Explainer Note On Drag Along Right (DAR) and Tag Along Right (TAG) In a Shareholder Agreement

The Shareholders’ Agreement is a legally binding document that governs the rights liabilities and obligations between the shareholders and Company. It lays down the mechanism in which the Company will be operated by the shareholders by laying down clauses pertaining to appointment of Directors, Shareholder meeting mechanism, board meeting mechanism, voting rights, reserved matters, transfer of shares, issuance of shares, future funding options, termination of agreement, etc. Drag Along Right and Tag Along Right gives shareholder certain rights pertaining to transfer of shares.

The DRAG along clause is considered as a right placed during the investment negotiations between the majority and minority shareholders. It allows the majority shareholders to compel the minority shareholders to sell their shares. It involves the transfer of equity shares. This clause benefits the majority shareholders in liquidity, flexibility and is an easy route for a majority shareholders. This clause may harm minority shareholders’ since selling off their shares may mean that they lose out on any future profits of the company.

The TAG along clause favours all the minority shareholders in a way that whenever promoters/ majority shareholders transfer their shares to incoming investors, the existing minority shareholders can also tag along with majority shareholders to sell their shares at same price and same terms and conditions to a prospective buyer. They are also called co-sale rights.  This clause protects the interests of minority shareholders. 

These rights are regulated by the Shareholders’ Agreement. The Shareholder’s Agreement is a private contract between the shareholders in comparison to the articles of association. The shareholder’s agreement gives a greater flexibility to the parties and make the provisions for resolution of disputes.

Further, while protecting the interest of the investor or any party to shareholders agreement the section 5(3) of the companies act also provides that the provisions of the articles can be altered by a way of entrenchment in the articles. The entrenchment provision lets the minority investors to exercise some amount of control and effectively put their view on board in respect to the concerned rights of minority investor or minority party to an agreement.

Indian Perspective

The Indian Companies Act do not have any provision pertaining to Drag Along Clause and Tag Along Clause and these clauses are purely contractual in nature and usually made a part of the Shareholders Agreement. 

Section 44 of the Companies Act 2013 describes the nature of shares and is reproduced herein below:

“44. Nature of shares or debentures.—The shares or debentures or other interest of any member in a company shall be movable property transferable in the manner provided by the articles of the company.”

The aforesaid provision of Section 44 of the Companies Act 2013 is similar to the provisions of Section 82 of the erstwhile Companies Act, 1956.

The Hon’ble Supreme Court of India in V.B. Rangaraj Vs. V.B. Gopalakrishnan and Ors. MANU/SC/0076/1992, held that:

“These provisions of the Act make it clear that the Articles of Association are the regulations of the company binding on the company and its shareholders and that the shares are a movable property and their transfer is regulated by the Articles of Association of the company.”

What emerges from the above discussion is that shares are, therefore, transferable like any other movable property. The only restriction on the transfer of the shares of a company is as laid down in its Articles, if any. 

The question that now arises is that whether Shareholders Agreement can put restrictions or give rights to shareholders on transfer of shares if the Article of Association is silent on the same. 

The Apex Court in the matter of Vodafone International Holdings BV v. The Union of India, (2012) 6 SCC 613 talked about drag and tag along clauses in an agreement and held that

“(66) SHA, therefore, regulate the ownership and voting rights of shares in the company including ROFR, TARs, DARs, Preemption Rights, Call Options, Put Options, Subscription Option etc. in relation to any shares issued by the company, restriction of transfer of shares or granting securities interest over shares, provision for minority protection, lock-down or for the interest of the shareholders and the company.”

The Apex Court in the abovementioned case held that inter-alia tag along and drag along rights are contractual which are biding no matter whether they are mentioned in the AoA of the company or not. The only precaution that needs to be taken is to make sure that shareholders’ agreement is not violative of anything in the AoA. 

However, the Hon’ble High Court of Delhi in World Phone India (P.) Ltd. v. WPI Group Inc. USA [2013] 178 Comp Cas 173 (Del), held that where the AOA of a company are silent on the existence of an affirmative vote, it would not be possible to hold that a clause in an agreement between the shareholders would be binding without being incorporated in the AoA.

SEBI vide Notification bearing no. LAD-NRO/GN/2013-14/26/6667 dated 3.10.2013 specified the different set of contracts in which one would not be required to take permission from SEBI in advance which included

“(c) contracts for pre-emption including right of first refusal, or tag-along or drag along rights contained in shareholders agreements or articles of association of companies or other body corporate;” 

In view of the various judgments and SEBI Notification, it is concluded that even though the Indian Companies Act do not provide any provision pertaining to Drag and Tag Clause, these clauses have gained legal validity through Shareholders Agreement and are enforceable rights in India. 

This Article has been Compiled by Ayushi Misra (Senior Associate) and Arun Gupta (Partner). 

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