A shareholders’ agreement is a legally binding contract between shareholders and a company, as well as between each shareholder of the company. The “drag along” and “tag along” provisions are a classic example of a balancing act between the rights of a majority shareholder and a minority shareholder. This article will explain what a shareholders’ agreement is and what drag along and tag along provisions are.

What is a Shareholders’ Agreement?

A shareholders’ agreement governs the shareholders, their business relationships and arrangements. It also sets out the shareholders’:

  • rights;
  • responsibilities;
  • liabilities; and
  • obligations.

There are many provisions contained within a shareholders’ agreement to ensure that each shareholder is treated fairly.

What is a Drag Along Provision?

A drag along provision allows the majority shareholder(s) to require the minority shareholder(s) to sell their shares. This is usually triggered in a takeover offer.

For example, a bidder would like to buy the entire company. The majority shareholder(s) holding more than 50% of the company agree to sell their shares. Therefore, in this situation, the majority shareholder(s) can “drag along” the remaining minority shareholder(s) and require them to sell their shares. Accordingly, the bidder can purchase the entire company.

Additionally, to protect the minority shareholders, the drag along provision will usually require the majority shareholder(s) to ensure that the minority shareholder(s) is able to sell the shares on the same terms and conditions.

What is a Tag Along Provision?

A tag along provision has the opposite effect of a drag along provision.

In a well-drafted and well-balanced shareholders’ agreement, when a shareholder wishes to sell their shares, the shareholder usually has to provide notice to the other shareholders. This requirement is usually contained within a “first right of refusal” clause.

However, if the majority shareholder(s) wants to sell shares to a third party, and does not provide notice to the other shareholders, the tag along provision will enable the minority shareholder(s) to tag along with the majority shareholder(s) and sell their shares for the same price and on the same terms and conditions.

Key Takeaways

Drag along and tag along provisions are important clauses in any shareholders’ agreement. A drag along provision allows a majority shareholder to make a minority shareholder sell their shares. In contrast, a tag along provision allows minority shareholders to sell their shares for the same price, on the same terms and conditions as the majority shareholder, if the majority shareholder:

  • is selling to a third party; and
  • has not notified the other shareholders.

If you need assistance drafting a shareholders’ agreement or understanding your drag along and tag along provisions, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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