A joint venture is a strategic business arrangement or collaboration between two or more parties, where these parties agree to share their expertise, experience and resources to accomplish a common business activity, goal or project. Joint ventures are usually formed in circumstances where businesses lack the resources, capital or knowledge to enter into an intended market or industry.
The popularity of joint ventures has increased in recent years due to various advantages being available to parties in a joint venture, including but not limited to the sharing of risks and costs, opportunity to gain access to new markets, and strategic move against competition. While joint ventures appear to be enticing, it is important to understand the different structures, terms and conditions applicable to a joint venture.
Types of Joint Ventures
There are two types of joint ventures: incorporated joint ventures and unincorporated joint ventures. Incorporated joint ventures involve the incorporation or formation of a new legal entity commonly referred to as a Special Purpose Vehicle. Unincorporated joint ventures operate predominantly on the existing legal status of the parties to the joint venture and their respective duties and obligations which are set out in a principal joint venture agreement.
Incorporated Joint Ventures
The parties to an incorporated joint venture contribute their respective assets and resources to the joint venture in exchange for ownership interest in the newly formed Special Purpose Vehicle (“SPV”). An SPV may take either one of two forms, being a company incorporated under the Companies Act 2016 or a limited liability partnership incorporated under the Limited Liability Partnership Act 2012. The SPV is a separate legal entity from the existing legal status of the parties to the joint venture. As such, its legal status prevents adverse project or financial risks from being transferred to or from the parties to the joint venture. This form of protection limits the liability of the parties to the joint venture to their shareholding in the SPV.
One example of an incorporated joint venture in Malaysia is the formation of Mazda Malaysia Sdn Bhd. This SPV was formed by a joint venture agreement executed between Mazda Motor Corporation and Bermaz Motor Sdn Bhd on 11 September 2012. The principal objective of the joint venture was to increase the local assembly and manufacturing activities of Mazda in Malaysia.
In the event an SPV is formed as a company under the Companies Act 2016, the shareholders of the SPV will execute a joint venture agreement and a shareholders agreement. The shareholders agreement will include, but is not limited to, the respective shareholding percentage of the shareholders, composition of the Board of Directors of the SPV, management committee, transferability of shares, voting rights and appointment of key personnel.
Unincorporated Joint Ventures
Unincorporated joint ventures are more commonly referred to as contractual joint ventures. The main difference between an incorporated and unincorporated joint venture is the absence of a separate legal entity in the case of an unincorporated joint venture. An unincorporated joint venture is created by way of an agreement, e.g. joint venture agreement, partnership agreement or collaboration agreement. The parties to an unincorporated joint venture will carry out and perform their respective roles, duties and obligations under the joint venture pursuant to the agreed terms and conditions as set out in the relevant agreement.
The profit-sharing arrangement between the parties to an unincorporated joint venture is, more often than not, structured based on the contributions made by the respective partners to the joint venture. Similarly, each partner will be responsible for debts and liabilities based on the share of their contributions. One enticing benefit to an unincorporated joint venture is that the unincorporated joint venture can be a short-term arrangement between the parties, as opposed to an incorporated joint venture, which is usually structured for a longer term between the parties to execute the objectives of the incorporated joint venture.
One example of an unincorporated joint venture in Malaysia is the joint venture between Ho Hup Construction Co Berhad and DSE Construction Sdn Bhd, where Ho Hup Construction Co Berhad has an 80.7% “profit-share” in the unincorporated joint venture. The unincorporated joint venture was awarded a RM221.4 million contract under the project to rehabilitate Sungai Besut in Terengganu. The term of the unincorporated joint was said to be three years.
The Joint Venture Agreement
A joint venture agreement is a definitive agreement that establishes the joint venture between the parties to the intended joint venture. A joint venture agreement should outline the contributions, expectations, obligations, rights, and duties and responsibilities of all relevant parties to the intended joint venture. Further, the joint venture agreement must be comprehensively drafted and specify the obligations of all relevant parties. A key element in joint venture agreements is the mechanism determining how profits and liabilities will be shared between the parties to the joint venture. The agreement should also be structured with precision to reflect the intentions of the parties to minimize the risk of disputes arising out of or in connection with the joint venture agreement.
Keys Terms in a Joint Venture Agreement
- Objectives and Scope of the Joint Venture
One of the most fundamental terms of a joint venture agreement is the objectives and scope of the joint venture. The purpose of a joint venture is to accomplish a common business activity or project between the relevant parties. Such common objectives must be set out in the joint venture agreement to avoid any dispute between the parties. If the objectives and scope of the joint venture cannot be agreed upon between the parties, it is highly likely that the joint venture will not achieve success.
- Contributions of the Parties
The joint venture agreement should also set out the respective contributions of the parties to the joint venture, as their respective contributions usually provide the base of the distributions of shares and sharing of profits between the parties in the joint venture. It is essential for the parties to come to a mutual understanding as to how profits and liabilities will be divided and thereafter such mutual understanding should be documented in the joint venture agreement.
- Rights, Duties and Obligations of the Parties
As each party has its own role in the joint venture, it is vital for the joint venture agreement to set out the rights, duties and obligations of each party to the joint venture. Such clauses in a joint venture agreement should be drafted comprehensively and cover all rights, duties and obligations of each party. A comprehensive joint venture agreement will help minimize the risk of one party alleging that the other party did not perform or adhere to its duties and obligations to the joint venture. After all, the success of a joint venture requires the joint effort of all parties involved. Any allegation of non-performance of duties and obligations by one party against another will undoubtedly cause the joint venture to suffer a tremendous setback.
- Exit Strategy and Termination
There is never a guarantee for success in business and, in some instances, one or more parties to a joint venture may come to realize that their business objectives and interests have shifted from the initial objectives and scope of the joint venture. Parties must consider including exit strategies in the joint venture agreement. Exit strategy provisions generally assist parties to a joint venture to terminate the joint venture predictably and amicably. Common exit strategies include liquidation, put and call option and the right of first refusal in the case of an incorporated joint venture. The inclusion of an exit strategy assists parties to avoid being compelled to remain in a business deadlock.
- Intellectual Property Rights
Parties to a joint venture usually see a contribution of their assets to the joint venture to assist the joint venture to accomplish its purpose. In addition, most joint ventures involve the development of a product by the joint venture, which may be of value to each party to the joint venture. A thorough and precise clause setting out the respective ownership of such intellectual property is fundamental to protect the rights of all parties to the joint venture. Such a term will also cover the extent to which the parties may use each intellectual property outside the joint venture.
- Dispute Resolution and Governing Law
There is always a possibility of a dispute arising out of a joint venture. Accordingly, parties to a joint venture should always carefully consider and agree on the mode of dispute resolution. More often than not, the first attempt to resolve a dispute is by way of negotiation or mediation, and should such an attempt fail, the parties may choose to refer the dispute to either arbitration or court.
It is also vital in cross border joint ventures for the joint venture agreement to set out the rules and laws of the jurisdiction which will govern the joint venture should disputes arise. Parties to a joint venture from different jurisdiction should be more careful in their approach in the selection of the governing jurisdiction.
Factors to Consider Before Entering a Joint Venture
There are many factors for parties to consider prior to entering a joint venture. Such factors to be taken into consideration should encompass a balance of due diligence and business model. Preliminary due diligence on the following should be conducted:
- Identity of the parties;
- Reputation of the parties;
- Financial statements;
- Corporate structure of corporate parties;
- Nature and scope of business;
- Objectives of the parties for the joint venture;
- Parties litigation claims (if any).
Parties should consider appointing a legal professional to conduct preliminary due diligence on parties to an intended joint venture to avoid the possibility of future setbacks. This essentially minimizes future risks and promotes transparency between all parties to the joint venture.
Despite the profit potential of joint ventures, parties should always be careful in their consideration and thorough in their preparation for a joint venture. It is often extremely beneficial for parties to seek legal advice early in the negotiations process, as even the choice between different types of joint ventures and the suitability of each joint venture types to their business objectives and intentions can make all the difference between success and failure. The negotiations between parties to an intended joint venture may be quick or long drawn, but a well-negotiated and comprehensive joint venture agreement will certainly assist in minimizing risks in any joint venture.
Note: This article does not constitute legal advice to any specific case. The facts and circumstances of each and every case will differ and therefore will require specific legal advice. Feel free to contact us for complimentary legal consultation.