Joint ventures are a means by which companies and businesses undertake activities and projects jointly. They may be undertaken when a project is beyond the capacity of an individual company. They are particularly important in the cross-border context and may provide opportunities for a company to enter into new markets and industries.
The terms of a joint venture are entirely a matter for agreement. There are a number of different means by which joint ventures are structured. If one or more business are based in different countries, it is usually desirable to form a new vehicle or company in the overseas jurisdiction.
The first choice to be made is whether or not a separate legal entity will be established as a vehicle for the joint venture. An alternative is to use another arrangement such as a partnership or limited liability partnership. A further possibility is a purely contractual cooperation agreement.
Where a company is used, all trading activities, assets and liabilities relating to the venture are placed in a single vehicle or its subsidiary. Where there is no pooling of assets and the arrangement involves a sharing of revenue and costs, a contract may suffice.
Joint ventures have proved a more successful mechanism for entering markets than acquisitions and other arrangements in many sectors. International joint ventures have proven to be a successful strategy in many cases. They may give the participant continued and very real input into the business in the foreign market.
An alternative to a joint venture may be easier and more appropriate in other cases. The acquisition of an existing entity may be a better strategy. A party may appoint an agent or distributor. It may establish its own subsidiary in the market concerned. It may license technology to another entity and may continue to participate in the commercial return by way of an agency fee.
Potential Risks and Disadvantages
Joint ventures may involve significant risks. Many fail. Apart from business risk, there are some inherent difficulties including the requirement for shared management. This may lead to a more cautious approach. There may be differences in culture amongst the joint venture parties. They may have different objectives and purposes which are ultimately incompatible. There may be differences and disputes regarding management.
Joint ventures which involve sharing intellectual property may involve risks for the party who discloses its proprietary information to the other. Regardless of how much effort is put into protecting it, it is difficult to prevent know-how and business relations from passing to the other participator.
The negotiation of joint ventures can be complex and can involve significant effort and time. Significant legal fees can be incurred.
Involvement in a joint venture may require the significant ongoing input of time and resources on the part of the participators. Difficult issues arise on termination. One or both parties may wish to have an exit route.
Differences and disputes may be difficult to resolve. In a 50-50 type joint venture, the deadlock resolution procedures may be unworkable artificial. They may slow down business decision-making.
International Joint Ventures
The negotiation of a joint venture can be complex. This is doubly so where the other participant is in another jurisdiction. There is a range of corporate, tax, regulatory, employment, intellectual property, pensions and other matters to be considered, negotiated and agreed upon. There is the matter of structuring the balance of powers and rights between two parties who may have an interest which conflicts to some extent.
The taxation regime and how it interacts with the taxation regime of the home state must be considered. The particular regime may not allow or facilitate regulatory approval for a non-national. There may be issues in repatriating profit. Withholding taxes may apply; exchange controls may apply or be a risk.
Where the joint venture is international, it is necessary to understand the legal position and regulatory regime in each jurisdiction. This may involve considerable challenges and necessitate working with advisors in another jurisdiction. There may be linguistic challenges and issues.
There may be investment incentives in the relevant jurisdiction. They may be subject to conditions and withdrawal.
There may be requirements for local directors and the use of local labourer. Issues of protection of confidential and proprietary information may arise in this context.
A confidentiality agreement should be put in place at an early date if parties are sharing financial, technical and commercial information. It may be necessary to ensure that the foreign jurisdiction provides for the protection of confidential information including a particular a remedy of injunction or equivalent to an injunction in order to restraint breaches.
A letter of intent or memorandum of understanding may be signed. The memorandum may establish the fundamental principles. It may deal with other issues such as confidentiality, public announcements, exclusivity and timeframes. These obligations may be legally binding.
The memorandum of agreement will set out key commercial terms. It will act as a roadmap and marker in the negotiation and conclusion of the agreement. The core terms and conditions will not usually be legally binding. It may set out key matters of principle which are thereafter difficult to change without jeopardising and reopening the commercial agreement made.
The memorandum of agreement may set out key matters as the commercial purpose, contribution of equity, loan finance, structure, e.g. corporate or otherwise, future finance, the composition of the board, matters reserved for board or shareholder approval, non-compete, transfer of technology, exit provisions, confidentiality, deadlock provisions governing law
There may be provisions for exclusivity for the buyer for a period. The courts are willing in principle grant injunctions to restrain a breach of exclusivity agreements during the requisite period. The position may be different in other non-common law jurisdictions.
A joint venture may involve due diligence by one party in relation to the market or in relation to the other party’s inputs to the project practice. However, it may be difficult to pursue warranty claims against the other party even if warranties are given. Warranties may be given in relation to basic matters such as, for example, that a particular joint venture vehicle which is to be used, is not traded and has no existing liability.
Given the practical difficulties in enforcing warranties abroad, it is preferable for the parties to satisfy themselves in relation to the material issues in relation to the proposed joint venture in advance.
If one party is contributing assets, due diligence may be appropriate in relation to them. The joint venture involves taking over an element of business run by one party. Due diligence may be appropriate as to matters relating to that business and entity such as:
- tax compliance;
- review of accounts,
- review of profitability,
- review of income
- intergroup loans and charges.
Legal due diligence is appropriate in respect of property, corporate records, contract agreements, disputes, regulatory issues, employment, pension and related issues.
Warranties and indemnities may be appropriate when assets are being contributed in by one party, and they are critical to the venture. Warranties may be given where the joint venture is in substance an acquisition or part acquisition There may be warranties together with disclosure. There may also be due diligence in relation to the assets similar to that on a share purchase.
Warranties in this context may include warranties as to title to assets, the absence of litigation and disputes, corporate capacity, the conduct of business in compliance with laws, the validity of intellectual property, no infringement claims and that the accounts give a true and fair view of the assets, liabilities, profits, income and expenditures.
Issues may arise as to who gives the warranties. The recipient party may wish to have the parent or the substantial entity within the other venturer’s group, give the warranties and other undertakings so that it is meaningful and back by capacity pay.
If the holding company or parent gives the warranties, this may incentivise a resolution of the issue in the event of dispute arising. Most warranty claims are unlikely to be litigated continued goodwill and necessary for the conduct of the joint venture.
The establishment of the joint venture may require regulatory consent. In the case of larger scale companies, mergers clearance may be required under the Competition Act domestically or exceptionally at EU level in the case of very large enterprises.
In certain sectors, there are detailed industry-specific regulatory requirements. Obtaining regulatory consent will usually be a critical pre-condition. In the areas of financial services, the regulation looks through to the underlying senior management and structures. There are many other areas where licences and regulatory scheme involves a consideration of the competence and character of the underlying parties.
Export control legislation will not usually be an issue in Ireland or the UK. However, it may be an issue in the foreign jurisdiction.
If employees are to be transferred from an existing entity to the new company, then the transfer of undertaking obligations arise. See separately the sections on the transfer of undertaking regulations and the Acquired Rights Directive.
Structure of Joint Venture
A basic but important issue at an early stage is the structure of the joint venture. This may be determined by matters such as regulatory requirements, funding requirements, taxation arrangements, ease of establishment, ease of winding-up, impact on the management structure, the cost of filing, publicity obligations and treatment in the accounts of the participants.
Investment in a joint venture may be a combination of debt and equity on the part of both or either party. There is no reason or principle where one party may not lend more than the other. It is a question of translating the underlying commercial arrangements as to the present and future interests in the venture into the debt and equity provisions.
Where there is an imbalance in nominal contributions, in particular with a view to making a 50-50 input, one party may reduce its input by leasing or licensing assets to the joint venture rather than transfer outright. This may apply in respect of real property and intellectual property rights.
Valuation of Contributions
The division of value and interest must be set. Many joint venture agreements will have a 50-50 arrangement. However, this is not necessarily so. Disputes and controversy may arise in determining the fair and relative value of the inputs given that they may involve existing assets and the present value of future expected earnings.
Where the joint venture is in the nature of a property venture, the value of the assets may be an appropriate benchmark. In the case of a trading company, profitability ratios are usually the better measure of value.
Shares may not usually be issued at a discount. If one party’s inputs are financial whereas the other’s is future skill and management, they may pay different initial amounts for the same shareholding or disproportionate amounts for different shareholdings. Shares must not be issued at a discount. The share price and any premium may be left outstanding may become a liability on a winding-up in the event of a shortfall.
The parties must agree commercially as to the relative value what each brings. One may be measurable in monetary terms whereas another may not be.
The essential legal arrangement is generally the formation of a company and the entry into a comprehensive shareholders agreement. There may be several ancillary documents. The agreement will usually cover the key matters commonly found in shareholders’ agreement including
- capital and equity contributions and interests,
- debt contributions, repayment and interest,
- giving guarantees,
- board structure,
- appointment of representatives,
- matters requiring unanimity or a percentage of shareholders,
- dividend policies,
- reporting to shareholders,
- non-compete restrictions,
- provision of services by the participators,
- secondment of staff
- employment matters,
- put and call options,
- provisions for the transfer of shares (restrictions),
- dispute resolution/deadlock
- governing law
- other template clauses.
The joint venture company may or may not be party to the agreement depending on its terms. Commonly, it is not a party, and the agreement is made between the shareholder/participators only. It may be undesirable that the joint venture company is a party. Some restrictions may be contrary to the Companies Acts which are better secured by agreement at the shareholders’ level.
There may be as a single overall agreement dealing with multiple matters such as the contribution of assets by one party, warranties and indemnities, the corporate organisation on completion, valuation of contribution, pre-conditions, completion together with shareholder agreement provisions which govern the ongoing relationship of the parties.
In the context of the establishment of the joint venture, there may be ancillary contemporaneous agreements such as asset transfer, supply agreements, employment agreements, licensing or transfer of intellectual property lease or sale of land.
Dividends and Returns
The parties may have different requirements in relation to dividends to be taken. It may be possible to abrogate this by providing for different classes of shares with different dividend rights. An alternative may be that each party sets up a holding company to which dividends can be paid usually in a tax-efficient basis without necessarily being distributed any further upwards.
Dividends or distributions may not be declared or paid out of the company for one party and left by another party with the same class of shares, company without changing the relative equity of the parties in the company. Dividends may be left a debt; they are usually taxed on declaration. An alternative may be that one or both parties set up a holding company to which dividends can be paid usually in a tax-efficient basis without necessarily being distributed to any further upwards.
Relationship with Constitution
The company constitutional documents should conform with the shareholders’ agreement. Generally, at a minimum, following matters will need to be incorporated into the company’s constitution/memorandum and article.
The share classes and division into classes reflecting the parties’ respective rights should be provided. There may be separate classes of shares for each holder which may require the participation of each to make decisions.
It is possible to entrench shareholders’ rights in the constitutional documents. This may be appropriate with respect to the basic class rights of each party. If the matters are set by the relevant shareholders’ agreement, then strictly speaking, then it is not necessary to incorporate them into the company constitutional documents.
A consideration may be that the company constitutional documents are public and available in the Companies Registration Office. As against this incorporating the provisions in a shareholders agreement maintains the advantage of privacy.
There may be pre-emption and other provisions on the transfer of shares. Restrictions on the transfer of shares may be included in the constitution so that third-parties will be on notice of the restrictions on transfer.
Joint Venture Documentation
The main documents in a corporate joint venture are the company constitution / Memorandum and Articles of Association of the JV company and the joint venture’s shareholders agreement. In the case of non corporate joint ventures, the agreement between the party will be similar to the shareholders’ agreement with differences which reflect the absence of a separate legal entity.
- The object and scope of the venture;.
- Capitalisation and finance;
- Composition of the board of directors and management arrangements;
- Distribution and sharing of profits and losses;
- Transferability of shares;
- Protection of the minority;
- Provisions for unwinding a deadlock in a 50/50;
- Provisions in relation to terminations;
- Restrictive covenants in relation to other businesses.
There would commonly be agreements in relation to the purchase of existing assets and the transfer of employees. There may often be a management agreement in relation to the operation of the venture.