Last month, the United States District Court for the Southern District of New York opined as to whether certain terms in share ownership “blockers” make the blockers illusory and thus not effective.
The company formerly known as Bed Bath & Beyond (“BBB”) was failing and needed additional capital. It entered into a financing arrangement with Hudson Bay Capital (“HBC”) that yielded $225 million at the closing with the ability to raise up to $800 million in future months. In return, BBB issued three new classes of derivative securities: (a) Series A Convertible Preferred Stock (“Series A”), (b) Common Stock Warrants (“Common Warrants”) and (c) Series A Convertible Preferred Warrants (“Preferred Warrants,” and together with “Series A” and “Common Warrants”, the “Derivative Securities”). The terms of the securities stated that on the date the holder of the Derivative Security gives notice of exercise or conversion, it will be considered to be the holder of the underlying security.
The Series A and Common Warrants each had conversion and exercise caps (“blockers”) that barred the holder from beneficially owning more than 9.99% of BBB’s outstanding common stock. “The blockers were included in the Financing Agreement transactional documents to avoid disclosure and disgorgement obligations under Sections 13 and 16 of the Securities Exchange Act that are triggered when an investor beneficially owns more than 10% of a company’s stock.” Both blockers stated that any holder could at any time tell BBB to increase or decrease the “Maximum [allowed] Percentage” of such holder to any other percentage not in excess of 9.99% as specified in such notice provided certain requirements are met but any shares improperly issued above 9.99% would be null and void.
HBC submitted 90 conversion and exercise requests between February 7, 2023 and April 23, 2023 but never submitted to BBB any information regarding its total holdings. BBB claimed that the numerous conversion and exercise requests, as well as the revisions of those requests “all but guaranteed that mistakes would be made and that the 9.99% cap would be breached” and was certain, according to its own calculations that the holdings exceeded 9.99%.
BBB (the Plaintiff) claimed that the shares underlying the Derivative Securities held by HBC (Defendant), together with its current common stock ownership, exceeded 10% of BBB’s outstanding shares and sought disgorgement for violation of Section 16(b) of the Securities Exchange Act of 1934 (“Section 16(b)”). It further claimed that the sales of hundreds of millions of shares by HBC from February 7, 2023 to April 18, 2023, combined with transactions in Preferred Warrants, Common Warrants, and call options which could be construed as purchases, resulted in a short-swing profit in that time period of $310,061,851.69.
The court found that:
- To establish liability under Section 16(b) the Plaintiff must show that there was (i) both a purchase and a sale of a particular security (ii) by a statutory insider (iii) within a six-month period; and
- “holding derivative securities is functionally equivalent to holding the underlying equity securities for purposes of Section 16” because holding such a derivative security gives the holder the right to acquire the underlying shares.
So, without a valid blocker in place, BBB would state a plausible claim that HBC was the “beneficial owner” of more than 10% of the outstanding BBB common stock and thus was a statutory insider subject to the restrictions on short swing transactions in Section 16(b).
Caselaw states that a conversion cap, or “blocker,” is a permissible way of avoiding Section 16(b) liability, but “[w]hen the limitations provided by [the blockers] are discovered to be illusory or a sham, they should be disregarded, and the courts should analyze the case as though no such limitations existed.”
In a prior case, the Securities and Exchange Commission (“SEC”) filed an amicus brief indicating the factors that “may indicate that a conversion cap is illusory. Those factors included whether the cap”:
• is easily waivable by the parties (particularly the holder of the
convertible securities);
• lacks an enforcement mechanism;
• has not been adhered to in practice; or
• can be avoided by transferring the securities to an affiliate of the holder.
Relying on factors listed in that prior amicus brief by the SEC, the court found the following factorsto be dispositive in determining the issue:
- Does the text of the subject blockers deny investors the right to acquire more than 10% of the underlying equity securities? Here, the court found that the blockers at issue confirm that the parties have agreed the investors do not beneficially own the common stock underlying the Derivative Securities.
- Are the blockers easily waivable? Here, the court found that the holder could not waive the blocker above the 9.99% threshold. The fact that the parties could (mutually) amend these agreements doesn’t make the Derivative Securities “easily” waivable.
- Do the blockers include an enforcement mechanism? The court found that the BBB blockers expressly required that “[t]he Company shall not effect the conversion [or exercise]” of any shares that would exceed the conversion cap and that “both blockers provide that any shares improperly issued over the conversion cap will be deemed “null,” “void,” and “cancelled ab initio.”” Further, caselaw says that an issuer need not have an independent ability to enforce a conversion cap for a blocker to be binding.
- Does the Plaintiff plausibly allege that the blockers were not adhered to in practice? BBB asserted that pursuant to Rule 13d–3 any investor is “deemed” to be the beneficial owner of a security “if that person has the right to acquire beneficial ownership of such security, . . . within sixty days. The court noted that prior caselaw states that ““Rule 13d–3(d)(1)(i) speaks to the ‘right,’ not the ‘ability’ to acquire” and thus “the investor’s ‘right to acquire’ stock is at all times subject to the conversion cap.”)” And once the investor sold shares, it lost its “beneficial ownership” over them which could have kept their holdings under 10%. “Beneficial ownership “does not turn on who owns legal title to the stock, or who is the registered owner” but “instead . . . focuses on any relationship that, as a factual matter, confers on a person a significant ability to affect how voting power or investment power will be exercised…””
Accordingly, the court granted HBC’s motion to dismiss the claims.
See the opinion 20230930-DK-BUTTERFLY-1, INC. v. HBC Investments LLC, U.S.D.C. SDNY No. 1:24-cv-03370-MKV (Decided September 30, 2025): https://storage.courtlistener.com/recap/gov.uscourts.nysd.620698/gov.uscourts.nysd.620698.53.0.pdf
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