While continued economic uncertainty has dampened M&A activity in the past months, the transition from crisis management to recovery mode in the short to medium term will likely see many companies explore potential divestitures in an effort to dispose of underperforming assets, to increase cash on hand and business resiliency and to mitigate risk.
When seeking approval for divestitures, many companies that have a shareholders’ agreement in place rely on drag-along provisions contained therein to quickly approve the transaction. However, in the context of an asset sale, the applicability of a drag-along is not always clear and both sellers and buyers need to consider what approvals are required under corporate legislation. In addition, companies need to be aware of what additional rights a proposed divesture of assets may provide to shareholders.
In this post, we consider the nature and limitations of drag along provisions as well as the impact of the legislative framework governing the sale, lease or exchange of all or substantially all the property of a corporation.
Generally, drag-along rights are included in a shareholders’ agreement and prevent a minority shareholder from blocking the sale of a company that is supported by the majority of shareholders. In practice, drag-along provisions give majority shareholders who wish to sell their shares to an unrelated third party the right to force the remaining shareholders to sell their shares on the same terms. The key limitation of drag-along rights is their general applicability to the sale of shares. In the absence of explicit provisions providing for their application to an asset sale, traditional drag-along provisions will generally be inapplicable.
Further, when entering into a shareholders’ agreement, majority shareholders and corporations are advised to ensure that the agreement specifies exactly what approvals are required and properly addresses statutory rights and approval requirements.
For example, subsection 189(3) of the Canada Business Corporations Act (the “CBCA“) states that “a sale, lease or exchange of all or substantially all the property of a corporation other than in the ordinary course of business of the corporation” requires a special resolution of shareholders, being not less than two-thirds of the votes cast by shareholders who vote in respect of the resolution.
Importantly, the CBCA provides that each share of the corporation carries the right to vote in respect of a sale, lease or exchange referred to in subsection 189(3), regardless of whether it otherwise carries the right to vote. This means that holders of non-voting shares have the right to vote for or against such a transaction. Moreover, where a class or series of shares is affected by the sale in a manner different from the shares of another class or series (e.g. through different distribution or return entitlements, preferential payments, etc.), the holders of such class or series are entitled to vote separately as a class or series in respect of the transaction. In such circumstance, the transaction must be approved by a two-thirds vote of each class of shares. In short, this means that the holders of a junior class of shares that are not entitled to receive the same benefit as the holders of a senior class, could stop a proposed disposition.
Threading the Needle
To address such risks, majority shareholders (including later series investors) should ensure that shareholders’ agreements provide that: (a) drag-along provisions apply to both share and asset sales; and (b) notwithstanding the statutory approval and class voting rights, each shareholder agrees to vote as a class in the same manner as the majority or senior shareholders vote, and provide mechanisms for recourse in the event of a breach of such obligations. Regardless of the approach, it is worth noting that such provisions and remedies must be carefully negotiated by the parties. Such mechanisms should be addressed proactively rather than in the context of an M&A deal, where a minority shareholder is provided with additional leverage. Below we set out a sample drag-along provision which contemplates both share and asset dispositions:
- If at any time one or more shareholders holding no less than a majority of the issued and outstanding Voting Shares (such shareholder(s), the “Dragging Shareholder”), receive a bona fide offer from a third party to purchase: (i) all of the Shares owned by all of the Shareholders; or (ii) all or substantially all of the assets of the Corporation or as an amalgamation, arrangement, reorganization or recapitalization of the Corporation or other transaction requiring the approval of the Shareholders (each a “Drag-Along Sale”), then the Dragging Shareholder shall have the right, after delivering the Drag-Along Notice, to invoke the provisions of this Section and require that each other Shareholder (each, a “Drag-Along Shareholder”) participate in such Drag-Along Sale on substantially the same terms and conditions as the Dragging Shareholder as set forth in the applicable Drag-Along Notice.
- Without limiting the obligations of the Shareholders to take all necessary actions to fulfil the provisions of this Agreement, each Shareholder agrees to: (i) vote in favour of the Drag-Along Sale (and any related actions necessary to complete such sale) and otherwise consent to and raise no objection thereto, (ii) refrain from exercising any dissent rights, rights of appraisal or other similar rights under applicable law at any time with respect to a sale of the Corporation in connection with the exercise of any drag-along rights provided for in this Agreement, and (iii) if applicable, to vote as a class in favour of the Drag Along Sale.
The above provision provides a simple example designed to ensure that the mechanics of a drag-along can be relied upon in an asset disposition. However, negotiating drag-along provisions can be lengthy and complex affairs. Those seeking advice on any aspect of shareholder agreements or asset deals should contact a member of NRFC’s M&A team.
Stay informed on M&A developments and subscribe to our blog today.