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).
You can direct your queries or comments to the author at info@factumlegal.com
Disclaimer-
The contents of this article should not be construed as legal opinion.
This article is intended to provide a general guide to the
subject matter. Specialist advice should be sought about your
specific circumstances. We expressly disclaim any financial or other
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