DealLawyers.com Blog

October 12, 2022

Drag-Along Rights: “To Exercise or Not to Exercise, That is the Question. . .”

Drag-along rights entitling the lead investor to compel other investors to participate in a sale transaction are a common feature in stockholders’ agreements for private equity deals.  But the decision concerning whether or not a lead investor should exercise those rights can be more complicated than you might think.  This Wilson Sonsini memo provides an overview of some of the things to think about when deciding whether to exercise those rights and whether they apply to a particular transaction.

Here’s an excerpt on some of the fiduciary duty issues that might be implicated if the exercise of drag-along rights requires board approval:

Drag-along provisions typically require a subset of the seller’s stockholders to approve the exercise of the drag-along rights, but many also require the approval of the seller’s board of directors. If the per share consideration in the transaction is not being allocated to shares of common stock and preferred stock equally, or there are other conflicts that could lead to a higher standard of judicial review in a stockholder suit (as detailed in cases such as In re Trados Incorporated Shareholder Litigation), the triggering of the drag-along rights could result in a claim for breach of fiduciary duty against the seller’s board of directors. In one decision (In re Good Tech. Corp. Stockholder Litig.), at least based on the facts before it in a breach of fiduciary duty claim, the Delaware Court of Chancery determined that it would ignore the exercise of the drag-along rights and the protections it affords.

The memo discusses a variety of other considerations, including whether the terms of the deal align with the terms of the drag-along rights and the importance of ensuring that the drag-along rights are exercised properly in order to avoid appraisal rights in the event that there is ambiguity concerning this issue in the terms of the rights.  It also offers practical advice on how to help decide whether or not to exercise the rights.

John Jenkins