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Drag along rights in company sales

Please note that the information herein is of a general nature and you should not act or refrain from acting on it without professional advice on the specific facts of your case. No liability is accepted by the author or Sykes Anderson Perry Limited in respect of this article. Law is a complex subject and the above is a basic outline only and is intended only as a general guide.

In small and medium sized companies it is sometimes the case that the major shareholders want to ensure that they can sell their shares, and that a minority shareholder cannot stop the sale. The major shareholders may be the people who have put the finance into the company and want to be sure they can exit if a good offer is made for the company. A “drag along” clause is often put in a shareholders agreement or in the articles of association for this purpose. It can be better to have this provision in a shareholders agreement because it is then not a public document.

The English courts have recently considered this in a case called Cunningham v Resourceful Land Limited. In this case there was a shareholders agreement which provided that, if three of the shareholders wanted to transfer their shares to a buyer, the other shareholders had to sell as well. There was power to sign the share transfers if any shareholder did not cooperate.

Resourceful Land Limited was purchased for shares, in other words the shareholders in the company received shares in the buyer company and not cash. The company was sold and afterwards a shareholder who refused to sign the transfer objected. The court decided the clause was valid and the shareholder could not be put back on as a shareholder in Resourceful Land Limited. This case is good news for larger shareholders.

A few of the key points for people involved in these deals are as follows:-

1. Majority shareholders will want a widely drafted drag along clause to allow them to sell easily. Maximum flexibility will be their goal.

2. If you are a minority shareholder (especially if also a working director) make sure these clauses are tightly worded. If you want a cash only exit then you need to have this clearly set out in the shareholders agreement. Otherwise a share sale could take place and you may not want to be part of the new owners group of companies.

3. Think about criteria for a sale. Does there have to be a minimum sale price? Must all cash in the company be paid out as a dividend first? Can you resign as a director and be compensated if you do not want to work for the new owners?

4. All shareholders should be offered the same terms but you may want to have a mechanism in the shareholders agreement to ensure you are protected. This is relevant if you are a minority shareholder working say as a director in the company.

5. Think about whether you agree to give majority shareholders power to sign on your behalf if you refuse. Perhaps have a requirement they give you 10 days’ notice of their intention to do so to enable you to take legal action before a sale. Being told your shares have been sold after it has happened puts you on the back foot.

September 2018
David Anderson
Solicitor-Advocate and Chartered Tax Adviser