This article has been written by Prateek Giri Goswami, pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.

Introduction

The Principles of Fairness and Equity have transcended from public laws/rights and can be found in private contracts by private corporations, one of the most important agreements for a Company is a Shareholder Agreement, it defines the rights, obligations, interests, and procedure for every shareholder of a company. The law cannot be absolutely comprehensive, the legislature cannot envisage every possible way to protect the rights of every shareholder or any other aspect of companies/organizations for the purpose of providing equitable Regulations, Therefore, to remedy such lacunae led to the creation of certain rights through contracts to protect the interest of every stakeholder of an organization, one of the most salient right to protect the interest of the minority shareholders in a company is Tag-Along Right. This article will aim to explain what tag-along rights are, their advantages and disadvantages and how to draft them effectively by considering all the factors.

Tag-Along clause 

The literal meaning Tag-Along is ‘tag along (after someone) and tag along (behind someone) to follow along after someone; to go along with someone, in the same context, Tag-Along right can be defined as a right provided to minority shareholders in a company to go along with a majority shareholder in the event the majority shareholder is selling his/her shares to some third party, if a majority shareholder is selling his/her shares via an agreement to some third party, then the minority shareholder also get the option to sell their share to the said third party via the same agreement and its terms and condition. Tag-Along right is also called ‘co-sale rights’, a Tag-Along Clause can be found in a company’s Article of Association or a Shareholder Agreement, it is a written expression of the Tag-Along right explicitly stating the procedure to be adhered to by the majority shareholder in the event he/she wishes to sell his/her share so that the minority shareholders can exercise its right to tag along.

Why would you want Tag-Along rights?

To understand what prompted the notion of Tag-Along right first we have to understand what were the problems faced by the minority shareholders:

1. The majority shareholders are the biggest contributor (financially) in a company therefore they wield the leverage and precedence over the company’s decision, hence, it was easy to influence or intimidate the minority shareholders by threatening the minority shareholders to abandon the company by selling their shares. Having Tag-Along Clause in the shareholder agreement precludes such unwarranted influence by the majority shareholder thereby balancing the equation of power and leverage among the shareholders.
2. The minority shareholders are usually not in a position to accentuate viable potential buyers to sell their shares at a handsome price, whereas majority shareholders can easily target and viable buyers and furthermore they have the wherewithal (legal expenditure, valuation, due diligence, etc) to negotiate and yield an adequately drafted agreement with the buyers. By virtue of the tag-along clause, the minority shareholders need not go through such hardship, since they can just get tagged along with the deal cracked by the majority shareholders for the sale of shares.
3. Many shareholders invest in a company on the basis of the existing majority shareholder because of their prestigious nature, their corporate practice, policies or principles, their propagated representations, and warranties, etc or due to a better understanding and coordination inter se, however, the idea of working with the new majority shareholder might not be welcomed by the minority shareholder, hence, tag along right provide the convenience to exit the organization accordingly. 
4. If the company is in a faltering condition, a Tag-Along clause precludes any abrupt exit by the majority shareholders, as a result, it provides a sense of protection to the minority shareholders which helps in attracting various investors.
5. Minority shareholders do not vigilantly monitor the activities and condition of the company so as to ascertain the right time to sell their stakes, the Tag alone provides them the opportunity to sell at the right time.

How are Tag-Along clauses structured?

Since there is no law in existence which provides contours for a Tag-Along Clause, we can take the idea of drafting Tag-Along clause by understanding the common practice through reading various shareholder agreement: –

1. Let’s assume that all the existing shareholders have exercised their right to the first refusal, which grants the shareholder the right to sell it to some third party.
2. As per the clause structure, the first obligation of the shareholder will be to issue a notice to other shareholders, stating that the intention to sell XYZ amount of shares to a third party (along with the details) along with the details of the agreement between the selling shareholder and the Purchaser such as terms and conditions, price of the shares, etc and Date, time, and whereabouts of the transfer.
3. Upon issuance of such notice, the receiving shareholders are required to respond within a stipulated time on whether they wish to get tagged along in such shale by participating in the transaction or they wish to keep their stake in the company, in the event if no reply is furnished within the stipulated time by the minority shareholder, it will deem to be waived.
4. If the minority shareholder wishes to get tagged along in such a sale, he/she is required to provide information as to how much share he/she wishes to sell in the said transaction along with the majority shareholder. (Remark: The information of these additional tagged along shares will be transpired to the third party (potential buyers) as he/she will be required to purchase these tagged shares also in addition to purchasing the shares of the majority shareholder).
5. In the event, the potential buyer refuses to purchase the additional tagged along share, the shares of majority shareholders and the additional tagged along shares of minority shareholders will be reduced so that the said sale can be effectuated. For example, if the majority shareholder was going to sell 1000 shares to the buyer, later the tagged along shares were 300 making the total no. of shares to be sold 1300, however, if the buyers refuse to purchase these additional 300 shares then the shares of majority shareholder and tagged along shares will be reduced 23% (23% reduction of 1000= 770 + 23% reduction of 300= 230 approx) making total share to 1000 again which was the acceptable range for the buyer.

“If the Potential Acquirer is not willing to purchase all of the Tag-Along Shares together with all of the Co-Sale Shares (and the Nominee Co-Sale Shares, if applicable), the number of Tag Along with Shares and the number of Co-Sale Shares (but not the number of Nominee Co-Sale Shares, if applicable) will be reduced pro-rata inter se so that the intended Transfer may be effected; if the Potential Acquirer is not willing to purchase such reduced number of Tag Along Shares.”

6. Once the transaction is agreed by the minority shareholder will execute the same agreement (identical) with the third-party buyer as the one negotiated and executed by the majority shareholder with the said third party buyer.

Exceptions and concessions for the Majority Shareholder 

The Tag-Along Clause is incorporated to protect the interest of the minority shareholder as explain, moreover, it bestows an obligation on the majority shareholder to adhere to the procedure instead of freely selling his/her share, which can be perceived as a drawback for the majority shareholders and cause consternation before investing in some organization which contains the rule of tag-along right in their article of association or shareholder agreement, in order to proffer certain upside the following can be done:-

Nature of shares covered

The scope of Tag along can be limited by specifically defining what kind of shares/security can be tagged along by the minority shareholder, for example only equity shares can be tagged not preferential shares, debenture, or any other sort of security.

Threshold for shares

It is pertinent to mention that Tag-Along Right is invoked only when the majority shareholder is selling his/her share to the extent that will bring change in control of the company if the Majority shareholder is selling 20-30 % of his/her share that will not bring any material change in control than the majority shareholder is not required to follow the protocol embedded under the Tag-Along Clause.

Increase in the price of shares

Usually, in a startup, the promoters are the majority shareholders, in order to attract various investors having the policy of Tag-Along Rights helps, and since the policy off tag-along right is adopted in the Article of Association or Shareholders, the promoters can sell their shares at an increased price to the investors as they are providing a safety net and sense of security to the minority shareholders.

Other consideration 

1. Majority Shareholder:- Since the Tag-Along Clause applies to the Majority Shareholder only (unless agreed otherwise in the contract), it is necessary to define what percentage of shareholding will constitute a majority shareholder.
2. Right to the first refusal, Drag along rights: Tag along rights is incorporated along with other contractual rights such as Right to the first refusal, Drag Along Rights, Piggyback Rights, etc, it is necessary to draft the Tag-along  Clause in consonance with other contractual rights, the order of these right shall also be kept in mind as they all are read in tandem with each other. For example, Right to tag along can only be exercised once the Right to the first refusal is exercised by the shareholders.

Conclusion

Currently, there is no law present to govern these Contractual Rights, the idea of these clauses can be taken from common corporate practice and perusing different Shareholder Agreement. In India the legal validation of such clauses can be inferred from the provisions of the Indian Contract Act and Section 111A of Companies Act, 1956 states that the shares in the public company must freely be transferable thereby implying that the shares can be transferred to freely transferred from one party to other be it the fellow shareholder (right to first refusal ) or to any third party by various shareholders (Drag Along), also Section 58 of Companies Act, 2013 follows the same line of reasoning but also additionally came with the clause that states:-

“Provided that any contract or arrangement between two or more persons in respect of the transfer of securities shall be enforceable as a contract.” Section 111A of Companies Act, 1956 was implicit about the separate contractual arrangement of parties whereas Section 58 of Companies Act, 2013 has made it very explicit that parties may individually enter into separate contractual arrangements.

References

1. https://taxguru.in/company-law/drag-along-tag-along-provisions-shareholders-agreement-enforceability.html
2. https://www.wallstreetmojo.com/tag-along-rights/
3. https://linkilaw.com/company-law/tag-along-drag-along-rights-explained/
4. https://www.upcounsel.com/tag-along-rights
5. https://www.investopedia.com/terms/t/tagalongrights.asp

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