A shareholders agreement is an arrangement among shareholders describing the rights and obligations of shareholders and regulating the relationship between shareholders and management of a company. There is no legal requirement to have a shareholders agreement. Nevertheless, the Memorandum and Articles of Association (“Constitution”) of a company is not always adequate to regulate the relationship of shareholders. Executing a shareholders agreement is a way and means to cater for future occurrences that might be integral to the company’s structure and business. A shareholders agreement is a binding document that supplements the Constitution of a company.
One of the standard clauses of a shareholders agreement is the drag-along and tag-along clause. This clause sets out rights of shareholders in the event that a third party wishes to purchase the whole of a company. These rights relate particularly to majority and minority shareholders in a company. Drag-along clause enables a minimum percentage of shareholders that wish to sell their shares to a third party, to force the remaining minority shareholders to sell under the same terms, in order to ensure that the third party can receive 100% of the shares. These provisions usually occur in the case of a merger or acquisition of the company, since they help to eliminate objection of minority shareholders and sell the full value of the company. On the other hand, Tag-along rights require shareholders selling their shares to include other minority shareholders under the same terms. By virtue of this clause, such minority shareholders are not cut out of the deal and are tagged along.
Benefits of Drag-Along and Tag-Along Clause
In some situations, a buyer would want to acquire the entire share capital of a company and gain complete control. A drag-along and tag-along clause is instrumental in helping the buyer achieve this purpose.
Drag-along clause protects the interest of majority shareholders. If majority shareholders are able to find a buyer willing to purchase the whole value of the company, they can drag along or force the minority shareholders to partake in the sale whether or not the minority shareholders are content with the sale. Conversely, tag-along protects the interest of the minority shareholders who seek to be carried along in an acquisition or transfer of shares by majority shareholders. The majority shareholders that seek to rely on a drag-along clause must offer the minority shareholders the same price, terms and conditions of sale of their shares. Although drag-along rights are more likely to protect the controlling shareholder(s), minority shareholders can often benefit from them as well. If the price, terms and conditions are uniform for all the shareholders, the minority shareholders can achieve favorable sale of their shares under terms that were otherwise unfavorable.[1]
[1] M. Johnsoon, “Drag along and tag along rights” https://www.rocketlawyer.co.uk/article/drag-along-and-tag-along-rights.rl (Accessed 10th August, 2021).
Implications of Drag-Along and Tag-Along Clause
Drag along clauses might impose a risk of abuse on the part of a majority shareholder who exercises his drag-along right. For example, the shareholder might act in bad faith, by setting a low price for the shares with the buyer, in order to defraud the other shareholders and share the benefits with the buyer or might sell at a low and unfair price to an affiliate or agent. Hence, it is imperative that the parties determine the minimum price for the shares to be sold. Furthermore a sale should be made at arms’ length or fair market value and this can be encapsulated in the clause. A provision can also be made for the price to be fixed by an independent third party in the event that notified shareholders are dissatisfied with the offered price.[1]
Minority shareholders may want to remain part of the company going forward and might not be content with receiving payment for their shares regardless of the price offered.[2] If shareholders are concerned about being dragged, they could protect their position by having a right of first refusal so they can acquire the majority shares on the same terms offered by a third party. However, if they don’t have the required funds readily available to purchase the shares, the provision will be inconsequential or of little use.[3]
Cunningham v Resourceful Land Limited[4] In this case, shareholders set up two companies. One owned the land from which the business operated (the landowning company), and the operating company ran the actual business. A shareholders agreement in relation to the landowning company contained drag-along provisions saying that if three original shareholders wanted to sell their shares in the company to a buyer in good faith in an arm’s length transaction, the other shareholders also had to sell their shares to that buyer on the same terms. The agreement allowed the three original shareholders to sign transfer forms on behalf of the other shareholders if they refused to do so. The operating
company later needed further funding from an investor. The investor agreed to provide this but only on condition that all the shares in the landowning company would be transferred to a subsidiary of the investor, to be set up for the purpose. In return for transferring their shares, the shareholders of the landowning company would be issued with shares in the subsidiary, but would receive no cash. The three original shareholders agreed to the deal, and told the other shareholders they had to transfer their shares to the subsidiary too, under the drag-along provisions in the shareholders’ agreement. One of the other shareholders objected. When a transfer form was signed on his behalf, and his shares in the landowning company registered in the new shareholder’s name, he sued and asked the court to rectify the register to reinstate his name in it on grounds the transaction breached the shareholders agreement. He claimed that a share-for-share exchange was not a ‘sale’, and the drag-along provisions only applied in the event of a sale. The dissenting shareholder also claimed that the transaction was neither in good faith nor at arm’s length as it resulted in fresh funding for the operating company’.
The court disagreed and held that while the main drag-along clause in the shareholders agreement did use the word ‘sale’, the clause allowing a transfer form to be signed on their behalf if a ‘dragged along’ shareholder would not sign one themselves also included the words ‘or any other consideration’. This wording was ‘deliberately wide’, and covered a share-for-share exchange where no cash changed hands, so the drag along rights applied. The court further held that the investor had not acted in good faith having treated all shareholders equally in the transaction, including those ‘dragged along’ under the shareholders agreement and the transaction had been an arm’s length one because there had been no ‘prior connection’ between the three shareholders and the investor before it was agreed.
Nigerian Law
Despite being a contractual conception, there exits some statutory provisions under Nigerian law bearing similarities with drag-along and tag-along clauses, particularly Section 129 and Section 130 of the Investment and Securities Act 2007 (“ISA”). Section 129 (1) & (2) of ISA provides:
“(1) Where a scheme or contract (not being a take-over bid under this part involving the transfer of shares or any class of shares in a company (in this section referred to as “the transferor company”) to another company, whether a company within the meaning of this Act or not (in this section referred to as “the transferee company”) has, within four months after the making of the offer in that behalf by the transferee company, been approved by the holders of not less than nine-tenths in value of the shares whose transfer is involved (other than shares already held at the date of the offer by, or by a nominee for the transferee company or its subsidiary), the transferee company may at any time within two months after the expiration of the said four months give notice in the prescribed manner to an dissenting shareholder that it desires to acquire his shares.
(2) When a notice under subsection (1) of this section is given, the transferee company shall be entitled and bound to acquire those shares on the terms on which, under the scheme or contract, the shares of the approving shareholders are to be transferred to the transferee company unless on an application made by the dissenting shareholder within one month from the date on which the notice was given the court thinks it fit to order otherwise.”
Under Section 129 of the ISA, a dissenting shareholder may make an application to the court within the stipulated timeframe to stop the sale of his shares and the court is left to decide whether or not the shares of the shareholder will be forcefully acquired. This section appears to be akin with a drag along clause. The dissenting shareholders are the minority shareholder because they own not more than 10% of the shares of the transferor company. Hence, where nine-tenths (90%) of the shareholders have agreed to a sale, the remaining shareholders will be forced or dragged along in the sale. Another similarity with drag along clause is that the dissenting or minority shareholders can only be forced to sell their shares on the same price and on the same conditions as the majority shareholders.
It is noteworthy that Section 129 sets a very high threshold and minority shareholders can be dragged along under that section only when 90% of shareholders of the transferor company assent to the sale. Nonetheless, shareholders may set a lower threshold in a drag-along clause. The percentage usually set in drag-along clauses is usually between 70% to 80% of shareholders but any percentage fixed by the shareholders will be enforceable, as the court will likely adopt the principle that parties have the freedom to contract. One difference between Section 129 and drag-along clause is that, under section 129, it is the buyer that is forcing the minority shareholders to sell their shares. However, in a drag along clause, the majority shareholders are the ones forcing the sale of the minority shareholders.
Section 130 of ISA provides:
“(1) This section shall apply where, in pursuance of any such scheme of merger, shares in a company are transferred to another company or its nominee, and those shares together with any other shares in the first- mentioned company held by, or by a nominee for the transferee company or its subsidiary at the date of the transfer comprise or include nine-teenths in value of the shares in the first-mentioned company or of any class of those shares.
(2) The transferee company shall within one month from the date of the transfer (unless on a previous transfer in pursuance of the scheme or contract it has already complied with this requirement) give notice of that fact in the prescribed manner to the holder of the remaining shares or of the remaining shares of that class, as the case may be, who have not assented to the scheme or contract.
(3) Any such holder may, within three months from the giving of the notice to him, require the transferee company to acquire the shares in question.
(4) If a shareholder gives notice under subsection (3) of this section with respect to any shares, the transferee company shall be entitled and bound to acquire those shares on the terms on which under the scheme or contract the shares of the approving shareholders were transferred to it, or on such other terms as may be agreed on as the court hearing the application of either the transferee company or the shareholder thinks fit.”
Section 130 of ISA appears to be akin with tag-along rights. By virtue of this section, when 90% of shares have been acquired by a buyer from a company, the buyer is obligated to give a notice to the remaining shareholders, and the remaining shareholders are entitled to require the buyer to acquire their shares. If this happens, the buyer is bound to acquire those shares on same terms with the sale of the majority shares in the company.
Conclusion
Although there is no legal requirement to have a shareholders agreement in place, having one might be vital to protect the investment of shareholders and to also cater for unforeseen circumstances. The focus of drag-along and tag-along clauses in a shareholders agreement is on possible transfer of shares in a company in the future. Shareholders have to be cautious in drafting these clauses due to legal issues surrounding them. Explicit provisions must be made in those clauses to effectively convey the intention of the shareholders and safeguard their interest and investment. At first glance, these clauses appear bilateral, that is between majority shareholders and minority shareholders. Nonetheless, the exercise of rights arising from the clause introduces a third party buyer into the equation making it tripartite. Given the growth and significance of drag-along and tag-along clauses in investments, it is imperative that these clauses be grasped and utilized by investors or shareholders as a means of protecting their investment in a company.
[1] Vladimir Griga, “Getting along shareholders’ rights: drag and tag along clauses” http://www.lawyr.it/index.php/articles/domestic-focus/1265-getting-along-shareholders-rights-drag-along-and-tag-along-clauses (Accessed 10th August 2021)
[2] Sophie Brooks, “The pros and cons of drag along rights” https://gateleyplc.com/insight/quick-reads/the-pros-and-cons-of-drag-along-rights/ (Accessed 10th August 2021)
[3] Ibid.
[4] Cunningham v Resourceful Land Limited [2018] Ch D
Atom Content Marketing, “Case law: Court gives guidance on interpretation of ‘drag-along’ rights in company shareholders’ agreements” https://www.icaew.com/library/subject-gateways/law/legal-alert/2018-09/case-law-court-gives-guidance-on-interpretation-of-drag-along-rights (Accessed 12th August 2021)
