Tag Along and Drag Along Clauses: Minority Protection and Coordination of Shareholder Exits

This article examines the contractual clauses known as tag along and drag along, widely used in shareholders’ agreements, investment contracts, and corporate reorganizations. These clauses govern scenarios involving the transfer of corporate equity interests, ensuring protection for minority shareholders (tag along) or enabling joint exit coordination (drag along). The analysis considers their legal basis, validity limits, and criteria for enforceability, in light of case law and specialized legal doctrine. Best drafting practices are also discussed to ensure effectiveness and legal certainty in liquidity events.

In business corporations—especially those with dispersed ownership structures or undergoing investment processes—it is crucial to include clauses regulating shareholder exits or the transfer of corporate control. Among such mechanisms, tag along and drag along clauses stand out as contractual instruments aimed at managing liquidity events while balancing the interests of majority and minority shareholders.

The tag along clause grants the minority shareholder the right to sell their stake under the same conditions offered to the controlling shareholder, protecting against unilateral transfers that may alter the company’s control. Conversely, the drag along clause allows the majority shareholder to compel the minority to sell their shares under previously agreed terms, thereby facilitating the full sale of the company.

This article explores the legal aspects of these clauses, their contractual basis, practical application, and limitations, focusing on their growing relevance in the Brazilian corporate environment.

2. Legal Basis and Contractual Nature

Both tag along and drag along clauses are atypical provisions permitted under the Brazilian legal system based on the principles of private and contractual autonomy (Articles 421 and 421-A of the Civil Code). They are obligatory in nature and must be included either:

·         In the articles of association (to be enforceable against third parties); or

·     In a shareholders’ agreement (binding only upon the signatories, by analogy to Article 118 of the Corporations Law for limited liability companies).

These clauses are legitimate provided that they:

·         Do not contravene mandatory legal norms;

·         Respect the essential rights of shareholders, including withdrawal rights and fair valuation of their stake;

·         Are drafted clearly and objectively.

3. Tag Along Clause: Protection of the Minority Shareholder

3.1 Definition

The tag along clause grants the minority shareholder the right to sell their interest under the same conditions offered to the majority shareholder in the event of a transfer of control.

3.2 Purpose

To prevent the minority shareholder from being forced into a business relationship with a new controlling party not of their choosing, thus safeguarding against unilateral changes in control and potential abuses of controlling power.

3.3 Practical Example

If shareholder A (holding 70%) sells their stake to a third party for R$100.000, shareholder B (30%) may exercise their tag along right and require the third party to also purchase their stake under the same proportional conditions.

3.4 Essential Requirements

·         Applicability in cases of control transfer or significant shareholding changes;

·         Parity of sale conditions;

·         Deadline for exercising the right (e.g., 15 days after notice);

·         Mandatory prior notice to the minority shareholder.

4. Drag Along Clause: Coordination of Joint Exit

4.1 Definition

The drag along clause allows the majority shareholder to compel the minority to sell their shares jointly, under pre-agreed terms and conditions, enabling the full sale of the company.

4.2 Purpose

To prevent a minority shareholder from blocking strategic corporate transactions, such as mergers, acquisitions, or third-party investments, when a qualified majority agrees to proceed.

4.3 Practical Example

Shareholder A (70%) wishes to sell their stake to an investor who requires 100% ownership. Under a drag along clause, A may compel shareholder B (30%) to sell their shares under the same terms, thereby ensuring the transaction's feasibility.

4.4 Essential Requirements

·         Predefined quorum for invoking the clause (e.g., 66% or 75%);

·         Fair market value, based on an independent appraisal if necessary;

·         Safeguards against abuse by the majority;

·         Penalty clause for unjustified refusal.

5. Case Law and Legal Treatment

"The tag along clause is obligatory in nature and aims to protect the minority shareholder against unconsented transfers of control, provided it is included in the articles of association."(São Paulo Court of Appeals, Civil Appeal No. 1037819-35.2021.8.26.0100, judgment of 06/12/2023)

"The exercise of the drag along clause cannot result in unjust enrichment and must ensure a fair and reasonable market value." (Minas Gerais Court of Appeals, Civil Appeal No. 1.0000.21.103498-1/001, judgment of 09/28/2022)

"The drag along clause is valid provided it is expressly included in the articles of association and complies with the principles of good faith and the social function of the contract."(STJ, REsp 1.806.112/SP, Reporting Justice Paulo de Tarso Sanseverino, judgment of 08/09/2021)

6. Best Practices for Drafting the Clauses

·         Explicitly include them in the articles of association to ensure enforceability against third parties;

·         Clearly define price terms and payment methods;

·         Establish a fair and impartial valuation mechanism in case of disputes;

·         Set deadlines for the exercise of the rights or the triggering of the drag along;

·         Provide penalties for non-compliance or omission;

·         Ensure compatibility with lock-up provisions, non-compete clauses, and buyback arrangements.

7. Final Considerations

Tag along and drag along clauses are essential legal tools in modern companies, particularly those with shared capital structures, institutional investors, or succession planning strategies.

When clearly drafted, balanced, and pre-agreed upon among shareholders, these clauses enhance legal certainty, predictability in shareholder exits, and protection for minority investors. Conversely, their absence or improper formulation can result in complex litigation, hinder strategic operations, or allow abuse of control.

Preventive legal planning, supported by technical and legal expertise during clause drafting and registration, is critical to safeguarding shareholder rights and avoiding costly corporate disputes.