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What are drag-along and tag-along rights in relation to transfers of company shares?

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Drag-along and tag-along rights are contractual provisions often agreed between majority and minority shareholders of a company to protect their respective interests.

These provisions are typically formalised in a shareholders’ agreement entered into between the parties or in the articles of association of the company concerned.

When it comes to selling a company, a drag-along right entitles a majority shareholder to require minority shareholders to approve the sale of the company by agreeing to sell their minority shareholdings to the proposed buyer. Such a right ensures that if the proposed buyer is only willing to acquire 100% of the company, then the minority shareholders cannot effectively block the sale by refusing to sell their minority shareholdings, thus protecting the position of the majority shareholder.

Conversely, tag-along rights operate to protect the position of minority shareholders. The operation of tag-along rights provides that if a majority shareholder decides to sell their shares in a company, then the minority shareholders will be entitled to require that the proposed buyer also acquires their minority shareholdings at the same price per share offered to the majority shareholder. Without tag-along rights, minority shareholders risk being left behind as a co-shareholder with an unknown third-party investor for example. Therefore, tag-along rights can provide minority shareholders with more security than would be available under conventional pre-emption rights, especially if minority shareholders lack the funds to buy out a majority shareholder.

Important considerations when negotiating drag-along rights

Price of the shares – Minority shareholders may insist on a guaranteed minimum price for their shares to avoid being forced to sell at a low price in circumstances where a majority shareholder simply wishes to complete a quick sale for example. Minority shareholders may also insist on rights to ensure that the price provided for their shares has been fairly valued.

Warranties – It is common for minority shareholders to require that they should not be expected to give any substantial warranties in the sale of company, perhaps only giving warranties as to title to the shares and freedom to contract. This would be especially the case where the minority shareholding is small and/or if the minority shareholders are not actively involved in the business and affairs of the company. For this reason, minority shareholders may insist that the drag-along rights are qualified by such conditionality.

Form of consideration for the shares – Minority shareholders are likely to object to any drag-along rights which would apply to the sale of their shares other than for cash, for example, a share exchange. For this reason, minority shareholders may also insist that the drag-along rights are qualified by a condition that the consideration for the minority shares must be paid in cash.

Important considerations when negotiating tag-along rights

Partial share sales – A point to consider when negotiating tag-along rights is whether such rights should be triggered if the majority shareholder decides to sell just a proportion of their shares. If this is not the case, then the minority shareholders risk being left behind with an incoming third-party investor for example, albeit along with the previous majority shareholder whose shareholding will have been reduced.

Warranties – Whether minority shareholders who trigger their tag-along rights should be required to give the same representations and warranties as the majority shareholder or a more limited set of warranties as noted above is essentially a matter for negotiation between the parties. However, given that the minority shareholders will receive the same price per share as the majority shareholder, there is an argument that the same warranties should be given, especially because it is the minority shareholders who will have triggered the tag-along rights themselves.

Summary

In summary:

  1. Drag-along and tag-along rights are contractual obligations which operate to protect both minority and majority shareholders in a company.
  2. Tag-along rights operate to protect minority shareholders.
  3. Drag-along rights operate to protect majority shareholders.

How can we help?

The Corporate and Commercial team at Wilson Browne Solicitors is ideally placed to advise on all legal aspects of the contractual arrangements between company shareholders, including both tag-along rights and drag-along rights. For a confidential and no obligation initial discussion about how we may be able to help, please contact the Corporate and Commercial team: 0800 088 6004

Duncan Crowther

Posted:

Duncan Crowther

Partner

Duncan is a Solicitor and Partner. He specialises in giving corporate & commercial, and employment advice to businesses and companies throughout the region. Duncan has a background in engineering and is well equipped to understand the most complex of contracts and issues facing businesses.