This is the latest article in our series exploring joint ventures in the Energy & Natural Resources sector. Previously we considered the legal mechanisms available to parties when seeking to terminate a joint venture faced with a deadlock situation. This article continues that theme by exploring the primary causes of termination, as well as listing the top ten issues to bear in mind when considering whether to terminate a joint venture.

Why do joint ventures terminate?

The enthusiasm and shared commercial goals which brought the joint venture participants together can dissipate for various reasons.

Termination for cause

It is possible that a joint venture will terminate as a result of an event of default. A well-crafted joint venture agreement (“JVA”) will specify the obligations of the joint venture parties and will clearly and accurately express those circumstances or events which constitute an ʻevent of defaultʼ. Commonly encountered event of default scenarios include: (i) insolvency of one party (or possibly its parent company), (ii) material or persistent breach of the JVA, (iii) change of control of a joint venture party (particularly if the party acquiring control is a competitor of the other joint venture party), or, (iv) an attempted transfer of a partyʼs interest in the joint venture other than in accordance with the JVA.

If an event of default occurs and the JVA does not contain any specific contractual remedies, then the innocent party may terminate and seek damages. Given the difficulty in quantifying the ʻlossʼ suffered, the JVA may contain a default ʻput and callʼ mechanism, which allows the innocent party either: (a) to acquire the shares of the defaulting party at a discount to fair value (although care should be taken to ensure that the discount is not so great as to constitute a ʻpenaltyʼ and, as a result, unenforceable) or (b) to sell its shares to the defaulting party at a premium to fair value (the premium acting as a deterrent to a party looking to engineer a default with a view to being bought out).

Fixed term or specific objective

Some joint ventures are established for a fixed term or for a specific objective. Once the term has expired, or the objective has been achieved, the joint venture automatically terminates, with the joint venture wound up and any assets distributed between the joint venture parties.

Termination as a result of an exit event

Joint ventures may come to an end simply through the sale of one or all partiesʼ interests in the joint venture (as was the case in the TNK-BP joint venture discussed in our first article). Please click here to view.

Termination due to deadlock

It is possible that, as a result of a deadlock, parties may be unwilling or unable to continue with the joint venture, resulting in an exit being sought. Our second article in this series contains more detail on this subject and highlights the various mechanisms available to deal with such a situation. Please click here to view. 

Key considerations when terminating a joint venture

We are often asked to advise on the key issues to consider when a party is contemplating bringing a joint venture to an end. In most instances, the business of the joint venture will continue and one party will simply acquire the joint venture completely and go it alone, on the basis that the interests of neither party are likely to be served if the business is broken up and the assets liquidated or a sale forced upon the parties. It is therefore from this angle that we have compiled the following list of top ten considerations. The key factors will, of course, vary depending on the structure of the joint venture. In the oil and gas sector, for example, contractual joint ventures are commonplace and so the considerations will therefore differ from those set out below.

1. Change of control

The joint venture company is likely to have entered into a number of commercial contracts with suppliers or customers. These contracts may provide that they can be renegotiated or terminated if there is a change in control or ownership of the joint venture company. These contracts should be identified prior to terminating the joint venture and appropriate consents obtained. Indeed, when negotiating such contacts, the definition of ʻchange of controlʼ should exclude the situation where one of the joint venture participants simply acquires outright control.

2. Risk profile

A joint venture is a popular vehicle for commercial activity in the Energy & Natural Resources sector due to the inherent uncertainty and risk associated with many types of energy projects. The number of variables, as well as the often significant capital requirements, particularly in offshore projects, means that it is often preferable for risk to be spread among one or more parties.

When termination of a joint venture occurs in circumstances where one party continues the business of the joint venture, then they do so with increased risk and will ultimately bear the sole risk of failure. A full and thorough risk assessment of the joint venture business should be carried out and measures taken to de-risk the venture to a suitable level, which may entail seeking a new partner.

3. Experience

In addition to the spreading of risk, experience will be a key determinant in selecting a joint venture partner at the outset. A party seeking to terminate a joint venture by buying out its joint venture partner will need to assess whether it alone has the requisite knowledge and experience to achieve the objectives of the joint venture. This will be material where there is a shortage of expertise in the particular field such as joint ventures involved in unconventional gas.

4. Financial considerations

If, as part of the termination, one party will acquire the other partyʼs interest then the acquirer should ensure that appropriate funding is in place for the initial purchase, which may require entering into capital/debt markets or even securing a new partner. It is also important to understand any existing finance provided to the joint venture by the exiting party, since this will undoubtedly require to be dealt with as part of the exit. If the exiting party requires its loans to the joint venture to be repaid, the remaining party should carefully consider its ability to refinance that debt.

5. On-going funding

It is also of critical importance that the on-going CAPEX and OPEX requirements of the joint venture business are understood to ensure termination does not result in a funding gap. The outgoing partner may also have granted a parent company guarantee in respect of the joint venture business, which may need to be replaced.

6. Assets

The joint venture may use assets, such as intellectual property or IT, which are owned by the exiting party. Consideration should be given as to how the joint venture business will operate without these assets or whether viable alternatives exist. If no reasonable alternatives exist then, as part of the exit, contracts will have to be put in place with the exiting party to ensure continued use (e.g. transitional arrangements, whether long term or for an appropriate run off period). Naturally these arrangements will come at a cost, which should be factored into the exit negotiations.

7. Goodwill protection

A well-drafted JVA will include controls on the use of confidential information shared for the purposes of the joint venture, as well as restrictive covenants which seek to protect the goodwill of the joint venture business. These provisions are likely to continue beyond termination of the joint venture, so the parties must fully appreciate what they can and cannot do following termination. An existing party will not want to discover that its core business is in fact caught by the non-compete restrictions within the JVA.

8. Staff

Responsibility for staff employed by the joint venture, either permanent or on secondment, can be problematic. Seconded staff are likely to return to their original employer, which may leave the joint venture under resourced. Alternatively, if the joint venture parties do not intend to integrate staff back into the parent businesses, the costs and related effects of redundancies will need to be considered.

9. Pensions

Any pension arrangements which have been put in place for the joint venture staff will merit consideration. Required actions will depend on whether the staff will transfer to another employer or be made redundant and also on the nature of the arrangements in place. The joint venture may have set up its own pension arrangements or used those of a joint venture party. The nature of the benefits provided by the arrangement will be relevant. A defined benefit arrangement with a funding deficit could have significant cost implications.

10. Tax implications

Tax implications will be a major consideration in deciding which method of termination is most appropriate for a specific joint venture. This article is based on the assumption that the joint venture is a limited liability company. In this case, the transfer of assets back to the joint venture parties on the winding up of the vehicle may give rise to a corporation tax charge (as well as stamp duty and VAT depending on the type of asset). The sale of shares in the joint venture by a joint venture partner may qualify for Substantial Shareholding Exemption, but would otherwise result in a corporation tax charge. It is also possible for a joint venture to be established as a partnership in which case the transfer of assets back to the partners can give rise to capital gains tax charges. Other taxes can apply depending on the assets and circumstances involved.

Do your homework

As is evident from the above, the effect of a termination event on the business of a joint venture can be far reaching. Joint venture parties should consider the wide range of commercial, operational, legal and practical issues which could arise as a result of terminating a joint venture. Indeed, joint venture parties would be well advised to carry out thorough due diligence in advance of any termination to ensure, where the intention is to continue the business, that: (i) the joint venture is sustainable; (ii) the value of the joint venture business will not be materially eroded, and (iii) there are no unwanted surprises following termination.