Buying shares in a simple joint-stock company: what a registered tag-along and drag-along mean for the buyer

Shares in a simple joint-stock company may only be book-entry registered shares (Section 220i(1) of the Commercial Code). An agreement to buy them therefore does not itself pass ownership; an obligation to transfer a book-entry security is discharged only upon registration of the transfer at the central securities depository or with a member (Section 22(1) of Act No. 566/2001 Coll.). Compared with other companies, a j. s. a. has one further peculiarity: its shares may carry a registered right to join in a share transfer (tag-along) or a registered right to require a share transfer (drag-along). On a transfer of shares under an agreement, such rights also take effect against the legal successors of the shareholder with whom the corresponding obligation is associated (Section 220w(4)). A buyer who overlooks them during due diligence takes on, together with the shares, an obligation agreed by the previous holder.

What the register shows and what it does not

The central securities depository publishes the data from the register of rights to join in a share transfer, except personal identification numbers and dates of birth, on its website and, on written request, issues anyone with a current extract or confirmation that no such right is registered in respect of an issuer’s shares (Section 107g(2) and (3)). The register of rights to require a share transfer is a separate record with the same regime (Section 107k(3)), so both extracts should be requested during due diligence.

The register, however, records only the issuer, the entitled and the obliged shareholder, the shares concerned and the duration of the right (Section 107g(1)). The conditions for exercising it, the time limits and the method of determining the price are in the shareholder agreement, which the buyer will not obtain from the depository. Here the Act places the duty on the seller:

Before transferring its shares under an agreement, the obliged shareholder must inform the third party of the existence and conditions of the right to join in the share transfer.

— Section 220x(4) of Act No. 513/1991 Zb. (unofficial English translation)

During due diligence on the company it is therefore appropriate to request the shareholder agreement in full, including amendments, and to compare it with the entry in the register.

Without the entitled shareholder’s declaration the depository will not register the transfer

Where a seller transfers shares subject to a registered tag-along, the central securities depository or the member will execute its instruction to register the transfer only if one of three written declarations is submitted with it (Section 107i(2) of Act No. 566/2001 Coll.): the entitled shareholder’s consent to the transfer, the entitled shareholder’s confirmation that they were enabled to join in the transfer in accordance with the shareholder agreement, or a declaration by the obliged shareholder that they enabled the entitled shareholder to do so. The last option does not require the entitled shareholder’s signature; if, however, the obliged shareholder’s declaration does not correspond to the facts, the entitled shareholder retains the claims described below.

The difference between consent and confirmation also matters for the buyer. If the entitled shareholder merely consents to the transfer, the right to join in it is preserved (Section 107i(3)) and, to the extent provided in Section 220w(4), it will take effect against the buyer as the new holder of the shares. Alongside this, the general rules apply: the transferor and the acquirer give instructions to register the transfer with identical content within the agreed period or, failing agreement, within seven days of conclusion of the agreement; instructions that do not match are returned by the depository (Section 23(1) and (2)).

What the buyer faces where a tag-along has been circumvented

If a registered right to join in a share transfer has been breached, the entitled shareholder may claim that the third party who acquired the obliged shareholder’s shares also acquire theirs on the same terms. Alternatively, they may require that the obliged shareholder buy their shares on the same terms and, if neither claim is pursued, the right is preserved (Section 220x(5)). The claims lapse if the entitled shareholder does not pursue them within one year of the transfer of the obliged shareholder’s shares to the third party (Section 220x(7)). A buyer who relied solely on the seller’s declaration may therefore end up in a dispute in which the entitled shareholder seeks to have the minority block bought as well, on the terms negotiated for a controlling stake. Where the tag-along is unregistered, the statutory claim lies only against the obliged shareholder (Section 220x(6)).

Much the same applies to a drag-along. If the shares being bought are encumbered with an obligation arising from a registered right to require a share transfer, the buyer assumes it and the entitled shareholder may later drag them into a sale to a third party. If, conversely, the buyer is acquiring the entitled shareholder’s shares, the right may be dealt with only together with the shares concerned (Section 220w(5)). A transfer of shares entered in the register of rights to require a share transfer is recorded in that register by the central securities depository (Section 107m(3) of the Securities Act), and a change in the details of the entitled shareholder must be notified by an instruction to amend the registration (Section 107l(8)). The Act does not expressly regulate whether the acquirer steps into the position of the entitled shareholder under the shareholder agreement as well, so this must be dealt with in the transfer agreement.

The articles of association must be checked separately. If they restrict the transferability of the shares, for example by requiring the company’s consent, and the transfer does not respect that restriction, the legal act by which the shares were transferred is invalid (Section 220k(3) of the Commercial Code).

How to reflect this in the share transfer agreement

Several provisions follow from the above that an agreement to buy shares in a j. s. a. should contain:

• a declaration by the seller as to all registered and unregistered rights attaching to the shares, with extracts from both registers as an annex,
• a condition precedent under which the transfer is completed only after delivery of the entitled shareholder’s declaration under Section 107i(2)(a) or (b), or after the right has been deleted,
• a mechanism for the event that the entitled shareholder joins in the transfer, that is, whether and at what price the buyer will also acquire their shares,
• the company’s consent, if required by the articles of association, and a timetable for the instructions to register the transfer,
• the seller’s liability for the accuracy of its declarations, including a contractual penalty or damages.

If the parties agree with the entitled shareholder that the right is to be extinguished, it is extinguished only upon registration of that agreement; the procedure is described in how to amend or delete a registered tag-along and drag-along. Exercising a drag-along against the wishes of a minority is dealt with in what to do when a minority shareholder refuses to sell, and the difference between a transfer, a transmission and an account movement of securities in a separate answer in our advice section.

How we can help

We prepare the agreement, the instructions and the coordination with the depository through our share and securities transfers service. If you are buying an entire company, including due diligence and warranties, the transaction falls under selling and buying a company. Amending, deleting or newly establishing registered rights after a transaction is dealt with under registered rights in a j. s. a.. We recommend requesting extracts from both registers before the term sheet is signed, so that the price also reflects the rights of minority shareholders.