The Drag Along Right is a mechanism whose purpose is the protection of the majority shareholders of the Company and it establishes itself as the Tag Along Right counterpart, which we have previously reviewed, and which aims to safeguard the minority shareholders interests.
This agreement can be agreed upon parties whether within a shareholders covenant, a purchase/sell of shares, in the company bylaws, etc. This right grants an option, thus, who gets the benefit, in this case the major shareholder, does not have the obligation to exercise his right, since it only depends of his will. This right is enforceable in the very moment of the purchase/sale of shares.
As we already mentioned, the exercise of this option grants a “drag” right, meaning that, when a third party is interested in the purchase of the entirety of the Company shares, and therefore, the sale of said shares by the shareholders, hence, taking total control of the Company; if the majority shareholders decide to sell their shares and the minority does not, then, attending to this pact and executing their Drag Along right, majority shareholders are able to force the minority shareholders who have agreed upon the drag along right, to sell their shares.
This eases the withdrawal of the majority shareholder(s) from the company, because in this way it guarantees the buying third party that he/she will be able to acquire the entire Company, making it more attractive to the offering party.
The Drag Along right can be more or less complex, nevertheless, there are certain important clauses that ought to be incorporated, among them, the exercise of the right term, the fixed minimum price that the rest of the shareholders are obligated to sell, the option for the rest of the shareholders to make an equal offer, a penalty in the case of non-compliance.
It is common that the sale conditions established for the minority shareholders to be at least equal to those established between the majority shareholders and the third party interested in the purchase.
Additionally, it is often included a call option which is established in the case of the refusal of a minority shareholder to comply with the agreement. Thus, in the scenario of the performance of the Drag Along Right option, the majority shareholder is the recipient of the right to buy the shares of the shareholder(s) who is/are not willing to sell, this may also be perceived as a forced sale of shares.