As Northern Ireland comes out of recession we expect that those company exits which have been placed on hold will now begin to come to market. One of the main issues for any group of shareholders looking to sell their business is how to deliver 100% of the company's shares to a buyer where there are a large number of minority interests.
This issue can arise as the result of a "lost" founder i.e. where a founding shareholder has moved on to other things and has taken his shareholding with him, or where a number of minority shareholders have been diluted down to very small holdings and have essentially lost touch with the company's management. Either way it can be difficult to encourage these shareholders to engage in a sale process.
Private equity investors typically plan for this eventuality in advance by including what are known as "drag-along" rights in the company's articles of association and/or its shareholders' agreement. This type of clause usually states that where a third party buyer makes an offer to purchase the company and a majority of shareholders wish to sell (perhaps 75%) then they can force (or "drag") the other shareholders to sell their shares to the buyer for the same price.
Drags can be seen as aggressive, particularly where the minority shareholders do not want to sell. In this case legal advice should be taken before attempting to enforce the drag as disgruntled hold outs will try to resist and drag-along drafting is often technical and must be complied with to the letter. Successful use of drag-along provisions will also depend on the specific facts of the case and will not always be suitable.
Inserting a drag
Where the articles of a company do not already contain drag provisions then it is theoretically possible for a majority of shareholders to insert them without the consent of the minority. Where this is being done in the face of aggressive hold outs then there is always a risk that the process will be open to challenge under the Companies Act 2006 which provides protection against the unfair prejudice of minorities. Where the purpose of the insertion is simply to mop up small minorities who have not engaged in the sale process then this may be less controversial and they may be happy to receive a windfall cheque in the post.
Furthermore, a Court would be unlikely to find that in a genuine sale process where a fair market price was received by all shareholders, that a minority had been prejudiced. Either way specific legal advice should be taken as soon as possible before attempting to do this.
Power of attorney vs agent
Generally, in order for shares to be legally transferred the owner must sign at least a stock transfer form. Where a drag-along is being used this will likely be because the shareholder has refused (or has not responded to requests) to sign anything. It is therefore important that someone is empowered to sign on behalf of the shareholder. Prior to the Companies Act 2006 coming into force in 2008 this was often accomplished by inserting a power of attorney into the articles of association.
Following the change of law however, it is arguable that this no longer works. There are two ways around this which are commonly used. The first is to provide in the articles that a person be appointed as an agent for the shareholder, which means they can sign a stock transfer form on their behalf (but not a deed). The second is to replicate the drag provision, including a power of attorney appointment, in a shareholders' agreement which has been signed as a deed. Either way, it is important to establish whether one of these solutions has been employed before attempting to rely on a drag.
In summary, drag provisions can be a useful tool in helping to ensure an exit for shareholders, but attempting to use them in an aggressive scenario should be approached with caution. Drag-along provisions can also contain pitfalls for the unwary, such as the power of attorney point referenced above and so it is important to establish early on whether the drag will actually work once invoked.