Drag-Along and Tag-Along Rights in Private Equity-Backed M&A: Shareholder Agreement Architecture and SEBI Implications

Summary: The article examines drag-along and tag-along rights in private equity-backed M&A transactions and their treatment under Indian corporate and securities law. Tag-along rights permit minority shareholders to participate in a majority shareholder’s sale on the same terms, while drag-along rights enable majority shareholders to require minority shareholders to sell alongside them. The article discusses Section 58 of the Companies Act, 2013, and states that shareholder agreements provide flexibility for establishing such rights. It refers to V.B. Rangaraj vs. V.B. Gopalkrishnan (1992) and Vodafone International Holdings B.V. vs. Union of India (2012) in discussing the enforceability of shareholder agreement provisions. It also discusses SEBI’s 3 October 2013 notification concerning pre-emption and options in shareholder agreements. The article highlights Regulation 31B of the SEBI LODR Regulations, introduced in June 2023, under which special rights granted to shareholders of listed companies are subject to shareholder approval through a special resolution once every five years. It identifies tag-along rights among the specified special rights and discusses the treatment of special rights during the IPO transition. The article concludes by emphasising careful drafting and coordination of exit and investor rights in shareholder agreements.

1. Introduction

In the context of private equity, mergers and acquisitions pose difficult problems with regard to exit strategies and minority shareholder protection. Important contractual procedures that balance the interests of founders, minority investors, and controlling shareholders include drag-along and tag-along rights. These clauses, which are incorporated into shareholder agreements, regulate the circumstances and processes by which shareholders may be forced to sell their shares or allowed to take part in exit transactions. A dynamic confluence of contractual freedom and regulatory protections has been created in the Indian context by the Securities and Exchange Board of India (“SEBI”), which has gradually established the legal framework governing these rights. The structure of these rights in shareholder agreements and their consequences under SEBI’s regulatory framework are examined in this article.

2. Conceptual Framework

Tag-along rights allow minority shareholders to join a sale being undertaken by a majority shareholder on the same conditions, while drag-along rights empower majority shareholders to compel minority shareholders to sell their stakes along with them so that the transaction can be closed more easily or completely. These provisions operate as a construal mechanism to manage shareholder coordination during liquidity events, addressing the fundamental tension between majority control and minority protection.

In practical terms, drag-along rights eliminate the risk of minority shareholders acting as holdouts or negotiating for premium terms independent of the majority shareholder’s transaction. Conversely, tag-along rights ensure that minority shareholders are not excluded from favorable exit opportunities negotiated by majority shareholders, thus providing downside protection against unfavorable dealmaking by controlling shareholders.

A. Economic Rationale in Private Equity Context

Minority investors seek out rights like put options, tag-along and drag-along provisions, or an agreed-upon IPO to permit liquidity within a specified timeframe in order to obtain exit alternatives. These contractual clauses are essential to investor confidence because of the private equity model, which is typified by specified hold periods and required exit strategies. Deal economics and fund performance indicators are directly impacted by the enforcement of exit procedures, and private equity sponsors invest funds with clear expectations about return timescales.

Drag-along provisions allow the majority investor to execute the transaction once the required approval threshold is met, with minority investors participating automatically. This architecture creates transaction certainty, enabling private equity sponsors to negotiate effectively with strategic or financial buyers without facing resistance from dispersed minority shareholders.

3. Legal and Statutory Framework

A. The Companies Act, 2013

The statutory treatment of drag-along and tag-along rights in India reflects a shift toward contractual autonomy over statutory prescription. Section 58 of the Companies Act, 2013, allows parties to establish separate agreements, providing flexibility in determining these rights. This provision represents a departure from earlier regulatory approaches, empowering shareholders to customize exit mechanisms through negotiated agreements rather than relying on statutory defaults.

Critically, the Shareholders’ Agreement has been given preference over the Articles of Association (“AOA”). This hierarchical approach ensures that sophisticated commercial arrangements negotiated by experienced investors receive contractual efficacy, provided they do not conflict with mandatory provisions of corporate law.

B. Supreme Court Jurisprudence

Before the Vodafone International Holding case (2012), the landmark case of V.B. Rangaraj vs. V.B. Gopalkrishna (1992), it was settled by the Supreme Court of India that the “shareholder agreement” restricting the share transfers is unenforceable unless and until it is explicitly incorporated or mentioned into the company’s AOA.

The landmark decision in Vodafone International Holdings BV v. The Union of India (2012) established the binding nature of shareholder agreement provisions regardless of their absence from the AOA. In the Vodafone International Holdings BV case as well, the Supreme Court of India stated that the right to drag along, the right to tag along, and pre-emptive rights are binding on the parties even if they are not mentioned in the AOA of a company.

This judicial pronouncement has profound implications for M&A practice. It validates the enforceability of contractual provisions embedded within shareholders’ agreements, provided such provisions comply with statutory requirements and do not violate the AOA. However, shareholders’ agreements must comply with the AOA and not violate any of its provisions.

C. SEBI’s Regulatory Position

Before 2023, SEBI’s regulatory stance on drag-along and tag-along rights remained relatively permissive for unlisted companies. SEBI has clarified the situation via its notification dated 3rd October 2013, wherein, in Clause (C) of the notification, it stated that companies are not required to take prior permission in contract arrangements for pre-emptive rights (which include the tag-along rights and drag-along rights). ← Minor wording correction

In order to facilitate the wider adoption of these measures in venture capital and private equity contexts, this 2013 announcement created a regulatory safe harbour for private companies looking to include them in shareholder agreements.

4. Regulation 31B of SEBI’s LODR Regulations: The Game-Changing 2023 Amendment

A. Regulatory Architecture

The introduction of SEBI Regulation 31B in June 2023 represents a paradigm shift in the regulatory treatment of special shareholder rights in listed companies. Regulation 31B came into effect in June 2023 and stems from the SEBI’s observation that shareholders’ agreements granting special rights to certain shareholders are drafted in such a way that those special rights would continue to be available to shareholders even as their shareholding is diluted through subsequent capital infusions.

Under the newly introduced Regulation 31B of the LODR, any special right granted to most shareholders of a listed company will be subject to shareholder approval through a special resolution once every five (5) years starting from the date when such special right is granted. This requirement fundamentally alters the treatment of drag-along and tag-along provisions post-IPO.

B. Scope and Implications

The regulatory categorization of these provisions as “special rights” subject to quinquennial approval reflects SEBI’s broader mandate to protect public shareholders from entrenchment mechanisms that disproportionately benefit pre-IPO investors.

Special rights under Regulation 31B include nomination rights; veto and affirmative voting rights; information rights; and protective mechanisms such as anti-dilution, right of first refusal, and tag-along rights. This broad definition has generated considerable debate within the legal and investment communities regarding whether Regulation 31B adequately distinguishes between minority protective mechanisms and majority-favoring entrenchment devices.

C. IPO Transition Rules

The regulatory approach to IPO-bound companies reflects SEBI’s commitment to fairness between pre-IPO shareholders and new public investors. As a default rule, to ensure parity between the pre-IPO shareholders and the public shareholders participating in the IPO, companies are expected to wipe the slate clean and terminate all special rights (including any existing shareholders’ agreements) before listing.

However, SEBI has demonstrated pragmatism by permitting certain special rights to survive the IPO transition. In several cases, companies have been allowed to include a narrow set of special rights for certain shareholders, albeit with the caveat that such rights can be exercised only after obtaining the approval of the shareholders following the IPO. This carve-out recognizes the commercial reality of private equity investments while imposing democratic safeguards through shareholder democracy.

5. Shareholder Agreement Architecture in PE-Backed Transactions

A. Standard Provisions and Best Practices

Tag-along, drag-along, and Right of First Refusal (ROFR) / Right of First Offer (ROFO) on secondary transfers have become standard components of PE shareholder agreements. Modern M&A practice demands precisely calibrated provisions that specify triggering thresholds, procedural safeguards, and pricing mechanisms.

Effective drag-along provisions typically include: (1) specified approval thresholds (e.g., 50% or 66.67% shareholder approval); (2) procedural requirements ensuring transparency and fair valuation; (3) representation and warranty provisions; and (4) explicit carve-outs for particular transaction types.

B. Interaction with Investor Rights

Investors typically negotiate heavily for comprehensive contractual rights such as board representation, information and inspection rights, and affirmative voting or veto rights with respect to specified reserved matters. Drag-along and tag-along provisions must be drafted in coordination with these other protective mechanisms to create a coherent governance framework.

The efficacy of exit rights depends critically upon the quality of drafting. Ambiguous provisions regarding valuation methodologies, tax allocation, or transaction costs can generate costly disputes at precisely the moment when liquidity events should be accelerating transaction execution.

6. Conclusion

In order to facilitate effective exits and allay the fears of minority shareholders, drag-along and tag-along rights are crucial elements of M&A arrangements supported by private equity. Careful architectural design that balances stakeholder interests and includes essential protective mechanisms is essential to their efficacy. A framework for contractual sophistication while upholding fundamental fairness principles has been established in the Indian regulatory context by SEBI’s progressive explanation of these rights’ status under takeover regulations and listing criteria.

In order to ensure that shareholder agreements incorporating these clauses comply with SEBI directions while successfully accomplishing transaction objectives, practitioners must manage the relationship between contractual freedom and regulatory limits. The governance rules around these rights will continue to change as India’s private equity markets develop and institutional involvement grows, reflecting complex demands for investor protection and transaction efficiency. Future advancements might see more emphasis on independent valuation benchmarks and improved standardization of terms, especially if regulatory scrutiny of exit mechanics’ fairness increases.

References

• Bryan Tehrani, “Drag-Along and Tag-Along rights in Shareholder Agreements” Hendershot Cowart P.C., (12^th May’26), https://www.hchlawyers.com/blog/2026/may/drag-along-and-tag-along-rights-in-shareholder-a/
• The Carta Team, “Drag-along vs Tag-along rights: Navigating shareholder provisions” (26^thMarch’26), https://carta.com/sg/en/learn/private-funds/management/drag-along-rights/
• Vodafone International Holdings B.V. vs. Union of India (2012) 6 SCC 613
• V.B. Rangaraj vs. V.B. Gopalkrishnan AIR 1992 SC 453
• SEBI permits contracts for pre-emption and options in shareholders’ agreements (notification dated 3^rdOctober 2013) https://www.sebi.gov.in/media/press-releases/oct-2013/sebi-permits-contracts-for-pre-emption-and-options-in-shareholders-agreements_25486.html
• Regulation 31 B: An attack on protective investors’ rights, The Competition and Commercial Law Review, https://www.tcclr.com/post/regulation-31-b-an-attack-on-protective-investor-rights
• India’s SEBI amends LODR to introduce tighter corporate governance norms, Majmudar & Partners (11^thJuly’23), https://www.majmudarindia.com/indias-sebi-amends-lodr-to-introduce-tighter-corporate-governance-norms/
• A Critical analysis of the amended SEBI LODR Regulations, Manupatra, (27^thMarch’24), https://articles.manupatra.com/article-details/A-CRITICAL-ANALYSIS-OF-THE-AMENDED-SEBI-LODR-REGULATIONS
• Navigating Share Transfer Restriction in Shareholders’ Agreements, Obhan & Associates, (16^thSept’25), https://www.lexology.com/library/detail.aspx?g=ebe5104a-2345-4310-bae2-f488f444dbcb