The Court of Appeal has highlighted in Arbuthnott v Bonnyman & others (Arbuthnott) that Companies who have (or will have) minority shareholders, should ensure that bespoke articles of association (Articles) and a shareholders agreement are drafted as soon as possible to include (along with other provisions) a ‘drag along’ clause. This provision will make sure that any sale of the company is both seamless and attractive to potential buyers.
A bespoke drag along clause drafted into a company’s Articles is essential as it allows a majority of the shareholders (usually more than 75%) to accept an offer to buy their shares and to force the remaining shareholders to accept such offer on the same terms.
The Court in Arbuthnott ruled that a company amending its Articles to include drag along rights was not invalid and did not encompass unfair prejudice to the minority shareholder which would allow them to bring a claim under section 994 of the Companies Act 2006 for unfairly prejudicial conduct.
In Arbuthnott, Mr Geoffrey Arbuthnott (Geoffrey) was a founding shareholder of a private equity company. The company was governed by Articles and a shareholders agreement which included drag-along provisions effective on an exit. When the original shareholders approached retirement, shareholders who wished to continue with the business offered to buy all of the shares in the company. All retiring shareholders accepted, apart from Geoffrey. He believed the valuation of the company was too low. The remaining shareholders altered the company’s Articles to include a drag along provision to enable them to proceed without Geoffrey’s consent, he presented an unfair prejudice petition under section 994 Companies Act 2006.
The Court of Appeal applied the long standing test to see whether the insertion of the drag along provision was valid. Namely, was the power to amend the Articles to insert the drag along provision ‘exercised in good faith for the benefit of the company as a whole’? It is for the shareholders, and not the Court, to determine what is for the benefit of the company, as long as no reasonable person would consider it to be so. The Court will not investigate the subjective views of the shareholders.
The Court was unable to find evidence of bad faith or improper motive. The amendments in this scenario were a ‘tidying up’ exercise. Making the Articles clearer to expedite the transfer of shares was for the benefit of the company. It was the burden of the minority shareholder to satisfy the court that no reasonable person would have thought the amendment was in the company’s best interests and Geoffrey failed to do so.
The Court was persuaded by its finding that the drag along provision was not inserted to purely target Geoffrey, the minority shareholder, as he was entitled to have his shares purchased on exactly the same terms as the majority shareholders, all of whom had agreed to the sale of their shares (these same shareholders would be unlikely to agree a price for their shares, which they did not honestly consider to be reasonable and fair). It is therefore important that any drag along provision that is inserted into the Articles provides that the minority shareholders are paid the same as the majority for their shares.
A big influence in this case was that the amendment to the Articles to allow the sale to proceed was not inconsistent with the original arrangements entered into by the founding shareholders, including Geoffrey in the Shareholders Agreement.
If you have minority shareholders in your company, it would be wise to insert drag along provisions in your Articles and any shareholders agreement sooner rather than later. This will ensure that minority shareholders are dragged along in any potential sale and enable you to deliver 100% of the shareholding to the purchaser within minimum fuss and no claim for unfair prejudice.