Drag along and tag along, as rights of members of business entities, although ensued in countries with common law legal systems, are increasingly encountered in continental law defined through shareholder agreements. With the aim of avoiding possible future conflicts that may arise between majority and minority members during the purchase of shares in the company, these rights are becoming more relevant in domestic contractual practice as clauses in the contract concluded by the members of the company. Their name indicates their essence - the right of dragging and the right of tagging. Original English names are indicated in the contracts with the original titles.
Drag along signifies the right of its owner to drag other members of the company with him to the sale of shares. Most often, the owner of that right is the majority member of the company - the member who has the greatest possibilities to negotiate the sale of all shares. In fact, this right authorizes the majority member to force the minority members of the company to sell their shares to a third party. In this way, the majority member drags the remaining members with him into the sale.
Considering that drag along is a matter of contract law, which has no legal ground or limitation in domestic legislation, except for the limitations of the general principles of contract law, the members have the possibility to determine the details by contract, such as:
- What scope of transfer authorizes the majority shareholder to activate the drag along right, i.e. if the drag along right applies only in the case of a sale in its entirety
- Method of activation. It is important to point out that according to the Law on Business Entities in Serbia, company members have a legal pre-emption right, and the drag along clause can be activated only after a minority member refuses to exercise his pre-emption right.
The aim of the drag along is to make the shares more salable to buyers who are interested in acquiring full control of the company. By entering into this clause, the minority members undertake to sell their shares to a third party with whom the holder of the drag along right - the majority member of the company has negotiated the sale.
Tag along - the right to join is like a mirror of the drag along. Tag along authorizes its owner to join the purchase of shares by demanding a buyer to buy his share as well with the same price and under the same conditions as price and conditions have been agreed with the majority member. The purpose of tag along is protection of minority members. Just as a drag along is proclaimed in favor of the majority member - with the obligation of the minority member to sell, so tag along protects the minority member and imposes an obligation on the majority member.
Mandatory elements of this contractual clause are the same as mandatory elements of drag along - determination of the conditions under which tag along will be activated, such as the participation capital threshold necessary for activation etc.
Due to their legal effects, these institutes are often compared to the institute of mandatory redemption of shares, however, although the truth is that there is a similarity in the mechanisms and the ultimate goal - turning a multi-member company into a single-member company, the differences are significant. The most significant difference is the legal basis which prescribes it.
The right of mandatory redemption is prescribed by the Law on Business Entites and as such is a legally regulated category whose application is subject of imperative legal norms, while drag along/tag along is a right that can be proclaimed by contract, and in that sense it is subject of the general principles of contract law. From this most significant characteristic - the existence of freedom of contract arise the all other differences between these two apparently similar institutes.
In the case of mandatory redemption- the price (method of determining compensation) is regulated by law, and in the case of contractual drag along and tag along - the freedom to negotiate the purchase price is limited only by the rules on excessive damage.
In addition to the above, there is also a significant difference in the position of the majority member after the activation of the drag along/tag along option. With mandatory redemption, the majority member becomes the sole member of the company, while with the drag along/tag along option the consequence is that the majority member leaves the company.
Drag along and tag along contract option allows members to communicate any future disagreements regarding any work that needs to be done. However, contacting legal professionals can be essential to identify all the important points, in order to reduce the risk and stop your company from going out of business.
*The information in this document does not represent legal advice and is provided for general informational purposes only.
**Partner, Senior Associate, Associate and/or Junior Associate refers to Independent Attorney at Law in cooperation with IVVK Lawyers.
Contact: Branka Dželalija, Senior Associate at IVVK in cooperation with LexQuire
E-mail: branka.dzelalija@ivvk.rs
16/01/2024
