On January 23, 2004, Chancellor Chandler of the Delaware Court of Chancery held that eBay directors may be liable for usurping a corporate opportunity. In this derivative action, eBay shareholders allege that certain of eBay's directors improperly received allocations of shares in hot IPOs being underwritten by Goldman Sachs in order to induce such eBay directors to steer business to Goldman Sachs. The court denied defendants' motions to dismiss, holding that—if the alleged facts are proven—such directors could be found to have wrongfully taken a corporate opportunity.

The Alleged "Spinning"

According to the allegations in the complaint, in 1995, two of the individual defendants founded eBay. In the late 1990s, eBay retained Goldman Sachs to underwrite eBay's initial and secondary public offerings, as a result of which Goldman Sachs earned substantial fees. In 1999, Goldman Sachs provided eBay with financial advice in exchange for over $8 million in fees.

During the same period, it is alleged, Goldman Sachs allocated to three current eBay directors thousands of IPO shares from other offerings managed by Goldman Sachs. Plaintiffs allege that Goldman Sachs engaged in improper "spinning," or the allocation of much-sought-after IPO shares to eBay directors, in exchange for directing future eBay business to Goldman Sachs.

The Court's Decision Regarding Corporate Opportunity

In holding that the directors could have usurped a corporate opportunity, the court applied the following test:

(1) Whether the corporation is financially able to exploit the opportunity; (2) whether the opportunity is within the corporation's line of business; (3) whether the corporation has an interest or expectancy in the opportunity; and (4) whether, by taking the opportunity for his own, the corporate fiduciary will be placed in a position adverse to his duties to the corporation. [citing Broz v. Cellular Information Systems, Inc., 673 A.2d 148, 154-55 (Del. 1996)].

First, the court noted that eBay could have taken advantage of the investment opportunity from Goldman Sachs. Second, the court held that the IPO investment opportunity was in eBay's line of business, because eBay consistently invested a substantial portion of its available cash in marketable securities. Third, the court ruled that eBay had an interest in the IPO opportunity, because investing is a significant portion of eBay's business. Finally, even though defendants asserted that IPO shares were too risky for eBay to purchase, the court held that eBay had never been given the opportunity to reject the IPO investments as too risky.

The court also rejected defendants' argument that this holding would signify that every advantageous investment opportunity presented to an officer or director would be ruled a "corporate opportunity." Rather, the court emphasized that plaintiffs allege that Goldman Sachs allocated these hot IPO shares to insider eBay directors to reward past business and to induce future corporate business. Such allegations, stated the court, differ from mere "broker's investment recommendations" to a wealthy client.

Even if the alleged activity did not constitute taking a corporate opportunity, the court ruled that such conduct could breach defendants' fiduciary duty of loyalty. Directors are not free, the court ruled, to accept consideration from a third party that does significant business with their corporation, which arguably induces the directors to provide future business to that third party in exchange for the consideration.

The Court's Decision Regarding Demand Futility

Delaware Court of Chancery Rule 23.1 requires shareholders to demand that a corporation's board pursue potential litigation prior to the initiation by a shareholder of such litigation on the corporation's behalf. When a plaintiff fails to make a demand on the board of directors, the plaintiff must plead with particularity why the demand is excused.

The court began its analysis by noting that three of the seven current eBay directors received allocations of IPO shares from Goldman Sachs and, therefore, are interested in the transactions at issue in the litigation. The court then evaluated plaintiffs' argument that the remaining four directors are not independent of the interested directors. Plaintiffs alleged that these four directors owe their board positions to the interested directors, for which they are compensated with substantial stock options, including unexercised options that "are worth potentially millions of dollars." Therefore, according to plaintiffs, a majority of the board allegedly could not impartially decide whether to bring a lawsuit against the interested directors.

The court agreed that these allegations were sufficient to raise a reasonable doubt regarding at least one eBay director's independence from the interested directors, resulting in a finding of a lack of independence by a majority of the board. Therefore, the court excused demand on eBay's board as futile.

Additional Information

This Update is intended only as a summary of the decision in In re eBay, Inc. Shareholders Litigation. You can find discussion of other recent cases and other topics of interest on our website.