978-1285427003 Chapter 29 Lecture Note Part 3

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You Be the Judge: eBay Domestic Holdings, Inc. v. Newmark1

Facts: Defendant, craigslist, Inc. owned the most popular website in the country for classified ads. It

had just two shareholders – Craig Newmark and Jim Buckmaster — and only 34 employees. eBay, Inc.

was a publicly traded company that operated online auction sites worldwide. It employed over 16,000

people. eBay bought a minority interest in craiglist with the goal of ultimately acquiring the company

or, failing that, learning the “secret sauce” of craigslist’s success. It turned out, though, that craigslist

and eBay were not a good match because they had entirely different cultures and approaches to

business. craigslist focused on enhancing its user community, rather than maximizing its profits or

expanding its business model. In contrast, eBay’s primary focus was to increase profitability and

market share.

Without undergoing any pre-marital discussions in which these divergent goals might have been

revealed, eBay purchased 28.4% of craigslist’s shares. Under the explicit terms of the deal, it had the

right to compete with craigslist. Craig and Jim said that if eBay was able to offer customers a better

experience, then it should be allowed to do so.

As eBay gradually realized that Craig and Jim would never sell out to them, at least in this lifetime, it

launched a competing classifieds website at www.Kijiji.com. In this process, it used nonpublic

information about craigslist that it garnered, without Craig and Jim’s knowledge, from its relationship

with the company. That “betrayal” further inflamed the situation. As other people have discovered,

agreeing in theory to an open marriage is very different from experiencing it in practice. Jim and Craig

were furious about eBay’s foray into online classifieds. They asked for a divorce, but eBay refused to

sell its stock.

Craig and Jim, in their role as directors, responded by adopting a Rights Plan that restricted eBay’s

ability to buy more shares of craigslist or sell its existing shares to third parties. They also eliminated

its right to choose one board member. eBay filed suit, alleging that this Rights Plan violated craigslist’s

fiduciary rights to eBay as a minority shareholder.

Issue: Did Craig, Jim and craiglist violate their fiduciary duty to the minority shareholder?

Excerpts from Chancellor Chandler’s Decision: All directors of Delaware corporations are

fiduciaries of the corporations’ stockholders. Similarly, controlling stockholders are fiduciaries of their

corporations’ minority stockholders.

[In a situation such as this] directors must (1) identify the proper corporate objectives served by their

actions; and (2) justify their actions as reasonable in relationship to those objectives. Thus, the two

main issues I confront are: First, did Jim and Craig properly and reasonably perceive a threat to

craigslist’s corporate policy and effectiveness? Second, if they did, is the Rights Plan a proportional

response to that threat?

Jim and Craig contend that they identified a threat to craigslist and its corporate policies that will

materialize after they both die and their craigslist shares are distributed to their heirs. To prevent this

unwanted potential future reality, Jim and Craig have adopted the Rights Plan now so that their vision

of craigslist’s culture can bind future fiduciaries and stockholders from beyond the grave. Having given

new meaning to the concept of a “dead-hand pill,” Jim and Craig ask this Court to validate their

attempt to use a pill to shape the future of the space-time continuum.

Ultimately, defendants failed to prove that craigslist possesses a palpable, distinctive, and

advantageous culture that sufficiently promotes stockholder value to support the indefinite

implementation of a poison pill. Jim and Craig did not make any serious attempt to prove that the

craigslist culture, which rejects any attempt to further monetize its services, translates into increased

profitability for stockholders.

I am sure that part of the reason craigslist is so popular is because it offers a free service that is also

extremely useful. It may be that offering free classifieds is an essential component of a successful

online classifieds venture. After all, by offering free classifieds, craigslist is able to attract such a large

community of users that real estate brokers in New York City gladly pay fees to list apartment rentals

1 2010 Del. Ch. LEXIS 187 Court of Chancery of Delaware, 2010.

in order to access the vast community of craigslist users. Giving away services to attract business is a

sales tactic, however, not a corporate culture. To the extent business measures like loss-leading

products, money-back coupons, or putting products on sale are cultural artifacts, they reflect the

American capitalist culture, not something unique to craigslist.

The defendants also failed to prove at trial that when adopting the Rights Plan, they concluded in good

faith that there was a sufficient connection between the craigslist “culture” (however amorphous and

intangible it might be) and the promotion of stockholder value. Jim and Craig simply disliked the

possibility that the Grim Reaper someday will catch up with them and that a company like eBay might,

in the future, purchase a controlling interest in craigslist. They considered this possible future state

unpalatable, not because of how it affects the value of the entity for its stockholders, but rather because

of their own personal preferences. Jim and Craig therefore failed to prove at trial that they acted in the

good faith pursuit of a proper corporate purpose when they deployed the Rights Plan.

I personally appreciate and admire Jim’s and Craig’s desire to be of service to communities. The

corporate form in which craigslist operates, however, 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. If Jim and Craig were the only stockholders affected by their decisions, then there

would be no one to object. eBay, however, holds a significant stake in craigslist, and Jim and Craig’s

actions affect others besides themselves.

As long as Jim and Craig have control they can maintain the craigslist “culture” regardless of whether

eBay sells some or all of its shares. The Rights Plan therefore does not have a reasonable connection to

Jim and Craig’s professed goal. It therefore falls outside the range of reasonableness.

I rescind the Rights Plan in its entirety.

Question: Chancellor Chandler gives two main reasons why Craig and Jim failed to make their

case. What are they?

Answer: First, they failed to prove that their corporate “culture” promotes stockholder value in any

Additional Case: Michael L. Retzer v. Nancy B. Retzer2

Facts: Mr. Retzer worked long hours to acquire five McDonald’s franchises. He owned 1,610 shares of

stock in the close corporation that owned the franchises; his wife had 1,600 shares. Mrs. Retzer was

unfaithful and a profligate spender. The couple divorced.

Issue: What are Mr. Retzer’s obligations to Mrs. Retzer as a minority shareholder?

Holding: Because of her adultery, Mrs. Retzer would not be entitled to any alimony. However, she was

entitled to a fair return as a shareholder and Mr. Retzer owed her a fiduciary duty. The court promised

that it would closely scrutinize Mr. Retzer’s conduct.

Question: What did Mr. Retzer owe Mrs. Retzer for alimony?

Question: What is Mr. Retzer’s duty to Mrs. Retzer as a shareholder of the company?

Question: Is the result in this case fair?

Answer: Although students often begin by saying that the case is not fair, they ultimately

2 578 So. 2d 580, 1990 Miss. LEXIS 858 Supreme Court of Mississippi, 1990.

Example: The Sinven Case3

Sinclair Oil owned 97 percent of Sinven. Sinven’s minority shareholders complained that Sinclair:

Forced Sinven to pay dividends so large that the subsidiary faced bankruptcy,

Hired other, wholly owned subsidiaries but not Sinven, and

Refused to force its other subsidiaries to abide by their contracts with Sinven. For instance, a

Sinclair subsidiary signed a contract with Sinven to buy crude oil but failed to purchase the

required amount.

Question: Was it fair for Sinclair to force Sinven to pay dividends so large that it faced bankruptcy?

Question: Was it fair for Sinclair to hire other, wholly owned subsidiaries rather than Sinven?

Question: Was it fair for Sinclair not to force its other subsidiaries to abide by their contracts with

Sinven?

Enforcing Shareholder Rights

Shareholders in serious conflict with management have two different mechanisms for enforcing their

rights: a derivative lawsuit or a direct lawsuit.

Derivative Lawsuits

Shareholders bring a derivative lawsuit to remedy a wrong to the corporation. The suit is brought in the

name of the corporation and all proceeds of the litigation go to the corporation.

Additional Case: In re eBay, Inc. Shareholder Litigation4

Facts: Pierre M. Omidyar and Jeffrey Skoll founded eBay, Inc. a company that hosts an online auction

site. Later, Robert C. Kagle and Margaret C. Whitman joined the eBay board. Whitman also became

President and CEO. Goldman Sachs Group Inc. twice served as lead underwriter when eBay sold

shares to the public. Then Whitman became a director of Goldman. Afterwards, Goldman served as

eBay’s financial advisor when it acquired PayPal, Inc.

During this period in which Goldman engaged in three major transactions with eBay, the

investment bank also served as underwriter for a substantial number of technology companies that

went public. Many investors wanted to buy stock in these initial public offerings (IPOs) because an

immediate and large profit was virtually guaranteed. Often stock prices doubled or tripled on the day of

the offering. Goldman allowed Omidyar, Skoll, Kagle, and Whitman, all directors of eBay, to buy

shares in hundreds of its IPOs, effectively giving them millions of dollars in profits. The following

chart reveals the percentage of eBay shares that each director owned and the number of Goldman IPOs

in which he or she was allowed to invest:

3 Sinclair Oil Corp. v. Levien, 280 A.2d 717, 1971 Del. LEXIS 225 Supreme Court of Delaware, 1971.

4 2004 Del. Ch. LEXIS 4 Court of Chancery of Delaware, 2004.

In each case, the eBay directors sold the stock immediately for millions of dollars in total profit.

eBay shareholders sued, alleging that Goldman had effectively bribed the defendants to continue

giving business to the bank. The lawsuit was brought as a derivative action in the name of eBay. The

plaintiffs alleged that demand was futile because the directors had a conflict of interest.

eBay’s board of directors had seven members: Omidyar, Kagle, Whitman, Philippe Bourguignon,

Scott D. Cook, Dawn G. Lepore, and Howard D. Schultz. (At the time of the lawsuit, Skoll was no

longer a director.) The court determined that the three defendants had a conflict of interest because they

were the targets of the lawsuit. It was obvious they would not vote for eBay to pursue the litigation. If

one of the remaining four directors also had a conflict, then that would constitute a majority and

demand would be excused. The shareholders could then proceed with the lawsuit.

Issue: Did a majority of the board of directors have a conflict of interest? Was demand on the board

futile?

Holding: Judgment for the shareholders.

Excerpts from Chancellor Chandler’s Decision: Plaintiffs allege that Cook, Lepore, Schultz, and

Bourguignon have received huge financial benefits as a result of their positions as eBay directors and,

furthermore, that they owe their positions on the board to Omidyar, Whitman, Kagle, and Skoll.

[I]n 1998, when Cook joined eBay’s board, it awarded him 900,000 [stock] options. In 1998, eBay

adopted a director’s stock option plan pursuant to which each non-employee director was to be

awarded 30,000 options each year. [T]he stock options are worth potentially millions of dollars.

I need not address each of the four outside directors, as I agree with plaintiffs that the allegations

of the complaint are sufficient to raise a reasonable doubt as to Cook’s independence from the eBay

insider directors who accepted Goldman Sachs’ IPO allocations.

First, Whitman, Omidyar, Kagle, and Skoll (and their affiliates) own about one-half of eBay’s

outstanding common stock. As a result, these eBay officers and directors effectively have the ability to

control eBay and to direct its affairs and business, including the election of directors and the approval

of significant corporate transactions.

Second, a significant number of options have not yet vested and will never vest unless the outside

directors remain directors of eBay. [“Vested” means that the owner is allowed to keep the options, even

if he leaves the company.] Given that the value of the options for Cook (and allegedly for the other

outside directors) potentially run into the millions of dollars, one cannot conclude realistically that

Cook would be able to objectively and impartially consider a demand to bring litigation against those

to whom he is beholden for his current position and future position on eBay’s board. With the specific

allegations of the complaint in mind, I conclude that plaintiffs have adequately demonstrated that

demand on eBay’s board should be excused as futile.

Update: Meg Whitman and the two other company officials agreed to pay $3 million to settle this suit.

Question: What is a derivative suit?

Question: Why would anyone want to do that?

Question: Why can’t they simply file a direct lawsuit?

Answer: The theory is that, if the corporation is injured, all shareholders suffer the same injury

Question: Why would any shareholder file suit if recovery goes to the corporation?

Answer: If the corporation loses, it must pay the legal fees of the victorious plaintiffs. Most

Question: Are there any circumstances under which a shareholder can bring a direct action against

the company?

Answer: Only if the shareholder has some “special injury.” This means that either:

Question: Can you give an example?

Answer:

Question: Could the shareholders have filed a direct lawsuit in this case?

Question: What was the injury to the corporation?

Question: Did they make money?

Question: How did this harm eBay?

Question: What did the court hold?

Question: What happened next?

Question: Some of the defendants in this case were billionaires. Why would they take stock from

Goldman?

Direct Lawsuits

Shareholders are permitted to sue the corporation directly only if their own rights have been harmed.

Multiple Choice Questions

1. CPA QUESTION Generally, a corporation’s articles of incorporation must include all of the

following except the:

(a) Name of the corporation’s registered agent

(b) Name of each incorporator

(d) Quorum requirements

2. CPA QUESTION A corporate stockholder is entitled to which of the following rights?

(a) Elect officers

(b) Receive annual dividends

(d) Prevent corporate borrowing

3. Participating preferred stockholders:

(a) only receive payment after other preferred shareholders have been paid

(b) only receive payment after common shareholders have been paid

(a) receive all their payments before all other shareholders

4. If a manager engages in self-dealing, which of the following answers will NOT protect him from a

finding that he violated the business judgment rule:

(a) The disinterested members of the board approved the transaction

(b) The transaction was of minor importance to the company

(d) The transaction was entirely fair to the corporation

5. The duty of care:

(a) Is not a requirement of the business judgment rule

(b) Protects directors who make an uninformed decision if it was entirely fair to the company

(d) Will not protect directors who make a decision that harms the company

6. The president of R. Hoe & Co., Inc., refused to call a special meeting of the shareholders although

55 percent of them requested it. One purpose of the meeting was to demand that the former

President be reinstated. Do shareholders have the right to make these two requests?

(a) Yes to both.

(b) No to both.

(d) The shareholders have the right to reinstate the President but not to call a meeting.

7. Under SOX and Dodd-Frank:

(a) Companies are prohibited from making personal loans to directors and officers.

(b) If a company restates its earnings, the five top executives must reimburse the company for any

income they have received during that period.

(d) Shareholders have the right to strike down golden parachutes.

Essay Questions

1. Michael incorporated Erin Homes, Inc., to manufacture mobile homes. He issued himself a stock

certificate for 100 shares for which he made no payment. He and his wife served as officers and

directors of the organization, but, during the eight years of its existence, the corporation held only

one meeting. Erin always had its own checking account, and all proceeds from the sales of mobile

homes were deposited there. It filed federal income tax returns each year, using its own federal

identification number. John and Thelma paid $17,500 to purchase a mobile home from Erin, but the

company never delivered it to them. John and Thelma sued Erin Homes and Michael, individually.

Should the court “pierce the corporate veil” and hold Michael personally liable?

Answer: The appeals court pierced the corporate veil and held the shareholder liable because the

2. You Be the Judge: WRITING PROBLEM Asher and Stephen formed a corporation

named “Ampersand” to produce plays. Both men were employed by the corporation. Stephen

decided to write Philly’s Beat, focusing on the history of rock and roll in Philadelphia. As the play

went into production, however, the two men quarreled over Asher’s repeated absences from work

and the company’s serious financial difficulties. Stephen resigned from Ampersand and formed

another corporation to produce the play. Did the opportunity to produce Philly’s Beat belong to

Ampersand? Argument for Stephen: Ampersand was formed for the purpose of producing plays,

not writing them. When Stephen wrote Philly’s Beat, he was not competing against Ampersand.

Furthermore, Ampersand could not afford to produce the play even if it had had the opportunity.

Argument for Asher: Ampersand was in the business of producing plays, and it wanted Philly’s

Beat. Ampersand was perfectly able to afford the cost of production—until Stephen resigned.

Answer: Producing “Philly’s Beat” was clearly within the scope of Ampersand’s business.

3. Angelica is planning to start a home security business in McGehee, Arkansas. She plans to start

modestly but hopes to expand her business within 5 years to neighboring towns and, perhaps,

within 10 years to neighboring states. Her inclination is to incorporate her business in Delaware. Is

her inclination correct?

4. Eve bought defective ball bearings from Saginaw Corp. Alfred was the sole shareholder of the

company and also its landlord. After Alfred sold all of Saginaw’s assets, he withheld enough money

to cover the rent that Saginaw owed him. As a result, Saginaw had no money to pay Eve. Does Eve

have a claim against Alfred?

Answer: The court ruled that Alfred had engaged in self-dealing, which violated his fiduciary duty

5. Congressional Airlines was highly profitable operating flights between Washington D.C. and New

York City. The directors approved a plan to offer flights from Washington to Boston. This decision

turned out to be a major mistake and the airline ultimately went bankrupt. Under what

circumstances would shareholders be successful in bringing suit against the directors?

Answer: Even if the plan was bad, it met the standard of having a “rational business purpose.”

Discussion Questions

1. States compete for lucrative filing fees by passing corporate statutes that favor management. One

proposed solution to this problem would be a federal system of corporate registration. Is this a

good idea? What are the impediments to such as system?

Answer: It would also solve the problem of qualifying to do business in other states. Under a

2. Ford Motor Co. and TheFacebook, Inc. have both created dual classes of stock so that the founders

can continue to control their company even after it goes public. Should corporate laws permit this?

Should some shareholders be more equal than others? If the founders want to control a company,

why shouldn’t they buy enough regular stock to do so?

3. ETHICS Edgar Bronfman, Jr., dropped out of high school to go to Hollywood, write songs, and

produce movies. Eventually, he left Hollywood to work in the family business—the Bronfmans

owned 36 percent of Seagram Co., a liquor and beverage conglomerate. Promoted to President of

the company at the age of 32, Bronfman seized a second chance to live his dream. Seagram

received 70 percent of its earnings from its 24 percent ownership of DuPont Co. Bronfman sold this

stock at less than market value to purchase (at an inflated price) 80 percent of MCA, a movie and

music company that had been a financial disaster for its prior owners. Some observers thought

Bronfman had gone Hollywood; others that he had gone crazy. After the deal was announced, the

price of Seagram shares fell 18 percent. Was there anything Seagram shareholders could have done

to prevent what to them was not a dream but a nightmare? Apart from legal issues, was Bronfman’s

decision ethical? What ethical obligations did he owe Seagram’s shareholders?

4. Pfizer Inc. paid $2.3 billion to settle civil and criminal charges alleging that it had illegally

marketed 13 of its most important drugs. This settlement made history, but not in a good way. It

was both the largest criminal fine and the largest settlement of civil health care fraud charges ever

paid. Shareholders filed a derivative suit against the Pfizer board and top executives. Defendants

responded with a motion to dismiss on the grounds that shareholders had not made demand on the

board. Is demand necessary?

Answer: The court excused demand because the Complaint alleged “misconduct of such

pervasiveness and magnitude, undertaken in the face of the board’s own express formal

5. ETHICS After a recent annual meeting, Cisco Systems reported the results of the votes on both

management and shareholder proposals. The company reported the results of its own proposals as a

simple ratio of those in favor divided by the total number of votes cast. But for shareholder

proposals, it reported the percentage as a ratio of those in favor divided by all outstanding shares.

As a result, it reported the favorable vote for one shareholder proposal as 19% when, in fact, 34%

of the votes cast supported this proposal. Is Cisco behaving ethically?