The High Court has recently set out some useful pointers as to how drag along rights should be interpreted in the case of Cunningham v Resourceful Land. These rights allow a majority of shareholders to force the other shareholders to sell their shares in certain circumstances.
In the case, a drag right was triggered by some shareholders of a company and used to transfer the shares of a Mr Cunningham. Mr Cunningham was unhappy with this, and challenged what had been done.
The background to the transaction was that the shareholders were engaged in a project to develop an anaerobic digestion plant using two companies – a property holding company for the site and an operating company. Further finance was required in order to build the plant, and the project ended up in significant distress. A funder was prepared to provide additional funding, but required that control of the property company be transferred to it on the basis of a share for share exchange which would result in substantial dilution for the existing shareholders. A sufficiently large majority of shareholders agreed to transfer their shares to a funder company, and they then triggered the drag rights.
Mr Cunningham challenged the transaction on several basis, including that the transfer to the funder was not a good faith transfer to an arm’s length buyer.
The court confirmed that the normal contractual interpretation rules apply to drag along rights. In particular it confirmed that when interpreting a written contract a court must identify the intention of the parties by reference to “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean“, focussing on the meaning of relevant words in their documentary, factual and commercial context.
Although the funder exerted commercial pressure in order to take control of the land holding company, this was a pragmatic approach to an undesirable situation not of its own making. It had not colluded with the dragging shareholders to force through the transfer, and there was no side deal or special inducement for the dragging shareholders to enter into the deal. The buyer was a subsidiary of the funder, and unconnected with the property company or its shareholders prior to completion. The dragging shareholders took the best offer available in difficult circumstances. On that basis, the court determined that the transfer was a good faith transfer to a bona fide arm’s length buyer, and the drag clause was properly exercised.
The case confirms the effectiveness of drag clauses, which are very important to ensure that dissentient minorities don’t frustrate exits. It also usefully confirms that the normal contractual interpretation rules apply to those clauses, and that with appropriate drafting they can be exercised where the consideration is shares in the buyer.
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