On July 7, 2026, the U.S. Court of Appeals for the Second Circuit issued a decision in 20230930-DK-Butterfly-1, Inc. v. HBC Investments LLC, upholding the validity of contractual “blocker” provisions as a means to cap beneficial ownership and avoid liability under Section 16(b) of the Securities Exchange Act of 1934.¹ Akin represented HBC Investments LLC and Hudson Bay Capital Management LP (together, “Hudson Bay”) in this matter before the Southern District Court of New York and on appeal to the Second Circuit. The Akin team was led by partners Douglas Rappaport, Kate Shapiro, William Wetmore and James Tysse.

The Second Circuit affirmed the district court’s dismissal of Plaintiff-Appellant 20230930-DK-Butterfly-1, Inc.’s (“Butterfly”) Section 16(b) disgorgement claim, finding that well-drafted blockers that were valid and enforceable on their face (the “Blockers”) shielded Hudson Bay from Section 16(b) liability.² Specifically, the court found the Blockers were not a “sham” or “illusory” despite Butterfly’s contention that they could be subsequently modified or hypothetically breached in secret, because they were self-enforcing, could not be unilaterally modified and were never actually breached.³ The Second Circuit also held that the Blockers were not a “scheme to evade” reporting requirements under SEC Rule 13d-3(b).⁴

This is a significant decision for the industry. Addressing an issue of first impression, the Second Circuit’s ruling confirms that a facially unambiguous and self-executing blocker will generally insulate an investor from Section 16(b) liability if it is adhered to in practice.⁵ The decision provides much-needed certainty to industry participants that well-drafted contractual blockers will be respected in accordance with their terms and cannot be easily challenged.

Section 16(b)

Section 16(b) is an SEC rule that was implemented to prevent certain corporate insiders from potentially profiting from inside information. The rule mandates that such insiders must return any profits made from the purchase and sale of company stock if both transactions occur within a six-month period. Insiders subject to liability include, among others, investors of a company that beneficially own, or have the right to acquire beneficial ownership of, more than 10% of the company’s shares.⁶

“Blockers,” which are also referred to as “conversion caps,” are contractual provisions that deny an investor the right to acquire more than ten percent of the underlying equity securities of an issuer at any one time. Blockers allow investors to acquire substantial amounts of warrants and convertible securities without ever holding more than ten percent at any given instant, therefore shielding investors from Section 16(b) liability while also allowing issuers to raise financing by selling large volumes of securities to investors.

Case History and Background

Shortly before Bed Bath & Beyond’s (“BBBY”) bankruptcy, Hudson Bay agreed to provide “rescue financing” by serving as the anchor investor on a public offering.⁷

To avoid the regulatory obligations that would attach to Hudson Bay if it became a beneficial owner of ten percent or more of BBBY stock, including potential Section 16(b) liability, Hudson Bay and BBBY agreed to include blockers in the public offering documents. The Blockers prohibited Hudson Bay from ever beneficially owning more than 9.99% of BBBY’s common stock at any one time. To that end, the Blockers provided that any preferred-stock conversion or warrant exercise would “be null and void and treated as if never made” if it brought Hudson Bay over the 9.99% threshold, and that Hudson Bay would “not have the power to vote or transfer” any shares issued in excess of that percentage.⁸

After finalizing these agreements, Hudson Bay proceeded to purchase a large volume of BBBY securities through the public offering, which Hudson Bay later used to acquire and sell BBBY stock. Despite the cash infusion from the offering, BBBY continued to spiral and eventually declared bankruptcy.⁹

In May 2024, BBBY’s post-bankruptcy wind-down entity, Butterfly, filed suit in the Southern District Court of New York against Hudson Bay, alleging that Hudson Bay was required to repay profits from sales and purchases of BBBY securities under Section 16(b) because the Blockers were illusory and Hudson Bay was thus liable as an insider with more than ten percent beneficial ownership of BBBY.¹⁰

The district court granted Hudson Bay’s motion to dismiss, finding that the Blockers shielded Hudson Bay from Section 16(b) liability and that Butterfly did not sufficiently plead that the Blockers were illusory or a sham. Butterfly appealed.¹¹

The Second Circuit Upholds the Blockers and Affirms Dismissal

Shortly after hearing oral argument on June 23, 2026, the Second Circuit unanimously affirmed the district court’s judgment.¹² In a decision penned by Judge Richard J. Sullivan, the Second Circuit held that: (i) well-drafted contractual blockers, such as the Blockers in this case, shield investors from Section 16(b) liability; (ii) the Blockers were not illusory or a sham under factors drawn from relevant precedent, and; (iii) the Blockers were not a scheme to evade reporting requirements under SEC Rule 13d-3(b).

Importantly, the Second Circuit confirmed that a “comprehensive and legally binding blocker should generally insulate a defendant from section 16(b) liability.”¹³ To challenge a well-drafted blocker past a motion to dismiss, “a plaintiff must allege that a facially unambiguous and self-executing blocker has in fact failed in practice.”¹⁴

The Second Circuit did, however, acknowledge that courts should disregard “sham” or “illusory” blockers. Drawing on its seminal decision in Levy v. Southbrook International Investments, Ltd., 263 F.3d 10 (2d Cir. 2001), the Second Circuit identified three relevant factors for assessing a blocker’s viability: whether (i) the acquiring party may waive the blocker in its sole discretion; (ii) the blocker lacks a means of ensuring compliance, and; (iii) as a practical reality, the investor has ever exceeded the blocker’s threshold.¹⁵ All three factors confirmed that Hudson Bay’s Blockers were not illusory.¹⁶

First, the Second Circuit found that the Blockers were “solid contractual provisions” that Hudson Bay could not unilaterally waive without BBBY’s consent. Rejecting Butterfly’s argument, the Second Circuit noted that “the mere fact that the parties could theoretically amend a contractual clause is not enough to make it illusory; to hold otherwise would render virtually every clause of every contract a sham.”¹⁷

Second, the Blockers contained robust means of ensuring compliance because any acquisition of securities above the 9.99% threshold was automatically rendered “null and void and treated as if never made.” The Second Circuit was unconvinced by Butterfly’s insistence that BBBY had no means of policing Hudson Bay’s compliance, explaining that it has “never found that a contractual clause is illusory simply because one party cannot actively audit the other’s compliance in real time.” Indeed, the Blockers here went “one step further” by “automatically nullify[ing]” any excess acquisitions.¹⁸

Third, Hudson Bay never actually exceeded the 9.99% threshold. The trading records showed its end-of-day beneficial ownership stayed below the cap, and Butterfly’s attempt to allege otherwise relied on “dubious math” that improperly counted shares Hudson Bay had already agreed to sell but still technically held. As explained by the Second Circuit, beneficial ownership “turns on whether the party in question enjoys ‘[i]nvestment power . . . to dispose, or direct the disposition of, [a] security,” and not where the security is held.¹⁹  

Critically, the Second Circuit rejected Butterfly’s characterization of Levy as endorsing a “substance-over-form, multi-factor standard that focuses less on the text of the blocker, and more on how it functioned ‘in practice.’”²⁰ Instead, the Second Circuit made clear that blockers should be interpreted and assessed like any other contract: “by looking to their text.” Thus, to challenge a “facially unambiguous and self-executing” blocker past a motion to dismiss, a plaintiff must allege that the blocker has in fact failed in practice, and “not merely speculate that the parties could hypothetically waive the blocker” or breach the contract.²¹

The Blockers Were Not Part of a Scheme to Evade

The Second Circuit also rejected Butterfly’s argument under SEC Rule 13d-3(b), which treats any person who uses a “contract, arrangement, or device” as part of a “plan or scheme to evade” reporting requirements as the beneficial owner of the relevant securities. Butterfly claimed that Hudson Bay used the Blockers to “execute a comprehensive plan of disclosure evasion.”²²

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 explained that Rule 13d-3(b) applies only where a transaction not only avoids disclosure but also confers the “substantial equivalence of the rights of ownership relevant to control” or includes steps that “stop short of, or conceal, the vesting of ownership” while ensuring ownership will vest “at the signal of the would-be owner.”²³ By contrast, a transaction designed merely to allow an investor to avoid disclosure obligations is not subject to the Rule. The Second Circuit noted that Judge Winter’s view was consistent with Supreme Court precedent allowing investors to structure transactions with the intent of avoiding liability under Section 16(b).²⁴

Here, Rule 13d-3(b) did not apply because the Blockers did not conceal Hudson Bay’s beneficial ownership or give Hudson Bay rights equivalent to ownership but prevented Hudson Bay from attaining beneficial ownership in the first place.

Finding Rule 13d-3(b) to be inapplicable, the Second Circuit affirmed the dismissal of Butterfly’s claim in full.²⁵

Key Takeaways

The Second Circuit’s ruling not only confirms that contractual blockers effectively protect investors from Section 16(b) liability, but also sets forth, for the first time, specific criteria by the Second Circuit to assess whether a Section 16(b) claim challenging a blocker can survive a motion to dismiss.

Investors and issuers drafting blocker provisions should ensure that such provisions: (i) are not unilaterally amendable or waivable; (ii) have effective enforcement mechanisms, including self-enforcement mechanisms that render any conversion or exercise in excess of the established threshold to be null and void, and; (iii) are subsequently adhered to in practice. By following these criteria, even purely contractual blockers will offer investors robust protection against claims by aggressive Section 16(b) plaintiffs and minimize litigation risks.

^{1 20230930-DK-Butterfly-1, Inc. v. HBC Investments LLC, No. 25-2728 (2d Cir. July 7, 2026).}

^{2 Id. at 2.}

^{3 Id. at 10-16.}

^{4 Id. at 16-19.}

^{5 Id. at 2, 15-16.}

^{6 Id. at 8-9 (citing 15 U.S.C. § 78p(a).).}

^{7 Id. at 5.}

^{8 Id. at 5-6.}

^{9 Id. at 7.}

^{10 Id.}

^{11 Id.}

^{12 Id. at 2.}

^{13 Id. at 15.}

^{14 Id. at 15-16.}

^{15 Id. at 10 (citing Levy, 263 F.3d at 12, 17 & 18).}

^{16 Notably, the Second Circuit did not adopt the factors set forth by the amicus brief that the SEC filed in Levy, observing that most courts have not expressly applied those criteria. In any event, “the three factors that Levy identified largely overlap with three of the SEC’s proposed factors.” See id. at 10, fn. 1.}

^{17 Id. at 10-11.}  

^{18 Id. at 11-12.}

^{19 Id. at 12-14.}

^{20 Id. at 14.}

^{21 Id. at 15-16.}

^{22 Id. at 16.}

^{23 Id. at 17 (citing CSX, 654 F.3d at 305 (Winter, J., concurring)).}

^{24 Id. at 17-18 (citing Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 422 (1972)).}

^{25 Id. at 19.}