Here we consider key matters which will be relevant not only at the outset of a joint venture, but also throughout the life of the arrangement.
For guidance or further information on particular topics mentioned here, you will find contact details for the Norton Rose Fulbright team in the biographies listed below.
Identifying required regulatory or merger control approvals: Joint venture arrangements take many different forms but even minority investments may require merger control clearances. This may be because the minority shareholder will have veto rights over important aspects of the JV company’s strategy (e.g. over its budget, business plan, major investments or appointment of senior management) or because the regimes in some jurisdictions catch low levels of strategic influence or shareholding (for example, in the UK acquisitions of material influence over a business are covered; a concept which is interpreted broadly). Parties also need to be careful not to miss mandatory filings in jurisdictions that may have little or nothing to do with the operational location of the JV but which catch transactions on the basis of the revenues or assets held by the parent companies (for example, the EU regime captures joint ventures operating entirely outside the EU if the corporate groups of the parent companies achieve sufficient revenues in the EU). Failure to make such filings could expose the parties to sanctions (including significant fines or liability for directors) regardless of whether competition issues are raised by the JV. Where completion of the transaction is contingent on receipt of merger control clearances, it will also be important to ensure that any steps taken to prepare for implementation of the deal do not infringe gun jumping rules which also carry heavy sanctions.
In addition to merger control clearances, another area of increasing relevance is to determine the extent to which foreign direct investment (FDI) or national security restrictions in relevant jurisdictions may trigger a review and affect the permitted identity and nationality of the JV participants.
Our briefing provides detail on FDI restrictions, merger control clearances and competition law implications of joint ventures generally.
Due diligence: Undertaking due diligence in preparation for a joint venture transaction has dimensions which differ from those typically encountered in M&A transactions. Not only is focus required on the venture itself, its rationale and commercial drivers, but care is also required with regard to the JV partners since selecting the right partners is axiomatic in any joint venture deal and assumes increased importance in difficult market conditions.
Relevant questions about prospective partners are likely to include:
- Will they respect agreed governance arrangements and are they compatible partners in terms of the culture of the combining organisations and from a compliance perspective (having regard to anti-bribery, corruption, human rights and sanctions concerns and the legal liabilities which can arise for the joint venture parties)?
- Are they financially robust, particularly where it is anticipated that recourse to shareholders will be necessary and where exit or default arrangements may be affected by the insolvency of a shareholder.
Structuring: A number of factors are likely to drive the selected structure of the joint venture, chief amongst these are often the tax and accounting treatment of the investment for its participants. However, a number of other points will be important to consider in selecting the most appropriate legal form of collaboration such as the legal liability for the joint venture’s owners, the extent of operating autonomy to be enjoyed by the vehicle and the extent to which the parties intend to realise their investment by a sale to a third party or perhaps a listing of the vehicle’s shares. Our presentation describes structuring considerations including a brief discussion of structures available in different jurisdictions.
Parties need to address how the joint venture will be run in practice – will the active involvement of representatives of the shareholders be required or will there be an existing or selected operational management team?
Key areas of focus are discussed below.
Board members or board observers?
Whilst it would be typical for shareholders with a certain level of shareholding to have the right to appoint one or more directors to sit on the board of the JV company, in difficult trading environments, there may be concerns about the personal liability implications of a board seat for relevant individuals. This may in part be addressed by D&O cover for those individuals on the board, but in some cases there may be a preference to hold non-voting positions as board observers (rather than as directors).
It is always important that individuals nominated to act as directors of JV companies on behalf of shareholders understand the responsibilities and duties which the law and the contractual framework of the JVA imposes. More details can be found in our briefing on the duties of directors under English law in the context of joint ventures. Even where such individuals are not formally appointed as directors, advice may also need to be taken as to the risks of such individuals of being held to be de facto or shadow directors.
Authority levels and consent matters
Defining the limits of delegated authority to executive management teams will be important whether shareholders are represented by nominee directors on the board or not. As a related point, further limits on the authority of the JV company’s management are also typically imposed by the use of so called reserved or veto matters. The scope of such matters, and the materiality levels which will apply to them are important areas of focus. They can create tension between shareholders who seek to retain visibility and control and management teams who wish for greater autonomy to make business decisions. Where reserved matters require the approval of the directors of the JV company, there may be inherent conflicts that such a role can present resulting in a preference for key decisions to be taken at shareholder rather than director level. This may be particularly so where the JV company finds itself in financial difficulties given the consequent shift in the emphasis of directors’ legal duties from the interests of shareholders to those of creditors. Further discussion of governance considerations in the context of joint ventures is included in this briefing.
Best business practice
In terms of the standards of business practice and compliance, a well drafted joint venture agreement will set out the business standards required of the joint venture as well as the processes and procedures underpinning such standards. Given the legal liabilities (including criminal liability) that may attach to joint venture participants under anti-bribery and corruption laws and the associated potential reputational risks and civil liabilities that may arise, continued adherence to these standards even in difficult operating environments is key.1
Flexibility of decision making
Governance protections will typically stipulate minimum notice periods for board meetings (and the frequency and permitted location of or manner of holding such meetings) but the parties may need additional flexibility or relaxations of such requirements in fast moving or emergency situations. However, caution may be needed, especially where tax reasons dictate the location and required physical presence of directors at board meetings.2
Failure to achieve consensus
Where there is disagreement on matters identified as requiring unanimity or the approval of certain identified shareholders, a related question is what should happen if a deadlock is reached. Whilst the practical answer may be that matters in question should simply not be effected or implemented without the required level of agreement, some shareholder agreements may also include structural solutions to these situations. Such solutions may include requiring or permitting a shareholder to buy out a dissenting shareholder. The workability of such structural solutions may be put under strain where the shareholders find themselves under financial pressure. In particular, an inequality in the financial strength of the shareholders may raise the risk of a shareholder manipulating such provisions by creating an artificial deadlock situation.
Business and financial information
Detailing the nature and extent of information to be provided to shareholders and board appointees (both to support the decision making processes and to track progress against plans) is important especially where an emergency or contingency plan may be in operation.
Reliance on shareholders
Depending on the underlying rationale for the joint venture, its anticipated level of operating autonomy and the skill sets of the joint venture partners, goods/and or services may be provided to the JV company by one or more shareholders. Where this is the case, a number of issues should be considered. In any economic environment, provisions to enable the validation and scrutiny of base line pricing and price escalation mechanisms are likely to be important. In challenging economic conditions, other issues may come to the fore such as understanding levels of resilience and considering alternative supply sources (with the flexibility to access these) should the relevant shareholder be unable to perform in a timely fashion. In extreme cases, there may also be implications for the relevant shareholder of its failure to perform. For example, should such failure constitute trigger a cross-default under the joint venture or shareholders’ agreement?
Should the parties agree a mutual duty of good faith?
The English courts have long struggled with the question as to whether certain types of legal relationship should import implied duties for the parties to deal with each other in good faith – with some cases highlighting that this can be the case in the context of so-called relational agreements. It would also seem clear that the English Courts will recognise an express exclusion of such a duty so the parties’ attitudes to the inclusion or exclusion of this principle should be explored at the outset of any joint venture. This topic is explored in more detail in this briefing.
Competing with the joint venture
The parties should address whether the shareholders will agree to non-compete and similar goodwill protections (such as non-solicitation of employees and customer base) in favour of the JV company and the other shareholders. The significance of this topic will clearly differ according to the nature of the joint venture and its shareholders (and their activities outside the joint venture) but it can be an area of contention for shareholders with competing or overlapping activities.
An associated issue will be the extent to which shareholders will be required to funnel new business development opportunities through the JV company with the potential for disagreement as to the extent shareholders may be able divert resources especially away from those ventures which are struggling.
Funding the joint venture
Funding the joint venture is always a key issue. In addition to considering how the venture will be funded, the rights and obligations of the shareholders in this context will also need to be documented. For example, whether their shareholdings may be at risk of being diluted in the event that new equity is required. Shareholders may require pre-emption rights entitling (but not requiring) them to invest pro-rata in any further issue of equity so as to avoid such dilution of their interest. However, in the context of a need for emergency funding, it may be appropriate for the documentation to permit an equity issue to be undertaken quickly and without respecting pre-emption provisions subject to other shareholders then having a window of time during which they are entitled to make a “catch up” acquisition. Whilst this may be pragmatic in theory, depending on the number of shareholders and their own internal processes, setting prescribed timescales (for both cornerstone and catch-up investment) may prove to be unrealistic or over ambitious.
Where the joint venture has a majority shareholder, that shareholder may require the right to advance debt funding to the JV company and to fund a failing minority shareholder’s share of such funding (ideally on pre-agreed terms) where this is required to preserve the financial position of the JV company.
Where the sources of funding include external finance providers, care will always be needed to ensure that the arrangements between the shareholders are consistent with the requirements and restrictions of such third-party arrangements. For example, ensuring that restrictions on incurring further debt or creating security are respected as well as compliance with financial and other covenants.
Making returns from the joint venture
Assuming the shares held by the shareholders do not carry preferential dividend rights, it would be usual to specify the joint venture’s policy with regard to the timing and quantum of dividend payments albeit that this may need to be made subject to compliance with any external financing arrangements.
Share transfers and exit provisions
There may be a range of approaches to the question of share transfers and exit generally. This topic and the question of dealing with default situations is explored in more detail in this briefing.
At one end of the spectrum the parties may wish to keep things simple such that share transfers are prohibited without the consent of all shareholders leaving the documentation silent on the question of the timing and likely exit mechanism.
Where there is appetite and need for more detailed provisions, topics to be addressed are likely to include:
- Identifying prohibited transferees such as sanctioned persons or competitors as well as categories of permitted transferees such as group companies or related financial investors.
- Whether existing shareholders have the flexibility to sell their shares at any time or only after an initial “lock-in” period. If such flexibility is intended, what associated rights should come with it – for example pre-emption or tag along rights conferred on the remaining shareholders or drag rights enabling outgoing shareholders to require a small number of remaining shareholders to sell their shares to a third-party buyer at the same time and for the same price.
- The rules of engagement around a trade sale or an IPO should these be the preferred exit method.
Shareholders may be focused on very clear exit mechanisms with defined timings for acceptance or determination of transfer values to ensure a quick and efficient sale process. Some strategic investors may even seek a right to “put” their shares at a heavily discounted price on the other shareholder rather than risk being locked into a failing venture.
In any situation where share transfers or exit arrangements are to be implemented, there will still be a requirement to consider the need for third party regulatory or merger control clearances and other mandatory consent matters as well as ensuring that, where there is external financing in place, lenders’ consent matters are respected.
Most joint venture agreements will identify a number of potential events of default. Structural remedies may be prescribed should any such event occur. These may include the right to buy out the defaulting shareholder or in some circumstances (most commonly in cases where there are two or a small number of shareholders) to require the defaulting party to buy its co-shareholders out.
An insolvency event affecting a shareholder (and sometimes its parent) is typically one such event of default. In the UK context, a liquidator or administrator of the defaulting shareholder may opt not to comply with such obligations if it would be in the interests of creditors generally to breach them. In practice, in the case of an obligation to sell, this is unlikely unless there is a more favourable buyer available, which is itself unlikely if the transfer of the JV company’s shares to a third party is prohibited or restricted by the JV company’s constitutional documents. Liquidators and administrators may also seek to set aside any contractual obligations which would have the effect of depriving the defaulting shareholder of an asset that would otherwise be available in its insolvency. Buy-out rights could have that effect if the offer price is significantly below market value but the English courts may be unlikely to set aside such arrangements if satisfied that they were entered into in good faith for sensible commercial reasons.
Dispute resolution considerations
This can be a complex and difficult area with many conflict of law and procedural points to be considered. As simple examples – what law should govern the contractual terms between the parties and should the courts of that jurisdiction be appropriate to hear the dispute or would some form of arbitration be a more effective dispute resolution mechanism. Parties keen to commence a joint venture may be reluctant to invest time and resources to the issues which arise where the parties are in dispute and the collaborative objective has failed. This briefing highlights some of the risks of such approach and some key points to consider at the inception of the joint venture.
Specialist work streams
Joint ventures often have a number of aspects where additional specialist input is required – examples of such aspects and links to more in depth treatments of them are below:
Tax considerations: As ever with joint ventures, tax issues will feature in their establishment, structure, funding, on-going operation and in the extraction of money from them. It will be important that the shareholders agree on a structure that allows both for assets to be contributed without a tax cost and for the efficient treatment of any capital or income return (which will depend on how any payments out of the JV company are taxed and how receipts are taxed in the hands of the shareholder). At the same time, care should be taken to ensure that that there will be no unnecessary tax leakage, for instance if debt payments to shareholders are not deductible for tax purposes. Equally, if the joint venture is a corporate entity which is loss-making, the shareholders may wish to monetise those losses by having them surrendered and offset against wider group profits. In many cases, this will be for payment, both so that other shareholders are not prejudiced and as a means of funding the venture. Finally, careful thought is required around the on-going operation of the JV company to ensure that there is proper cooperation between all the shareholders in relation to tax matters. Further information on tax considerations can be found here.
IP ownership and development rights: Depending on the nature and intended operations of the joint venture, the question of how ownership or rights to use IP rights are to be conferred on the joint venture will need to be documented. Agreement will also be required on the ground rules for ownership and use of intellectual property generated during the life of the joint venture and on its termination. More detail on this area can be found here.
Data protection issues: The data protection issues and risks in the context of a JV will vary greatly depending on the extent to which personal data will be shared in connection with the formation and operation of a JV and, particularly, whether the sharing and use of personal data is one of the main drivers for the collaboration. Data protection issues are considered in more detail here.
Human capital issues: This area will have more or less complexity depending on whether employees are be transferred to the joint venture on a permanent basis or are to remain in the employment of shareholder groups with secondment arrangements to be put in place with the joint venture. Some of the areas for consideration in relation to employees, their remuneration and incentive arrangements can be found here.
Whilst joint ventures may promise enhanced financial and market bench strength they also require a high degree of collaboration and cooperation against a backdrop of competing commercial requirements and priorities.
Good planning and expert advice are key to the successful balancing of these competing features.