On August 19, 2013, the Court of Appeals for the Ninth Circuit held in Hildes v. Arthur Andersen LLP that a stockholder who enters into a voting agreement with a buyer in favor of a stock-for-stock merger before the buyer files its Form S-4 registration statement can still bring a claim under Section 11 of the Securities Act based on any misrepresentations by the buyer in its registration statement. The decision reversed the ruling by the US District Court for the Southern District of California, which denied plaintiff's motion to add a Section 11 claim as futile because the doctrine of "negative causation" would have barred the claim.

In April 2000, Peregrine Systems Inc., a Delaware corporation headquartered in California, entered into a stock-for-stock merger agreement with Harbinger Corporation. Under the agreement, Harbinger would become a wholly owned subsidiary of Peregrine. The merger was subject to certain common conditions, including that:

The plaintiff, Hildes, owned Harbinger common stock and executed a voting agreement with Peregrine, which granted Peregrine an irrevocable proxy to vote his shares in favor of the merger. The voting agreement and irrevocable proxy would terminate if the merger terminated under the terms of the merger agreement, including if:

A few weeks after the signing, Peregrine filed its Form S-4, which included its audited financial statements, with the SEC. The stockholders of each company approved the merger and the merger closed in June 2000.

Three years later, the SEC filed a complaint against Peregrine, alleging financial fraud arising out of materially incorrect financial statements filed with the SEC by Peregrine during a two-and-a-half year period that included the date of the merger. Peregrine shareholders brought a consolidated class action for financial-statement fraud, with the class plaintiffs eventually settling their claims with certain defendants. Hildes, however, opted out of the settlement agreements and filed the current lawsuit, bringing claims under Section 11 against Peregrine's accounts, Arthur Andersen LLP, and other individuals. Hildes also sought to add Section 11 claims against the former directors of Peregrine, as Section 11 imposes liability on every person who signs a registration statement that contains an untrue statement of material fact or that omits to state a material fact.

The District Court denied Hildes motion to amend his complaint to bring a Section 11 claim against the directors, holding that the Section 11 claim would be futile because of the directors' "negative causation" defense. "Negative causation" prevents a plaintiff from recovering losses if the defendant can show that the loss was not attributable to the alleged misrepresentation or omission. Because, as the District Court understood the voting agreement, Hildes had entered into a binding commitment to exchange his shares when he signed the voting agreement and irrevocable proxy before the Form S-4, the District Court determined that any loss he suffered could not be attributed to the misrepresentations or omissions in the Form S-4. Hildes timely appealed to the Ninth Circuit.

The Ninth Circuit reversed, holding that a stockholder who enters into a voting agreement with a buyer in favor of a merger before the buyer files its Form S-4 registration statement can still bring a claim under Section 11 based on the buyer's misrepresentations in its registration statement. In so ruling, the Ninth Circuit first noted that Section 11 does not require a plaintiff to show reliance on the registration statement if it purchased a security within 12 months of the registration statement. Therefore, because Hildes received Peregrine stock within 12 months of Peregrine filing the Form S-4 with the SEC, Hildes did not have to demonstrate reliance under Section 11.

The Ninth Circuit disagreed with the District Court's holding that the voting agreement irrevocably committed Hildes to exchange his shares. Rather, the voting agreement committed Hildes only to have his shares voted in favor of the merger, with the actual exchange of his shares remaining contingent on the closing of the merger. Hildes suggested various scenarios in which the merger would not have closed had Peregrine's true financial state been revealed, including that:

The Ninth Circuit agreed with the plaintiff's interpretation of the voting agreement, finding that the exchange of shares was not automatic and that the misrepresentations had in fact caused Hildes' subsequent losses. The Ninth Circuit therefore concluded that Hildes had alleged a potentially meritorious Section 11 claim because he had plausibly argued that the misrepresentations in the Form S-4 resulted in the completion of the merger, the exchange of his shares and his subsequent losses.

The Ninth Circuit's holding might come as a surprise to buyers who had assumed that a voting agreement amounts to a waiver of any litigation claims arising from the buyer's disclosures. At least within the jurisdiction of the Ninth Circuit, a stockholder can now continue to bring a Section 11 claim as a result of a misrepresentation in the buyer's Form S-4 registration statement, even if the Form S-4 is filed after the stockholder has entered into the voting agreement.

The decision implies that if a majority of the voting shares are locked up in voting agreements, a stockholder who has entered into a voting agreement will have no basis to bring a Section 11 claim. However, as long as a majority of the voting shares are unbound by voting agreements, the stockholder will retain the right to sue under Section 11 on the theory that his losses are directly attributable to the buyer's misrepresentations.

In response to the decision, buyers negotiating voting agreements with significant target-company stockholders can consider providing in the voting agreement for an irrevocable proxy of not only the stockholder's voting obligation but his share-exchange obligation as well. However, no stockholder will agree to this proxy without exceptions for when the merger does not close, so the effectiveness of this strategy may be limited.

For a sample voting agreement used in connection with the acquisition of a public company, see Standard Document, Voting Agreement.