Drag-Along and Tag-Along Clauses: Opportunities and Protections

What are Drag-Along and Tag-Along Clauses?

In the realm of extraordinary transactions, such as the acquisition of ownership interests, two types of clauses have long been in use in our legal system. These clauses allow majority shareholders to compel, under equal terms, the sale of minority shareholders’ interests or grant the right to minority shareholders to sell their interests at the previously negotiated price of the majority shareholders’ sale.

 

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In essence:Drag-Along and Tag-Along Clauses

  • Drag-Along: These clauses empower majority shareholders to compel minority shareholders to sell their respective interests, based on the price negotiated by the majority shareholder.
  • Tag-Along: These clauses grant minority shareholders the right (but not the obligation) to sell their interests as part of the sale of majority ownership, utilizing the same economic terms offered to the majority shareholder.

Initially, these clauses were primarily found in shareholders’ agreements, but they have become commonplace in corporate bylaws.

 

Understanding the Substantive Differences Between the Two Clauses

From the above summary, it is clear that these clauses serve different needs, primarily for either majority or minority shareholders:

  • Drag-Along Clauses: In these clauses, minority shareholders “suffer” the actions of the majority shareholder, who has the authority to compel the minority shareholders to sell their interests. This obligation is initiated by the majority shareholder, who, if deciding to sell, essentially “drags” the minority interests into the sale. The minority shareholder is obliged to exit, which means that, for example, in a rapidly growing market, they are compelled to divest their interests. Furthermore, these clauses allow a third-party buyer to potentially eliminate a hostile minority.
  • Tag-Along Clauses: In contrast, tag-along clauses offer greater protection to minority shareholders, as they have the choice to have their interests sold or to remain with the company. Unlike drag-along clauses, they are not under a mandatory sale obligation. In this case, the interests of minority shareholders include seizing the opportunity to sell their interests since, otherwise, the standalone sale of minority interests might be unattractive, as is often the case.

Therefore, these clauses primarily serve two distinct needs: facilitating the rapid divestment of even minority interests (drag-along) and giving the minority shareholder the option to stay with the company or benefit from the sale of their interests (tag-along).
A thoughtfully crafted inclusion of these statutory clauses should take into account these different requirements and, if necessary, strike the right balance or make corrections.

 

Introduction of Clauses into Bylaws: Majority Requirements

A much-debated issue concerns the voting thresholds required to introduce these clauses into a company’s bylaws. In light of jurisprudence and scholarship that have addressed this topic, it can be summarized as follows:

  • For Drag-Along Clauses: It is evident that these clauses particularly affect minority shareholders, imposing an obligation on them. Therefore, the introduction of such clauses is typically required to be unanimous or, at the very least, with the consent of all those (minority shareholders) burdened by the sale obligation.
  • For Tag-Along Clauses: In contrast, a majority resolution is generally sufficient for the introduction of these clauses.

In both cases, those who did not participate in the approval of the resolution introducing these clauses have the right to withdraw their shares according to Article 2437 of the Civil Code, paragraph 2, letter b, which pertains to “the introduction or removal of restrictions on the transfer of shares.”

 

Conclusions

As briefly outlined, drag-along and tag-along clauses enable the effective satisfaction of different needs, either by allowing or obligating, depending on the circumstances, the rapid divestment of ownership interests in acquisition operations. Given the complexity of the issue, and the practical implications that may arise, it is always advisable to carefully draft these clauses with a view to their underlying rationale for inclusion in the company’s bylaws.

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