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October 29, 2025 | By Patrick T. McCloskey
With $310 million of alleged short-swing profits at stake, the SDNY recently dismissed a Section 16 action challenging the “blocker provisions” included in so-called death spiral convertible preferred stock and related warrants.1
Relying principally on Levy v. Southbrook Intern. Inv. Ltd., 263 F.3d 10, 12 (2d Cir. 2001), the court concluded the blocker provisions were valid and binding contractual provisions. In addition, while acknowledging that Chevron deference was abrogated by the US Supreme Court in Loper Bright Enters. v. Raimondo, 603 U.S. 369, 385 (2024), the court ruled that application of the factors set forth in the SEC’s amicus brief in Levy did not render the blocker provisions “illusory.”
As summarized by the court and as is typically the case, “[t]he blockers were included in the [] transactional documents to avoid disclosure and disgorgement obligations under Sections 13 and 16 of the [1934 Act] that are triggered when an investor beneficially owns more than 10%2 of a company’s stock.”
The court noted that during the first two weeks after the subject financing, the defendants resold shares that nearly doubled the public float and caused the stock price to plummet. The plaintiff alleged the defendants were greater than 10% stockholders between the date of the financing agreements (February 7, 2023) and April 17, 2023, and that their profits were therefore subject to Section 16 disgorgement. There were “hundreds of thousands of trades” during this scrutinized period, during which the defendants allegedly sold “hundreds of millions of shares.” According to the court’s opinion, the defendants submitted 90 conversion and exercise notices during this period.
The blocker provisions governing the convertible preferred stock and the warrants stated “[u]pon delivery of a written notice to the Company any Holder may from time-to-time 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.” The blocker provisions could not otherwise be amended. These features proved critical in the court’s analysis, as the court found they directly contradicted the plaintiff’s argument that the blocker provisions were “easily waivable.”
Citing Levy, the court recited Second Circuit precedent that “a conversion cap, or ‘blocker’ is a permissible way of avoiding Section 16(b) liability.” The court agreed with three amici law professors that “binding Second Circuit precedent has enforced blockers just like any other contract.”3 However, the court disagreed with the amici law professors that the question presented was whether Section 16(b) liability “applies when contractual . . . ‘conversion caps’ or ‘blockers’ make it contractually impossible for the investor to beneficially own more than 10 percent of a corporation’s securities.” This statement, according to the court, “presum[ed] a dispositive issue” and “failed to address a second inquiry expressly contemplated by Second Circuit precedent.” Specifically, the court clarified that in Levy the Second Circuit held “[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.”4
The court rejected the plaintiff’s argument that the court was bound to apply the factors from the SEC’s amicus brief in Levy. For one thing, the court ruled it was not bound by SEC interpretations set forth in amicus briefs filed in other cases (the SEC did not file an amicus brief in this case). More significantly, the court cited the US Supreme Court’s decision in Loper to clarify “the general requirement that courts defer to agency interpretations, which was in place when Levy was decided, has since been overruled.” For the court, the demise of so-called Chevron deference meant the court was not bound to accept the SEC’s interpretations even if the agency had submitted an amicus brief in the case.
Nonetheless, the court acknowledged “a dearth of case law in [the Second Circuit] on the issue of sham or illusory blockers,” so “in addition of course to textual analysis of the contract,” the court applied the SEC factors “to the extent they [were] persuasive and applicable.”
The court “was not convinced that the SEC’s ‘non-exclusive’ list of potential factors conflicts with the Levy opinion,” and it ultimately held the blocker provisions were not illusory under either standard. It concluded “[s]imilar to the cases cited by the defendants—in which courts found that blockers were binding and thus defendants were not beneficial owners of over 10% of a company’s stock—the blockers in this case are ‘clear prohibition[s]’ on derivative security holders’ right to acquire more than 9.99% of BBBY’s common stock.”
Takeaways
There are two important takeaways from this decision. First, anyone seeking to draft or challenge a blocker provision for convertible preferred stock or warrants should carefully review the factors the court examined, especially if the Second Circuit is the governing jurisdiction. Second and more broadly, the court’s treatment of the factors enumerated by the SEC in its amicus brief in the Levy case may be a sign of what lies ahead without Chevron deference. The court specifically acknowledged that it was no longer required to consider the SEC’s interpretations, but it still applied the factors due to a “dearth of case law” to the extent “persuasive and applicable.”
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This post is for general informational purposes only and does not constitute legal advice. No one should rely on the information in this blog post without seeking appropriate legal, accounting, tax or other appropriate advice from an attorney, accountant or other professional properly licensed in the applicable jurisdiction(s).
1 20230930-DK-Butterfly-1, Inc. f/k/a Bed Bath & Beyond Inc. v. HBC Investments LLC and Hudson Bay Capital Management LLC, case no. 1:24-cv-03370-MKV (SDNY Sep’t 30, 2025).
2 A Section 13(d) filing obligation is triggered once beneficial ownership eclipses 5%, but the beneficial ownership threshold for Section 16 filings and potential short-swing profit liability is greater than 10%.
3 Citing Levy and Roth v. Armistice Cap, LLC, No. 24-950, 2025 WL 2471028, at *4 (2d Cir. Aug. 28, 2025).
4 Citing Levy 263 F.3d at 17 n.5 (quoting Brief of the Securities and Exchange Commission, 2001 WL 34120374, at *25 (2d Cir. Mar. 23, 2001)).
