Forget all the manuevering in the Microsoft/Yahoo dance, the real excitement in the tech world could be two lawsuits arising out of shareholder squabbles at craigslist. (WSJ story here.) I thought I would get out a good, overall post, but I think this will have to be a series. First, I'll tackle why folks at eBay is mad at the folks at craigslist.
Imagine a closely-held corporation (craigslist, Inc.) with shareholders A, B and C. You are C, and know that A and B are aligned and that you only have a 28% stake. Simple Business Associations question: how do you protect yourself? Well, if you are eBay Domestic Holdings, Inc., you ask for certain things to be in the Articles of Incorporation: cumulative voting, a 75% voting requirement to eliminate cumulative voting, unstaggered board. You might also want a right of first refusal agreement. eBay received these things, and A and B (Criag Newmark and James Buckmaster) agreed to put an eBay designate on the board. However, A and B are worried about some things, too. Although everyone is acting nice, C wants desperately to be in the same business that craigslist, Inc. is in, and C is really, really big. So, A and B agree to the right of first refusal agreement, but include language that it is contingent on no shareholder entering into competition with craigslist. (A and B know that as a 28% shareholder, C has no fiduciary duties to them that would prevent competition.) So, in August 2004, eBay becomes a minority shareholder in craigslist, Inc. (actually its predecessor, 1010). OK, this will work -- for awhile.
However, in June 2007, eBay launches an American version of its classified ad service, Kijiji. Newmark and Buckmaster send an email in July to Meg Whitman of eBay, notifying her that the right of first refusal has been revoked pursuant to its terms. (N.B., it seems that the shareholder agreement was drafted in such a (bizarre) way as to revoke everyone's right of first of refusal due to eBay's competitive action, so that now eBay could sell its stake without approval.) Newmark and Buckmaster say they are uncomfortable with having eBay as a shareholder now that they are competing and would like to discuss a repurchase or divestment. Whitman replies that she would love to talk about purchasing Newmark and Buckmaster's shares. Oops!
eBay does recognize there is a semblance of conflict with the individual is a director because of possible connections with Kijiji, so that director resigns. eBay suggests a replacement, but hears no word on that. (So, what happens at that point? Is there a vacancy? This will become important later.)
In October, Newmark and Buckmaster have a series of meeting as the Board of Directors of craigslist with outside counsel, Edward Wes of Perkins Coie. The minutes of these meetings reflect that the board was concerned with "the potential threat of an unwelcome takeover that would harm investors' interests." (N.B., craigslist is not a pubicly held corporation and has 3 shareholders, so an unwelcome takeover in the traditional sense does not seem possible. This will become important later.) The end result of these meetings is that certain changes have been made to craigslist's governance and charter. eBay now contests these actions in a direct and derivative lawsuit filed in Delaware, alleging that Newmark and Buckmaster breached their "fiduciary duties of loyalty, care and good faith to the stockholders of the Company." Here are the specific complaints:
1. Remember that the articles of incorporation provide for cumulative voting, and that this right may not be revoked without a 75% share vote. eBay owns 28%. So, one of the changes is to reorganize the board into a staggered board. Now that only one director spot will be up for bids each year, a 28% shareholder will not have guaranteed representation on the board.
2. And just in case that was not enough to lessen eBay's influence, by asking all shareholders to sign a new and improved right of first refusal agreement that would give craigslist the right of first refusal. As consideration of entering into the agreement, each signer will receive one "reorganization share" of common stock for every five shares of craigslist already held. Because Newmark and Buckmaster signed, their stockholdings increased, resulting in dilution of eBay's shares. Because eBay did not join in this fancy footwork, eBay's holdings now represent 24.85% of the shares, making the 75% trigger in th articles not that helpful anymore.
3. The Board approved a rights plan, or poison pill, that gives each stockholder a right that is exercisable should any shareholder acquire additional stock in the company or any new shareholder acquire 15% or more of the stock. Basically, this right would be triggered by eBay attempting to sell its shares or buy either Newmark's or Buckmaster's shares. (The plan is redeemable under the standard conditions.)
4. The eBay complaint also states that the articles of incorporation were amended. For this to happen, there should have been a board resolution and some sort of shareholder meeting, but the complaint is silent about this. I cannot get the articles online without paying, so I'll have to wait on that. Anyway, one change to the charter was to stagger the board, and also to create new mechanisms for changing the number of directors.
5. The Board also approved an indemnification agreement for Newmark and Buckmaster.
In some ways, the first general inclination is remind ourselves that eBay is sophisticated and knew what it was getting into by agreeing to become a minority shareholder. Delaware is not accepting of shareholder oppression claims. I would think the greatest hope would be in some sort of process claim. Without knowing the details of what procedures were taken, one could imagine that Newmark and Buckmaster effected some of these changes without proper notice to shareholders, but hopefully not. Perhaps the right of refusal could run afoul of rules that require transfer restrictions after issuance to be agreed upon by the holder -- is the threat of dilution to coercive? The complaint also argues that the issuance of the "reorganization shares" are without valuable consideration as the ROFR agreement doesn't benefit the corporation. This could be a wacky case like Adlerstein v. Wertheimer, 2002 WL 205684, where shenanigans to get around a majority shareholder/director didn't get around the chancery court. But here, eBay isn't the majority shareholder.
I am not an expert in Delaware law, so hopefully Gordon or others will chime in. If I were betting the odds, I'd bet the shareholder loses, even if it's eBay.
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1. Posted by Gordon Smith on May 14, 2008 @ 20:25 | Permalink
Great post, Christine. I haven't been able to study the documents, but I wonder: it appears that the three craigslist shareholders had a voting agreement that ensured eBay a board seat, so why does eBay need cumulative voting?
Aside from my idle curiosity about the lawyering, I see two major problems with craigslist's actions:
(1) The right of first refusal cannot be enforced against eBay. DGCL Section 202: "No restrictions so imposed shall be binding with respect to securities issued prior to the adoption of the restriction unless the holders of the securities are parties to an agreement or voted in favor of the restriction."
(2) The most troubling action is the dilution of eBay's interest via the issuance of "reorganization shares." Dilutive issuances are not prohibited, unless motivated by a desire to maintain control. Was there any other reason for the issuance of the "reorganization shares"?
2. Posted by Christine on May 16, 2008 @ 13:49 | Permalink
Thanks for commenting, Gordon. From the complaint, I would guess that there is no written agreement between eBay and the other two shareholders. The complaint references a voting agreement between the two individuals and just says something like "eBay asked for Mr. X to be a board director, and the other two shareholders agreed." So, I'm guessing the articles provisions were important to eBay (as they say over and over in the complaint).
So my question about your #1 is this. It seems at this point that the ROFR is not enforceable against eBay because they didn't sign it. If eBay had signed it, would it be enforceable if the only reason that eBay signed it was to avoid dilution? Now, eBay did not sign, but are diluted. And, because of the "rights agreement," which is a separate action, eBay would be diluted even more if they tried to sell to an outsider. So is the ROFR even necessary?