Corporate Governance

eBay Domestic Holdings v. Craigslist: Wanted Enforcement of Fiduciary Duties to Minority Shareholder

By Misty Dalke

In an earlier post, we reported that eBay had brought an action against Craigslist alleging breach of fiduciary duty in the Delaware Court of Chancery.  The Chancery Court decision is here. 

In 2004, eBay became a minority shareholder in Craigslist when it purchased a 28.4% shareholder position from Philip Knowlton, one of three Craigslist shareholders.  The terms of the transaction were set forth in a shareholder purchase agreement ('SPA') which included clauses treating as confidential certain information from Craigslist, restricting the transfers of shares, requiring consent to certain transactions, and authorizing eBay to compete with Craigslist.  The SPA also required eBay's approval of a new charter that called for a three person board with cumulative voting rights.  According to the agreement, each of the three shareholders would elect one director to the new board.  eBay appointed its former CEO, Pierre Omidyar, to the board. 

In 2007, eBay started its own online classified site, Kijiji.com.  Craigslist gave eBay 90 days to shut down the site before Craigslist would take action pursuant to the SPA.  eBay refused to shut down the website.  

In response, the two controlling shareholders of Craigslist, Craig Newmark ('Newmark') and James Buckmaster ('Buckmaster), took action.  They: 

• Adopted a rights plan that limited eBay's ability to buy and sell Craigslist shares ('Rights Plan')
• Amended the charter to adopt a staggered board that took away eBay's right to unilaterally elect a director ('Staggered Board Amendments')
• Obtained a right of first refusal over shares owned by Newmark and Buckmaster by issuing to both additional shares, thereby diluting eBay's position from 28.4% to 24.9% ('Dilutive Issuance')

Ebay challenged the actions.

The court ultimately concluded that the two shareholders of Craigslist breached their fiduciary duties by adopting the rights plan and by making the right of first refusal offer.   Both measures were required to be rescinded.  The staggered board provision, however, was upheld. 

The Rights Plan

The court used the Unocal test as the appropriate standard of review to analyze the rights plan.  The Unocal test placed the burden on the directors to show that their actions were reasonable.  Specifically, the directors are required to identify the corporate objectives served by their actions and reasonably justify those actions in accordance with the corporate objectives. 

Newmark and Buckmaster argued by adopting the rights plan, they were protecting their corporate culture.  The court acknowledged that the corporate cultures of eBay and Craigslist were as compatible as 'oil and water.'  The court, however, rejected the argument, ultimately finding that the adoption of the rights plan to protect Craigslist's' corporate culture did not better serve the shareholders. 

Staggered Board Amendments

With respect to the staggered board, eBay argued that it effectively eliminated the right to cumulative voting.  With only one director elected each year, eBay's right to cumulate shares would be insufficient to elect a director to the board.  eBay argued that in adopting the staggered board provision Newmark and Buckmaster were acting not in the best interests of Craigslist but were acting in their personal best interest which harmed eBay. 

The court rejected eBay's arguments finding Newmark and Buckmaster did not personally benefit from the staggered board amendments.  Additionally, the court noted under Delaware law, minority shareholders, such as eBay, were not required to have board representation.  Therefore, Delaware corporations did not have to ensure that cumulative voting rights actually benefited minority shareholders.  eBay, as the minority shareholder, was not deprived of any rights and consequently, Newmark and Buckmaster did not owe a fiduciary duty to eBay with regards to the staggered board amendments.

Right of First Refusal

Newmark and Buckmaster agreed to provide a right of first refusal to their shares that would continue indefinitely.  In granting the right, each would receive one newly issued Craigslist share for every five shares over which they granted a right of first refusal in craigslist's favor.  The same opportunity was offered to eBay. 

The court found the right of first refusal and the dilutive consequences was subject to an entire fairness review.  Under the fairness review, the burden falls on the controlling directors to show the transaction was fair.  To determine if Newmark and Buckmaster's actions were fair, they must show that the transaction was done at a fair price and the product of fair dealing. 

The court applied the entire fairness standard, noting that Newmark and Buckmaster stood on both sides of the transaction (as directors and shareholders).  The right of first refusal provided that shareholders agreeing to give Craigslist a right of first refusal would receive one additional share for each five owned.  Although offered to all three shareholders, eBay did not accept.  As a result, the company's ownershp percentage was reduced from 28.4% to 24.9%. 

The court concluded that the dilutive issue was not fair "because it requires eBay, the minority stockholder, to give up more value per share" than the other two shareholders.  Essentially, eBay, by agreeing to the right of first refusal, would have to give up the possibility that its shares would become freely transferable.  Newmark and Buckmaster's shares, on the other hand, were already encumbered (each had an option to by the shares of the other) so providing a right of first refusal to Craigslist resulted in no additional impairment of transferability.  The court held that Newmark and Buckmaster's dilutive issuance did not serve any corporate purpose for maintaining Craigslist's corporate culture and rescinded the dilutive issuance. 

The primary materials for this post can be found on the DU Corporate Governance website. 

Full post as published by The Race to the Bottom on February 14, 2011 (boomark / email).