Key Takeaways
- • Second Circuit unanimously upholds contractual "blockers" as valid Section 16(b) liability shields in *20230930-DK-Butterfly-1, Inc. v. HBC Investments LLC* (No. 25-2728, July 7, 2026), affirming a district court dismissal of disgorgement claims and resolving an issue of first impression for the appeals court.
- • Well-drafted blockers must satisfy three criteria to survive motion to dismiss: (i) not unilaterally waivable or amendable without counterparty consent; (ii) contain effective enforcement mechanisms, including automatic nullification of excess acquisitions; and (iii) be adhered to in practice without actual breach.
- • Hudson Bay's 9.99% ownership cap on Bed Bath & Beyond securities withstood challenge despite plaintiff arguments that the blockers were "illusory" or "sham"—the court found Hudson Bay never exceeded the threshold, could not unilaterally modify the provision, and benefited from self-executing enforcement that rendered excess conversions automatically void.
- • SEC Rule 13d-3(b) "scheme to evade" doctrine does not apply to blockers that prevent beneficial ownership outright rather than conceal it; blockers need only avoid disclosure obligations, not confer "substantial equivalence of ownership rights," to remain valid under precedent including *CSX Corp. v. Children's Investment Fund Management*.
- • Institutional investors and issuers structuring financings now have clear guidance that purely contractual blockers eliminating the 10%+ beneficial ownership threshold will shield against Section 16(b) short-swing profit claims if drafted with non-waivable terms, robust self-enforcement, and actual compliance.
Summary
The U.S. Court of Appeals for the Second Circuit issued a landmark decision on July 7, 2026, upholding the validity of contractual "blocker" provisions as effective shields against Section 16(b) liability under the Securities Exchange Act of 1934. The ruling, authored by Judge Richard J. Sullivan in *20230930-DK-Butterfly-1, Inc. v. HBC Investments LLC*, affirmed a Southern District of New York dismissal and provides the first appellate guidance on when well-drafted blockers can survive a motion to dismiss challenging their enforceability.
Hudson Bay Capital Management LP, represented by Akin Gump partners Douglas Rappaport, Kate Shapiro, William Wetmore, and James Tysse, had structured a "rescue financing" transaction with Bed Bath & Beyond shortly before the retailer's bankruptcy. To avoid Section 16(b) liability—which requires insiders beneficially owning more than 10% of equity to disgorge short-swing profits from purchases and sales within six months—Hudson Bay and BBBY agreed to include blockers in public offering documents capping Hudson Bay's beneficial ownership at 9.99%. The blockers provided that any preferred stock conversion or warrant exercise exceeding this threshold would be "null and void and treated as if never made," and Hudson Bay would lack voting and transfer rights on excess shares. Following the offering, Hudson Bay purchased substantial BBBY securities and later traded them. After BBBY's bankruptcy, its wind-down entity Butterfly sued in May 2024, alleging that Hudson Bay was required to repay profits under Section 16(b) because the blockers were illusory, rendering Hudson Bay a 10%+ insider liable for short-swing trading.
The Second Circuit unanimously rejected Butterfly's characterization of the blockers as sham provisions. The court applied three factors drawn from *Levy v. Southbrook International Investments, Ltd.* (263 F.3d 10, 2d Cir. 2001) to assess blocker validity: whether the acquiring party may unilaterally waive the blocker, whether enforcement mechanisms exist, and whether the investor has exceeded the threshold in practice. On all three counts, Hudson Bay's blockers satisfied the test. First, the blockers were "solid contractual provisions" Hudson Bay could not amend without BBBY's consent; the court rejected Butterfly's argument that any theoretically possible amendment rendered the clause illusory, noting such logic would invalidate "virtually every clause of every contract." Second, the blockers contained robust enforcement mechanisms, including self-execution that automatically nullified excess acquisitions—a feature the court found superior to active policing and explicitly stated it "has never found that a contractual clause is illusory simply because one party cannot actively audit the other's compliance in real time." Third, Hudson Bay's trading records confirmed it never exceeded the 9.99% threshold, with end-of-day beneficial ownership consistently remaining below the cap; Butterfly's attempt to allege otherwise relied on "dubious math" improperly counting shares Hudson Bay had already agreed to sell.
Critically, the Second Circuit made clear that blockers should be interpreted "like any other contract: by looking to their text." To challenge a "facially unambiguous and self-executing" blocker past motion to dismiss, plaintiffs must allege it has *actually failed in practice*—not merely speculate that parties could hypothetically waive or breach it. This text-based approach rejected Butterfly's characterization of *Levy* as endorsing a "substance-over-form, multi-factor standard" focused on practical function rather than contractual language.
The court also rejected Butterfly's argument under SEC Rule 13d-3(b), which treats persons using contracts, arrangements, or devices as part of a "plan or scheme to evade" reporting requirements as beneficial owners. Relying on Judge Winter's concurrence in *CSX Corp. v. Children's Investment Fund Management (UK) LLP* (654 F.3d 276, 2d Cir. 2011), the Second Circuit held that Rule 13d-3(b) applies only where a transaction confers the "substantial equivalence of the rights of ownership relevant to control" while concealing it. By contrast, transactions designed merely to avoid disclosure obligations—as opposed to concealing actual ownership rights—fall outside the rule. Hudson Bay's blockers prevented beneficial ownership from vesting in the first place rather than concealing hidden control, thus satisfying this distinction and rendering Rule 13d-3(b) inapplicable.
The ruling provides institutional investors and issuers with concrete drafting guidance: blockers should be non-unilaterally amendable or waivable, contain self-executing enforcement mechanisms rendering excess conversions null and void, and be subsequently adhered to in practice. Following these criteria will offer "robust protection" against aggressive Section 16(b) litigation and minimize regulatory risk in complex financing structures.
Hudson Bay Capital Management LP, represented by Akin Gump partners Douglas Rappaport, Kate Shapiro, William Wetmore, and James Tysse, had structured a "rescue financing" transaction with Bed Bath & Beyond shortly before the retailer's bankruptcy. To avoid Section 16(b) liability—which requires insiders beneficially owning more than 10% of equity to disgorge short-swing profits from purchases and sales within six months—Hudson Bay and BBBY agreed to include blockers in public offering documents capping Hudson Bay's beneficial ownership at 9.99%. The blockers provided that any preferred stock conversion or warrant exercise exceeding this threshold would be "null and void and treated as if never made," and Hudson Bay would lack voting and transfer rights on excess shares. Following the offering, Hudson Bay purchased substantial BBBY securities and later traded them. After BBBY's bankruptcy, its wind-down entity Butterfly sued in May 2024, alleging that Hudson Bay was required to repay profits under Section 16(b) because the blockers were illusory, rendering Hudson Bay a 10%+ insider liable for short-swing trading.
The Second Circuit unanimously rejected Butterfly's characterization of the blockers as sham provisions. The court applied three factors drawn from *Levy v. Southbrook International Investments, Ltd.* (263 F.3d 10, 2d Cir. 2001) to assess blocker validity: whether the acquiring party may unilaterally waive the blocker, whether enforcement mechanisms exist, and whether the investor has exceeded the threshold in practice. On all three counts, Hudson Bay's blockers satisfied the test. First, the blockers were "solid contractual provisions" Hudson Bay could not amend without BBBY's consent; the court rejected Butterfly's argument that any theoretically possible amendment rendered the clause illusory, noting such logic would invalidate "virtually every clause of every contract." Second, the blockers contained robust enforcement mechanisms, including self-execution that automatically nullified excess acquisitions—a feature the court found superior to active policing and explicitly stated it "has never found that a contractual clause is illusory simply because one party cannot actively audit the other's compliance in real time." Third, Hudson Bay's trading records confirmed it never exceeded the 9.99% threshold, with end-of-day beneficial ownership consistently remaining below the cap; Butterfly's attempt to allege otherwise relied on "dubious math" improperly counting shares Hudson Bay had already agreed to sell.
Critically, the Second Circuit made clear that blockers should be interpreted "like any other contract: by looking to their text." To challenge a "facially unambiguous and self-executing" blocker past motion to dismiss, plaintiffs must allege it has *actually failed in practice*—not merely speculate that parties could hypothetically waive or breach it. This text-based approach rejected Butterfly's characterization of *Levy* as endorsing a "substance-over-form, multi-factor standard" focused on practical function rather than contractual language.
The court also rejected Butterfly's argument under SEC Rule 13d-3(b), which treats persons using contracts, arrangements, or devices as part of a "plan or scheme to evade" reporting requirements as beneficial owners. Relying on Judge Winter's concurrence in *CSX Corp. v. Children's Investment Fund Management (UK) LLP* (654 F.3d 276, 2d Cir. 2011), the Second Circuit held that Rule 13d-3(b) applies only where a transaction confers the "substantial equivalence of the rights of ownership relevant to control" while concealing it. By contrast, transactions designed merely to avoid disclosure obligations—as opposed to concealing actual ownership rights—fall outside the rule. Hudson Bay's blockers prevented beneficial ownership from vesting in the first place rather than concealing hidden control, thus satisfying this distinction and rendering Rule 13d-3(b) inapplicable.
The ruling provides institutional investors and issuers with concrete drafting guidance: blockers should be non-unilaterally amendable or waivable, contain self-executing enforcement mechanisms rendering excess conversions null and void, and be subsequently adhered to in practice. Following these criteria will offer "robust protection" against aggressive Section 16(b) litigation and minimize regulatory risk in complex financing structures.
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