Drag-along provisions are not generally a mechanism for
an existing shareholder to procure another shareholder's exit
from the joint venture.
Drag-along provisions are contained in joint venture agreements,
generally speaking, to enable majority participants to require
minority participants to sell their shares to a third party
purchaser. Is that all they can do?
A recent attempt to use them in a more creative fashion has been
thwarted by the New South Wales Supreme Court (William McCausland v
Surfing Hardware International Holdings Pty Ltd  NSWSC
A surfboard joint venture gets choppy
Mr and Mrs McCausland held approximately 30% of the shares in
SHI Holdings Pty Limited which developed and sold customisable
surfboard fins. Mr McCausland was also an employee of the business.
The Shareholders' Agreement said that if:
"the Company or any Shareholder receives an offer from a
bona fide buyer for the Share Capital (Third Party Offeror)"
it may serve an offer notice, on behalf of the Third Party Offeror
on the company or all of the shareholders (as the case may be)
the shareholders passed a resolution with at least 60% of the
total votes accepting the offer notice,
the board of the company was obliged to require each shareholder
to sell its shares to the relevant purchaser.
"Third Party Offeror" was defined by reference to a
"bona fide buyer for the Share Capital" without actually
referring to a third party purchaser
"Share Capital" referred to all of the shares in the
By 2004, various disagreements had played out between Mr
McCausland and other managers of the company and his employment was
terminated. A consortium (which included almost all of the other
shareholders) also made an offer to buy all of the shares in the
company and relied on the drag-along provisions, which resulted in
Mr and Mrs McCausland's shares then being sold.
Court rejects creative use of drag-along provision
The McCauslands argued, amongst other things, that the sale of
their shares breached the terms of the Shareholders' Agreement
– only an offer from a third party for all of the shares in
the company could trigger the drag-along provisions. An offer by an
existing shareholder, by definition, could not satisfy this
The Court agreed– the drag-along clause was intended to be
invoked by an offer from a non-shareholder. In particular:
the offer could not be for all of the share capital of the
company as required by the drag-along clause. "As a matter of
ordinary language an offeror cannot accept its own offer. Another
person must do that"; and
the offer was bona fide in every sense other than the fact that
it was not for 100% of the share capital – essentially, the
consortium was not a "bona fide" buyer for all of the
shares because it already held ordinary shares which it had no
intention (or ability) to purchase under the offer.
What if a shareholder had used a nominee or related company to
acquire the shares? Although the Court did not have to rule on
this, it said that:
"it would be quite open to argue that [that purchaser] was
not a "bona fide buyer for the Share Capital", as the
term "bona fide" draws in broader judgments about the
honesty or genuineness of the offer, not just the financial
capacity of the offeror".
Drag-along provisions and planning an exit
Typically, drag-along provisions are included to facilitate the
sale of all of the shares in a company to a third party
Unless otherwise agreed upon by the parties, they are
not a mechanism for an existing shareholder to procure another
shareholder's exit from the joint venture.
The Court also suggested that even if a nominee or related
company of a shareholder offers to acquire all of the shares, it is
unlikely that that purchaser would be deemed to be "bona
The key lessons from the case are:
you must think about shareholder exit mechanisms at the time of
drafting your agreement, not later;
courts will analyse the intention behind a drag-along provision
as well as its express language; and
failure to properly draft, and appropriately interpret,
drag-along provisions may result in an illegitimate exercise of
purported rights under the drag-along clause.
Clayton Utz communications are intended to provide
commentary and general information. They should not be relied upon
as legal advice. Formal legal advice should be sought in particular
transactions or on matters of interest arising from this
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We discuss whether certain clauses commonly found in ordinary commercial contracts could be considered to be penalties.
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