|Steven Davidoff thinks that eBay will prevail against Craigslist:|
An Edge for eBay in Its Dispute With Craigslist
By Steven M. Davidoff
New York Times
December 8, 2009, 1:53 pm
Meg Whitman is a good witness.
I watched her testimony on Monday (courtesy of Courtroom View Network) in the trial between eBay and Craigslist and was impressed with her calm, cool demeanor. Craigslist and its two controlling stockholders — Craig Newmark and Jim Buckmaster — are being sued by eBay over the the two men’s attempt to strip eBay of governance rights in Craigslist. This trial is the culmination of that effort. Ms. Whitman, eBay’s former chief executive, was the first witness.
The dispute itself is the opening scene in my new book, “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion.” I use this story to show how personalities can drive and shape deals and how deal makers can still push the edges of the law in their disputes.
The fight arises out of eBay’s acquisition of 28.5 percent of Craigslist in August 2004. The parties co-existed at the time, but apparently fell out over eBay’s own efforts to extend itself into the online classified services industry through Kijiji.
In October 2007, Mr. Newmark and Mr. Buckmaster, both directors of Craigslist, responded by adopting (1) a share issuance plan under which any Craigslist shareholder who granted Craigslist a right of first refusal on their shares received a share issuance and (2) a poison pill preventing any current shareholder from transferring their shares other than to family members or heirs. (See my post on these actions here.)
The poison pill effectively prevented eBay from transferring its shares, except in discrete blocks below a 15 percent threshold, to any single person. Moreover, Mr. Newmark and Mr. Buckmaster agreed to the right of first refusal and received the authorized share issuance; eBay did not, probably because it wanted to reserve the right to sell its position freely.
The result of these moves was to dilute eBay’s ownership of Craigslist to 24.85 percent. Under the parties’ shareholder agreement, if eBay falls below the 25 percent ownership threshold, Craigslist’s charter can be amended to eliminate cumulative voting. Cumulative voting provides minority shareholders the ability to concentrate their votes by allowing them to cast all of their votes for a single candidate for the board of directors rather than one vote for each candidate.
So if, for example, there are three directors up for election, eBay would have three votes and could cast all of them for one candidate. In the case of Craigslist, this right had enabled eBay to elect one director to the three-member Craigslist board. But Mr. Newmark and Mr. Buckmaster acted to amend Craigslist’s charter to eliminate this right, and eBay thus lost its board seat. Moreover, the poison pill effectively prevented eBay from selling its shares. The amendment and the poison pill thus combined to lock eBay into a voiceless minority position.
EBay responded by suing in Delaware. Craigslist has sued in California for false advertising and unfair and unlawful competition. The latter complaint appears to be brought more to establish publicly Craigslist’s own grievances rather than make a litigation claim.
As for the Delaware litigation, I am going to go out on a limb and predict that Craigslist is going to lose that one. If you disagree, I’d appreciate seeing your thoughts in the comments below.
The fact pattern of this dispute would serve as fine grist for a law school final exam. But the simple fact is that a poison pill in a private company context to protect majority shareholders is extremely smelly (that’s a technical term in Delaware).
More specifically, to the extent that Unocal applies here (this is the standard of review for a company’s defensive actions under Delaware law), there must be a threat to the corporation, the corporation’s response must be reasonable in relation to the threat posed and the board’s actions must not be preclusive or coercive. Is the threat of a minority shareholder in this case sufficient to pass muster under Unocal review?
Clearly, the focus of Ms. Whitman’s testimony (from eBay’s side) was to show that eBay knew what it was getting into here and that control would have passed only if Mr. Newmark and Mr. Buckmaster allowed it. EBay accepted those ground rules and wanted to work with Craigslist. Meanwhile, Craigslist was out to show how eBay had a surreptitious plan to exploit Craigslist’s intellectual property and business plan to expand its own classified service and/or take control of Craigslist. The existence of a threat appears to be how apparent eBay’s intentions were. Ms. Whitman made a fine case that Mr. Newmark and Mr. Buckmaster knew exactly what eBay wanted and acquiesced (at least at the beginning).
In any event, the applicability of Unocal here is in doubt. EBay contends it does not apply because there is no change of control issue at hand. Instead, eBay asserts that this is a simple breach of fiduciary duty case. First, the Craigslist board’s actions should be reviewed under entire fairness — to determine if there has been fair price and fair dealing. EBay argues that these actions don’t pass muster because they are designed to specifically harm eBay to the benefit of Mr. Newmark and Mr. Buckmaster.
The action was in bad faith for similar reasons. There is even a breach of duty of care claim — Craigslist failed to consult a financial adviser until after the fact. Those of you who remember the case of Smith v. Van Gorkom remember that this can do in any good board. The Delaware courts have been rather adamant about the need for some financial advice in some form.
It is all a bit odd, and to tell the truth I suspect that Chancellor William B. Chandler III is going to rule against Craigslist, Mr. Newmark and Mr. Buckmaster on the simple grounds that the parties here privately ordered their conduct. Craigslist’s actions were clearly designed to frustrate that agreement. Chancellor Chandler likely won’t say this deliberately, as it invokes claims like oppression which Delaware does not recognize. Rather, he will rely on simple breach of duty of loyalty claims vis-à-vis minority shareholders. Mr. Newmark and Mr. Buckmaster are acting unreasonably and to their benefit.
In the end, these are bizarre devices — after all, a poison pill in a private company? I suspect that Perkins Coie, counsel to Craigslist, served as its own Delaware counsel in structuring these devices. The company’s Delaware law firm, Potter Anderson & Corroon, only came in later. And once again, bad material has come out in discovery. One internal memo at Perkins Coie uses phrases like “crafty” to describe the actions here.
I had said the facts here could constitute a good law school exam. An even better question to my class would be: how could Craigslist have accomplished all of this without running afoul of Delaware law? This should have been particularly easy, given that eBay has apparently lost its antidilution right in Craigslist and its ability to block out share issuances. Given the options, even if Craigslist loses, it looks like this dispute might drag on. We may be provided the answer to this question in round two of this dispute. Access the eBay-Craigslist trial briefs can be found here.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the legal aspects of mergers, private equity and corporate governance. A former corporate lawyer at Shearman & Sterling, he is a professor at the University of Connecticut School of Law. He is the author of a new book, “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion,” that explores modern-day deals and deal-making.