Joint ventures: A primer
A joint venture involves two or more entities pooling their expertise and resources in order to achieve a common business objective. A successful joint venture will allow for the combined strengths of the various parties involved to be leveraged. For instance, one party may be institutional and hold a number of strategic investor relations, while others may have developed new or emerging technologies and have access to additional consumer or customer markets. A joint venture can take many forms and involve two or more individuals, trusts, corporations, partnerships, sole proprietorships, or any combination thereof.
Joint ventures conducted through different forms of legal entities are subject to various federal, provincial, territorial, and potentially even foreign laws, and may be subject to competition law scrutiny. For instance, if a JV Corporation is used (as it often is in Canada), the applicable governing corporate statute in the jurisdiction of incorporation will apply. It is important, therefore, to consult with Canadian legal counsel to ensure that the intentions of the parties entering into the joint venture are enforceable and that all underlying legal requirements have been satisfied.
Choosing the joint venture vehicle
When forming a joint venture, one of the preliminary items that the parties will consider is the vehicle through which the joint venture should be operated. This is primarily a tax-driven decision. In Canada, joint ventures are often carried on through a newly formed corporation in order to limit the liability of the parties involved, and to take advantage of certain tax incentive programs. In some circumstances, however, such as when initial losses are expected in the venture, the parties may desire to structure the venture as a joint venture by contract, or as a partnership, to enable the parties to immediately deduct such losses against their taxable income from other sources. The parties’ tax advisors will be engaged to consider the tax implications of the structuring alternatives for the joint venture.
The parties to the joint venture will enter into definitive agreements to govern their relationship. The titles given to these definitive agreements vary depending on the context, however, these documents are often referred to as Joint Venture Agreements, Unanimous Shareholders’ Agreements, Contribution Agreements, Licence Agreements, or Co-Ownership Agreements (“Definitive Agreements”). These Definitive Agreements, at a very high level, outline the contributions, roles and responsibilities of the various parties partaking in the joint venture. Some of the common considerations that are typically addressed in such agreements are set out in greater detail below.
The Definitive Agreements that the parties enter into will outline how the various resources being pooled will be contributed and what the parties are to receive as consideration, including any ownership interests to which each party will be entitled for its contributions. It is advisable for the parties to determine at the outset how any cash, expertise, or assets needed by the joint venture will be contributed by each party.
For instance, the parties making cash contributions should consider whether they wish to contribute the cash in one lump sum at the outset or if they want to provide the payments in instalments (the timing of the instalments can be set by dates or achievement of milestones). Additionally, if the parties will be contributing assets (including intellectual property), the Definitive Agreements should set out how the rights in such assets are to be provided (i.e. whether they will be transferred to the joint venture, or leased/licensed). If the assets are to be leased/licenced, the parties will have to decide whether the lease or licence will be exclusive or non-exclusive and for what periods of time (i.e. fixed or indefinite).
Additionally, as the joint venture progresses, so too will its financial needs. As such, the parties should consider how and when additional financing requests (commonly referred to as “cash calls”) will be made. It is important for the parties to consider at the outset what they are willing to contribute during the entire life of the joint venture and agree on the consequences if one of the parties fails or declines to make additional contributions when requested. Some of these key considerations include:
- How will the cash be contributed? Will it be structured as an additional capital contribution or a loan?
- Will those that contribute additional funding be entitled to additional ownership interest?
- What are the consequences for a party who fails to contribute to a cash call?
- What are the procedures for initiating a cash call? Will certain events automatically trigger a cash call? Who should be entitled to initiate a cash call?
Similar considerations should also be explored and addressed in the Definitive Agreements in relation to financing received from third-parties, if contemplated.
The various parties to the joint venture will no doubt want to be kept apprised of the progress of the venture and its financial circumstance, especially if they are not involved in day-to-day management. The Definitive Agreements should set out the specific financial reporting requirements of the joint venture. For instance, are annual financial statements sufficient or will quarterly or monthly reporting be necessary? What form should the reports take? Are unaudited internally-prepared reports fine, or will the reports be reviewed or audited by accountants? If not properly addressed at the outset of the joint venture, reporting requirements can be the source of internal conflict between the parties.
Day-to-day management of the venture
Another aspect of the joint venture that will be crystalized in the Definitive Agreements is how the day-to-day operations of the venture are to be managed. Will the parties be involved in the day-to-day decision making of the venture? Who will be entitled to appoint these individuals? Under what circumstances can these individuals be removed and if so, what will be the process of replacing them? Management of a joint venture is usually comprised of individuals who are affiliated with the joint venturers (such as senior officers or employees). However, sometimes the parties prefer to appoint independent managers who are unaffiliated with any of the parties to maintain impartiality. The exact identities, qualifications or requirements for management should be properly documented in the Definitive Agreements.
Typically, parties distinguish between operational decisions that management may decide on, and major decisions that must be referred to the joint venturers for their prior approval. For instance, the parties to the joint venture will typically agree upon an initial plan and budget for the venture and require any material deviations from such plan and budget to first be approved by some percentage of the joint venturers (in some circumstances this could be a simple majority, some super-majority such as 66 2/3%, or unanimous agreement). Other examples of major decisions that would typically be referred to the joint venturers include:
- alteration or amendment of the constating documents of the joint venture;
- issuance of new equity interests;
- transfers of a party’s interests in the joint venture;
- material acquisitions or sales;
- material capital expenditures or borrowing;
- winding up/dissolving the joint venture; and
- key management appointments.
Disagreements between the joint venturers on any number of issues, including those listed above, may result in a deadlock (for instance, if there is a 50:50 split on a vote requiring majority approval, or if the parties are unable to achieve the required super-majority or unanimous approval to move forward with the joint venture). The Definitive Agreements should provide a mechanism for resolving any deadlocks that may arise. Some examples of mechanisms to address a deadlock include:
- Referring the matter to mediation or arbitration; and
- Including a buy-sell provision (also referred to as a “Shotgun” or a “Russian Roulette” provision) that gives each joint venturer the right to force a sale of interests in the joint venture. Under this provision, any joint venturer is entitled to offer to buy the ownership interest of another party and sell their ownership interest to another party at a stipulated price. The other party may then choose to either accept the offer and sell its interest, or reverse it and become the purchaser at the same stipulated price. The aim is to induce the party triggering the process to offer a fair price, as it always runs the risk of reversal.
Ending the joint venture
In addition to the above, how the joint venture is to end or terminate is often informed by the underlying business context. For instance, if the joint venture is with regard to a specific project such as the construction of an apartment building or mining operation, then the joint venture may automatically terminate at the completion of such project. The Definitive Agreements will also normally set out certain events or occurrences that would allow for the early termination of the joint venture, or for the early removal of a party, such as:
- certain financial milestones are not achieved in a timely manner;
- certain funding or other contribution obligations of one or more parties never materializes;
- one or more of the parties breaches the terms of the Definitive Agreements;
- one or more of the parties undergoes a change of control; and/or
- one or more of the parties files for bankruptcy, insolvency, or is dissolved.
While joint ventures are not necessarily the optimal choice in every business context, they offer a number of unique advantages that are not normally available under other business structures, and provide for an interesting alternative to traditional mergers and acquisitions. That being said, the legal implications of a joint venture must be carefully considered to ensure that the arrangement is lawful and enforceable in Canada. As the relationship created through a joint venture is primarily contractual, it is also extremely important that the Definitive Agreements being entered into be fulsome and provide meaningful mechanisms for addressing potential areas of conflict.
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