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eBay Domestic Holdings, Inc. v. Newmark, C.A. No. 3705-CC (Del. Ch. Sept. 9, 2010)

September 9, 2010

In this post-trial opinion, the Court of Chancery concluded that the directors of craigslist, Inc. did not breach their fiduciary duties by implementing a staggered board structure for the purpose of preventing a stockholder, eBay Domestic Holdings, Inc. (“eBay”), from unilaterally electing a director to the craigslist board. The Court rescinded two other transactions, however — a shareholder rights plan (the “Rights Plan”) and a stock issuance — concluding that craigslist’s directors breached their fiduciary duties to eBay in implementing those measures.

eBay first became a stockholder of craigslist in August 2004, acquiring a 28.4% interest. Defendants Craig Newmark and James Buckmaster owned the remaining outstanding shares — approximately 42.6% and 29% interests, respectively. When eBay became a stockholder in 2004, it entered into a Shareholders’ Agreement with Newmark, Buckmaster, and craigslist “Defendants”) that, among other things, granted eBay veto power over certain corporate transactions and gave the parties rights of first refusal over each other’s shares. The Shareholders’ Agreement expressly permitted eBay to compete with craigslist, but provided that if eBay engaged in “Competitive Activity,” as defined in the Shareholders’ Agreement, it would lose both its veto rights over certain corporate transactions and its right of first refusal over Newmark’s and Buckmaster’s shares. At the same time, however,  Defendants would lose their right of first refusal over eBay’s shares under such circumstances.

The Court noted that the eBay-craigslist relationship “was marred by inconsistent expectations” from the beginning, as Newmark and Buckmaster wanted eBay to be a supportive stockholder that would appreciate craigslist’s “unique mission and philosophy,” while eBay’s goal was to acquire craigslist or, failing that, to enter into the online classifieds market itself. In March 2005, eBay launched its Kijiji online classifieds website outside the United States. Evidence introduced at trial suggested that eBay’s development of the platform that spawned the Kijiji website was aided by nonpublic craigslist information. Evidence also showed that once eBay launched Kijiji internationally, eBay continued to internally circulate nonpublic craigslist information (in what the Court termed a “liberal” fashion) to enable eBay to launch Kijiji domestically, which it ultimately did on June 29, 2007. Upon that launch, Defendants promptly informed eBay that it was engaged in Competitive Activity within the meaning of the Shareholders’ Agreement and, in accordance with that Agreement, gave eBay 90 days to cure. eBay did not cure.

On January 1, 2008, Buckmaster and Newmark executed written consents in their capacities as directors and stockholders approving (i) the adoption of the Rights Plan; (ii) amendments to craigslist’s certificate of incorporation and bylaws, which divided the three member board into three classes with staggered three-year terms (the “Staggered Board Amendments”); and (iii) a transaction whereby craigslist offered one new share of stock for every five shares of currently outstanding stock over which any stockholder (including eBay) granted craigslist a right of first refusal (the “ROFR Issuance”) (collectively the “Actions”). The Rights Plan effectively prevented any current stockholder from acquiring additional craigslist shares or transferring blocks of 15% or more of the shares to third parties without board approval. The Staggered Board Amendments essentially eliminated the effect of the cumulative voting provision in craigslist’s certificate of incorporation, which had previously enabled eBay to unilaterally elect one of the three craigslist directors. Furthermore, as eBay had not accepted the ROFR, while Newmark and Buckmaster had, the ROFR Issuance increased Newmark’s and Buckmaster’s share ownership and decreased eBay’s percentage ownership from 28.4% to 24.9%.

Focusing first on the Rights Plan, the Court noted that Newmark and Buckmaster adopted the Rights Plan neither to preclude other craigslist stockholders from considering a  potentially value-maximizing transaction nor to protect their own board seats(which had already been ensured through a voting agreement requiring each to vote the other onto the board). Nonetheless, the Court found that the Unocal analysis was the most appropriate standard of review. The Court, therefore, focused on whether Newmark and Buckmaster “properly and reasonably perceive[ed] a threat to craigslist’s corporate policy and effectiveness” and, if so, whether the Rights Plan was “within the range of reasonableness” to respond to such a threat. Defendants argued the Rights Plan was a necessary protection to the continued existence of craigslist’s corporate culture because, upon the eventual deaths of Newmark and Buckmaster, eBay would be able to purchase their shares from their heirs and thereby “fundamentally alter craigslist’s values, culture and business model from [craigslist’s] public-service mission in favor of increased  monetization of craigslist.” While the Court expressed personal admiration for Defendants’ desire to service communities through free online classifieds, the Court concluded that Defendants had failed to prove that such a business model gives rise to a “palpable, distinctive and advantageous culture that sufficiently promotes stockholder value.” Furthermore, even if a sufficiently distinctive corporate culture had been established, the Court found that the Defendants failed to show that the Rights Plan was deployed in defense of such a culture rather than as a “punitive response” to eBay’s competitive actions. The Court also noted that, as controlling stockholders, Newmark and Buckmaster are presently able to maintain the craigslist culture regardless of whether eBay sells any of its shares in the Company. Thus, the Rights Plan affected neither when eBay could sell its shares nor when the craigslist culture could change, and, therefore, did not have a reasonable connection to Defendants’ professed goal of protecting the craigslist culture at some point in the future.

Unlike the Rights Plan, the Court found that the Staggered Board Amendments were not a defensive measure and should not be analyzed under Unocal because, even without the amendments, Newmark and Buckmaster would still be able to control a majority of the craigslist Board. Entire fairness review was also not appropriate because Newmark and Buckmaster did not realize any financial benefit and eBay was not deprived of any right to which it was entitled because Delaware law expressly grants corporations the power to implement staggered boards and requires neither board representation nor cumulative voting for the benefit of minority stockholders. The Court therefore analyzed the Staggered Board Amendments under the business judgment rule and found that, although they effectively stripped eBay of the ability to unilaterally elect one director, Newmark and Buckmaster did not adopt the Staggered Board Amendments in bad faith, but rather for the legitimate and rational business purpose of preventing eBay, now a direct competitor, from gaining continued access to confidential corporate information by having the power to unilaterally elect one of the three directors. In addition, such a result was not inequitable because eBay, before launching its domestic Kijiji website in direct competition with craigslist, was aware that such Competitive Activity would trigger Section 8.3 of the Shareholders’ Agreement and strip eBay of its veto power over certain charter and bylaw amendments.

With respect to the ROFR Issuance, the Court concluded that entire fairness was the appropriate level of review because Newmark and Buckmaster had stood on both sides of the transaction by first approving the transaction in their capacities as directors and then counter-signing in their individual capacities as stockholders. The Court explained that “[t]he entire fairness test is not bifurcated; the Court must consider allegations of unfair dealing and unfair price. Price, however, is the paramount consideration because procedural aspects of the deal are circumstantial elements of whether the price is fair.” Starting with the fair price analysis, the Court noted that although all craigslist stockholders were technically offered the same consideration, Newmark’s and Buckmaster’s shares were already encumbered under the Shareholders’ Agreement (pursuant to which they still had rights of first refusal with respect to each other’s shares), whereas eBay’s shares had been released from any encumbrance as a result of its Competitive Activity. Thus, while eBay would have to surrender full transferability of its shares, Newmark and Buckmaster simply transferred the right of first refusal from themselves to craigslist. Additionally, the Court found that eBay was forced to make one of two choices. If eBay refrained from participating, its ownership position would decrease from 28.4% to 24.9%. Conversely, if eBay did participate, the expected value of its craigslist shares would immediately decrease as third parties would be less willing to incur the transaction costs associated with bidding on eBay’s shares when craigslist could match any offer. Furthermore, the Court concluded that Newmark and Buckmaster had implemented the ROFR Issuance to “control craigslist’s stockholder composition for their personal and sentimental benefit at eBay’s expense” without advancing a valid corporate purpose. As a result, the Court held that the ROFR Issuance failed the price element of entire fairness review. Having reached such a conclusion, the Court found it unnecessary to address eBay’s allegations related to fair dealing as well as whether the ROFR Issuance violated the DGCL. 

Finally, the Court rejected eBay’s request for attorneys’ fees, finding Defendants to have “subjectively believed the [] Actions. . . were legally permissible under Delaware law” and to have throughout trial “vigorously defended their legal position without making frivolous arguments.”

The full opinion is available here