO.

Selectica Restructures and Explores Alternatives

In early July 2008, after determining that the Company needed to change course, the Board terminated Jurkowski as CEO and eliminated several management positions in the sales configuration business. Later that month, prompted by the receipt of five unsolicited acquisition offers over the span of a few weeks, the Board announced that it was in the process of selecting an investment banker (ultimately, Jim Reilly of Needham & Company) to evaluate strategic alternatives for the Company and to assist with a process that ultimately might result in the Company's sale. In view of the potential sale, the Board decided to forgo the expense of replacing Jurkowski and, instead, asked Zawatski and Thanos jointly to assume the title of Co-Chair and to perform operational oversight roles on an interim basis.

The Needham Process

Needham has actively carried outs its task of evaluating Selectica's strategic options since its selection by the Board. Needham first discussed with the Board the various strategic choices that the Company could take. These included a merger of equals with a public company, a reverse IPO or other going-private transaction, the sale of certain assets, and the use of cash to acquire another company, as well as *593 stock repurchases or the issuance of dividends if Selectica decided to continue as an independent public company in the absence of sufficient market interest for an acquisition.

In October 2008, Needham prepared an Executive Summary of the assets and operations of Selectica and subsequently reached out to potential buyers, keeping in touch with various interested parties throughout the remainder of the year and into the first part of 2009. By February 2009, at least half a dozen parties had come forward with letters of intent and were in the process of meeting with Selectica management and conducting due diligence in the Company, with Needham evaluating their various proposals for the purchase of all or part of Selectica's operations. As of April 2009, Selectica, through Needham, had signed a letter of intent and entered into exclusive negotiations with a potential buyer.

Trilogy's Offers Rejected

On July 15, 2008, Trilogy's President, Joseph Liemandt, called Zawatski to inquire generally about the possibility of an acquisition of Selectica by Trilogy. On July 29, Trilogy Chief Financial Officer Sean Fallon, Trilogy Director of Finance Andrew Price, and Versata Chief Executive Officer Randy Jacops participated in a conference call with Selectica Co-Chairs Zawatski and Thanos on the same topic. During the call, Thanos inquired as to how Trilogy would calculate a value for the Company's NOLs. Fallon replied that Trilogy, "really [did not] pursue them with as much vigor as other[s] might since that is not our core strategy."^[8]

The following evening, Fallon contacted Zawatski and outlined two proposals for Trilogy to acquire Selectica's business: (1) Trilogy's purchase of all of the assets of Selectica's sales configuration business in exchange for the cancellation of the $7.1 million in debt Selectica still owed under the October 2007 settlement with Trilogy; or (2) Trilogy's purchase of Selectica's entire operations for the cancellation of the debt plus an additional $6 million in cash. Fallon subsequently followed up with an email reiterating both proposals and suggesting that either proposal would allow Selectica to still make use of its NOLs through the later sale of its corporate entity.

Shortly thereafter, the Board rejected both proposals, made no counterproposal, and there were no follow-up discussions. On October 9, 2008, Trilogy made a second bid to acquire all of the Selectica's assets for $10 million in cash plus the cancellation of the debt, which the Board also rejected. Although Trilogy was invited to participate in the sale process being overseen by Needham, Trilogy was apparently unwilling to sign a non-disclosure agreement, which was a prerequisite for participation. Around this same time, Trilogy had begun making open-market purchases for Selectica stock, although the Board apparently was not aware of this fact at the time.

Trilogy Buys Selectica Stock

On the evening of November 10, Fallon contacted Zawatski and informed her that Trilogy had purchased more than 5% of Selectica's outstanding stock and would be filing a Schedule 13D shortly, which it did on November 13.^[9] On a subsequent call *594 with Zawatski and Reilly, Fallon explained that Trilogy had begun buying because it believed that "the company should work quickly to preserve whatever shareholder value remained and that we were interested in seeing this process that they announced with Needham, that we were interested in seeing that accelerate...." Within four days of its 13D filing, Trilogy had acquired more than 320,000 additional shares, representing an additional 1% of the Company's outstanding shares.

NOL Poison Pill Adopted

In the wake of Trilogy's decision to begin acquiring Selectica shares, the Board took actions to gauge the impact of these acquisitions, if any, on the Company's NOLs, and to determine whether anything needed to be done to mitigate their effects. Sems immediately asked Brogan to revise his Section 382 analysis—which had not been formally updated since July—to take into account the recent purchases. The revised analysis was delivered to Sems and the Company's new CFO, Richard Heaps, on November 15. It showed that the cumulative acquisition of stock by shareholders over the past three years stood at 40%, which was roughly unchanged from the previous calculation, due to some double counting that occurred in the July analysis.^[10]

The Board met on November 16 to discuss the situation and to consider amending Selectica's Shareholder Rights Plan, which had been in place since February 2003. As with many Rights Plans employed as protection devices against hostile takeovers, Selectica's Rights Plan had a 15% trigger. The Board considered an amendment that would reduce that threshold trigger to 4.99% in order to prevent additional 5% owners from emerging and potentially causing a change-in-control event, thereby devaluing Selectica's NOLs. Also present at the meeting were Heaps, Brogan, and Reilly, along with Delaware counsel.

Heaps gave an overview of the Company's existing Shareholder Rights Plan and reviewed the stock price activity since Trilogy had filed its Schedule 13D, noting that shares totaling approximately 2.3% of the Company had changed hands in the two days following the filing. Brogan reviewed the Section 382 ownership analysis that his firm had undertaken on behalf of the Company, noting that additional acquisitions of roughly 10% of the float by new or existing 5% holders would "result in a permanent limitation on use of the Company's net operating loss carryforwards and that, once an ownership change occurred, there would be no way to cure the use limitation on the net operating loss carryforwards." He further advised the Board that "net operating loss carryforwards were a significant asset" and that he generally advises companies to consider steps to protect their NOLs when they experience a 30% or greater change in beneficial ownership. Lastly, Brogan noted that, while he believed that the cumulative ownership change calculations would decline significantly over the next twelve months, "it would decline only modestly, if at all, over the next three to four months," meaning that "the Company would continue to be at risk of an ownership change over the near term."

Reilly discussed the Company's strategic alternatives and noted that Steel Partners and other parties had expressed interest in pursuing a transaction that would realize *595 the value of Selectica's NOLs. He also reviewed potential transaction structures in which the Company might be able to utilize its NOLs. Responding to questions from the Board, Reilly noted that "it is difficult to value the Company's net operating loss carryforwards with greater precision, because their value depends, among other things, on the ability of the Company to generate profits." He confirmed that "existing stockholders may realize significant potential value" from the utilization of the Company's NOLs, which would be "significantly impaired" if a Section 382 ownership change occurred.

At the request of the Board, Delaware counsel reviewed the Delaware law standards that apply for adopting and implementing measures that have an anti-takeover effect. The Board then discussed amending the existing Shareholder Rights Plan, and the possible terms of such an amendment. These included: the pros and cons of providing a cushion for preexisting 5% holders, the appropriate effective date of the new Shareholder Rights Plan, whether the Board should have authority to exclude purchases by specific stockholders from triggering the Rights Plan, and whether a review process should be implemented to determine periodically whether the Rights Plan should remain in effect.

The Board then unanimously passed a resolution amending Selectica's Shareholder Rights Plan, by decreasing the beneficial ownership trigger from 15% to 4.99%, while grandfathering in existing 5% shareholders and permitting them to acquire up to an additional 0.5% (subject to the original 15% cap) without triggering the NOL Poison Pill.

The Board resolution also established an Independent Director Evaluation Committee (the "Committee") as a standing committee of the Board to review periodically the rights agreement at the behest of the Board and to "determine whether the Rights [Plan] continues to be in the best interest of the Corporation and its stockholders." The Committee was also directed to review "the appropriate trigger percentage" of the Rights Plan based on corporate and shareholder developments, any broader developments relating to rights plans generally—including academic studies of rights plans and contests for corporate control—and any other factors it deems relevant. The Board set April 30, 2009, as the first date that the Committee should report its findings.

Trilogy Triggers NOL Poison Pill

The Board publicly announced the amendment of Selectica's Rights Plan on Monday, November 17. Early the following morning, Fallon e-mailed Trilogy's broker, saying "[W]e need to stop buying SLTC. They announced a new pill and we need to understand it." Fallon also sent Liemandt a copy of Selectica's 8-K containing the amended language of the NOL Poison Pill. Trilogy immediately sought legal advice about the NOL Poison Pill. The following morning, Liemandt e-mailed Price, with a copy to Fallon, asking, "What percentage of [Selectica] would we need to buy to ruin the tax attributes that [S]teel [P]artners is looking for?"^[11] They concluded that they would need to acquire 23% to trigger a change-in-control event.

Later that week, Trilogy sent Selectica a letter asserting that a Selectica contract *596 with Sun Microsystems constituted a breach of the October 2007 settlement and seeking an immediate meeting with Selectica purportedly to discuss the breach, even though members of Trilogy's management had been on notice of the contract as early as July. Fallon, Liemandt, and Jacops from Trilogy, along with Zawatski, Thanos, and Heaps from Selectica met on December 17. The parties' discussions at this meeting are protected by a confidentiality agreement that had been circulated in advance. However, Selectica contends that "based solely on statements and conduct outside that meeting, it is evident that Trilogy threatened to trigger the NOL Poison Pill deliberately unless Selectica agreed to Trilogy's renewed efforts to extract money from the Company."

On December 18, Trilogy purchased an additional 30,000 Selectica shares, and Trilogy management verified with Liemandt his intention to proceed with "buying through" the NOL Poison Pill. The following morning, Trilogy purchased an additional 124,061 shares of Selectica, bringing its ownership share to 6.7% and thereby becoming an "Acquiring Person" under the NOL Poison Pill. 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. Fallon asserted that the reason for triggering the NOL Poison Pill was to "bring some clarity and urgency" to their discussions with Selectica about the two parties' somewhat complicated relationship by "setting a time frame that might help accelerate discussions" on the direction of the business.

Fallon placed a telephone call to Zawatski on December 19 to advise her that Trilogy had bought through the NOL Poison Pill. During a return call by Zawatski later that evening, Fallon indicated that Trilogy felt, based on the conversations from December 17, that Selectica no longer wanted Trilogy as a shareholder or creditor. He then proposed that Selectica repurchase Trilogy's shares, accelerate the payment of its 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." Zawatski recalled that Fallon told her that Trilogy had triggered the pill "to get our attention and create a sense of urgency;" that, since the Board would have ten days to determine how to react to the pill trigger, "it would force the board to make a decision."

Board Considers Options and Requests a Standstill

The Selectica Board had a telephonic meeting on Saturday, December 20, to discuss Trilogy's demands and an appropriate response. The Board discussed "the desirability of taking steps to ensure the validity of the Shareholder Rights Plan," and ultimately passed a resolution authorizing the filing of this lawsuit, which occurred the following day. On December 22, Trilogy filed an amended Schedule 13D disclosing its ownership percentage and again the Selectica Board met telephonically to discuss the litigation. It eventually agreed to have a representative contact Trilogy to seek a standstill on any additional open market purchases while the Board used the ten-day clock under the NOL Poison Pill to determine whether to consider Trilogy's purchases "exempt" under the Rights Plan, and if not, how Selectica would go about implementing the pill.

The amended Rights Plan allowed the Board to declare Trilogy an "Exempt Person" during the ten-day period following the trigger, if the Board determined that Trilogy would not "jeopardize or endanger the availability to the Company of the NOLs...." The Board could also decide *597 during this window to exchange the rights (other than those held by Trilogy) for shares of common stock. If the Board did nothing, then after ten days the rights would "flip in" automatically, becoming exercisable for $36 worth of newly-issued common stock at a price of $18 per right.

The Board met again by telephone the following day, December 23, to discuss the progress of the litigation and to consider the potential impact of the various alternatives under the NOL Poison Pill. The Board agreed to meet in person the following Monday, December 29, along with the Company's financial, legal, and accounting advisors, to evaluate further the available options. The Board also voted to reduce the number of authorized directors from seven to five.

On Wednesday, December 24, the Board met once again by telephone upon learning that the Company's counsel had not succeeded in convincing Trilogy to agree to a standstill. The Board resolved that Zawatski should call Fallon to determine whether Trilogy was willing "to negotiate a standstill agreement that might make triggering the remedies available under the Shareholder Rights Plan, as amended, unnecessary at this time." Zawatski spoke with Fallon on the morning of December 26. Fallon stated that Trilogy did not want to agree to a standstill, that relief from the NOL Poison Pill was not Trilogy's goal, and that Trilogy expected that the NOL Poison Pill would apply to it. Fallon reiterated that the ten-day window would help "speed [the] course" towards a resolution of their claims.

The Board and its advisors met again on December 29. Thanos provided an update on recent developments at the Company, including financial results, management changes, and the Needham Process, as well as an overview of the make-up of the Company's shareholder base. Reilly then provided a more detailed report on the status of the Needham Process. Thereafter, Brogan presented his firm's updated analysis of Selectica's NOLs, which found that the Company had at least $160 million in NOLs and that there had been a roughly 40% ownership change by 5% holders over the three-year testing period. Since those were not expected to "roll off" in the near term, there was "a significant risk of a Section 382 ownership change."

Brogan subsequently discussed the possible consequences of the two principal mechanisms for implementing the triggered NOL Poison Pill to the change-in-control analysis. He stated that employing a share exchange would not likely have a materially negative impact on the Section 382 analysis. He expressed concern, however, about the uncertain effect of a flip-in pill on subsequent ownership levels (specifically, the possibility that a flip-in pill would, itself, trigger a Section 382 ownership change). Reilly once again addressed the Board to explain the ways he believed the NOLs would be valuable to the Company in its ongoing exploration of strategic alternatives, and reiterated his opinion that an ownership change would "reduce the value of the Company."

The Board also discussed Trilogy's settlement demands. It found them "highly unreasonable" and "lack[ing] any reasonable basis in fact," and that "it [was] not in the best interests of the Company and its stockholders to accept Trilogy/Versata's settlement demands relating to entirely separate intellectual property disputes as a precondition to negotiating a standstill agreement to resolve this dispute." The Board discussed Trilogy's actions at some length, ultimately concluding that they "were very harmful to the Company in a number of respects," and that "implementing the exchange was reasonable in relation to the threat imposed by Trilogy." In *598 particular, that was because (1) the NOLs were seen as "an important corporate asset that could significantly enhance stockholder value," and (2) Trilogy had intentionally triggered the NOL Poison Pill, publicly suggested it might purchase additional stock, and had refused to negotiate a standstill agreement, even though an additional 10% acquisition by a 5% shareholder would likely trigger an ownership change under Section 382.

The Board then authorized Delaware counsel to contact Trilogy in writing, one final time, to seek a standstill agreement. It also passed resolutions delegating the full power of the Board to the Committee to determine whether or not to treat Trilogy or its acquisition as "exempt," and nominating Alan Howe as a new member of the Board. On the evening of December 29, Selectica's Delaware counsel e-mailed Trilogy's trial counsel at the Board's instruction, seeking a standstill agreement "so that the Board could consider either declaring them an `Exempt Person' under the Rights Plan ... or alternatively, settle the litigation altogether in exchange for a long term agreement relating to your clients' ownership of additional shares." The following afternoon, Trilogy's counsel responded that Trilogy was not willing to agree to the proposed standstill.

Two days later, on December 31, the Board met telephonically and was informed of Trilogy's latest rejection of a standstill agreement. The Board discussed its options with its legal advisors and ultimately concluded that the NOL Poison Pill should go into effect and that an exchange was the best alternative and should be implemented as soon as possible in order to protect the NOLs, even at the risk of disrupting common stock trading. The Board directed advisers to prepare a technical amendment to the NOL Poison Pill to clarify the time at which the exchange would become effective.

Board Adopts Reloaded Pill and Dilutes Trilogy Holdings

On January 2, the Board met telephonically once more, reiterating its delegation of authority to the Committee to make recommendations regarding the implementation of the NOL Poison Pill. The Board also passed a resolution expressly confirming that the Board's delegation of authority to the Committee included the power to effect an exchange of the rights under the NOL Poison Pill and to declare a new dividend of rights under an amended Rights Plan (the "Reloaded NOL Poison Pill"). The Board then adjourned and the Committee—comprised of Sems and Arnold—met with legal and financial advisors, who confirmed that there had been no new agreement with representatives from Trilogy, reiterated that the NOLs remained "a valuable corporate asset of the Company in connection with the Company's ongoing exploration of strategic alternatives," and advised the Committee members of their fiduciary obligations under Delaware law.

Reilly presented information to the Committee about the current takeover environment and the use of Rights Plans (specifically, the types of pills commonly employed and their triggering thresholds), and reviewed the Company's then-current anti-takeover defenses compared with those of other public companies. Reilly stated that "a so-called NOL rights plan with a 4.99% trigger threshold is designed to help protect against stock accumulations that would trigger an `ownership change,'" and that "implementing appropriate protections of the Company's net operating loss carryforwards was especially important at present," given Trilogy's recent share acquisitions superimposed on the Company's existing Section 382 ownership *599 levels. Finally, Reilly reviewed the proposed terms and conditions of the Reloaded NOL Poison Pill, discussed the methodology for determining the exercise price of the new rights, and made recommendations. The Committee sought and obtained reconfirmed assurances by its financial and legal advisors that the NOLs were a valuable corporate asset and that they remained at a significant risk of being impaired.

The Committee concluded that Trilogy should not be deemed an "Exempt Person," that its purchase of additional shares should not be deemed an "Exempt Transaction," that an exchange of rights for common stock (the "Exchange") should occur, and that a new rights dividend on substantially similar terms should be adopted. The Committee passed resolutions implementing those conclusions, thereby adopting the Reloaded NOL Poison Pill and instituting the Exchange.

The Exchange doubled the number of shares of Selectica common stock owned by each shareholder of record, other than Trilogy or Versata, thereby reducing their beneficial holdings from 6.7% to 3.3%. The implementation of the Exchange led to a freeze in the trading of Selectica stock from January 5, 2009 until February 4, 2009, with the stock price frozen at $0.69. The Reloaded NOL Poison Pill will expire on January 2, 2012, unless the expiration date is advanced or extended, or unless these rights are exchanged or redeemed by the Board some time before.

ANALYSIS

Unocal Standard Applies

In Unocal, this Court recognized that "our corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs."^[12] The Court of Chancery concluded that the protection of company NOLs may be an appropriate corporate policy that merits a defensive response when they are threatened. We agree.

The Unocal two part test is useful as a judicial analytical tool because of the flexibility of its application in a variety of fact scenarios.^[13] Delaware courts have approved the adoption of a Shareholder Rights Plan as an antitakeover device, and have applied the Unocal test to analyze a board's response to an actual or potential hostile takeover threat.^[14] Any NOL poison pill's principal intent, however, is to prevent the inadvertent forfeiture of potentially valuable assets, not to protect against hostile takeover attempts.^[15] Even so, 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.

Threat Reasonably Identified

The 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. The Selectica Board concluded that the *600 NOLs were an asset worth preserving and that their protection was an important corporate objective. Trilogy contends that the Board failed to demonstrate that it conducted a reasonable investigation before determining that the NOLs were an asset worth protecting. We disagree.

The record reflects that the Selectica Board met for more than two and a half hours on November 16. The Court of Chancery heard testimony from all four directors and from Brogan, Reilly, and Heaps, who also attended that meeting and advised the Board. The record shows that the Board first analyzed the NOLs in September 2006, and sought updated Section 382 analyses from Brogan in March 2007, June 2007, and July 2008. At the November 16 meeting, Brogan advised the Board that the NOLs were a "significant asset" based on his recently updated calculations of the NOLs' magnitude. Reilly, an investment banker, similarly advised the Board that the NOLs were worth protecting given the possibility of a sale of Selectica or its assets. Accordingly, the record supports the Court of Chancery's factual finding that the Board acted in good faith reliance on the advice of experts^[16] in concluding that "the NOLs were an asset worth protecting and thus, that their preservation was an important corporate objective."

The record also supports the reasonableness of the Board's decision to act promptly by reducing the trigger on Selectica's Rights Plan from 15% to 4.99%. At the November 16 meeting, Brogan advised the Board that the change-of-ownership calculation under Section 382 stood at approximately 40%. Trilogy's ownership had climbed to over 5% in just over a month, and Trilogy intended to continue buying more stock. There was nothing to stop others from acquiring stock up to the 15% trigger in the Company's existing Rights Plan. Once the Section 382 limitation was tripped, the Board was advised it could not be undone.

At the November 16 meeting, the Board voted to amend Selectica's existing Rights Plan to protect the NOLs against a potential Section 382 "change of ownership." It reduced the trigger of its Shareholders Rights Plan from 15% to 4.99% and provided that existing shareholders who held in excess of 4.99% would be subject to dilutive consequences if they increased their holdings by 0.5%. The Board also created the Review Committee (Arnold and Sems) with a mandate to conduct a periodic review of the continuing appropriateness of the NOL Poison Pill.

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. The Court of Chancery explained those findings, as follows:

The threat posed by Trilogy was reasonably viewed as qualitatively different from the normal corporate control dispute that leads to the adoption of a shareholder rights plan. In this instance, *601 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. It was reasonable for the Board to respond, and the timing of Trilogy's campaign required the Board to act promptly. Moreover, the 4.99% threshold for the NOL Poison Pill was driven by our tax laws and regulations; the threshold, low as it is, was measured by reference to an external standard, one created neither by the Board nor by the Court [of Chancery]. Within this context, it is not for the Court [of Chancery] to second-guess the Board's efforts to protect Selectica's NOLs.

Those findings are not clearly erroneous.^[17] They are supported by the record and the result of a logical deductive reasoning process.^[18] Accordingly, we hold that the Selectica directors satisfied the first part of the Unocal test by showing "that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person's stock ownership."^[19]

Selectica Defenses Not Preclusive

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.^[20] Under Unitrin, a defensive measure is disproportionate and unreasonable per se if it is draconian by being either coercive or preclusive.^[21] A coercive response is one that is "aimed at `cramming down' on its shareholders a management-sponsored alternative."^[22]

A defensive measure is preclusive where it "makes a bidder's ability to wage a successful proxy contest and gain control either `mathematically impossible' or `realistically unattainable.'"^[23] A successful proxy contest that is mathematically impossible is, ipso facto, realistically unattainable. Because the "mathematically impossible" formulation in Unitrin is subsumed within the category of preclusivity described as "realistically unattainable," there is, analytically speaking, only one test of preclusivity: "realistically unattainable."

Trilogy claims that a Rights Plan with a 4.99% trigger renders the possibility of an effective proxy contest realistically unattainable. In support of that position, Trilogy argues that, because a proxy contest can only be successful where the challenger has sufficient credibility, the 4.99% pill trigger prevents a potential dissident from signaling its financial commitment to the company so as to establish such credibility. In addition, Professor Ferrell, Trilogy's expert witness, testified that the 5% cap on *602 ownership exacerbates the free rider problem already experienced by investors considering fielding an insurgent slate of directors, and makes initiating a proxy fight an economically unattractive proposition.^[24]

This Court first examined the validity of a Shareholder Rights Plan in Moran v. Household International, Inc.^[25] In Moran the Rights Plan at issue had a 20% trigger.^[26] We recognized that, while a Rights Plan "does deter the formation of proxy efforts of a certain magnitude, it does not limit the voting power of individual shares."^[27] In Moran, we concluded that the assertion that a Rights Plan would frustrate proxy fights was "highly conjectural" and pointed to "recent corporate takeover battles in which insurgents holding less than 10% stock ownership were able to secure corporate control through a proxy contest or the threat of one."^[28]

The 5% trigger that is necessary for a NOL poison pill to serve its primary objective imposes a lower threshold than the Rights Plan thresholds that have traditionally been adopted and upheld as acceptable anti-takeover defenses by Delaware courts. Selectica submits that the distinguishing feature of the NOL Poison Pill and Reloaded NOL Poison Pill—the 5% trigger— is not enough to differentiate them from other Rights Plans previously upheld by Delaware courts, and that there is no evidence that a challenger starting below 5% could not realistically hope to prevail in a proxy contest at Selectica. In support of those arguments Selectica presented expert testimony from Professor John C. Coates IV and Peter C. Harkins.

Professor Coates identified more than fifty publicly held companies that have implemented NOL poison pills with triggers at roughly 5%, including several large, well-known corporations, some among the Fortune 1000. Professor Coates noted that 5% Rights Plans are customarily adopted where issuers have "ownership controlled" assets, such as the NOLs at issue in this case. Professor Coates also testified that Selectica's 5% Rights Plan trigger was narrowly tailored to protect the NOLs because the relevant tax law, Section 382, measures ownership changes based on shareholders who own 5% or more of the outstanding stock.

Moreover, and as the Court of Chancery noted, shareholder advisory firm RiskMetrics Group now supports Rights Plans with a trigger below 5% on a case-by-case basis if adopted for the stated purpose of preserving a company's net operating losses.^[29] The factors RiskMetrics will consider *603 i