The ongoing, brutal legal battle pitting the online classified juggernaut craigslist against eBay recently resulted in a post-trial opinion from the Delaware Court of Chancery rescinding a rights plan, or “poison pill,” deployed by craigslist allegedly in order to stave off eBay’s threat to craigslist’s “corporate culture.” The decision is the first of its kind in Delaware to examine a poison pill adopted by a privately owned company, as well as the first of its kind to examine whether the protection of a purportedly unique “corporate culture,” divorced from any effort to promote shareholder value, can justify implementation of a poison pill. The resounding conclusion of the court was no.
Beyond the topic of poison pills, the eBay decision also offers some useful guidance regarding staggered boards. The decision examines, and ultimately approves, implementation of a staggered board structure that effectively prevents eBay, a competitor and minority craigslist stockholder, from seating a representative on the craigslist board. Additionally, the decision discusses the familiar “entire fairness” standard of review under Delaware law, including the interplay between fair price and fair process, confirming the importance of the former.1
Poison Pills Implemented by Privately Held Companies Will Be Subject to Familiar “Enhanced Scrutiny” Judicial Review
For decades, poison pills have been trusted weapons in the arsenal of boards confronting hostile takeover threats. Indeed, as recently as August 2010, the Court of Chancery approved Barnes & Nobles’ rights plan after subjecting it to the customary “enhanced scrutiny” test under Unocal, which provides that the adoption of a defensive measure, such as a poison pill, will be protected by the business judgment rule if: (i) the board had reasonable grounds for believing that a danger existed to corporate policy and effectiveness, and (ii) the defensive response was reasonable in relation to the threat posed.2
While poison pills are common on the Delaware corporate scene, rarely are they deployed by privately held companies that generally do not confront the collective action problems of boards relying on rights plans to protect shareholders from coercive offers and to promote value-maximizing transactions. Nevertheless, the board of craigslist (a privately held company) deployed its poison pill as a defensive measure after eBay launched an online competitor. At the time the dispute between craigslist and eBay arose, craigslist had three stockholders: Craig Newmark and James Buckmaster, who collectively owned 71.6 percent of craigslist and held two of craigslist's three director seats, and eBay, which acquired 28.4 percent of craigslist in 2004, along with the ability to elect one member of the three-person board under a cumulative voting regime. Under the terms of a shareholders’ agreement, eBay retained the right to compete against craigslist in the online classifieds business. Exercising this right in 2007, eBay launched “Kijiji.” The other shareholders sought to repurchase eBay's shares of craigslist, expressing discomfort with having eBay remain a stockholder with a board representative privy to craigslist's nonpublic information. eBay rejected this overture. In response, craigslist not only adopted a rights plan, but also pursued certain other measures, including a staggered board and a dilutive stock issuance, all of which eBay challenged.
As for the poison pill, the eBay court applied the traditional “enhanced scrutiny” review. Use of Unocal in this context, however, was not a foregone conclusion, as many of the normal concerns present when a publicly traded company deploys a rights plan were nonexistent. For example, because the two craigslist directors who adopted the pill also were craigslist’s majority stockholders (owning over 70 percent of the stock), there was not the usual concern that a plan might be used to preclude consideration of value-maximizing transactions. Nor was there any concern that the real purpose of the pill was to entrench the directors who approved it (Newmark and Buckmaster), as their seats were secured through a voting agreement, and no third party could unseat them through a proxy contest.
Notwithstanding these differences, the court still relied on what it described as the “innovative” Unocal standard, noting that “enhanced scrutiny” is not limited to the “historic and classic” paradigm of a publicly held company with a widely dispersed and potentially vulnerable stockholder base. “It is entirely possible that the board of a closely held company such as craigslist could deploy a rights plan improperly.”3 Indeed it did, according to the court.
Protection of “Corporate Culture,” as an End in Itself, Does Not Justify Adoption of a Poison Pill
The eBay decision appears to signal the end of any legitimate discussion about whether “corporate culture,” standing alone and as an end in itself, might justify defensive actions by directors (an issue that some suggested might be open to discussion following Paramount Communications, Inc. v. Time Inc.).4 The court emphatically ruled that “[p]romoting, protecting, or pursuing non-stockholder considerations [such as corporate culture] must lead at some point to value for stockholders.”5 Thus, the protection of corporate culture, divorced from the promotion of shareholder value, should not sustain deployment of a poison pill.
The court further determined that craigslist had no “palpable, distinctive, and advantageous culture” that supported stockholder value. In fact, craigslist’s purported “culture” specifically rejected monetization of services and did not focus on wealth maximization. The court was unequivocal in its rejection of this:
“Directors of a for-profit Delaware corporation cannot deploy a rights plan to defend a business strategy that openly eschews stockholder wealth maximization – at least not consistently with the director’s fiduciary duties under Delaware law.”6
Ultimately, the court concluded that the directors who adopted the plan did not act in “good faith pursuit of a proper corporate purpose”; instead they improperly deployed the plan to punish eBay for competing against craigslist in the online classifieds business.
Removal of a Competitor From a Board Through Adoption of Staggered Board Amendments Can Be Appropriate
In approving the staggered board structure implemented by craigslist, which effectively eliminated eBay’s ability to seat a director on the board, the court observed that Delaware law does not require minority stockholders to be provided with board representation, irrespective of the size of their holdings. Even more importantly, the court confirmed the use of a staggered board structure to exclude competitors from boards – even where a competitor has a sizeable, albeit minority, stake in the company.
“Preventing a competitor that is also a minority stockholder from unilaterally placing a director on the board so that confidential corporate information will not be freely shared with that competitor is a legitimate and rational business purpose.”7
Interestingly, the court analyzed the board’s seemingly defensive decision under the deferential business judgment rule instead of “enhanced scrutiny,” finding that the adoption of the board structure was not a defensive act of entrenchment because, under the circumstances of the case, the staggered board structure does not affect Newmark’s and Buckmaster’s pre-existing ability to seat two directors and thus control the board.
The Importance of “Fair Price” in an Entire Fairness Analysis
In rescinding a right of first refusal/dilutive stock issuance approved by craigslist's interested directors, the court reiterated an important theme developed in a June 2010 opinion: When evaluating an interested transaction under Delaware law’s “entire fairness” standard, which requires a showing of fair price and fair process, the focus should be on fair price.8
“Price … is the paramount consideration because procedural aspects of the deal are circumstantial evidence of whether the price is fair.”9
Nevertheless, companies and boards should continue to follow and require good process as courts, including the eBay court, continue to emphasize that the entire fairness test is not bifurcated.
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1 eBay Domestic Holdings, Inc. v. Newmark,, C.A. No. 3705-CC, 2010 Del. Ch. LEXIS 187 (Del. Ch. Sept. 9, 2010). The eBay decision employs at least three separate standards of review when examining craigslist’s decisions to implement a poison pill (enhanced scrutiny), a staggered board (the business judgment rule) and a dilutive stock issuance (entire fairness). In many respects, the eBay decision demonstrates what Delaware courts do best, namely address intriguing and often unique business disputes, with tried and true, but also innovative and flexible legal standards familiar to the business and legal communities.
2 See Yucaipa Am. Alliance Fund, L.P. v. Riggio, C.A. No. 5465-VCS, 2010 Del. Ch. LEXIS 172 (Del. Ch. Aug. 12, 2010) (approving a rights plan with a 20 percent triggering threshold) (citing, Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985)). See also In re CNX Gas Corp.Holders Litig., C.A. No. 5377-VCL, 2010 Del. Ch. LEXIS 119 (Del. Ch. May 25, 2010) (confirming the legitimacy of having a board of directors of a subsidiary deploy a rights plan against a controller’s tender offer); Selectica, Inc. v. Versata Enters., Inc., C.A. No. 4241-VCN, 2010 WL 703062 (Del. Ch. Feb. 26, 2010) (approving a rights plan with a low 4.99 percent triggering threshold) aff’d, No. 193, 2010 (Del. Oct. 4, 2010)).
3 2010 Del. Ch. LEXIS 187, at *80. See also Versata Enters., Inc. v. Selectica, No. 4241 (Del. Oct. 4, 2010) (explaining that the Unocal test is a useful analytical tool because of the “flexibility of its application in a variety of fact scenarios”).
4 571 A.2d 1140 (Del. 1990).
5 2010 Del. Ch. 187, at *84 (emphasis added).
6 2010 Del. Ch. LEXIS 187, at *90. See id. *89 (“The corporate form in which craigslist operates … 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.”)
7 2010 Del. Ch. LEXIS 187, at *108.
8 See Monroe Cnty. Emps.’ Ret. Sys. v. Carlson,, C.A. No. 4587-CC, 2010 Del. Ch. LEXIS 132 (Del. Ch. June 7, 2010) (dismissing a complaint that contained only allegations of unfair process and no factual allegations about unfair price).
9 2010 Del. Ch. LEXIS 187, at *112.
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