Understanding drag along/tag along rights in shareholder agreements

What is a shareholder agreement?

A shareholder agreement is a private contract between the shareholders of a company and the company, and between each shareholder of the company. The agreement governs the shareholders’ respective rights, responsibilities, obligations, and liabilities.

Shareholder agreements contain various provisions that 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 and are generally relevant when a company 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 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 sell their shares. This will result in the buyer purchasing the entire company, which is often a more attractive option to the purchaser.

Why are drag along provisions used?

Drag along provisions allow majority shareholders a right to sell the entire company without the potential of the sale being blocked by minority shareholders refusing to sell their shares.

A potential purchaser may be less inclined to purchase a majority interest if they are going to be stuck with minority shareholders that they have not had previous business dealings with.

When a company can be sold as a whole, there is also the potential of receiving a more favourable offer.

Without drag along rights in a shareholder agreement, uncooperative minority shareholders could block a third-party acquisition, even in circumstances where the sale is desirable to the rest of the shareholders.

What is a tag along provision?

In comparison, tag along provisions give minor shareholders a right to ‘tag along’ with a larger shareholder or group of shareholders, if they find 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.

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 as a condition of selling the majority shares.

Are drag along rights oppressive?

Drag along rights may seem ’oppressive’ at first, however, this is not necessarily the case. As noted, 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 themselves.

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 prove that the company’s affairs were 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.

Minority shareholders’ wishes being overpowered by the operation of difference in voting power is not enough to prove ’oppression’ under the Corporations Act, just as dissatisfaction of a shareholder or resentment are also not necessarily enough to prove oppressive, unfairly prejudicial, or discriminatory conduct.

The best way to prevent drag along rights being regarded as contrary to the interests of the shareholders as a whole or oppressive, unfairly prejudicial, or discriminatory to minority shareholders’ is to have drag along rights drafted appropriately in the shareholder agreement.

Accordingly, we recommend seeking legal advice when preparing, and/or before signing, a shareholder agreement.

Conclusion

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.

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