Drag Along and Tag Along
The most commonly found mechanisms for exit are so-called drag-along and tag-along rights. In the case of a drag-along right, a party shareholder who wishes to sell its interest to a third-party has the right to require other shareholders to join in the sale to a third-party on the same terms as it sells for that. The objective is to ensure that the entire interest in the company can be sold to the third-party.
A tag-along right is a right for one shareholder to be able to participate in a sale by another shareholder to a third-party. The majority shareholders are obliged to ensure that any purchaser who makes an offer for their shares must make an offer on equivalent terms in respect of their shares. This ensures that the minority shareholder is not left locked in with a new majority partner. The principles can apply to two party and multi-party joint ventures.
Where there is provisions for transfer of shares to a third-party, the incoming third-party will at a minimum be required to adhere to the joint venture agreement. It will be provided that they must first enter a deed of adherence by which they undertake the terms and obligations of the outgoing party with the continuing party.
In practice, there may be a re-negotiation in restructuring of the entire arrangement to reflect the particular circumstances. However, the presence of the obligation provides a backdrop and framework against which the remaining party may require the incoming party to negotiate.
The Russian Roulette mechanism is intended to deal with a deadlock. There are variations of the principles. A difficulty is that one party will maybe in a financial position to force the other party may trigger the clause at an inopportune moment. It may be provided that the obligation arises only on an ultimate default. It may be provided that the clause can be effected at any time.
The essence of the arrangement is that a party serves a notice by which it offers to sell its shares or to have it to buy the other party’s shares at a price set out in the notice. The other party is obliged to choose either to accept the offer to buy its shares or to itself buy the other party’s shares at that price or on those terms. In some versions of the clauses, the initial notice offers to buy and sell shares but with the other party having the choice whether to buy or sell.
Under another variation, the party offered is obliged to either accept the offer to buy the other party’s shares at the stated price or to reject it or when it is obliged to sell its shares at the same price.
The notion behind the clause is that a party is incentivised to propose a price, which is a fair price being dealt at which it is indifferent to buy or sell.
The clauses are preferred only if it can be triggered only in at a deadlock and breakdown situations or the parties have roughly equal shareholdings and are equally able to fund purchase. The clauses may be destabilise the company.
Careful attention needs to be given to the terms of which the option may be arise if as is preferable it may be invoked only on a total breakdown. This should be carefully defined. It may arise, for example, after a number of attempts have been made to resolve an impasse. It might be provided that it applies if the parties, fail to agree certain key matters.
The so-called Texas Shoot-Out makes a provision that allows a party to serve a notice on the other to the effect that it is going to buy the other’s interest at a proposed price. The other party is obliged within a fixed period to serve a counter notice indicating that it is prepared to sell its interest at the price or that it wishes to buy the other party’s price at a higher price than that indicated in his offer to buy in this latter event where both parties wish to purchase out the other as sealed bid system or auction comes into effect and the highest bidder purchases the other.
As with the Russian Roulette option structure, it is preferable that the clauses operate only in extreme circumstances and as a last resort. If it is available on an ongoing basis, it has the potential to be manipulated and to destabilise the company.
Insolvency Completion & Breakdown
The purchase-out or winding-up provision may be triggered on the insolvency of one party. It may be provided that the provisions are triggered when the parent or holding company enters insolvency or by other factors that cause a risk of insolvency to the entire group.
Where the joint venture company has fulfilled its purpose or can no longer fulfill its purpose, there may be a provision for winding up. Compulsory acquisition by one party of the other would not be appropriate in these circumstances.
Many joint ventures are based on the relationship between two parties. Where corporate entities are involved or referred to, the presence of certain other group companies or personnel skills or capacity within the relevant group may be required. It may be provided that if there is a change of control with one or the other parties, this may terminate fundamental reliance and understanding, and the one party may be unwilling to continue with the changed party.
Triggered by Default
The parties may provide that a winding up is to occur even though there is a breach of agreement or breakdown of the relationship. Key events may be deemed to trigger a offer to sell by the party in default. This may include, for example, material default, that parties’ insolvency, change of control and that party termination of the joint venture. The relevant party is in default that the other party may have the option of triggering termination and winding up.
It may not be self-evident as to whether there has been a breach and which party is in default. There may be a dispute as to whether one party repudiation failed another’s default or was itself unjustified justifying the other party in repudiating. It may be necessary that the matter is referred to litigation, arbitration or some other dispute resolution mechanism.
Clauses of this nature usually require that the defaulting party is deemed to appoint the other or an independent party, attorney for the purpose of completing the mechanism. There is usually deemed to be service of an irrevocable transfer notice backed by a revocable power of attorney. It may be provided that the nominee directors are automatically to cease to hold office.
Pre-Emption & Options
In these circumstances, it may be provided that the pre-emption rights arise for the party who has not changed. They may be given the option of acquiring the other party’s interest or the option right to sell its interest to the changed party.
Parties may have mutual put or call options on an ongoing basis or triggered by default, insolvency, etc. A put option is a right on one party to require the other party to purchase its share. The call option is the right to purchase the other party’s shares. The price may be determined by a set formula or a valuation by a third party. The change of control will require careful definition.
Joint venture agreements usually provide for issues that arise upon termination and winding up. Where the joint venture continues, it is likely to be provided that the outgoing participator should not compete with the business, at least for a period after the termination of its interest in the joint venture.
Intellectual property rights may be preserved. Where the joint venture company has owned intellectual property rights, provision must be made as to how they may be used in the future. Where one party is outgoing, it is unlikely to retain any intellectual property rights.
Confidentiality agreement provisions should confirm the obligations of each other to keep joint venture information, financial, and technical details confidential during the course of the joint venture.
Provision must be made for outstanding loans. It may be provided that an incoming party has to assume them or redeem them. There may be provision that the loans are left in the business for a period.
If a party has given guarantees or indemnities to a third party on behalf of the joint venture, the agreement’s termination provisions must provide for substitution or release of the agreements. This will not be within the gift of the parties. It may be provided that if there is to be an indemnity by the other party or incoming parties or both in respect of any such guarantees. It may be provided that they are company as to negotiate their release.
Termination of the joint venture company does not necessarily mean that a winding up is required provided that the company is not insolvent. If the company provided the company is not insolvent, the parties have considerable freedom as to how to deal with its affairs and assets.
If there is a fundamental breach of agreement and the joint venture agreement is terminated, rescinded, or repudiated, the company’s constitution would still apply in respect of basic shareholding rights. There may be a voluntary winding up. This may involve distribution of assets in specie to the parties by their disposal.