When contemplating a potential divestment of a target company with multiple shareholders, it is vital to take into consideration the impact a single minority shareholder can have on the transaction should it be unwilling to co-operate. In this article, Sandra Seah and Terrance Goh from our Singapore corporate team share some strategies that shareholders may wish to implement from the outset of a joint venture to prevent the majority from being held hostage by a minority shareholder and to ensure a smooth exit if parties choose to divest.
As a company grows, it is usual for new funding to be sought and most often, this is achieved by way of capital injection by investors in exchange for shares in the company. However, with more shareholders coming on board, a downside is that it will be more cumbersome for a company (or its founders) to obtain consent in relation to certain important affairs of the company, such as in the event of a divestment.
In a company with multiple shareholders, it is usual and advisable to put in place a well-drafted shareholders’ agreement. The shareholders’ agreement serves as a contract setting out how the company’s affairs are to be managed and is an important tool towards protecting the company’s (and founders’) interests as well.
For a transaction dealing with the divestment of all of the issued share capital of a target company, a sensibly drafted drag-along provision can go a long way towards assisting the company/founders eliminate any obstacles when working with uncooperative minority shareholders or even a minority shareholder who is seizing the opportunity to demand a huge pay-out in exchange for its co-operation.
What is a drag-along provision?
A drag-along provision is essentially a clause in the shareholders’ agreement giving the majority shareholder(s) the right to force minority shareholder(s) to participate and accept an offer from a bona fide purchaser to purchase the target company.
As for the terms of sale offered to the dragged minority shareholders, these would generally be the same as that being offered to the other consenting shareholders. For instance, the purchaser’s offer price, which the majority shareholder had accepted for their shares, would apply to the shares of the minority shareholders as well.
We set out below three points that should be taken into consideration when drafting a drag-along provision.
Strategy 1: Set the percentage thresholds in which the drag-along provision can be triggered
There are various percentage thresholds that should be incorporated in a well-drafted drag-along provision.
The first percentage threshold will be the percentage of shares that the potential purchaser offers to purchase and which the majority shareholders(s) will accept before the drag-along right can be triggered.
Typically, it is observed that drag-along provisions are usually triggered only when there is an offer to purchase the entire issued share capital of the target company.
That said, this percentage threshold can certainly vary and be tailored to suit the unique circumstances of each company. For instance, it would be possible, although rare, to provide that the drag-along provision can be triggered when there is a bona fide offer for 80% of the target company’s shares (with the shareholders’ shares in the target company being sold in proportion to their shareholding).
The second percentage threshold relates to the percentage of shareholders accepting the bona fide offer and, in turn, triggering the drag-along right.
Generally, it is common to see a drag-along provision requiring shareholders holding at least 51% to 75% of the company’s shares (with voting rights) to accept the bona fide offer from the potential purchaser before the drag-along right can be triggered. Considerations such as the ease of obtaining the set level of majority shareholder approval will be paramount in determining the threshold to be fixed.
Strategy 2: Provide that an agent/attorney can be appointed in the event of non-compliance to execute and deliver transfer documents by the dragged minority shareholder(s)
Given that a dragged shareholder would have already been uncooperative/unresponsive towards accepting the proposed sale of the company to trigger the drag-along right, it will be unrealistic to expect cooperation from the dragged minority shareholder(s) in complying with the procedures to effect the transfer such as surrendering the share certificates and executing the share transfer instruments.
It is, therefore, paramount that the drag-along provision expressly provides that in the event of a failure to execute the transfer of shares by the dragged minority shareholder(s), such shareholder(s) shall be deemed to be defaulting shareholder(s) and shall be deemed to have irrevocably appointed an agent/attorney nominated by the target company to execute and deliver all necessary documents on the defaulting shareholder(s)’ behalf.
Once an agent/attorney is deemed to be duly appointed by the dragged minority shareholder(s), this helps the target company (or majority shareholders) avert legal disputes with the dragged minority shareholder(s) based on a lack of consent to act on behalf of the dragged minority shareholder(s) when enforcing the drag-along provision.
The powers of the agent/attorney may even extend to include requesting the company secretary to cancel and issue duplicate share certificates if the original share certificates are withheld by the dragged minority shareholder.
Strategy 3: Provide that the dragged shareholder will be liable for all legal expenses in relation to the exercise of the drag mechanism
To invoke the drag mechanism, it is inevitable that the Company will incur higher legal fees and administrative expenses as compared to a scenario where the shareholder voluntarily transfers his/her shares without much fuss.
To take into account these higher legal fees and expenses, it is recommended that the apportionment of such legal expenses should be expressly provided for in the constitutional documents or shareholders’ agreement or both, to make it clear that the dragged shareholder shall be responsible for and shall bear all legal fees and expenses in connection with the transfer of his/her shares.
This will also, in a way, disincentivise shareholders from not co-operating with the company/founders.
Conclusion
Ultimately, the incorporation of a drag-along mechanism in a shareholders’ agreement or the constitution will provide certainty and cost-effectiveness in the event of a sale of the target company without being encumbered by uncooperative shareholders and the threat of claims for procedural lapses.
This article is produced by our Singapore office, Bird & Bird ATMD LLP, and does not constitute legal advice. It is intended to provide general information only. Please contact our lawyers if you have any specific queries.
For further information, please contact:
Sandra Seah, Partner, Bird & Bird
sandra.seah@twobirds.com
