July 11, 2026
Case Summary
On July 7, 2026, the U.S. Court of Appeals for the Second Circuit affirmed the S.D.N.Y.’s dismissal of a Section 16(b) disgorgement claim brought by 20230930-DK-BUTTERFLY-1, INC. (the post‑bankruptcy successor to Bed Bath & Beyond) (“Butterfly”) against HBC Investments LLC and Hudson Bay Capital Management LP (“Hudson Bay”).
The case arose out of a highly dilutive financing, which resulted in Hudson Bay purchasing convertible preferred stock and warrants with an aggregate conversion value representing beneficial ownership well in excess of 10% of Bed Bath & Beyond’s outstanding common stock, but for the provisions described below.
To avoid triggering short‑swing profit liability under Section 16(b) of the Securities Exchange Act of 1934, the parties embedded beneficial ownership “blocker” provisions in the governing instruments. These blocker provisions provided that any conversion or exercise that would result in beneficial ownership above 9.99% of Bed Bath & Beyond’s outstanding common stock would be “null and void and treated as if never made,” and that any excess shares would carry no voting or transfer rights. Each time Hudson Bay exercised or converted, it certified that it was not exceeding the 9.99% cap.
Butterfly argued that the blockers were illusory, that Hudson Bay effectively had the right to acquire more than 10% of the common stock, and that Hudson Bay was therefore strictly liable for short‑swing profits exceeding $300 million.
Applying the three-factor framework first articulated in Levy v. Southbrook International Investments, Ltd., 263 F.3d 10 (2d Cir. 2001) (the Circuit’s seminal blocker case), the Second Circuit rejected these arguments and held that the blockers were effective and enforceable, concluding that the blockers were not illusory because: (1) they could not be unilaterally waived by Hudson Bay in its sole discretion; (2) they contained a means of ensuring compliance (automatic nullification of any issuance above 9.99% and no voting or transfer rights for any excess shares); and (3) the trading records showed that Hudson Bay’s beneficial ownership, measured on an end-of-day basis, did not exceed 9.99%.
Notably, the Second Circuit observed that the blocker provisions at issue went even further than the one at issue in Levy, because they nullified excess issuances automatically, rather than merely giving the investor an option to revoke a non-compliant conversion request to the extent that it would exceed the conversion cap.
The court also rejected an attempt to recast the structure as a disclosure‑evasion scheme under SEC Rule 13d‑3(b). The court distinguished between contracts that prevent an investor from ever acquiring ownership above the threshold (which are permissible) and devices that conceal de facto ownership or control that vests at the signal of the would-be owner (which are not permissible). The court also noted that the side letter between the parties in this transaction, which required the issuer to honor Hudson Bay’s exercises “in accordance with” the terms of the transaction documents, did not override or weaken the blockers.
The court further noted that shares that had already been sold (though still “sitting” in Hudson Bay’s account pending settlement) should not be treated as beneficially owned by Hudson Bay, because Hudson Bay was already contractually obligated to deliver the shares to purchasers and thus no longer had the discretion to direct the disposition of the shares.
Practical Implications for Market Participants
Market participants who engage in transactions involving publicly listed companies should bear in mind the following principles when drafting beneficial ownership blocker provisions for convertible instruments, or when converting and/or monetizing such investments.
Beneficial ownership blocker provisions for such instruments are more likely to be viewed as valid and non‑illusory where:
- There is a “means of ensuring compliance”: The documents should specify what happens if the conversion cap would otherwise be inadvertently exceeded (e.g., excess shares are automatically void; the investor cannot vote or transfer them).
- There is no unilateral waiver right in favor of the investor: While the parties theoretically may always amend a contract bilaterally, the investor should not have the unilateral ability to completely ignore or suspend the blocker provision at will.
- Side letters and other ancillary agreements should not contradict the blocker provisions: Any investor side letters or other ancillary agreements in connection with a financing arrangement should not override or contradict the blocker provisions, nor should they give the investor substantially the same rights as a beneficial owner with a stake in excess of the conversion cap.
- The investor maintains real-time position monitoring and consistent, documented compliance: For example, Hudson Bay’s trading records reflected that its end‑of‑day beneficial ownership never exceeded the conversion cap, and it delivered a certification with each conversion or exercise (as required).
Note that this decision is not binding on other Federal circuits, and furthermore, there can be no assurances regarding the outcome of any subsequent judicial action in any court. As of the date of this client alert, the docket for this case does not reflect any petition for re-hearing or other appellate action.
You can read the Second Circuit’s opinion here.
If you have any questions regarding this client alert, please call or e-mail your SRFC attorney.
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