What are Tag Along and Drag Along Clauses?
The terms Tag Along and Drag Along are probably unfamiliar to most of the population, as they are referred to a very specific corporate law field.
For this reason, the purpose of this article is to inform potential partners or shareholders of a company about these two clauses that are key during the withdrawal of one or more partners from a commercial company: these are the Tag Along Right and Drag Along Right clauses.
Apart from operating as protective measures, the purpose of these clauses is to allow partners or shareholders of a commercial company to react in case they do not agree with other partners or shareholders actions of the company.
Tag Along Right clause
The minority part of shareholders of a company should pay particular attention in case they find themselves in a similar situation as the below mentioned:
Majority shareholders inform to the minority part of the shareholders of the company about the acceptance of a financial offer made by a third party for the purchase of the shares taken by the majority shareholder. As a result, the third-party takes the material control of the company by acquiring the major part of the shares.
In this case, the minority shareholder would find themselves in a situation where an unknown shareholder has taken the full control of the company and is able todecide and act by its own means, while the minority shareholder is unable to oppose to any transaction
In this cases it is very important to receive a good legal advice:
- to limit the majority shareholder’s power to act and,
- to provide full advice to the partners at the beginning of a relationship so important as the joining of the company owners in an exercise of foresight and prevention.
In the described situation, it would have been very useful to incorporate a Tag Along clause, commonly known as the “right of accompaniment”, where the minority shareholder could take advantage of from the majority shareholder’s negotiating capacity by joining in the sale of the company´s shares under identical conditions to the sale and purchase agreement signed between the majority shareholder (seller) and a third party outside the company (buyer).
It should be emphasized that this is not compulsory, so it will rely on the person who is in favour of the Tag Along right to assess whether the offer received by one of the partners satisfies their claims and is beneficial to him.
Tag Along can be of two types, depending on whether
- a) it is intended to lead to the conclusion of a sale and purchase of shares´ transaction dependent on the persuasiveness of the shareholders who should convince the buyer to also buy the shares of the shareholders by exercising their right to accompany, or
- b) it is intended to respect the number of shares to be sold by the buyer, so that the selling shareholders carry out the transfer in proportion to the ownership percentages of the shares.
Drag Along Right Clause
We will now focus on the hypothetical case in which the purchase of the shares by the third party is ongoing, but the minority shareholders refuse to sell their shares.
We should consider that the main objective of the person interested in buying the company is to be the sole shareholder, so it would be difficult for him to agree to buy only a part of the shares.
Thus, if it is not possible to convince the minority shareholder to sell its shares, the person interested in acquiring the ownership of the company will most probably desist from the purchase, making it impossible to conclude the legal transaction.
In these cases, the best solution is to make a forecast of the possible disagreements that could arise between the company´s partners. Thus, it is very useful for the majority shareholder to have included a Drag Along Right clause in the agreement.
In the context of the drag-along right, a multitude of conditions can be agreed, such as the period of the right´s exercise or the selling price that determines the right of drag-along. However, these conditions should be negotiated at the appropriate time between the parties.
On the other hand, it should be noted that both the tag-along right and the right of drag-along can be incorporated both in the Articles of Association and in the Shareholders’ Agreement.
At LAWANTS we are lawyers specialized in legal, accounting and labor advice. If you have doubts about any of these clauses or need more information, do not hesitate to contact us. We will be pleased to answer your questions.