Learning from the Craigslist-eBay Mess

Lawsuits pitting the online classified and e-commerce giants should make prospective partners think hard before seating a rival on the board

Frenemies be afraid. Alliances with would-be competitors can be perilous. Nowhere in techdom is that clearer than in the battle now brewing between e-commerce giant eBay (EBAY) and classified site Craigslist. Fallout from the companies' legal dispute could serve as an object lesson for other tech companies considering teaming up with a rival.

Lawsuits between the two companies relate to eBay's half-decade-old investment in Craigslist and the ill will that ensued as eBay's changing business focus brought it into closer competition with the smaller ally. A host of tech companies—including Microsoft (MSFT), Yahoo! (YHOO), Google (GOOG), and News Corp.'s (NWS) MySpace—are engaged in or considering their own partnerships with potential competitors. No two pairings are the same, but legal experts close to all the players will no doubt be on the lookout for any parallels in the eBay-Craigslist contretemps.

The suits raise legal questions that all competitive partners may someday face: Can a company executive hold a seat on a rival's board? And what recourse does a company have when it believes an investor is using information gleaned from a board position to bolster a competing business? "You would certainly want to be very careful when you are on the board of a company you could compete with," says Kathryn Deimer, a partner at San Jose-based law firm Deimer, Whitman & Cardosi, which specializes in business litigation and business breakups.

Too Close for Comfort

By way of background, eBay invested about $30 million in Craigslist in December, 2004, picking up a board seat, in hopes of gaining a toehold in the $4 billion U.S. classified advertising business. At the outset, theirs seemed an ideal match. EBay wasn't a direct competitor; its members bought and sold items using an online payment service, typically over distances, often incurring shipping charges. Craigslist users also engaged in e-commerce, though they typically did so locally, using cash.

Yet eBay had an eye on expanding its classified business. In November, 2004, it had purchased Netherlands-based Marktplaats, a leading foreign classifieds site, for $290 million. According to Craigslist's suit, eBay had begun making overtures to Craigslist earlier that summer. Craigslist says eBay wanted to buy a large stake with the possibility of buying it outright. Garrett Price, then eBay's senior director of corporate development, told executives: "We just purchased the largest classifieds site in the Netherlands for $290 million, what do you think we would pay for the largest classifieds site in the United States?" according to Craigslist's lawsuit. Craigslist and eBay representatives declined to discuss the matter, citing the pending litigation.

Craigslist soon found it didn't like having such a close competitor on its board. In less than three years, the eBay-Craigslist dream tieup became a competitive nightmare. In court papers, eBay says Craigslist illegally constrained its influence by diluting eBay's 28% stake, eliminating its board seat, and inhibiting eBay's ability to get the highest price for its share of the company (BusinessWeek.com, 5/2/08). Craigslist is countersuing eBay (BusinessWeek.com, 5/13/08) for allegedly using its board position to launch a direct U.S. competitor. Both companies seek rulings that would prevent the other from interfering in its business.

Anticompetitive Rivalry

A key sticking point is the presence of an eBay representative on Craigslist's board. Legal experts say having a rival appoint a director should be avoided—especially in California, which has stringent anticompetitive rules preventing board members from taking advantage of their positions. Typically, such rules would forbid a rival from holding a seat on another's board altogether. After all, a board member from the competing company is still an agent of that company, even if the person is not directly responsible for the business unit that competes with it.

Craigslist and eBay appear to have entered their tieup with eyes open about the prospect of future competition. Craigslist had designs on expanding more aggressively into Europe and eBay knew it may someday want to compete on Craigslist's turf, according to court papers. According to eBay's suit, the partners were so aware of the chance of rivalry they wrote a provision into their agreement to change the terms of their deal so that, should they become direct competitors, Craigslist could limit the amount of information to which eBay's investment entitled it.

Deimer says that agreement may not hold up in court, given eBay stepped up its emphasis on the classified business after investing in Craigslist. "It certainly is suspicious looking that somebody walks in a door, gets involved in a deal, and then is suddenly competing in the same business," Deimer says. "It would be virtually impossible to convince anyone that it would be acceptable to enter into a contract to steal someone's trade secrets." In July, 2007, eBay launched a U.S. version of its global classifieds site, Kijiji (BusinessWeek.com, 7/6/07).

Well-Meaning Boards Behaving Badly

Why did Craigslist agree to a board seat in the first place? In its lawsuit, Craigslist indicates it was looking to eBay to help improve trust and safety on the site. In public statements, former eBay Chief Executive Meg Whitman often spoke enthusiastically about the partnership. In its lawsuit, eBay contends the launch of a U.S. competitor to the site gave Craigslist no right to take away its board seat. Per their agreement, Craigslist could limit eBay's access to valuable competitive information, but not ban the company from board meetings, dilute its investment, or limit eBay's ability to its stake. Craigslist contends eBay was using its board seat to help bolster Kijiji's competitive stance, and therefore no longer deserved to be on the board.

To successfully counter that argument, eBay may need to prove it didn't steal anything from Craigslist. That means showing its Kijiji site did not rely on proprietary Craigslist information and that its board appointees were sufficiently firewalled off from eBay's classifieds business. In its suit against Craigslist, eBay argues it changed board appointees precisely so that it could keep the two businesses separate. Craigslist alleges appointees were always tied to Kijiji.

Even if eBay was behaving in an anticompetitive manner, Craigslist still doesn't have a right to harm the company as an investor, Deimer and other lawyers say. When a board member and investor is behaving badly, the company can't simply strip them of their contract-given board seat and shareholder rights. In other words, Deimer says, two wrongs don't make a right. Under the law, eBay is entitled to the same rights as any other investor, despite Craigslist's suspicions, legal experts say.

In the end, both companies could prevail. That would mean only more legal battling as they try to figure out which verdict is applicable. And when the wrangling is over, both companies may wish they had been more choosy about which rival to turn into a frenemy.

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