Include piggyback, drag-along clauses in shareholders’ agreements

Katz, principal of Anton M. Katz Barrister & Solicitor, says the mechanisms kick in after a shareholder secures an offer from a third party willing to buy their shares.

While many shareholders’ agreements provide a right of first refusal to remaining shareholders — meaning those with an existing stake in the corporation have the option to pre-empt the sale by matching the seller’s offer on the table — Katz says the right may not always be exercised.

“The remaining shareholders may be either unwilling or unable to meet the terms and conditions agreed to by the third party, perhaps because they don’t want to pay that amount or they can’t afford it,” he tells AdvocateDaily.com.

Without any other clauses governing the transaction, Katz says the sale to the third party can proceed, leaving both the buyer and the remaining shareholders to face the potentially risky prospect of unknown or unwilling business partners.

However, shareholders in private corporations have options when drafting their shareholders’ agreements, says Katz, who explains that two types of similarly functioning clauses provide the potential for a clean break for everyone when one shareholder wishes to sell up.

• Piggyback: When triggered, this clause allows the remaining shareholders to “piggyback” on the seller’s deal by forcing the third-party buyer to purchase all of their shares on the same terms and conditions: “The remaining shareholders can refuse to exercise their right of first refusal, but may still say yes to triggering a piggyback clause and leverage off that sale to the third party,” he says.
• Drag-along: In this case, the clause is triggered by the selling party with the majority of shares to “drag along” the unwilling remaining minority shareholders, forcing them to join the deal that has been negotiated at the same price. “It’s of comfort to a third party, who may not want just a controlling interest in the corporation, but the entire interest,” Katz says.

“All other things being equal, the piggyback clause tends to favour minority shareholders who are maybe financially less well off. If they can’t afford to pre-empt a sale, they are at least able to be paid for their shares,” he says.

“By contrast, the drag-along clause favours the majority shareholder in a situation where they are looking to take out the minority, who could be an impediment to their own sale of shares,” Katz adds.