A shareholder agreement is a private contract between the shareholders of a private company and the company itself, and between each of the shareholders of the company to each other. The agreement governs the shareholders’ respective rights, responsibilities, obligations, and liabilities.
Shareholder agreements typically contain various provisions that amongst other things help steer the management of the company and cover a range of contingencies. “Drag along/tag along” provisions are often found in shareholder agreements. They are aimed at balancing the rights between majority shareholders and minority shareholders of the company and are generally relevant when a company or any of its shares is being sold to a third party.
What are drag along rights?
A drag along provision allows a majority shareholder to demand a minority shareholder to sell their shares and effectively join the majority shareholder in the sale of shares in the company. This usually occurs where a takeover offer is made. For example, majority shareholders who hold more than 50% of a company may agree to sell their shares. In this situation, the majority shareholders can ‘drag along’ the remaining minority shareholders and essentially force them to also sell their shares. This would result in the buyer being able to purchase the entire company, rather than just the shares of a majority holder, which is often a more attractive option to the purchaser.
Why are drag along provisions used?
Drag along provisions provide a means for majority shareholders to sell the entire company where sale might otherwise be blocked by minority shareholders refusing to sell their shares. A potential purchaser may be less inclined to purchase a majority interest only, due to concerns about being ‘stuck’ in a company with minority shareholders with whom they have not had previous business dealings. When a company can be sold as a whole, there is also the potential of receiving a more favourable purchase offer. Without drag along rights in a shareholder agreement, uncooperative minority shareholders could potentially block a third-party acquisition, even in circumstances where the sale is desired by the other shareholders.
What is a tag along provision?
Tag along provisions give minor shareholders a right to ‘tag along’ with a larger shareholder or group of shareholders if they as the majority receive an approach or offer from a purchaser wanting to buy their shares. Under the tag along option, where a majority shareholder is selling shares in the company, the minority shareholder has the right to join the transaction and sell their minority stake to the purchaser on the same terms.
Why are tag along provisions used?
Tag along provisions help to protect minority shareholders so that they are not ‘left behind’ if a major shareholder decides to sell their shares in the company. A tag along provision allows minority shareholders to force majority shareholders to get the same sale terms and price for the minority shareholders as a condition of selling their majority shares.
Are drag along rights oppressive?
Drag along rights can be considered ’oppressive’ to minority shareholders. Conversely in the absence of a Drag along provision a minority shareholder could prejudice a share sale that is desired by the majority of shareholders. There are some protections for the minority, as, drag along provisions usually require majority shareholders to ensure that minority shareholders are able to sell their shares on the same terms and conditions as the majority shareholders.
The Corporations Act 2001 (Cth) contains provisions aimed at protecting the rights of minority shareholders from oppressive actions by majority shareholders in their company. The Act provides minority shareholders with remedies if they can establish that the company’s affairs have been conducted in a way that were either contrary to the interests of the shareholders as a whole, or are oppressive, unfairly prejudicial, or discriminatory to minority shareholders.
The best way to prevent drag along rights being considered by minority shareholders as oppressive, unfairly prejudicial, or discriminatory to minority shareholders’ is to have drag along included in a properly drafted shareholder agreement. Accordingly, we recommend seeking legal advice when preparing, and/or before signing, a shareholder agreement.
Drag along/tag along provisions are an important consideration when preparing a shareholder agreement and should be drafted to balance the rights between majority and minority shareholders.
This information is for general purposes only, and we recommend you obtain professional advice relevant to your circumstances before taking any action.