Chancellor Chandler's opinion in eBay v. Newmark, issued today, is a fascinating read, and it would be impossible to do this opinion justice in a single blog post. The facts of the case are rather complex (see Chirstine's post over two years ago on this case), but Chancellor Chandler did a magnificent job with the analysis, as usual. The aspect of the opinion that most caught my eye on the first reading was its resemblance to the iconic Dodge v. Ford Motor Co., which I examined in some detail in The Shareholder Primacy Norm, and I will focus on this part of the opinion here.
The case stems from a minority investment (28.4%) by eBay in craigslist. The other two stockholders in craigslist are Craig Newmark (42.6%) and James Buckmaster (29%). When eBay made its investment in August 2004, the three stockholders negotiated a Stock Purchase Agreement and a Stockholders' Agreement, both of which contained provisions of interest in the litigation. Perhaps most importantly, the Stockholders' Agreement expressly reserved eBay's right to compete with craigslist, but specified various consequences that would follow from such competition: (1) eBay would lose various negative covenants (which Chancellor Chandler calls "rights to consent") with respect to craigslist; (2) eBay would lose any preemptive rights in connection with the issuance of craigslist shares; and (3) eBay would lose its right of first refusal with respect to any sale of shares by Newmark or Buckmaster. On the bright side, eBay would be freed from any right of first refusal belonging to Newmark or Buckmaster with respect to the sale of shares by eBay.
The craigslist charter provided for a board of directors of three people, who would be elected under cumulative voting. Under these voting rules, eBay had enough shares to ensure itself one director position. Newmark or Buckmaster had entered into a voting agreement, which ensured that they would have the other two director positions.
Chancellor Chandler describes the relationship between eBay and craigslist as "oil and water." eBay was interested in monetizing craigslist, but Newmark or Buckmaster were having none of it. Not long after the investment, eBay launched Kijiji, an international classified ads service. When eBay expanded Kijiji to the U.S. in June 2007, craigslist sprang into action, eventually making three moves that were the focus of eBay's lawsuit:
(1) implementation of a staggered board through amendments to the craigslist charter and bylaws (the “Staggered Board Amendments”); (2) approval of a stockholder rights plan (the “Rights Plan”); and (3) an offer to issue one new share of craigslist stock in exchange for every five shares on which a craigslist stockholder granted a right of first refusal in favor of craigslist (the “ROFR/Dilutive Issuance”).
While the right of first refusal seems like a good candidate for a statutory challenge, Chancellor Chandler decided eBay's challenges to all three actions exclusively on fiduciary duty grounds. As is so often the situation in Delaware, the search for the right standard was central to the decision. In this case, Chancellor Chandler held as follows:
- The Rights Plan "implicates Unocal concerns in my view because rights plans (known as 'poison pills' in takeover parlance) fundamentally are defensive devices that, if used correctly, can enhance stockholder value but, if used incorrectly, can entrench management and deter value-maximizing bidders at the stockholders’ expense." I might have some quibbles with this, but I will reserve those for a later day. The analysis of the Rights Plan is the most interesting part of the opinion to me, and I will say more about that below, but for now, let's just accept Chancellor Chandler's conclusion that Unocal applies.
- The Staggered Board Amendments "do not function as a defensive device under the unique facts of this case"; therefore, the amendments are not subject to review under the Unocal standard. The Staggered Board Amendments in this case function to deprive eBay of its board seat, nullifying the effect of cumulative voting. You might be forgiven for thinking that staggered boards, like poison pills, "fundamentally are defensive devices," but Chancellor Chandler's rejects this conclusion because the voting agreement between Newmark or Buckmaster ensures that eBay cannot capture control of the board of directors.
For eBay the Staggered Board Amendments still make the difference between having a board representative and not having a board representative. While I can see Chancellor Chandler's point, this effect seems defensive to me. In any event, Chancellor Chandler concludes that the Staggered Board Amendments should be subject to the business judgment rule, and he ultimately upholds the amendments. (Lots more one could say about this, but, again, I will save it for another post.)
- The ROFR/Dilutive Issuance is subject to the "entire fairness" standard because Newmark or Buckmaster "stood on both sides" (i.e, they are simultaneously the directors who approved the issuance and the stockholders who benefit from the issuance). Chancellor Chandler cleverly analyzes the ROFR, concluding, "it actually costs eBay more to grant a right of first refusal over five of its craigslist shares than it costs [Newmark or Buckmaster] to do the same." As a result, the action is not entirely fair, and Chancellor Chandler orders recission of the action.
We already know the punchline of the case: Newmark and Buckmaster breach their duties to eBay. But let's take a closer look at Chancellor Chandler's analysis of the Rights Plan, and you will see an amazing similarity with Dodge v. Ford Motor.
- First, this is a minority oppression case. Chancellor Chandler invokes theUnocal standard, and he never mentions the word "oppression," but the case has oppression written all over it. craigslist is a closely held corporation, and Newmark and Buckmaster are acting in concert as controlling stockholders (think Henry Ford). Chancellor Chandler observes, "controlling stockholders are fiduciaries of their corporations’ minority stockholders." Similarly, the Dodge court noted, "There should be no confusion (of which there is evidence) of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders."
- Second, Chancellor Chandler gives us an impassioned defense of shareholder primacy, which contrasts with the controlling stockholders' public-service orientation:
"[Newmark and Buckmaster] did prove that they personally believe craigslist should not be about the business of stockholder wealth maximization, now or in the future. As an abstract matter, there is nothing inappropriate about an organization seeking to aid local, national, and global communities by providing a website for online classifieds that is largely devoid of monetized elements. Indeed, I personally appreciate and admire [Newmark's and Buckmaster's] desire to be of service to communities. The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders."
You can see in this passage the echoes of Dodge:
"A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes."
- Third, the principal wrong to which the controlling shareholders are responding is competition from the minority shareholders. In this case, eBay is competing directly with craigslist, and craigslist was attempting to prevent eBay from gaining a competitive advantage by virtue of eBay's stock ownership in craigslist. Similarly, in Dodge, the Dodge brothers were setting up a new car manufacturing company to compete with Ford Motor Company, and Henry Ford wanted to prevent them from gaining capital by virtue of their stock ownership in Ford Motor.
This lawsuit is an interesting and unusual context for the application of the Unocal standard, which normally applies to large, publicly traded companies. As a doctrinal matter, the case is also unusual in that Chancellor Chandler held that Newmark and Buckmaster did not reasonably perceive a threat to craigslist’s corporate policy and effectiveness. This is a rare holding, as the Delaware courts traditionally have little problem locating a threat and spend most of their analytical energy on the proportionality prong of Unocal. Whatever the doctrinal clothing, it seems to me that Chancellor Chandler got the right result.
UPDATE: Josh Fershee explores the Ford analogy and finds a distinction between the cases:
For Ford, there seemed to be something of a change in the business model (and how the business was operated with regard to dividends) once the Dodge Brothers started thinking about competing. All of a sudden, Ford became concerned about community first. For craigslist, at least with regard to the concept of serving the community, the company changed nothing. And, in fact, it seems apparent that craiglist’s view of community is one reason, if not the reason, it still has its “perch atop the pile.”
Thus, while it is true craigslist never needed to accept eBay’s money, eBay also knew exactly how craigslist was operated when they invested. If they wanted to ensure they could change that, it seems to me they should have made sure they bought a majority share.
When I first picked up the case yesterday, I wondered if Chancellor Chandler might go in this direction. This seems consistent with Delaware's history with regard to minority oppression cases (see, e.g., Nixon v. Blackwell), and it's not an unreasonable response to eBay's complaint.
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