We looked at the issue of enforcing drag rights last year when the High Court upheld drag provisions which had been inserted into articles without the consent of the minority shareholder who was being dragged. This was the high profile decision in Arbuthnott v Bonnyman, involving the partners in Charterhouse, the well-known private equity firm, one of the most notable cases of 2014.
That decision was upheld by the Court of Appeal in May 2015 on the same grounds as before. Here are the main takeaways from the Court of Appeal’s judgment.
The change to the articles to insert a drag was made by the shareholders for the benefit of the company (to achieve an MBO which would better align the ownership of the company with those who work in it). The Court of Appeal said that, as a principle, the Court should not look behind the subjective views of the shareholders who made the change. If those shareholders in good faith thought the change to the articles to insert or amend a drag would benefit the company, the person challenging the amendment would need to satisfy the Court that no reasonable person would have thought that.
Comment: This is a high burden to place on a minority shareholder; we would expect a reasonable corporate benefit argument to be made out fairly easily in most cases.
Equality of price
The dragged shareholder was required to sell his shares on terms which were “no less favourable to him than those being offered to any other shareholder”. This type of wording is common in drag provisions. The Court of Appeal thought that on the facts of this case (sophisticated financial professionals who had sufficient trust in each other to go into business together) there was an implied term that the majority exercising the drag would not agree to an exit except on terms which they honestly considered to be fair and reasonable.
Comment: In an arms’ length transaction, again, we would expect the majority shareholders to be able to meet this test fairly easily in most cases.
Amending an existing drag
The existing articles and shareholders’ agreement already included drag rights and the amendment to the articles was essentially a “tidying up exercise” – making the articles clearer and more consistent and facilitating the transfer and registration of shares compulsorily acquired under the drag. The Court of Appeal found that these changes were for the benefit of the Company, even if they also benefited the majority shareholders.
Comment: This decision will help where an existing drag needs to be amended to fit a new situation, including inserting a mechanism to allow for the drag to be enforced, where necessary.