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Wed 14 Jan 2009 12:00 AM

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Legal Download 2.0 - Structuring joint ventures for success

Simon Bryan and Jamie Ryder of DLA Piper look at some of the issues surrounding succesful management of Joint Ventures

There is no single definition or standard of what constitutes a Joint Venture (JV), which perhaps may be attributed to the fact that JV’s can take many different forms and can be entered into for any number of different purposes.

For example, the following terms could all be used to define or describe a JV:

A contractual agreement joining together two or more parties for the purpose of executing a particular business undertaking

A business association of two or more businesses or persons whereby the teams work together on a single project

Two or more companies that form a new venture

A business jointly controlled by two or more parties

An undertaking of risk with another party

The temporary association of two or more businesses to secure and fulfil a procurement bid award

It will be the specific aim of the parties to a JV which will determine the form and structure of a JV, and it is important that the parties understand the legal as well as the commercial basis of any proposed JV before attempting to document any arrangement or moreover, commence on any project.

One of the most common misconceptions about JVs is that all JVs involve the coming together or merging of equals and that the parties to a JV will or should contribute and participate equally.

In reality, participating parties in a JV often bring completely different attributes and offerings, and this is one of the exciting and attractive features of JV's. In particular, it allows unrelated parties to work together to achieve a common goal, often in a market or in respect of an opportunity that, working alone, neither party would be unable to achieve by itself.

With this in mind, it is crucial to the success of a JV that each party knows, from the outset, what the other party, and itself, is bringing to the table. Further, the parties must be clear on what it expects of the other party and, equally, what is expected of it.

If the parties’ interests and expectations are not aligned then there is a real risk of a breakdown in the parties’ relationship with the resulting failure of the JV. It is therefore essential that the parties establish a common goal and objectives so all parties to a JV are clear (and on the same page) regarding the purpose, objective and desired outcome or output of the proposed JV collaboration.

Choosing a JV Partner

The careful choice of partners is, of course, fundamental to the success of any JV, and the importance of conducting due diligence to identify suitable JV partners and assess their capability and track record should not be underestimated. After all, your JV partners will be sharing in the business of the JV.

Further, parties should use the due diligence process to identify and outline expectations and limitations, both of themselves and their JV partners. Expectations of parties to a JV should be reasonable and above all realistic. If the parties’ expectations or objectives are at all misaligned, this may indicate that the parties are not ideally suited which could lead to problems further down the line.

Finally, the relationship of the parties to a JV is a fundamental key to the success of any JV, and therefore time should be spent getting to know your prospective JV partners to establish the strength of any relationship, and whether that relationship may be maintained in the long term. After all, if the relationship between the parties to a JV breaks down, then there is a high probability that the JV is destined to fail.

Structure and Form of JV

At the outset of a JV’s formation, the parties’ primary objective should be to identify clear and common objectives of both the JV and each of the parties to the JV. After all, if the object and/or purpose of the JV is not clear, the parties to the JV will find it difficult to measure the success of their participation in that JV.

Everything else, including determining the structure and form of a JV will flow naturally from a clearly identified object and purpose.

Given that a JV can take a number of different legal forms including, amongst others: Limited Liability Company; Partnership; Contractual Agreement; Limited Liability Partnership etc, it is critical that the parties take advice upon which is the most appropriate form of vehicle to best meet their objectives. Selection of the right JV structure can be central to the ultimate success of that JV. The old adage “fail to prepare, prepare to fail” could not ring more true.

Some of the factors which the parties will need to consider are set out below. The matters to be considered will, of course, differ depending on the circumstances, but could include the following:

• What is the purpose of the JV?• Where will the JV be based and accordingly, what will be the governing law/jurisdiction?• Are there any regulatory issues regarding the proposed purpose?• What will be the nature of the business?• What are the ownership interests of the parties?• Who will be responsible for running the business?• How will risks and successes be apportioned between the parties (i.e. not necessarily in ownership stakes)?• What form will the JV take?• What are the formalities for establishing the JV in its chosen form?• Any restrictions on foreign ownership (if applicable)?• Are there any specific tax implications?

Whilst there is no hard and fast rule in determining the legal form and structure of a JV (unless for example as may be required by rules of a tender or bid process etc.), the parties’ position in relation to each of the above may be persuasive in determining the JV is better suited to one legal form rather than another.

Funding the JV

Having considered and determined the object and purpose of the JV, the parties should then consider how the JV is to be funded and operated.

It is likely that the biggest area of potential dispute between the parties to a JV is disagreement over the financial terms of a JV. Accordingly, as much as possible regarding the manner in which the JV is to be funded, including each party’s contributions and (hopefully) their subsequent profit share, should be agreed and documented up-front, leaving as little as possible open to interpretation or subject to future agreement (or disagreement as the case may be).

Some of the issues the parties may wish to consider are set out below:• What are the JV’s initial and ongoing working capital requirements?• Will the parties be making cash or in kind contributions (or both)?• If contributions are to be in kind, how will they be valued?• Will proportionate funding mean proportionate shares or will either party hold preference shares?• Will the JV require any external funding?• How will profits and/or losses be calculated?• How often will profits be distributed and in what proportion?• What form will the profits take?- Dividends/interest?- Royalties (IP Licensing Agreement)- Fees (for example in Management Agreements)• Will the JV require any retained earnings?

The parties may also wish to consider at this point the potential for the future participation in the JV by third parties who join at a later date, and the financial implications of such.

Notwithstanding the above, it is fundamental to the success of a JV that each should know when to expect a windfall, but also when it will be required to put its hand in its pocket.

Negotiating and Documenting the JV

“My father said: ‘You must never try to make all the money that’s in a deal. Let the other fellow make some money too, because if you have a reputation for always making all the money, you won’t have many deals’.” - Jean Paul Getty

All JV arrangements should be appropriately documented in writing, and the parties to a JV should co-operate in the drafting and negotiation of master agreements governing both the JV entity (if applicable) and also the parties to the JV. In negotiating JV arrangements, parties should seek to be:

• clear;• specific;• objective; and• reasonable!

The manner in which JV negotiations are conducted can also be a useful indicator of how the parties will work together during the course of the JV relationship. If negotiations are difficult and uncompromising in the initial stages, the parties should consider carefully whether this is merely a feature of the negotiations, or evidence of potential difficulties to follow in being able to agree upon the day-to-day operation of the JV.

Above all else, parties should seek to ensure that the JV documentation leaves nothing to chance. ‘Agreements to agree’ are not only legally unenforceable, they may allude to problems being experienced further down the line i.e. if matters can’t be agreed at this stage, the likelihood is that they will never be agreed, which is a dispute waiting to happen.

Management and Control

The general trend in respect of JV control is that, so to speak, the party with the deepest pockets has the loudest voice. However, this may not always be the case, or the best approach.

Consider, for example, a scenario whereby an IT&T specialist enters into a JV with a financial investor to operate in a specialist (e.g. IT&T) market. In this case, it may make more commercial sense (when contemplating the success of the JV) to have the specialist operator, not the financial investor, controlling the day to day operation and management of the JV.

Ultimately, when considering how control should be apportioned, each party will be understandably keen to protect their own position and investment as much as possible, but a balance must be struck between protecting the JV parties’ interests without strangling the day-to-day operation and management of the JV business. Once again this comes back to ensuring the careful alignment of the interests of the parties in establishing clear objectives for the JV.

In addition, the parties need to establish an appropriate mechanism for the resolution of deadlock issues which may arise in the operation and management of the JV business. Deadlock issues, if possible, should be identified at the documentation stage, and an adequate, mutually satisfactory mechanism for resolution should be provided. Invariably, deadlock issues are difficult to resolve, and in the absence of a resolution mechanism, may lead to the downfall of a JV.

Exit and Termination

As much as it may seem counter intuitive at the commencement of a JV, one of the most important up-front issues is determining when and how a JV comes to an end, and what the separation provisions will be in terms of realisation and distribution of the JV’s assets (and any remaining liabilities).

Whilst some JV’s may be specified to exist for a fixed term, many are not, and the parties should not only consider the time and circumstances when a JV may come to an end, but also each parties’ right (if any) to bring the JV to an early conclusion, for example in circumstances of breach and insolvency. It should be noted that it is not always appropriate for the parties to have equal rights of termination, and this will depend upon the circumstances.

As well as agreeing the circumstances giving rise to exit/termination, the parties should also agree the consequences of such exit/termination. Of particular concern will be how assets are to be distributed including, for example, any joint IP, and any other assets of the JV.

All parties should ensure that they fully understand their ability and manner in which they, and the other parties to a JV, may exit the JV arrangement and the consequences thereof. In the words of Joseph Joubert: "Never cut what you can untie".

Given the varied nature of JVs, there can never be a hard and fast set of rules which govern the formation and management of JVs.

However, we have summarised below a few of the items discussed in the above article which, if followed, should go some way to ensuring the success of your joint ventures:

1. Due Diligence is key:• identify market opportunity;• establish viability of JV arrangement; and• identify most appropriate and suitable JV partner and most appropriate and suitable form of JV structure.

2. Get to know your JV partner(s) and understand your JV partner(s):• capabilities;• strengths and limitations; and• expectations (from them and from you).

3. Negotiate hard but fair:• be reasonable; and• remember it is a collaboration.

4. Clearly identify at the outset:• roles;• responsibilities;• obligations; • deliverables;• termination and expiry; and• consequences of termination.

5. Co-operation and communication are the key to a continued, successful joint venture arrangement.

Written by Simon Bryan, Partner and Jamie Ryder, Legal Consultant, DLA Piper Middle East LLP

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