International joint ventures involve myriad legal questions coupled with cultural and relationship complexities. And success is not always easy to come by. What are the major considerations to keep in mind when planning and establishing a JV?
While a well-drafted legal agreement provides vital protection for parties against numerous issues, it cannot prevent irresolvable arguments and a breakdown in the relationship. A successful JV is more than a mere well-drafted legal agreement. It is a relationship of trust between the parties that can last on a handshake. Choosing the correct partner, with whom there is a high level of trust coupled with strategic business synergy, is fundamental. In many cases, this will involve undertaking appropriate due diligence on the proposed partner. Once an appropriate partner is selected, the parties should clearly document their respective legal rights and obligations.
The structure of a joint venture
The structure of a JV can take various forms, depending on the jurisdiction and the goals of the parties. There are generally two primary approaches. One is an equity JV involving the formation of a separate legal entity to house the JV business in which each partner holds an equity stake. The second is a contractual JV whereby the partners collaborate through contractual agreements without a separate legal entity intermediating. Deciding the most suitable structure will be based on the commercial, legal and tax issues, among others, at play in the relevant jurisdictions.
The question of governance
The jurisdiction of the formation of an international joint venture can mean governance structures vary but some general considerations apply.
Voting standards ensure how decisions are made and which party is in control of the decision-making. They must be considered carefully. Clear drafting as to which matters require escalation to the JV partners for determination is imperative. This should be distinct from those matters reserved to the management for determination. Where the JV is a separate legal entity, the parties must understand the available statutory minority protections in local law for the relevant jurisdictions, and a reasonable balance should be struck between partner control and management discretion.
The partners should also consider appropriate contractual provisions to ensure the JV (and its personnel) understand the requirements and business standards expected by the partners. These are likely to include representations and warranties, partner audit rights and covenants to support the implementation of appropriate compliance systems, processes and training.
Funding and returning value
Funding commitments between partners usually align with the capital required to allow the JV to turn a profit in line with an agreed-upon business plan and budget model. The agreement should clearly outline each party’s initial contributions, whether in the form of cash (equity or debt) and/or assets and establish appropriate mechanisms for determining when additional funding is required and how it will be contributed. Ensuring goal-incentive alignment between management and the partners is important. Consequently, it is often advisable to link funding commitments to the achievement of key performance indicators in the business plan on which management must deliver before a capital call can be made.
Closely related to funding is how to structure and safeguard the investment return to the joint partners, whether that be by way of dividend, repayment of loan principal and interest or royalty. This often involves a thorough understanding of the tax implications of the joint venture. Depending on the jurisdiction, there may be specific tax advantages or disadvantages to particular mechanisms by which value is returned to the JV partners.
Protection of goodwill
Carefully drafted restrictive covenants help protect the interests and goodwill of all parties involved in a JV. This includes both traditional restrictive covenants such as non-competes. It may also include provisions regarding appropriate information barriers between the JV and its partners and provisions to prevent the partners from poaching talented JV personnel. The negotiation of these provisions requires close cooperation with the business team to identify areas of potential overlap with existing business lines, to assess the degree of competition and to evaluate the potential impact of a covenant on those business lines.
Exiting a joint venture
Thinking about an exit before the international joint venture is established may seem a strange priority but this must be addressed early by corporate counsel. Exit mechanisms are some of the most critical provisions in any JV agreement. They go to how parties ensure value realisation and return on investment, as well as how to pick up the pieces if the JV becomes unviable or the relationship between the joint venturers breaks down. Planning for a potential exit allows the parties to be better prepared for any unforeseen changes in the JV, while also protecting their respective interests.
It is typical in an equity JV for the partners to agree on a period of time during which the parties commit to not disposing of their equity interests. This ensures stability and gives the JV the chance to execute its business plan. After this initial ‘lock-up’ period there are multiple ways in which an exit could be managed. This includes selling a partner’s interest in the JV to the other partner(s), buying out the other partner(s) to obtain full control, selling the JV company to a third party, going public or dissolving the JV if it is no longer profitable or viable. Some combination of drag and/or tag-along rights, rights of first offer or refusal for existing shareholders, rights to initiate a third-party-led sale or listing process, and/or deadlock mechanisms will most likely have a role to play in most agreements.
Finally, it is worth noting the challenges on multiple non-legal levels such as language, cultural differences in approaching sensitive issues, risk tolerance and underlying perceptions of various jurisdictions. Complex legal matters coupled with such non-legal challenges can be a recipe for lengthy negotiations and the misalignment of expectations. Through engaging with one another in person, the parties often come to a clearer and more thorough understanding of what their contract says, especially when their lawyers are present to clarify legal issues, guide discussions and document the final understanding in real-time. Given the benefits of such a high-level engagement by everyone involved, in-person meetings are very often the most efficient way of negotiating successful international joint ventures.
A nuanced interplay of factors
International JVs involve a nuanced interplay of personal, cultural, commercial and legal factors. Harmonising these various factors is crucial to the success of any international JV. A corporate counsel’s role is primarily legal in nature but they play an important part in counselling their business teams on striking the appropriate balance between the personal, cultural, commercial and legal dimensions at play. Issue-spotting at an early stage helps the business team has a more holistic understanding of the proposed venture in ways that both better ensure commercial viability and success and build rapport and trust with the JV partner.