It is common to talk in terms of a ‘joint venture agreement’ when partners incorporate their alliance or cooperation into a legal entity (other than a general partnership) and to refer to the joint legal entity as the ‘joint venture’ (or ‘JVC’). Most of what is discussed in connection with contractual alliances and collaboration agreements and the strategic rationale for seeking a collaboration also applies to joint ventures.
The ITC Model Contract for an international corporate joint venture provides a general framework for a joint venture that is to be jointly owned by two parties. A more extensive model joint venture agreement (for incorporated JV’s) is from Weagree (available from our model contracts platform). Of course, joint ventures may well be entered into by multiple parties – it would require more attention in finetuning the dispute resolution mechanism (but with multiple parties its might also be easier to solve any disagreements).
It is almost without exception that a joint venture agreement will have a number of related project agreements attached to it, so as to organise the various relationships and qualities of each joint venture partner vis-à-vis the JVC. Examples of such project agreements could include:
- Reseller or distribution agreements between the JVC and each JV-partner (if the partners or the JVC will act as a distributor for the other)
- Sales agreements, Long-term supply agreements or General purchase agreements between the JVC and each JV-partner (to provide for the terms and conditions on which a partner will supply the JVC, or vice versa)
- A Joint development agreement between all partners and the JVC (to organise any jointly undertaken R&D work, and to allocate any IP rights resulting from it)
- Licence agreements between the JVC and each of the JV-partners (if any technology must be licensed by a partner to the JVC, or vice versa)
- Contribution agreements or subscription agreements between the JVC and each JV-partner (setting forth the terms and conditions for such JV-partner’s cash contribution or contribution-in-kind in exchange of receiving its shares in the capital of the JVC)
- An agreed form of the articles of association (or deed of incorporation) for the joint venture company
These project agreements can be straightforward versions of a model reseller, distribution, sales, long-term supply agreement etc. Reflecting such relationships in separate agreements (that will be attached as a schedule or annex to the joint venture agreement and thereby be made an integral part of it) makes drafting, negotiations and managing a joint venture much easier. Do not try to arrange for everything in one single JV agreement. Consider using this model joint venture agreement that already anticipates attaching such project agreement.
Joint venture agreements and the JVC #
Equality or majority
The ITC Model Joint venture agreement is designed for 50 /50 participation by two parties. Occasionally, for psychological, tax or accounting reasons, the parties may need to establish a 49/51 or 48/52 percent participation share. The ITC Model Contract can also be used for those cases. If there are more than two parties, or if one is to have an articulated majority share, the provisions will need to be adapted. In multi-party joint ventures, the dynamics of JVC management, decision making, deadlock resolution and termination differ considerably.
The JVC business and joint venture business plan
Establishing a JVC requires a match of objectives among the parties, most importantly regarding its financial and business aspects. Although mutual trust between the parties is an essential element for successful cooperation, it is crucial to align on business aims and intentions, as well. The parties should carefully determine the scope of the JVC. A few guidelines:
- Identify the business: the nature of the JVC’s business, its commercial environment (e.g. internet-related, target groups), specific products or services, and production methods;
- What falls within the JVC’s scope, perhaps by clearly identifying what is outside its scope (competitive business, competitors, excluded business);
- The functionality of the JVC business and application of the joint venture production processes and products;
- The JVC’s field of activities, which can be delimited geographically as well as by sector or industry;
- How synergetic effects are expected to be realised;
- Various temporal effects: how can or should the JVC develop or vary over time – relevant factors may include (i) targets reached, (ii) changes in market circumstances, (iii) discontinuance of any activities by the parties, and (iv) new technologies.
For clarity about the development of the JVC’s business, it is good practice to agree on a business plan at the outset. A business plan can take any form: from a PowerPoint presentation to a simple Excel sheet with forecasted sales projections. The business plan could be attached to (or at least identified in) the joint venture contract.
Conditions in a joint venture agreement
In the context of a joint venture contract, certain ‘conditions precedent’ may need to be satisfied before the collaboration can actually be launched. Such conditions may include regulatory approvals (e.g. from competition authorities or other market supervisory bodies), the establishment of the JVC (legal) entity, or the grant of government subsidies (see the ITC Model Contract, Article 3).
Establishment of the JVC
A corporate JVC must be formed in a particular jurisdiction. Usually, this will also determine the governing law of the joint venture contract. It will be necessary to prepare articles of association, bylaws or other constitutional documents in that jurisdiction, and these documents must be consistent with the joint venture contract. It is good practice to ensure that the joint venture contract addresses key items as a matter of contract between the parties.
If there are conditions to be satisfied, or if the JVC will be established after the joint venture contract is signed, a number of actions must be postponed. To avoid a renegotiation of terms, the key aspects of such actions should be agreed and listed in the contract. While the actual establishment of a JVC is called ‘closing’ or ‘completion’, such a list is often referred to as the ‘closing agenda’ – see Article 4 of the ITC Model.
Joint venture party contributions and management of the JVC #
Contributions in kind
Many joint ventures involve a contribution by a party of assets, property, technology or services, or associated distributorship or supply arrangements. These will often require “ancillary contracts” to spell out detailed terms (e.g. price, specification, limitation of liability). In a simple, lean joint venture, contributions ‘in kind’ can be included in the joint venture agreement (see the ITC Model Contract, Article 9). However, in most cases, it is more appropriate to provide for these in separate contracts, (and other ITC Model Contracts can be used for this purpose).
If a postponed closing or completion is planned, it is important to agree on (the key items of) such ancillary contracts at the time of signing the joint venture contract (and attach them in ‘agreed form’ – see the ITC Model Contract, Article 4.4). The JVC and the appropriate party or parties will then sign on the closing date.
In many JVC’s, each party makes an initial financial contribution to the capital of the JVC. The amount may differ per party: a large contribution in kind by one party can be balanced by additional cash from the other party. It is important to stipulate whether or not a party will have any subsequent obligation to provide further finance to the JVC. Article 5 envisages that any future finance requires mutual consent.
Overall direction and management of the JVC is usually in the hands of the JVC board of directors: an executive team of representatives from each of the joint venture partners. They will (attempt to) manage any conflicting interests among the partners and ascertain that the partners do what they have agreed to do. They coordinate the parties’ performance, represent their appointing party within the JVC, and manage the JVC (like a business unit of a company). This list of responsibilities makes it clear that the board of directors has a complex task.
Decision making in joint ventures
Obviously, it is impossible (if even desirable) to foresee in advance and include in the joint venture contract everything that will eventually need to be settled. Nevertheless, it is important to clarify at the outset the balance of decision-making power. Decision making within a JVC affects: (a) the parties as shareholders, (b) the board, and (c) individual executives of the JVC. It is common to specify that certain “Reserved Matters” will require the mutual consent of the parties, either as shareholders or on the board.
Business-related matters are not necessarily the subject of decision making by the shareholders, but this is almost inevitably the case for actions or policies affecting:
- the financial commitments and obligations of each party (including applicable accounting policies, especially if the JVC is consolidated in the accounts of one or both parties);
- the creditworthiness of the JVC;
- the shareholding percentage;
- the freedom of a party to compete and the freedom of the JVC to enter new markets and territories;
- litigation (affecting the name or reputation of a party);
- key employee related aspects; and
the JVC’s freedom to merge, take over other companies, initiate reorganisations and to apply for insolvency proceedings.
Termination of the joint venture agreement and the JVC #
Overview. Most joint ventures will cease to exist within the first year of their existence. The main reasons for this include the incompatibility of the parties’ organisations or operational functioning, differences in internal (decision-making) culture, a change of strategy by one of the parties, a material breach of contract or even a dispute regarding interpretation of contractual obligations. A sale by a party of its shares in the JVC can, under the ITC Model Contract, only be made with mutual consent.
Termination grounds affecting mutual trust will typically lead to a deadlock in decision making. Therefore, it is appropriate not to include an exhaustive list of possible termination situations but simply to provide for ‘deadlock’ as a ground for termination. If a party wishes to bring the joint venture to an end, this usually requires mutual agreement. In the ITC Model, Article 14.3 contemplates that (after a reasonably lengthy procedure) a party can nevertheless call for a winding up of the JVC in certain circumstances of breakdown or deadlock.
Russian roulette, Texas shoot-out etc. It is not uncommon to provide for an alternative termination mechanism. In many joint venture configurations, the sale of JVC shares to a third party or to only one of the parties is not acceptable. Sometimes, the parties may foresee which of the two would be the most appropriate acquirer of the JVC shares. The key issue in such cases is the valuation of the shares at a reasonable price. The contract clauses providing for a valuation or acquirer-appointing mechanism have been given exotic names such as ‘Russian roulette’ or ‘Texas shoot-out’. It is beyond the scope of this book to elaborate on all the ins and outs of such clauses, but a brief description of three common mechanisms is given below.
- Russian roulette (two-party JVC’s). When it is uncertain who will buy out the other party, a common mechanism provides for an internal auction (also called Russian roulette). Both parties should indicate whether they want to buy or sell, and at what price. If one party wants to sell and the other wants to buy, then the latter must buy at the price proposed by the former party. If both parties want to sell, then the highest bidding party must buy at the lowest offered price (and vice versa in case of two willing buyers). The combination of these two outcomes embodies an implicit incentive for the willing seller to offer at an appropriate price (i.e. if it offered at a too high price, it would become the buyer; and there is no reason to anticipate an offer at a below-value price).
- Texas shootout (multiparty JVC’s). When it is uncertain who will buy out the other party, another common mechanism can be applied in a multi-party JVC (it is known as a Texas shootout). An independent person who will facilitate the process must propose a share price for the JVC. All parties will indicate whether they are willing to buy or sell at that price. The indicated sellers will sell at that price; if more than one party wants to buy, the process is repeated among the willing buyers at a bid price increased by five or ten percent, until there is one buyer left. If at some point all the remaining willing buyers turn into willing sellers, the price is decreased by 1 percent (and goes down until there is one buyer). The prices to be paid by the buyer will be the prices at which the relevant seller was still willing to buy. If the first round provides only sellers, instead of increasing, the price will decrease by 5 or 10 percent (and while the reference price goes down each time, the mechanism works mutatis mutandis the same).
- One pre-appointed acquirer. If one particular party must eventually acquire all the shares, the bidding mechanisms described above do not work. Instead, the valuation must be more adequate. A termination mechanism would require each of the parties to propose a valuation of the JVC shares (including a breakdown and explanation as to how the valuation has been calculated. If there is a difference between them, the parties will discuss both valuations and deviations. If after a period of (for example) 60 days no consensus is reached on the price, each party may require the appointment of an independent accountant, and it is therefore important that the joint venture agreement provides for an appointing authority in case the parties fail to agree on one person or firm. The appointed independent accountant will establish the price at which the prospected seller must sell and the anticipated buyer must acquire. The mechanism might contain instructions as regards the valuation method (but in many cases, it is best not to include such instructions).
This mechanism matches the auction principle developed by Nobel Prize winner William Vickrey.
Completing your joint venture agreement #
The provisions in the ITC model Corporate Joint Venture Agreement may be added to the Alliance or collaboration agreement:
- Article 5 (capital and further finance)
- Article 6 (directors and management)
- Article 7 (reserved matters for important decisions)
- Article 9 (additional contributions)
- Article 13 (restrictions on the parties)
- Article 14 (deadlock and termination)