Dragged along to a sale

Article

04 September, 2018

In the case of Angus James Cunningham v Resourceful Land Limited and others, the High Court has upheld a drag-along provision in a Shareholders' Agreement and has ordered that the register of members does not require rectification.

Background

A group of individuals incorporated two companies in order to develop and run an anaerobic digestion plant. The first entity REL was incorporated with a view to running the business and the second entity RLL was incorporated for the purpose of holding the land upon which REL would operate from.

Shares were allotted in RLL to five shareholders, three shareholders known as "Syndicate Shareholders" were allotted 100 shares of £0.01 each, Mr Cunningham was allotted 270 shares and another shareholder allotted 30 shares.

A Shareholders' Agreement was entered into in respect of RLL and its shareholders. The agreement provided that "the shareholders have agreed to enter into the agreement for the purpose of regulating arrangements between themselves as shareholders and arrangements between them, as shareholders, and the Company".

Key clauses in the SHA

For the purpose of this case, there are a number of clauses that are of particular importance including:

  • an overriding power provision in clause 3, which stated that the Syndicate Shareholders had the overriding power to commit the Company to do any act or thing or refrain from doing any act or thing which would otherwise be in the power of the Board to resolve that the Company should do or refrain from doing. This meant that the 3 shareholders known as Syndicate Shareholders held 50% of the issued share capital, although this provision provided them with ultimate control;
  • a drag along provision which provided that if the Syndicate Shareholders wish to transfer all their interest in ordinary shares to a bona fide arm's length purchaser (third party purchaser), they have the option to drag along (Drag along Option) requiring all shareholders to sell and transfer their shares upon the same terms to the third party purchaser or as the third party purchaser shall direct. Furthermore, if the shareholders fail to execute transfers upon the Company receiving the purchase monies or any other consideration payable for the shares, the Syndicate Shareholders may execute the transfers on their behalf.

In order to develop the plant, REL obtained finance for a project from Privilege Project Finance Limited (Privilege) via a loan agreement, an all monies debenture over REL's assets and a first legal charge granted over a lease from by RLL to REL. REL sought further finance from Privilege when cash flow got tight. Privilege agreed on the condition that it would receive an equity stake in return.

Privilege incorporated a new subsidiary in order to purchase shares in RLL and in exchange it agreed to issue the shareholders new shares in the subsidiary's own share capital alongside Privilege. This offer was put to all the shareholders of RLL. The Syndicate Shareholders agreed to the sale and a share purchase agreement was entered into. The claimant and one other shareholder did not respond to the offer. However, the Syndicate Shareholders exercising their rights under the Shareholders' Agreement served notice on the non-responding shareholders imposing the drag along clause. The transfer was completed relying on the drag along clause.

Claims

The claimant applied to court requesting that his name be reinserted on RLL's register of members. He advanced the following arguments:

  • the Shareholder Agreement provided for a sale that would result in shareholders receiving cash for shares - as the consideration was shares rather than cash, the drag along clause could not be relied upon;
  • the sale was not made "in good faith" because of the additional funding that was received;
  • the sale was not on an arm's length basis as RLL obtained a shareholding in the incorporated subsidiary.

The Court's decision

The Court found in respect of each of the claimant's arguments as follows:

  • the drag along clause provided that a transfer would take place upon the Company receiving "purchase monies or any other consideration payable for the shares". The use of the words "any other consideration payable for the shares" permitted the Syndicate Shareholders to transfer the shares in return for a shareholding in a different company. The use of such wording is deliberately wide and permits a non-cash transfer;
  • in respect of good faith - the Court did not find that there was a collateral or improper purpose. Further that Privilege treated all the shareholders including those that were dragged in the same way;
  • as to the sale not being on an arm's length basis - the Court found that there was no prior connection between Privilege and the shareholders at the time of the sale. Agreeing to acquire shares in a company before the drag along provisions kicking in did not make them connected parties. The requirement in the Shareholders' Agreement for an arm's length purchase was at the time of the sale not after completion of the purchase.

Therefore, the Court disagreed with the arguments advanced by the claimant finding that there were no grounds for rectification of RLL's register of members.

Implications of the decision

This case is important as it provides insight as to how a court is likely to approach a drag along provision in a Shareholders' Agreement. As such provisions that attempt to result in forcing a shareholder to sell their shares in certain circumstances will be carefully scrutinised by a court alongside the intentions of the parties at the time of signature.

As this case demonstrates having a drag along provision can be very important to a business either in being able to attract additional funding or to enable an investor to exit. Once the decision to include such a provision is taken, it is then necessary to consider what the provisions should contain such as setting thresholds for it to be triggered, whether it applies to sales for cash only or otherwise and how the transfer is to be transacted.

Our Corporate team regularly act for shareholders and companies in relation to drafting and/or amending shareholders' agreements providing for a range of rights including drag-along provisions. If you have any questions or would like assistance, please contact our Corporate team via email or on 0333 207 1130.

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