08/04/2024

Entitlements of ESOP beneficiaries as co-owners of the company

The rights of ESOP beneficiaries can be secured through various contractual clauses, including prohibitions and restrictions on the transfer of options or equity rights, as well as drag along and tag along. What do they consist of?

When deciding to implement an ESOP (in English – Employee Stock Option Plan) in a company, i.e. an option plan that allows employees and associates of the company to become co-owners, entrepreneurs should safeguard their interests and those of the company by introducing appropriate contractual clauses into the regulation of the option plan, such as prohibitions and restrictions on the transfer of options or stock rights, or drag along and tag along powers.

Prohibition on the sale of options

The ESOP regulation may include a clause prohibiting or restricting ESOP beneficiaries from selling or encumbering options or participation rights. The purpose of introducing such provisions into the contract is to protect the interests of the company and its other co-owners in connection with changes in the company’s ownership structure. However, it also brings additional benefits. First, it can influence greater ESOP beneficiary loyalty and keep them in their ranks for a longer period of time. Secondly, it is also an effective protection against speculation – transactions and changes in ownership structure, which in the long run can negatively affect the business being conducted. Third, this type of provision in the ESOP accession agreement ensures that the business goals of ESOP beneficiaries participating in the program are consistent with those of the rest of the company.

Coverage of drag along laws

The program’s adherence agreements may also include “drag along” clauses, or drag along laws. They consist of granting powers to a specific majority shareholder to force minority shareholders to sell their shares in connection with the sale of their shares in the company, under the same conditions and to the same entity. It is worth remembering that the application of the drag along right may be limited to cases where no shareholder exercises the right of priority.

The advantage of introducing a drag along clause into the ESOP’s bylaws or the ESOP participation agreement entered into with its beneficiaries is that it facilitates and expedites potential divestitures of the company – the potential buyer or the majority shareholder does not then have to negotiate terms with the other shareholders. Besides, the lack of negotiations effectively prevents the generation of disputes and conflicts in the ownership structure. Another benefit of drag along is to safeguard the interests of all shareholders. Contrary to appearances, it safeguards the interests of all owners of the company’s shareholding rights. Why? Because they are obliged to sell their shares on terms no worse than the shareholder or majority shareholder.

Tag along

A tag along, or “take along,” clause may also appear as part of the regulations related to the introduction of ESOPs, which is a safeguard for the interests of minority shareholders or shareholders. It is based on granting them the right to sell the shares they hold in the company under the same conditions as the majority shareholder in the event the majority shareholder would make such a sale.

The advantage of the tag along is primarily to protect the interests of ESOP beneficiaries who are minority shareholders or partners by providing them with a level playing field in share sales and control premium distribution transactions. Such a clause also has the benefit of avoiding intra-company conflicts and greater business stability.

Karolina Krawczyk Of Counsel