For some time now it has been recognised that joint ventures (JVs) are on the rise in Australia and internationally. Historically, particularly if assessment is made of the advancement of the multi-unit firm during the 20 Century, corporate growth primarily occurred through acquisition.
The narrative on economic history focuses on rapid corporate expansion in the US and Europe during the second half of last Century driven by the desire for vertical integration – forward into distribution to secure sales volume and backward into raw materials to ensure throughput of inputs. However, in modern business, JVs and strategic alliances are seen by many as a more promising alternative to acquisition or merger transactions, particularly in times of economic uncertainty.
Our experience underscores this evolution. In a post-GFC economy, we are now seeing more clients negotiating and forming JV agreements with domestic partners and internationally (particularly when doing business in China). This approach is not limited to big business. Start-up and other growing small businesses view JVs as an opportunity to expand into new markets and new products. For many, a JV seems to present an ideal solution: the parties can pair their complimentary skill set to achieve common objectives that they otherwise couldn’t fulfill on their own.
But despite the perceived advantages, JV arrangements often fail - the objectives of the JV are not achieved; the underlying project does not conclude; irreconcilable differences between the JV parties emerge. While this is not the case for every JV, in our experience, JV arrangements are poorly understood and regularly end in dispute. Our firm has acted on 5 significant JV-related disputes in the last 2 years. These disputes are time-consuming, expensive and take a toll on all parties to the arrangements.
What is a JV?
A JV has been defined in case law as an association of persons for the purposes of a particular trading, commercial, mining or other financial undertaking or endeavour with a view to mutual profit, with each participant usually, but not necessarily, contributing money, property or skill.
Despite this conceptual definition, generally speaking (and subject to our observations in relation to fiduciary obligations below), there are no strict limitations on how the relationship between JV parties can be structured. The underling JV agreement can establish a unique set of rights and obligations that the parties wish to govern their relationship. Furthermore, JV’s may be incorporated or unincorporated. Typically, an incorporated JV involves the JV parties incorporating a new company, holding shares in that company and entering into a shareholders’ agreement that governs the operation of the JV company. Under an unincorporated JV structure, the parties remain separate and enter into a JV agreement that sets out how their relationship will be governed. The flexibility of these attributes adds to the perceived attraction of using a JV structure.
However, it is well settled at law that the terms of a JV agreement may produce a fiduciary relationship between the parties. Contrary to the position with respect to partnerships, the existence and scope of fiduciary obligations owed by JV parties to one another is determined by examining the unique circumstances of their relationship and, in particular, whether a party has undertaken to act in the interests of another (and not just in their own interests). Given the nature and purpose of JVs, this will be the case in most JV arrangements.
As a result, JV parties usually owe each other a higher standard of care when compared to other contractual relationships. Furthermore, while the contractual obligations may be clearly set out in a JV agreement, the nature and scope of the fiduciary duties owed to one another may be broad reaching and commercially difficult to define. These variables can be dangerous when the relationship breaks down.
Why do they fail?
Despite all that they promise, our experience (and anecdotal evidence when assessing recent cases passing the Equity Lists of the NSW Supreme Court and courts of other jurisdictions) indicates that JVs have a high tendency to fail and end in dispute. Due to the often complicated legal relationship between the parties (and, sometimes, poorly drafted JV agreements) the consequences of failure can be devastating.
So why don’t JV’s work? In our opinion, in the case of JVs, it is the very thing that creates potential that simultaneously weakens the structure. While JVs present businesses with an opportunity to combine different (yet complementary) skills sets and resources to achieve common goals, the bringing together of these separate organisations (with different structures, cultures and, importantly, discordant end-game objectives) to work towards a particular outcome is typically the catalyst of most JV failures.
This inherent feature of JV relationships is often exacerbated when the JV parties and JV agreements also fail to properly address how differences of opinion, direction or priorities are to be managed.
Considerations for successful expansion
While JVs are (and will continue to be) a popular option to expand into new markets, significant care needs to be taken when: (1) determining whether a JV is the right structure in the circumstances; and, if it is, (2) preparing a JV agreement that appropriately mitigates the inherent risks in using a JV structure.
The parties should strongly consider whether alternative structures, such as a partnership or a particular strategic contract, may be a more appropriate way to govern the commercial relationship (and avoid the risks often presented with using a JV structure). Where it is decided that the parties will proceed with a JV structure, it is essential that the JV agreement incorporates a clear and effective dispute resolution mechanism. This will require a lot of thought (and negotiation) between the parties at the outset.
Our top tips for those considering or negotiating a JV structure are:
- Explore all the options. Don’t simply settle on another party’s suggestion that a JV is the right structure. You should always do your research and obtain appropriate structuring advice before agreeing that the JV structure is the best option.
- Consider each party’s culture and whether they may (or may not) be compatible.
- Clearly set out the key objectives of the JV in the JV agreement. This will assist in resolving potential divergences and disputes between the parties later on.
- Make dispute resolution a priority when negotiating how the structure will work. Most joint venturers do not ever expect that a dispute will arise and, therefore, fail to properly turn their mind to how any such dispute would or could be resolved if, and when, one arises. This often results in a JV agreement that doesn’t provide guidance as to how differences of opinion or direction will be resolved or fails to do so in a manner that actually assists in resolving the problem.
Contributor - Ryan Gray