It should be noted first of all that Tag-along Rights and Drag-along Rights (“Tag-and-Drag-Alone Rights”) balance each other. Accordingly, Tag-Along right works in favour of minority shareholders, and Drag-Along Right works in favour of majority shareholders, a fact we will discuss below. Therefore, both rights are defined next to each other in a shareholders’ agreement so that both sides are protected.
Each of thee rights entails “a request to sell shares along with other shareholder(s)”. The most apparent difference between them is who that “other shareholder” as the seller will act along with him. In the case of tag-along rights, the obligor’s shares are sold while, in a drag-along right, the shares of rightful owner are sold.
“TAG ALONG” RIGHT
Tag-along Right may be defined as a mechanism whereby a shareholder selling its own shares assumes the obligation to sell the shares of the other shareholder subject to same terms and conditions.
Accordingly, this obligation undertaken by the shareholder is the obligation to sell the shares of the other shareholder subject to same terms and conditions. In practice, this right is used as follows: (i) The rightful owner sells shares out of those ones that the shareholder will sell and at a specific ratio, or (ii) the rightful owner sells additional shares independent of the percentage of the shares that the shareholder shall sell.
The most noteworthy function of the tag-along right for shareholders is that it allows to sell the shares at a higher value. Tag-along right is usually vested in minority shareholders. Moreover, thanks to this right, a minority shareholder may dilute his shareholding, even partially, or exit the company at all when a new third party that he does not know well is to purchase the majority shareholding in the company.
This right is exercised as follows in practice:
- A shareholding willing to sell his shareholding to a third party informs the other party about the offer between him and the third party due to his obligation “not to sell his shareholding individually” under the shareholders’ agreement so that the other rightful owner shareholder may exercise his right as well. This way, the other shareholder shall be informed about the parties to a potential agreement and its terms.
- If the other shareholder decides not to exercise his such right (if this right is time-bound and the time has expired), the shareholder willing to sell his shareholding to a third party shall be relieved of his obligation not to sell his shareholding individually. In other words, the transfer right on shares is lifted and these shares may be sold to a third party.
- If the rightful owner shareholder wishes to exercise his right that is still valid and in force with respect to term, etc., this is notified to third party (to whom the tag-along right holder wishes to sell his shares). If the third party accepts this request, a sales agreement shall be signed with two (or more than two, as applicable) subject to same terms and conditions, and shareholders transfer their respective shares to the third party in question.
- Where the third party rejects this request, the first shareholder willing to transfer his shares may not sell those shares to the sad third party, in which case two (or more than two, as applicable) will remain as shareholders.
In order to avoid a deadlock in practice to exercise this right as described above, it is important to detail certain matters in a shareholders’ agreement, including the term of notice, the duration by which an answer should be given, etc. in detail.
There are various mechanisms that can be pursued in practice, such as limiting this right to specific classes, differences or priorities among these classes with respect to terms, or the exercise of such right depending on whether other rights are exercised. For instance, this right may be used if First Right-First Option is not used.
- Makes it easier to sell the company at an attractive price economy-wise
- Share value increases.
- Prevents alienation in the company.
- It serves its purpose in a company where acting in concert and unison is essential.
- It defends the rights and interests of minority shareholders.
“DRAG ALONG” RIGHT
Certain concepts that this right entails, such as “forcing”, “dragging” refer to the obligor’s position upon the exercise of his right. As a matter of fact, a shareholder who is obliged to exercise this right is dragged to sell his shares next to the shareholder entitled to exercise such right.
After this right is granted and when the entitled shareholder wishes to sell his shares to a third party, he may require the obliged shareholder to sell his shares along with him (the first party). Upon receipt of such a request, the obliged shareholder becomes liable to sell his shares to the third party along with the shareholder exercising his right.
It is strictly recommended to agree on this right in a shareholders’ agreement so that lucrative offers conditional upon the purchase of the entire shareholding in the company will not be missed. As a matter of fact, it is common that the investment is not consummated because potential investors in quest of the entire shareholding in the company fail to reach agreement with minority shareholders.
It is possible to govern the terms, duration, etc. of this right in various ways in line with the wishes of shareholders just like the tag-along right. In order to avoid any problems in practice, it is critical to define the scope of the right and other details in a diligent manner.
There may be certain bargains when detailing this right, such as defining a valuation or formula, or subjecting that right to a specific period of time, and an approval by a specific quorum in the company’s general assembly meeting to exercise this right.
- It protects majority shareholders, because they are trapped in the company due to the minority shareholders.
- It makes sure that minority shareholders see the same treatment like the majority shareholders.
- It ensures that a higher sales value is captured for shares.
- It attracts investors.
* The book authored by Dr. Gülşah Yılmaz and titled “Tag-Along Right and Drag-Along Right arising from Shareholders’ Agreement” was consulted.