Drag Along Rights

The majority forces the remaining minority shareholders to join the deal

What are drag along rights?

Drag along rights empower a majority shareholder to force minority shareholders to join in the sale of the company. It ensures that minority shareholders comply with the terms of a sale, providing greater fluidity to transactions. Drag along rights are typically codified within a shareholders’ agreement. The specific terms, triggering events, and conditions of these rights would be detailed in this agreement.

Why are drag along rights used?

They are used to protect the interests of majority shareholders, ensuring that minority shareholders cannot obstruct a sale. This facilitates smoother sales transactions and can add to the value of a company during a sale.

How are drag along rights triggered?

These rights are typically triggered when a majority shareholder wants to sell their stake and the acquiring company wants to purchase 100% of the company. The exact triggering threshold can be defined in a company’s bylaws or shareholders’ agreement.

Advantages and disadvantages of drag-along rights

The advantages include simplified sale processes and protection for majority shareholders. Disadvantages may include potential unfair treatment of minority shareholders and reduced attractiveness to potential minority investors.

Benefits of drag-along provision

Benefits of drag-along rights for minority shareholders

A provision safeguards the interests of minority shareholders, ensuring that they receive the same amount for selling their share in the company as any other seller would have received in the market..

Benefits of drag-along rights for majority shareholders

The majority of shareholders, who may constitute a portion or the entirety of the company’s owners, exercise this right only during mergers and acquisitions when it is beneficial to them. In M&As, the buyer might stipulate a condition that they require complete ownership of the acquired company, and may even offer a little more than what is typically offered. In such instances, the owners could receive a greater amount by utilizing these drag-along rights.

Benefits for buyers of the company

For the buyers, the primary advantage is acquiring 100% ownership of the firm, which removes any interference with their methods and policies for running the company. Even if they have to pay a higher amount to acquire the targeted company, they remain interested, as it provides a way to manage and improve the company more effectively.

Can a minority shareholder block a sale?

Generally, if drag along rights are in place, minority shareholders cannot block a sale. However, the exact ability to block or not may depend on the specifics of the agreement and local laws.

Key considerations when negotiating drag-along rights

It’s essential to clearly define triggering events, notice periods, liquidation preferences, minimum price, and other terms to ensure fairness and transparency for all parties involved.

1. Type of Consideration

Drag-along rights are generally structured to allow invocation by the majority shareholder only when the transfer to a third-party buyer involves cash consideration.

However, extending the drag provision to non-cash consideration transfers might be met with opposition from minority shareholders. This resistance is rooted in the risk that minority shareholders could be forced to exchange their current shareholding for shares in an unfamiliar company, where exit options might be constrained. For example, the governance framework of the new company may prohibit share transfers or may not provide tag-along rights.

2. Determination of Price

When minority shareholders are in a robust negotiating position, they might demand a minimum price threshold to prevent being dragged into a sale at an undervalued rate, such as in a scenario where the majority shareholder faces insolvency and needs a rapid “fire sale.”

Moreover, if non-cash consideration forms part of the deal, minority shareholders might seek a mechanism to ensure that their shares’ price is fair and exceeds the minimum price level. This verification process helps in protecting their interests.

3. Stipulations Regarding Representations and Warranties

Typically, minority shareholders subject to drag-along rights are not required or expected to provide representations and warranties beyond those concerning capacity and title. The rationale behind this is that minority shareholders lack control over the warranty package that the selling majority shareholder may agree upon in the sales documentation. Consequently, limiting their obligations to capacity and title is seen as a fair and balanced approach.

Process of implementing drag-along rights

Implementing drag-along rights typically involves including specific clauses in the company’s shareholders’ agreement or bylaws, and seeking professional legal guidance to ensure that the provisions are enforceable.

What are tag along rights?

Tag along rights allow minority shareholders to join a sale initiated by majority shareholders. It’s a protection for minority shareholders, ensuring that they can sell their shares at the same price, terms, and conditions as the majority shareholder.

The key terms within drag along rights clauses

  • Triggering transactions: Defines what constitutes a sale. Drag along rights provisions are activated by a transfer or an event considered to be a “deemed liquidation.”
  • Triggering threshold: Specifies the percentage or condition triggering the drag along.
  • Notice to minority shareholders: Stipulates the notice period and method.
  • Form of sales proceeds: Describes how payment will be made.
  • Liquidation preferences: Outlines the priority of payments.
  • Minimum price: May set a floor price for the sale.
  • “lock-up” period: Specifies a period during which shares cannot be sold.

Example of drag-along rights

In the 2019 merger between Bristol-Myers Squibb Company and Celgene Corporation, Bristol-Myers Squibb acquired Celgene for around $74 billion in a cash and stock deal. Post-acquisition, Bristol-Myers Squibb held 69% of the combined entity, while the remaining 31% was held by converted Celgene shareholders. The minority shareholders of Celgene were required to accept one Bristol-Myers share plus $50 for each Celgene share owned, without any special options. Though drag-along and tag-along rights were not explicitly mentioned, the delisting of Celgene shares and the majority shareholder’s potential ability to negotiate special share rights underlined the inherent implications of drag-along rights, underscoring the importance of these provisions in protecting majority and minority shareholder interests in such significant transactions.

Drag along rights vs. Tag along rights

While drag along rights protect majority shareholders by forcing the sale of minority shares, tag along rights protect minority shareholders by granting them the option to join the sale. The two can coexist within the same agreement, serving to balance the interests of both majority and minority shareholders.

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