In the acquisition of a private company by merger, a purchaser will often desire to obtain a release, an indemnification obligation, and a consent to an appointment of a post-closing representative from each of the shareholders or other owners of the target entity, including even those who do not vote for or consent to the merger (and who do not dissent or exercise appraisal rights). The current approach – the inclusion of agreements and covenants in, and relying upon, a letter of transmittal from each shareholder requesting delivery of the merger consideration – has been made questionable (if not invalidated) under Delaware law by the recent decision of the Delaware Chancery Court in Cigna Health and Life Insurance Company v. Audax Health Solutions, et al. A purchaser desiring to effect such an acquisition by merger and obtain such rights or benefits will apparently be forced to adopt a somewhat different approach.
A private company that anticipates a purchaser’s demand for those kinds of rights or benefits, however, might make itself more “purchaser-friendly” by including a well-drafted “drag-along” provision in one of its governing documents or in a separate agreement among the shareholders or other owners of the entity.
A “drag-along” provision permits an equity owner or ceratin equity owners to force all or certain other equity owners to sell some or all of their equity interests or to approve a sale of an entity. Such a provision is usually a part of a shareholders’ agreement, an LLC company agreement, or a joint venture agreement, though it may also be the topic of a separate agreement between or among equity owners. The provision may be intended to provide a right to a certain group of equity owners (e.g., a private-equity investor group) to cause a sale, or it may be intended as a mechanism to assure that the equity owners will approve a sale desired by those owners with a large percentage of the ownership interests. Although there may not be a decision that specifically holds that a drag-along provision is enforceable under Delaware law, there have been at least a couple of court decisions suggesting that a drag-along provision is enforceable under Delaware law.
A drag-along provision typically includes, among other things, the agreement of each equity owner who is “dragged along” in the sale to (as necessary) vote or deliver a consent for the sale and to enter into the same, or comparable, agreements and covenants as the “dragging” owner or owners enter into in the sale of agreement and related documents to effect the sale.
To facilitate a possible future sale, a drag-along provision might elaborate on the general agreement and obligation of the dragging owner by specifically obligating the owner to take one or more of the following actions, to the extent the dragging owner also does so:
- agree to indemnification obligations, including the mechanisms that may be put in place to implement those obligations, such as escrow arrangements, contingent proceeds funds, and offsets;
- execute and deliver a release of any claims of the owner against the target company;
- consent to the appointment of a selling owners’ representative with authority to deal with the purchaser after the sale regarding indemnification and other post-closing matters (e.g., purchase price adjustments);
- agree to the establishment of a fund or other mechanism to pay the expenses incurred by the selling owners’ representative;
- agree to the exculpation and indemnification of the selling owners’ representative.
Such an approach may well make it easier for owners who desire, and have the right, to cause the private company to be sold to accede to some of the typical demands of a purchaser.