Drag-Along and Tag-Along Rights

Both clauses deal with the same moment: an outside buyer wants the shares of a private corporation. They protect opposite sides of that deal.

A drag-along right protects the majority and the sale. Most buyers of a private business want every share, because minority co-owners bring governance and liability problems. Without a drag-along, one small holder can block a sale or hold out for a better price by refusing to sell. Once the agreed threshold is met, the drag-along obliges that holder to sell on the same terms as the majority.

A tag-along right, also called a co-sale right, protects the minority. If the controlling shareholders sell to a new owner, minority holders are not left behind with a stranger in control. They can sell alongside the majority, at the same price per share and on the same terms.

Neither right exists in the Business Corporations Act (Ontario) (OBCA). Both are created by contract, almost always a shareholder agreement, usually alongside a right of first refusal and other transfer restrictions. Our article on essential shareholder agreement clauses shows where they sit among the other core terms.

The drag-along matters in Ontario because there is no statutory way to force a private company's minority to sell in a negotiated share sale. The OBCA's compulsory acquisition procedure, which lets a bidder acquire the remaining shares once holders of at least 90% of the shares covered by a take-over bid (other than the bidder's own) accept it within 120 days, applies only to offering corporations (sections 187 and 188). Other squeeze-out routes, such as an amalgamation, require shareholder votes and trigger dissent rights. For a closely held corporation, a contractual drag-along is usually the cleanest path to a 100% sale.

Drag-along threshold. The agreement sets who must approve the sale before the drag can be used. Common formulations are holders of a majority, two-thirds or three-quarters of the voting or common shares, sometimes with board approval as well. In venture-backed companies, investors often require that holders of a majority of the preferred shares also approve, so that founders cannot drag investors into a sale that pays less than their liquidation preference. Some agreements add a minimum price, a cash-only rule, an arm's length buyer requirement or a date before which no drag can be used.

Tag-along trigger. A tag can apply to any sale by a named shareholder, or only to a sale that transfers control. A proportional tag lets each holder sell the same percentage of its shares as the selling shareholder. A full tag lets minority holders sell all their shares when control changes hands. Permitted transfers, such as a transfer to a shareholder's holding company or family trust, are normally excluded.

Notice and timing. Both rights run on written notice. The sellers deliver the buyer's terms; the minority then has a fixed period to elect to tag, or must deliver its shares into the deal; and the clause sets a deadline for closing, after which the process must restart.

A drag-along is enforceable because the minority agreed to it in advance. The protections negotiated at that point decide whether being dragged is fair:

• Same price and consideration. Every holder of a class receives the same price per share and the same mix of cash, shares or deferred payments, or a cash alternative.
• No side deals. Consulting fees, rollover equity or bonuses paid only to the majority should count toward the sale price, or be disclosed and capped.
• Limited representations. Dragged holders give only fundamental representations about title to their shares, capacity and authority, not business representations they cannot verify.
• Capped, several liability. Indemnity exposure is several rather than joint and capped at the proceeds each holder actually receives. Holdbacks and escrows are shared pro rata.
• No restrictive covenants. Passive holders are not asked to sign non-competition or non-solicitation covenants.
• Costs. Transaction expenses are shared pro rata.

The majority's enforcement tools are usually a power of attorney in the agreement and an obligation to deliver signed share transfers into escrow. A drag used to push through a sale that unfairly favours insiders can still be challenged under the OBCA oppression remedy in section 248.

Transfer clauses must be drafted as a sequence, or they contradict each other:

1. Right of first refusal first. When a shareholder wants to sell to an outsider, the other shareholders usually get the first chance to buy.
2. Tag-along second. If the right of first refusal is not exercised and the sale goes ahead, minority holders may tag into it.
3. Drag-along carve-out. An approved drag-along sale of the whole company is usually exempt from the right of first refusal, so the deal is not delayed for the full matching period or picked apart by individual holders.

Other points to align: a shotgun clause is an internal buyout and normally sits outside both rights; a change of control clause in key contracts may require consents before any sale closes; and new shareholders should sign a joinder so the rights reach them. Where the rights sit in a unanimous shareholder agreement, section 108 of the OBCA deems transferees and new subscribers to be parties, subject to limited rights for a purchaser for value without notice. Lamba Law's free shareholder agreement builder lets owners add drag-along, tag-along and right of first refusal terms and produces a discussion term sheet to review with a lawyer.

Arjun Mehta and Sofia Rossi founded a Toronto software company and hold 360,000 common shares each. Three angel investors hold the remaining 280,000 shares, for 1,000,000 in total. Their shareholder agreement lets holders of at least two-thirds of the common shares drag the rest into an arm's length sale for cash, provided every holder receives the same price per share. Dragged holders give only title and capacity representations, and their liability is capped at their proceeds.

A strategic buyer offers $15,000,000 for all the shares, or $15 per share, with 10% held back for 18 months to cover indemnity claims. Grace Kim, an angel holding 80,000 shares, wants to wait for a bigger offer. The founders alone hold 72%, above the threshold, so they deliver a drag notice. When Grace does not sign, her shares are transferred at closing under the power of attorney in the agreement.

Grace receives $1,080,000 on closing, with her $120,000 share of the holdback payable later. She gives only the limited representations and signs no non-compete. Had the founders instead sold only their own 72% to the buyer, a tag-along clause would have let each angel sell on the same terms.