Drag-along Rights Clause
(Operating Agreement) (LLC)

Summary

This is a template for a drag-along rights clause that may be inserted into an operating agreement to enable the majority membership interest holder in a limited liability company to force a sale by minority membership interest holders to bring about a change of control even if some or all don't want to sell their membership interests. This clause contains practical guidance and an alternate clause. Drag-along rights (like tag-along rights) are typically seen in the venture capital and private equity contexts for business entities—generally private companies—in which investors' equity interests are certificated in the form of capital stock. Limited liability companies (LLCs) usually do not issue equity interest certificates. Accordingly, bootstrapping corporate capital stock language into the LLC context, where "membership interests" apply, can be particularly tricky. This issue is further syntactically compounded because—unlike shareholders, who can own more than one share—each member of an LLC has one (and only one) membership interest, albeit the percentage of each member's membership interest can, and usually does, vary with respect to the other members. At the time of the LLC's formation, the founding member (i.e., essentially the "majority" owner) may have enough bargaining power (in relation to prospective minority members who may be quite eager to join the business venture) to establish a drag-along rights provision in the operating agreement. A drag-along rights provision may be instrumental to the majority interest holder at such time that the majority interest holder should decide to "sell out" and bring about a "change of control" of the Company. Accordingly, a drag-along rights provision enables the majority membership interest holder to force a sale by minority membership interest holders in such circumstances—essentially dragging them along in the change of control even if some or all don't want to sell their membership interests. However, this does not put the minority interest holders at a comparative disadvantage as they too will benefit from the same terms of sale as the majority interest holder. Drag-along rights must be coordinated with any right of first refusal (ROFR) and/or right of first offer (ROFO). If members have a ROFR, then upon the planned sale by the ostensible selling member (regardless of whether the ROFR provision applies only to a selling majority member or also to selling minority members) of his, her or its membership interest to a third party(which is always required for a ROFR), the other (i.e., the non-initiating ) members will have the first priority right to purchase the selling member's membership interest. In the case of a ROFO, the selling member intending to sell his, her, or its membership interest (again, regardless of whether the ROFR provision applies only to a selling majority member or also to selling minority members) does not have to first obtain a bona fide offer from a third party. Rather, once the divesting member informs the other members of the planned divestment, it's up to the other members to produce a colorable "first offer" acceptable to the divesting member. For both ROFR and ROFO, if the non-selling members do not purchase the selling member's membership interest under those rubrics, they nevertheless can still participate (as sellers themselves) in the sale of the selling-member's interest in accordance with the drag-along rights provision (or a tag-along rights provision, if any). For a full listing of key content for in-house counsel and corporate secretaries when performing corporate functions, see In-House Corporate Secretary Resource Kit. For additional information and a template operating agreement, see Operating Agreement (Member-Managed, Multiple Classes of Members) (LLC).