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Joint venture companies, shareholder agreements and articles

With a changing and uncertain economic environment, joint ventures continue to be a popular option for many businesses when seeking to expand or diversify.  

Based on our experience of advising joint venture companies and business people considering a joint venture we have summarised below the key issues to be considered when implementing a workable joint venture.

Overview of joint venture companies, shareholder agreements and articles:

back to topTypes of joint venture structures  

There are three types of joint venture structure available.   The structure most appropriate for any particular venture will be dependent upon the size of the joint venture participants, their respective objectives, tax, legal and competition issues (all of which should be considered at the outset).

back to topJointly Owned Corporate Entity 

Typically, a joint venture will take the form of a jointly owned company (or, possibly, limited liability partnership LLP).  The considerations for a business entering into a corporate joint venture include:   

  • A corporate entity offers each partner limited liability to the extent of their respective contributions to the company, except where a partner gives guarantees and assurances to third parties on behalf of the joint venture company.  
  • A participant's interest in the joint venture company will most likely have tax and accounting implications for any group structure;   
  • The annual accounts and returns of a joint venture company must be filed regularly and will be openly available to the public.  
  • A company offers flexibility in ownership (including changes in ownership), control and management through share rights, articles of association and  shareholder agreements.

 

Partnerships and limited liability partnerships (LLPs)

Where a separate legal entity is not formed, but persons (including corporate entities) come together and carry on business in common with a view to profit, a partnership or a limited liability partnership (LLP) will be formed.   A partnership agreement will govern the relationship between the partners in connection with the business of the partnership.

The crucial elements of a partnership, and of which a business should be aware before entering into a joint venture of this sort, are: 

  • No separate legal identity distinct from the partners. Unless a third party is aware of a partner's lack of authority, that partner will be jointly and severally liable to that third party for all the wrongful acts and omissions, debts and liabilities of the partnership.   
  • All property contributed to the partnership at the outset, and introduced to the partnership during its life, will be partnership property and will be available to meet the debts and liabilities of the partnership. 
  • A partnership offers flexibility in sharing of profits (and losses). 
  • Partnership profits will be calculated in the same way as profits of a company, but tax will be paid by each partner on its share of the profits. 
  • There is no requirement to file a partnership's accounts for public scrutiny.  Limited liability partnerships do have to file public records at Companies House but there are provisions for abbreviated accounts for small limited liability partnerships (LLPs).  
  • A partnership can be burdensome when dealing with changes to its structure and composition

 

Contractual/Co-operation Agreement

The alternative to a jointly owned corporate entity and partnership or limited liability partnership (LLP) is a contractual co-operation agreement.  The agreement will set out scope of the arrangement between, and the rights and obligations of, each participant.   The significant differences of a co-operation agreement to the other joint venture structures are:

  • Although a participant can be exposed to claims and liabilities arising from both its own activities and those of its co-participants for whom it agrees to bear responsibility, it may avoid liability for the actions of the joint venture and its co-participants. 
  • Except where otherwise agreed, the assets and property of each participant will remain its own property. 
  • Each participant will account and be taxed separately in respect of its participation in the joint venture. 
  • The arrangement will avoid formality and permanence of a separate corporate entity or association and may be particularly suitable for single purpose projects or where participants make their contributions at different stages.

Joint venture company - basic questions

  • Is the joint venture company to acquire outright any business, shareholding or assets on establishment?
  • Is the joint venture company going to enter into any licence, services, supply or other agreement (ongoing or transitional) on establishment (e.g. agreements with shareholders regarding intellectual property, technology, names, occupation rights, head office functions or financing)?
  • Are there any other transactions linked to the establishment of the joint venture (e.g. financing of investment in the joint venture)?
  • Consider need for non-announcement/confidentiality arrangements.
  • Consider whether a heads of terms/letter of intent/memorandum of understanding and/or exclusivity arrangements would be appropriate.

back to topHolding shares in the joint venture company - the articles of association and shareholders agreement

  • How will the equity in the joint venture company be held between the parties.  It is often necessary to have a separate shareholders agreement setting out the rights and obligations relating to share capital
  • Do the articles of association for the joint venture company need bespoke tailoring to protect the interests of shareholders and preserve share capital?

back to topScope of the joint venture business

  • Where will the joint venture company be incorporated (taxation is potentially a key factor)?
  • What will each party's percentage interest to be?
  • Does the joint venture group's proposed business require any statutory or regulatory consents, licences or approvals in any relevant jurisdiction?
  • To what extent can shareholders compete with the joint venture company? Will shareholders be obliged to refer any business/opportunities to the joint venture company, if relevant?
  • Who is responsible for incorporating the joint venture company? Who is responsible for drafting any joint venture or shareholders' agreement and/or the joint venture's constitutional documents?

back to topFinancial aspects - funding, business plans and dividends

  • How will the joint venture company be funded initially? What is the proposed initial capital structure of the joint venture company?
  • If the joint venture company needs non-internally generated funding in the future, how will this be obtained?
  • Are shareholders to be obliged at the outset to provide future funding? If so, in what form (e.g. equity contributions, loans or additional assets or services)? Is future funding to be provided by shareholders pro rata? What are the consequences of a shareholder failing to fund the joint venture company if and when obliged to do so?  It will be necessary to record such obligations in the shareholders agreement and or the articles of association of the joint venture company.
  • Will the joint venture company borrow from banks? If so, will shareholders guarantee any of joint venture company's obligations? Will shareholders be obliged at the outset to guarantee any obligations joint venture company incurs going forward (e.g. (further) bank borrowings or commercial contracts)?  It will be necessary to record such obligations in the shareholders agreement and or the articles of association of the joint venture company.
  • What will be the process for drawing up and agreeing budgets and business plans? Is there to be a prescribed format? What is the consequence of failure to agree a budget and/or business plan?
  • What is the consequence of non-adherence to the then current budget and/or business plan?  These details are usually recorded in the shareholders agreement.
  • What is the dividend policy of joint venture company to be? Is this to be legally binding? These details are usually recorded in the shareholders agreement.

back to topManagement of the board of directors

  • What is the composition (and balance) of joint venture company's  board to be? Who has power to appoint and remove which directors?
  • How will the chairman be appointed? Will he have a casting vote at either shareholders' or board meetings?
  • Will certain matters require shareholder approval (and, if so, by what majority)?  Consider:  structural issues (e.g. changes to joint venture company's constitution or capital structure); and operational issues (e.g. changes to scope of business, M&A transactions, external financing and transactions with shareholders and their affiliates).
  • Will certain matters (not requiring shareholder approval) require board approval and/or require special board approval (e.g. approval by unanimous vote or approval by majority vote including at least one director appointed by each shareholder)?   These matters are usually recorded in the shareholders agreement and kept separate from the joint venture company's articles of association.
  • Who will have the right to appoint the CEO/CFO/other senior management?
  • Will joint venture company have its own employees? Are any personnel to be seconded to joint venture company from shareholders?  It may be necessary to prepare employment contracts and directors' service agreements.
  • How will the joint venture company be managed generally? Will any management services be provided by shareholders?
  • What are the quorum, notice period, board papers and other requirements for joint venture company board meetings? Is there to be a minimum frequency for board meetings? Is there any requirement (e.g. for tax reasons) for board meetings to be held in a particular place?
  • What is to be the position where a director has an interest in matters affecting joint venture company (e.g. discussions on contracts between joint venture company and the shareholder appointing that director) - must he declare his interest, can he vote, does he count in the quorum, etc?  These areas are dealt with in the articles of association rather than the directors' service agreement.
  • If applicable, how will "deadlock" (in particular failure to agree on any matter reserved for shareholder or special board approval) be resolved?

back to topExit - duration, default and transfers

The exit strategy is a very important consideration.  In practice details on how an exit will happen and how the parties will be paid needs to be reflected in the joint venture agreement and in the articles and shareholders agreement since it overlaps between the scope of the joint venture and the share capital of the joint venture. 

Similar considerations are required if the joint venture vehicle is an limited liability partnership LLP or a common law partnership.

  • Is the joint venture to be of fixed term or indefinite duration? If fixed term, is there an overall exit strategy, e.g. call option, auction sale of shares, IPO or winding up?
  • Can a shareholder terminate the joint venture early (e.g. on material breach, insolvency, change of control)? What are the consequences of termination (e.g. should there be put and/or call options, and what are consequences for shareholders' respective contributions to the joint venture including intellectual property)?
  • Is a shareholder permitted to exit by transferring its shares to third parties? If so, what are consequences for that shareholder's contribution to the joint venture (e.g. in relation to any intellectual it has transferred or licensed to joint venture company)?
  • Will other shareholders have pre-emption or specific veto rights on any transfers to third parties? If pre-emption rights are to be conferred, what price per share will apply (e.g. is there to be a "fair value" override)?
  • On a transfer, if permitted, is the transferor to be given drag along rights? Is other shareholder(s) to be given tag along rights?
  • Should termination or any transfer of shares trigger a change of joint venture company's name?  

back to topTaxation

back to topCo-ventures(s) in the joint venture vechicle

The documentation implementing the joint venture vechicle, the articles of association, shareholders agreement or limited liability LLP partnership agreement will need to address:

  • Is the other shareholder(s) in joint venture company a corporation? If so, is it a substantial/the ultimate parent of its group - if not, will the ultimate parent (or someone else substantial) give a guarantee?
  • Will other shareholders (or any other member of its group) require shareholders' approval to enter into the joint venture? Should change of control of the other shareholder/its guarantor/its ultimate parent have any consequences?
  • Is legal due diligence, or an expert valuation, appropriate in relation to anything to be contributed to joint venture company by the other shareholder?

back to topAccounting

Accounting aspects will be addressed in the documentation implementing the joint venture vechicle, the articles of association, shareholders agreement or limited liability LLP partnership.  Considerations include:

  • Is consolidation an issue? Is any particular accounting treatment sought?
  • Who will be joint venture company's accountants/auditors and financial director?
  • Does the joint venture company have to be managed in a particular way, or have a particular year end, for accounting purposes? 
  • Is any special access to joint venture company required for either party's accounting, audit or compliance purposes? Are there any other accounting drivers or issues?

Conclusion

Setting up a joint venture company requires consideration of various commercial issues, well drafted documentation setting out the rights and obligations.  Part of the implementation process requires consideration of the share capital of the joint venture company and usually a shareholders agreement and especially tailored articles of association dealing with the rights of shareholders in the joint venture company and share capital. 

If the joint venture vechicle is a limited liability partnership LLP or a common law partnership similar considerations arise in addition to considerations specific to partnership law.  

Focus on implementation is not complete without consideration of the exit, sale of the shares, taxation, and profit extraction. 

This paper is designed to provide a summary of the issues addressed. Therefore, it is not intended as a detailed commentary on the relevant law and any comments made should not be acted upon without first taking specific legal advice.

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