What is a Joint Venture?

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Mergers and acquisitions are often done by way of joint venture. A joint venture being a commercial enterprise or business undertaken by two or more parties, together. 

There are a number of legal structures which are referred to as a joint venture.  The three most commonly used are: 

  • a partnership 
  • a contractual joint venture (also known as an unincorporated joint venture) 
  • a joint venture company (also known as an incorporated joint venture). 

Partnership 

Broadly speaking a partnership is a relationship which exists between persons carrying on a business in common with a view to profit.  If a partnership relationship arises, then the law of partnership applies and in particular the Partnership Act 1892 (NSW). A partnership is governed by the contract between the parties (a partnership agreement), general law and the Partnership Act.

A partnership agreement is usually entered into by the partners and sets out specifics of the partnership including objectives of the partnership, each party’s contribution, each party’s rights and obligations, the rules setting down how the partnership will operate including the management structure, the term, the distribution of profits, events of termination, and how to deal with disputes. 

Characteristics of a partnership which prospective joint venture participants may wish to consider are: 

  • Each partner is jointly and severally liable for all the debts of the partnership, with no limited liability.  Accordingly, a third party’s claim against a partnership can be enforced against any partner, leaving that partner to collect from the other partners (if possible). 
  • Generally, a partner who makes a commitment on behalf of the partnership binds the partners to perform that commitment as far as third parties are concerned (regardless of whether the partnership deed limits that authority nor not). 
  • Each partner is a fiduciary to the other partner(s). A fiduciary relationship is a relation between two parties where one party (fiduciary) has the duty to act in the best interest of the other party (beneficiary or principal). As such, a partner cannot obtain a personal profit from the use of property, information or opportunities which become available to it in the course of partnership activities, without the consent of the other partner(s). 
  • In Australia, every partnership is a separate business for tax purposes, although the net profit or losses are attributed to the partners in agreed shares.  Accordingly, a single set of accounting policies must be established for tax purposes.  Individual partners cannot adopt their own policies for matters such as depreciation and other discretionary issues.

Contractual joint venture (an unincorporated joint venture) 

A contractual joint venture tends to be unusual at law. A contractual joint venture is a form of association established by agreement between the parties and is a creature of that agreement.  It is not a company and therefore is not a separate legal entity from the participants, and it is not intended to be a partnership.  Accordingly, restrictions imposed by the Corporations Act 2001 (Cth) and the Partnership Act do not apply. 

The key difference in concept between a partnership and a contractual joint venture is that in a contractual joint venture, the parties both put in assets but have separate interests in these assets and continue to carry on separate businesses with a common goal.  In a partnership, the businesses of the parties merge and are run in common.  Also, partners do not have a separate interest in the partnership assets.  Like partnerships, parties under a contractual joint venture usually share profits and losses in proportion to their respective interests. 

If the parties are not in partnership then in theory at least, an unincorporated joint venture structure means that the parties are not jointly liable for each other’s liabilities and each party cannot bind the other. However whether a relationship in fact amounts to a partnership is a question of law, even if the parties expressly say they are not in partnership. 

Joint venture company (incorporated joint venture)

The term joint venture company is generally used to describe the situation where parties get together and form a company to use as a vehicle for carrying out the merger or acquisition.  The parties operate through the company and have shares in the company in their respective portions. 

The assets of the company belong to the company, not the shareholders and the profits of the company are shared by the shareholders in proportion to their shareholdings. 

The provisions of the Corporations Act, which impose obligations and restrictions on companies, apply to joint venture companies. 

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Documenting the arrangement

Generally, the participants of a contractual joint venture and a joint venture company enter into a joint venture agreement or shareholders agreement to regulate their relationship.  Such agreements should cover the following: 

  • Statement of joint venture activity and objectives – this is usually a list of the general objectives of the venture with some degree of detail. 
  • Conditions to the agreement (if any). 
  • Term of the venture – how long will the relationship/investment last including methods of termination. 
  • Raising of initial capital and continuing funding. 
  • Ownership interests and profit share. 
  • Accounting policies. 
  • Decision making – the structure of the management committee (for a contractual joint venture) and the board of directors (for a joint venture company). 
  • Default and dispute resolution. 
  • Good faith obligations. 
  • Joint venture companies should also have provisions dealing with restrictions on the issue or transfer of shares by the shareholders (pre-emptive rights).   

Further, joint venture documentation may also include: 

  • Confidentiality Agreement (also known as a Non-Disclosure Agreement or NDA) which is most often entered into by the joint venture parties before any meaningful business or technical discussions in respect of the joint venture begin. 
  • Management Agreement which is required the joint venture operations will be carried out by certain nominated persons or companies. 
  • Constitution which is required by a joint venture company to give effect to the shareholders agreement between the shareholders of the joint venture company. 

Important: it is imperative that the joint venture relationship is accurately and effectively defined at the outset.  If this fundamental requirement is neglected and matters such as ownership and profit sharing, parties’ rights and obligations, management and decision making, and dispute mechanisms are poorly dealt with, then the risk of irreconcilable disputes occurring is a very real threat which may defeat the common purpose of the joint venture. 

Contractual joint venture or joint venture company?

In determining whether to enter a contractual joint venture or a joint venture company the following factors will be relevant: 

  • Risk – the liability of shareholders within an incorporated joint venture is limited to any unpaid call on their shares in the joint venture company.  Accordingly a third party cannot generally claim against a shareholder in an incorporated joint venture.  This is seen as a major advantage that a joint venture company has over a contractual joint venture. 
  • Privacy – an unincorporated joint venture agreement is a private arrangement and therefore is not subject to public scrutiny like the registration details and constitution of a joint venture company. 
  • Familiarity – the nature of the business or the attitude of one or more joint venture parties may lead to a choice of incorporated entity.  The framework provided by corporate law and protection available to shareholders may be preferred and better understood as opposed to contractual rights of an unincorporated joint venture. 
  • Accounting flexibility – joint venture partners may prefer an unincorporated venture allowing them to keep separate accounts and maintain their own accounting policies.  When the participants are involved in a high risk venture, where losses or early losses are likely, there is no satisfactory way of passing the losses back to the participants from a company.  However, losses made by a contractual joint venture can be channelled back to the participants for tax purposes and offset against their income.  This is often seen as a major advantage of a contractual joint venture over a joint venture company. 
  • Legislative requirements – under a contractual joint venture, parties are free from many of the restrictions of the Corporations Act so that parties can incorporate whatever provisions they wish to deal with the decision making procedures, authorities, assignment of interest, defaults and other arrangements without the restrictions of such legislation. 
  • Transfer of interests – it is easier to transfer shares under an incorporated joint venture company.  Whereas because it tends to be specific as to the parties’ needs, a transfer of shares is unusual once an unincorporated joint venture is fully operational. 
  • Financing – if the parties want to use collective financing and grant security over the joint venture assets, a company can be an advantage.  Also, partly paid up shares can be issued as a way of securing further capital. 
  • Fiduciary relationships – shareholders within an incorporated joint venture would not ordinarily have concern unless special provisions are inserted into the joint venture agreement. 

Determining an Appropriate joint venture structure

The appropriate ownership structure for a merger or acquisition by way of joint venture is determined by a number of factors which may include availability of suitable finance, tax considerations, bargaining positions of the various participants and the requirements of the parties in terms of liability. If a form of joint venture is contemplated, the parties must ensure that the arrangement is accurately documented from the outset.