Joint ventures have been prevalent in the shipping industry for many years. Following dramatic falls in vessel values in 2008, a number of private equity firms sought exposure to this attractively priced asset class by establishing ship-owning joint ventures with shipowners and operators. To a certain extent, this helped to fill the funding gap arising from the traditional ship financing banks exiting, or reducing their exposure to, the shipping sector.
Joint ventures continue to be a popular operating model in the shipping sector. In early 2021, Norton Rose Fulbright conducted a survey on joint ventures, aimed at deepening our understanding of how our clients had experienced the strengths and weaknesses of joint venture arrangements. The Joint Venture Survey received input from many sectors, and its key findings resonated with our experience of the risks and rewards of joint ventures in the shipping context. A link to the full report on the Joint Venture Survey can be found here.
Financial investors remain interested in gaining exposure to the shipping sector which, in certain segments, has proved to be a resilient sector during the global pandemic. However, there are many other reasons why parties might form a shipping joint venture. For example, we have recently worked on a number of joint ventures where major users of shipping services such as steel producers or energy companies have teamed up with specialist shipowners/managers to help meet their operational needs in a more efficient way, and joint ventures between shipping companies and technology developers aimed at creating low-carbon fuel solutions are increasingly common.
We have also advised on shipping joint ventures between shipping industry participants with particular areas of expertise so as to form a wider business. An example of this is the joint venture between Stena and Glovis whereby Glovis transport vehicles from Asia to Europe and Stena then use their European network to transport those vehicles around the European market. An associated venture with a freight forwarder then seeks to fill the vessels returning to Asia.
The Joint Venture Survey found that, of those that had clear plans, 44 percent were looking to form a joint venture in the next 12-24 months, so what are the key issues when entering into a joint venture arrangement in the shipping sector?
Joint venture structures
When establishing a joint venture, one of the first decisions to make concerns the form of the joint venture. It is possible to establish a purely contractual cooperation. However, the majority of shipping joint ventures involve the establishment of a corporate joint venture vehicle. The jurisdiction of establishment of such a vehicle will be driven primarily by tax considerations (including possible tonnage tax) and the familiarity of the parties with a particular jurisdiction. Most shipping JV vehicles tend to be established in off-shore jurisdictions, however, there are a wide-range of these from which to choose.
Many ship holding companies are incorporated in the Marshall Islands. As a result, shipowners are familiar with this jurisdiction. Marshall Islands limited liability corporations are popular vehicles for shipping JVs as they offer a highly flexible legal framework within which to contract. Marshall Islands law is based on New York law and therefore, Marshall Islands joint venture agreements tend to be New York law (rather than English law) style agreements and disputes tend to be subject to the jurisdiction of the New York Courts. This suits the New York-based private equity investors that are active in the shipping market.
For clients who are more familiar with English law-style documentation, the Channel Islands (Jersey and Guernsey), Cayman Islands and British Virgin Islands are popular jurisdictions and clients located further east sometimes opt for Mauritius.
Shipping JVs tend to be established for a very specific purpose. For example, a joint venture might be established to acquire and operate specified fleets of vessels, new builds or sometimes a single vessel. Even where a joint venture is established as a “blind pool” investment, the type and size of target vessels is often narrowly defined together with agreed policies on chartering strategy.
Even with a narrowly-defined purpose, it is critical to ensure that the business objectives and imperatives for the joint venture are clearly articulated at the outset. The choice of the right joint venture partner, and ensuring that there are aligned or complementary business and compliance cultures, will avoid a mismatch which may otherwise threaten the robustness of the collaboration.
The Joint Venture Survey found that the main reasons for expectations not being met in an arrangement were “differences in business strategy” (50 percent), “lack of joint culture, values and behavioural standards” (43 percent) and “conflicts at partner level” (40 percent).
In the shipping market, it is not unusual to see structures where the asset-holding entities, and the investment vehicle itself are located in low-tax jurisdictions, as noted above. However, it is unlikely that all the day-to-day activity that relates to the ongoing employment and management of the vessels is all taking place in those jurisdictions. Accordingly, care needs to be taken in ensuring that the anticipated tax treatment of the asset-holding entities is maintained, despite the activities of personnel in “onshore” jurisdictions. This is particularly the case in light of the OECD’s Base Erosion and Profit Shifting measures, which are increasingly being adopted by jurisdictions in order to ensure that international businesses pay tax in the jurisdictions in which they operate.
A financial investor will often seek to ensure its shipping partner is offering in-scope investment opportunities to the JV first, rather than taking advantage of them itself, and will require contractual protection in this regard. A shipowner/operator will wish to ensure that such protections are narrowly drafted only to cover the vessels which are likely to be acquired by the JV and that there are requirements for the JV to decide promptly when an opportunity arises.
Management, control and deadlock
Unlike joint ventures in other sectors, day-to-day control of shipping JVs does not necessarily follow equity ownership. In many cases, particularly where financial investors are involved, control of the board (or other management body) will be given to the appointees of the party with shipowning expertise regardless of relative stakes. Such control rights are usually subject to a list of reserved matters in respect of which unanimity is required. These decisions might include major financial decisions such as the decision to buy or sell a vessel or to enter into or materially amend key agreements such as long term charters.
The parties will want to consider what should happen if a deadlock arises (in other words a dispute arises between the parties as to the action to be taken in relation to a material matter). Often JV agreements provide that if the dispute cannot be resolved through good faith discussions within a specified period, then the matter must be escalated to more senior individuals within the respective shareholder organizations. If the dispute is not resolved following escalation, the parties might provide for an exit mechanism to apply such as steps to be taken to liquidate the company or a buy-sell mechanism allowing the shareholders to offer to buy each other out or even a “splitting of the steel” (as to which see below). The JV parties may be concerned as to the potential for these provisions to be “gamed” particularly in circumstances where there is an imbalance in the financial resources of the parties. In this case, the parties may prefer not to provide for an contractual exit mechanism and instead rely on commercial negotiations at the time, trusting that it is in neither party’s interest to continue a relationship which has broken down.
The Joint Venture Survey found that “determination of management and control” and “deadlock resolution” were the most common issues that were controversial during negotiations, each being selected by 45 percent of the respondents.
Lock-in and exit
Depending on the purpose of the JV, the parties are likely to want to maintain the status quo for a period of time in order to allow the business to get established and grow. For this reason, it is common for the parties to agree a lock-in or moratorium period (of say, three to five years) during which time neither can transfer their shares without the consent of the other, subject to limited exceptions. Following this period, transfers may be permitted subject to a right of first offer (where the other shareholder has a right to make an offer for the other’s shares before they are marketed) or subject to a right of first refusal (where the other shareholder has a right to make an offer to buy the other’s shares at the price a third party has bid for the shares). Where a sale to a third party does arise, often the JV agreement will provide the non-selling shareholder with the right to tag-along at the same price or for the selling shareholder to “drag” the non-selling shareholder at the same price.
There are a myriad of alternative potential exit arrangements including obligations on the parties to work towards a trade sale or an IPO, a liquidation of the company within an agreed timeframe, buy-sell procedures pursuant to which the parties can make an offer to the other at which they are prepared or buy the other’s stake or sell their own stake. Another alternative unique to shipping JVs is referred to as “splitting the steel”: the fleet of vessels owned by the JV entity is first valued by agreed ship valuers taking account of any associated bank debt or charterparties. The shareholders then each choose which vessel they want to receive until the fleet has been divided up between them. If one shareholder has received vessels with a greater aggregate value than those of the other shareholder, it can then be required to make a balancing cash payment to the other shareholder. Such arrangements can be complex to operate and may require third party involvement, for example, to allocate or novate charter and financing arrangements.
It is perhaps not surprising that “exit structuring” was the third most difficult area in negotiations identified in the Joint Venture Survey, with 40 percent of respondents citing this as the most controversial topic.
Well-planned joint ventures can deliver results
Although it is clear from our experience and the results of the Joint Venture Survey that negotiating a joint venture arrangement can be a more complex process than an outright acquisition, most joint ventures are seen as successful, with little need to renegotiate terms. If parties are suitably prepared, then the Joint Venture Survey indicates that joint ventures deliver on their objectives, with 78 percent of respondents assessing the success of their joint venture being “as expected” or “better than expected.”