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Drag along rights: how far can you go?

A drag along clause is a provision, contained in a company’s articles of association, conferring on the majority shareholders the right to accept an offer to buy their shares and to force the minority shareholders to accept such an offer.

In Arbuthnott v Bonnyman [1] the Court of Appeal was concerned with the insertion of drag along provisions into the company’s articles without the consent of the minority shareholder, which then resulted in the sale of the company to a third party. The amendment was made following a management buy-out offer and in the knowledge that one of the shareholders was reluctant to sell, considering the price offered to be a substantial undervaluation. The minority shareholder argued that this constituted unfair prejudice under section 994 of the Companies Act 2006.

The Court of Appeal looked at the terms of the shareholders’ agreement that the parties had previously entered into and the articles of association, as amended, together. It held, on the facts, that amendments to the articles were no more than a tidying-up exercise with no evidence of bad faith or improper motive and that the amendment to allow the sale to proceed was not inconsistent with the original arrangements entered into by the shareholders. For example, the agreement contained a provision that the minority would be bound by the price with which the majority was content. The amendments to the articles also accorded with “commercial common sense”, in particular the need to align ownership of the company with those who worked in the business and to avoid a scenario in which a majority of the shares were held by retired or retiring members.

The Court also held that a term could be implied that, as sophisticated financial professionals, the majority would not accept a price which they did not honestly consider to be fair and reasonable, something which could have significant precedential value in further cases of this type.

WM comment

The case highlights several key issues of interest on the question of amending articles:

  • generally, a company is free to amend its articles. However, shareholders’ powers of alteration are not completely without limit
  • a power to amend will be validly exercised if done so in good faith in the interests of the company.
  • it is for the shareholders to say what is in the interests of the company, but an alteration will not be in the interests of the company if no reasonable person would consider it to be such
  • the fact than an alteration adversely affects one or more minority shareholders does not, of itself, invalidate the alteration if it is otherwise made in good faith in the interests of the company
  • however, an alteration should not amount to oppression of the minority; it should not be unjust; and it should not be outside the scope of the power to amend
  • the burden of proof lies on the party alleging invalidity of an amendment.

[1] Charterhouse Capital Ltd sub nom Geoffrey Arbuthnott v James Gordon Bonnyman & 18 others [2015] EWCA Civ 536