Drag along rights

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.

Drag along clauses can be vital to ensure that any sale of the company is both seamless and attractive to potential buyers.

Why is a drag along clause important?

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.

Facts of Arbuthnott case

Mr Arbuthnott 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 Arbuthnott. 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 Arbuthnott’s consent, he presented an unfair prejudice petition under section 994 Companies Act 2006.

Findings

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. 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 Arbuthnott failed to do so.

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.

Negotiating drag along terms

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.

Drag along clauses are generally part of wider negotiations. Commonly, where drag along rights are agreed, tag along rights are part of the negotiation. Limitations, whether in terms of time period for the drag along to apply or other associated caveats and conditions may provide some comfort to minority shareholders. We are experienced in advising on the negotiating points and how to get the most equitable, practical and cost effective solution in place

Get in touch with us for cost effective advice on all aspects of shareholder agreements, articles and company law.

John Deane

John solves commercial problems for SMEs and their investors. It is said that he is unbelievably practical and seasoned in finding the right solution without too much fuss. He has an established reputation in the technology, art and media industries.

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