In today’s fast-paced corporate landscape, shareholders play a pivotal role in the success and governance of private limited companies. They not only provide essential capital and liquidity but also oversee management decisions, forming a diverse community that includes family, friends, and professional acquaintances. While the prospect of business ventures and partnerships holds excitement, the complexity of shareholder relationships necessitates vigilance to prevent potential disputes or deadlocks that could disrupt operations.

At MahWengKwai & Associates, we specialise in guiding our clients through the intricate process of drafting shareholder agreements and company constitutions. Our focus is on creating documents that accurately reflect shareholder rights and establish a robust corporate governance framework. Among the myriad of shareholder provisions, drag-along rights and tag-along rights stand out for their critical, albeit contrasting, roles in safeguarding shareholder interests during significant corporate transactions. This article delves into the nuances of these rights, outlining their functions, benefits, and legal considerations to ensure a harmonious and equitable corporate environment.

Functions of Drag-Along Rights

Drag-along rights empower majority shareholders with the benefit and power to compel minority shareholders to participate in a proposed sale of the company’s shares. These rights, if expressly agreed in a shareholders’ agreement or company constitution, can be exercised by majority shareholders when a purchaser has made an offer to the majority shareholders to acquire the shares of the company, especially if the offer comes with a condition that the proposed sale and purchase transaction include the entire issued share capital of the company. Minority shareholders may be allowed to oppose a proposed sale of shares under certain circumstances. Still, without any clear expression of such circumstances, majority shareholders may be able to exercise the drag-along rights and compel the minority shareholders to participate in the proposed sale of shares. However, the majority shareholders need to ensure all relevant terms and conditions are fair and equal to the minority shareholders.

Drag-along rights strongly benefit majority shareholders in companies. The example below highlights how drag-along rights can facilitate a complete sale of a company, ensuring that majority shareholders can capitalise on lucrative offers by including minority shareholders’ shares in the sale:

  • BBG Sdn Bhd has a total issued share capital of RM100,000 consisting of 100,000 ordinary shares, which are made up of RM1.00 per share.
  • Mr Ong holds 50,000 ordinary shares (50%), while Mr Chen and Mr Ooi hold 25,000 ordinary shares (25%) each.
  • Mr Wong tabled an offer to Mr Ong to acquire BBG Sdn Bhd in whole at a purchase consideration of RM10.00 per share. It is a strict condition that this proposed sale and purchase transaction must include 100% of the shares in BBG Sdn Bhd, failing which the acquisition offer shall not proceed.
  • Under the shareholders’ agreement between Mr Ong, Mr Chen, and Mr Ooi, there is a drag-along right provided to the majority shareholder. Accordingly, Mr Ong can exercise the drag-along right to compel Mr Chen and Mr Ooi to include their respective shares in the proposed sale of BBG Sdn Bhd to Mr Wong.

Functions of Tag-Along Rights

Conversely, tag-along rights safeguard the interests of minority shareholders, who will have the option to participate in a proposed sale of shares with the majority shareholders. If expressly provided under a shareholders’ agreement or company constitution, these rights can help to prevent minority shareholders from being cast aside or excluded from a proposed substantial change in control in the company that could result in an undesired partnership with the new incoming majority shareholder. In this regard, tag-along rights give minority shareholders a sense of fairness and security.

In the example below, the protective mechanism tag-along rights offer to minority shareholders, enabling them to exit the company alongside a majority shareholder under equal conditions, while still allowing others, the choice to retain their stake:

  • BBG Sdn Bhd has a total issued share capital of RM100,000 consisting of 100,000 ordinary shares, which are made up of RM1.00 per share.
  • Mr Ong holds 50,000 ordinary shares (50%), while Mr Chen and Mr Ooi hold 25,000 ordinary shares (25%) each.
  • Mr Wong tabled an offer to Mr Ong to acquire Mr Ong’s shares in BBG Sdn Bhd at a purchase consideration calculated at RM10.00 per share. The offer tabled by Mr Wong to Mr Ong was made known to Mr Chen and Mr Ooi.
  • Upon receiving this information, Mr Chen informed Mr Ooi that he would like to exercise the tag-along right as agreed and provided under their shareholders’ agreement. On the other hand, Mr Ooi does not intend to exercise the tag-along right.
  • Accordingly, Mr Ong informs Mr Wong that the proposed sale and purchase of shares in BBG Sdn Bhd can proceed on the condition that Mr Wong’s offer includes the purchase of Mr Chen’s shares in BBG Sdn Bhd on the same terms and conditions offered to Mr Ong, while Mr Ooi shall remain as a shareholder of BBG Sdn Bhd.

Legal Considerations

Although these drag-along and tag-along rights offer a form of protection to shareholders, it is still common to come across draft shareholders’ agreements and company constitutions that do not contain these rights. Whether shareholders are aware of such rights beforehand, drag-along and tag-along rights contribute to the governance of the transfer of shares in a company and the safeguarding of the interests of majority and minority shareholders.

In determining whether to incorporate either or both of these rights, majority and minority shareholders need to consider the following elements which may be different under both of these rights.

Drag-along Rights

  • Parameters and structure should be clearly defined in a shareholders’ agreement or company constitution.
  • Terms of drag-along rights must not infringe on or violate the rights of the minority shareholders, as the laws of Malaysia provide protection against minority oppression.
  • Minimum percentage of shares required to trigger the drag-along rights to compel the inclusion of minority shareholders.
  • Right for minority shareholders to object to the exercise of drag-along rights under certain circumstances, including where a proposed sale is not in the company’s best interests.

Tag-along Rights

  • Parameters and structure of tag-along rights should be clearly defined in a shareholders’ agreement or company constitution.
  • Minimum percentage of shares required to trigger the tag-along rights to participate with the majority shareholder in a proposed sale of shares.
  • Collective participation of all minority shareholders in the proposed sale of shares in the event of an exercise of tag-along rights by one minority shareholder.

Majority and minority shareholders will undoubtedly look to protect their respective interests; thus, all shareholders should discuss, negotiate, and achieve a proper balance between the rights of majority and minority shareholders. The exercise of certain rights, such as drag-along and tag-along rights, can be structured to be exercised proportionately without violating the rights of the other shareholders.

Conclusion

Drag-along and tag-along rights play an essential role in safeguarding the interests of shareholders and promoting transparency and fairness in corporate governance. These rights are excellent mechanisms that balance the competing interests of majority and minority shareholders and ensure all parties are treated equitably in the sale of shares or transfer of ownership of a company. By understanding the legal framework surrounding drag-along and tag-along rights and incorporating them into a shareholders’ agreement or company constitution, the shareholders can minimise or prevent potential conflicts and uncertainties, and foster a conducive business environment for sustainable growth and investment.

Our Corporate and M&A Team has vast experience advising shareholders and investors on their rights in shareholder agreements and company constitutions. We ensure that all agreements and corporate documents are drafted clearly and meticulously that set out all of our clients’ desired rights. If you would like to establish a balanced and fair corporate governance structure for your company and stakeholders, our lawyers in the Corporate and M&A Team will be happy to assist you with your enquiry.

By Tommy Wong and Aaron Liew

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Note: This article does not constitute legal advice to any specific case. The facts and circumstances of each and every case will differ and therefore will require specific legal advice. Feel free to contact us for complimentary legal consultation.