Toward the end of 2009, a case brought by Internet auction giant eBay against Craigslist went to trial in the Delaware Court of Chancery. See eBay Domestic Holdings Inc. v. Newmark et al., No. 3705-CC. The case featured testimony from top officials from both companies, including the ex-CEO of eBay and current Republican gubernatorial candidate Meg Whitman. In anticipation of the Chancery Court’s decision, the Race to the Bottom will cover the main legal arguments presented in the pretrial briefings by both parties.
In a complaint filed on April 30, 2008 (“Complaint”), eBay Domestic Holdings, Inc. (“eBay”) alleged that Craig Newmark (“Newmark”) and James Buckmaster (“Buckmaster”), the only two directors and majority stockholders of Craigslist, Inc. (“Craigslist” or “Company”), breached their fiduciary duties of care, loyalty, and good faith to eBay, the third stockholder, when they (1) approved a plan to implement a Right of First Refusal (“ROFR”) agreement; (2) adopted a Shareholder Rights Plan; and (3) amended Craigslist’s Charter and Bylaws to create a staggered board. Defendants denied such allegations and further stated in their pre-trial brief that adoption of such governance measures was protected by the business judgment rule. In addition, they asserted that eBay’s misconduct precluded it from obtaining an equitable relief.
In August 2004, a former Craigslist executive sold his 28% share to eBay. Newmark, Buckmaster, and eBay entered into a Shareholders' Agreement ("SHA") that imposed certain rights and obligations on the parties. Among other things, the SHA imposed: "(i) certain transfer restrictions and rights of first refusal on the shares held by eBay, Newmark and Buckmaster; and (ii) granted eBay informational, reporting and inspection rights and the right to approve certain transactions directly or through a director designated by eBay."
The agreement further provided that some rights and obligations of the parties would terminate upon eBay engaging in competitive activity. These included: "(i) eBay's right of first refusal to purchase equity securities sold or issued by the Company or to purchase the shares of Newmark or Buckmaster should either attempt to sell his shares, and (ii) Newmark and Buckmaster's right of first refusal to purchase eBay's shares should eBay attempt to sell its shares."
In 2005, eBay started Kijiji.com, an overseas company marketing classified ads. In 2007, eBay began marketing the services in the United States. Viewing the site as competition, the Board of Craigslist implemented protective measures, in addition to those outlined in the SHA, to ward off potential threats presented by eBay. These threats allegedly included the risk of future misuse of Craigslist’s confidential information; impairment of board functions by having an agent of a direct competitor influence Board decisions; and the threat of a future hostile takeover when the defendants' pass away and their respective shares become liquid.
The matter ultimately ended up in litigation, with eBay challenging the actions by Craigslist. The litigation raised a number of issues:
Standard of Review: Entire Fairness v. Business Judgment
In its pretrial brief, eBay urged that the court should use the stricter “Entire Fairness” standard because the majority shareholders, Newmark and Buckmaster, stood on both sides of the transactions when they authorized governance measures that unfairly benefited them to the detriment of eBay. eBay asserted this standard applies “unless the transaction is (1) recommended by a disinterested and independent special committee; and (2) approved by stockholders in a non-waivable vote of the majority of all the minority stockholders.”
Conversely, defendants’ pretrial brief stated that the business judgment rule applied here because the Board did not implement the governance measures by a unilateral action, a necessary prerequisite for enhanced scrutiny of their actions. The governance measures required and received proper shareholder approval. The defendants added that even if the shareholders are impacted differently under the measures, Delaware law did not require equal treatment of all shareholders in all circumstances, especially in situations where a shareholder poses a future threat to the enterprise.
Staggered Board: Staggered Board Squeezing Out eBay’s Directors?
Craigslist amended the certificate of incorporation to provide for a staggered board upon receiving notice of eBay’s competitive activity. eBay asserted that this action effectively removed eBay’s right to elect any director by cumulative voting as all shareholders would vote for one director instead of three at each election. Defendants contended the measure restricted eBay’s ability to unilaterally place conflicted eBay agents on the Craigslist Board. Furthermore, this measure protected (1) the company against further misuse of its confidential information and plans and (2) the Board’s ability to function properly. Defendants further stated that eBay would still have the right to nominate directors.
eBay directly attacked the implementation of the staggered board by stating that the amendment required approval of directors’ actions by disinterested shareholders. In this case, the directors constructed this measure and authorized it as the shareholders. eBay further claimed the action imposed an unfair disadvantage because Newmark and Buckmaster owned the majority of Craigslist stock and are parties to a voting agreement under which each has agreed to vote for the other’s nominee.
Defendants replied that such a measure prevented any shareholder from unilaterally seating a nominee without support from other shareholders. They further argued that eBay understood that any competitive activity on its part would result in surrendering its claim to a Board seat. As a consequence, eBay would have to propose an acceptable independent board nominee in order for that person to be elected.
The pleadings and other primary materials for the post are available on the DU Corporate Governance website.