Setting up and operating a joint venture

Structure

Are there any particular drivers in your jurisdiction that will determine how a joint venture is structured?

Much consideration goes into determining the most suitable structure and vehicle for any joint venture in Canada. These include without limitation the following key drivers: the overriding business deal; the nature and location of the assets and the business being carried on, ease and cost of initial set up as well as ongoing maintenance and compliance; tax considerations of the entity or venture parties as well as any applicable accounting treatment; liability and exposure of the parties (including as partners, and any representatives on the Board and who participate in management); ownership of intellectual property and related issues; labour and employment considerations; regulatory and competition issues; length of duration of the venture; liquidity and transferability of interests in the venture including any exit and dissolution considerations. To be clear at every stage, legal analysis is considered in conjunction with business considerations in establishing any joint venture in Canada.

Tax considerations

When establishing a joint venture, what tax considerations arise for the joint venture parties and the joint venture entity? How can tax charges be lawfully mitigated?

Depending on the residence of the joint venture partners, a contribution of property to a joint venture may be effected in an income tax-deferred manner, thereby deferring taxable income or gain for the transferor. Pre-formation structuring can also facilitate an eventual exit strategy. Depending on the identity of the transferor and the nature of the property transferred, there may be sales or other transfer taxes that should be considered, as well as relieving measures that may be available. Consideration should also be given to the manner of funding the joint venture in light of interest deductibility and thin capitalisation rules.

Tax analysis and considerations should always be reviewed and taken into consideration in both selecting whether and what type of joint venture vehicle is desirable, as well as the terms of any such agreement governing the applicable joint venture entity. Pre-formation structuring can also facilitate an eventual tax efficient exit strategy. Consideration should also be given to the manner of funding the joint venture in light of interest deductibility and thin capitalisation rules. Depending on the identity of the transferor and the nature of the property transferred, there may be sales or other transfer taxes that should be considered, as well as relieving (including deferrals and elections) or possible mitigating measures that may be available. Depending on the residence of the joint venture participants (including whether as a direct or foreign controlled Canadian entity), a contribution of property to a joint venture may be effected in an income tax-deferred manner, thereby deferring taxable income or gain for the transferor.

Asset contribution restriction

Are there any restrictions on the contribution of assets to a joint venture entity?

Generally, there are few restrictions on the contribution by one or several joint venture parties of assets to a joint venture and such transfers range from, among other things, the transfer of real or personal property including cash, physical assets, or know-how and expertise, save and except for consideration of residency (foreign ownership), industry-specific restrictions on transfers or ownership and, in limited circumstances, the nature of the asset being conveyed. As is the case with any transfer and conveyance of assets, the respective parties should conduct adequate diligence, obtain appropriate representations, warranties and indemnifications by the transferor and assess and consider the ascribed value of such assets relating to the contribution and transfer (both in what is being conveyed and what is being paid for such assets).

Depending on the identity of the transferor and the nature of the property transferred, there may be sales or other transfer taxes that should be considered, as well as relieving measures that may be available. Depending on the residence of the joint venture participants (including whether as a direct or foreign controlled Canadian entity), a contribution of property to a joint venture may be effected in an income tax-deferred manner, thereby deferring taxable income or gain for the transferor. In many joint venture structures, assets are merely used by the joint venture for a specific purpose on agreed to terms but title and ownership remain with the original ownership. In this case, the implications and details of such use should be sufficiently dealt with in any agreement.

Interaction between constitution and agreement

What is the interaction between the constitution of the joint venture entity and the agreement between the joint venture parties?

In Canada, a joint venture is not itself recognised as a distinct form of legal entity, and accordingly there is no mandated priority in law between the ‘constitution’ of a joint venture and the contractual agreement between the joint venture parties. This would obviously only apply to a corporate joint venture or partnership joint venture structure (as opposed to a purely contractual joint venture where there would not be a ‘constitution’, whether it be the articles of incorporation and corresponding by-law for a corporate joint venture or declaration and any related documents for limited partnership). Joint venture parties should therefore always in the first instance ensure that that the contractual agreement and any constitutional documents are not in conflict with each other, and in any event it is customary to insert in the contractual agreement a paramountcy or prevailing clause that would require the constating documents be amended to confirm with the stated agreement or vice versa.

Where the joint venture is an incorporated entity, the issues and arrangement covered in the joint venture agreement can to a limited extent be incorporated into the articles (which are a public document) and accordingly this might not be desirable and can be dealt with in the main agreement. It is also recommended for several reasons that the joint venture entity be included as a party to the main agreement to ensure it is bound by appropriate covenants but also more importantly that it has contractual standing and privity to the extent necessary to enforce certain breaches or alleged breaches by the other joint venture parties.

It should also be noted that, as it relates to application to third parties between main agreement and articles, the articles (and corresponding governing law) would apply.

There is no requirement under Canadian law to register or file the agreement that governs a joint venture. It is a confidential private contract between the contracting parties.

Party interaction

How may the joint venture parties interact with the joint venture entity? Are there any restrictions?

As is the case between any contracting parties, the interaction between a joint venture entity and the joint venture parties will first and foremost (absent applicable governing laws for corporations and partnerships) be governed by the terms of the contractual agreements between the parties and, in respect of a joint venture that is a company or a partnership, it will be the governed by the terms of the contractual agreements and the constitutional documents of the joint venture entity and applicable law. Where the joint venture is a corporation or partnership, there will be additional statutory provisions applicable to the joint venture entities and their representatives’ interactions, and responsibilities and limitations that apply additional duties, rules and limitations or restrictions on how the joint venture parties (and their representatives) can interact with the joint venture entity. Often some or all of these statutory requirements are incorporated by reference or directly incorporated into the main contract.

In addition, and particularly where the venture parties are competitors (or potential competitors) or there are other sensitive relationship issues (supplier or customer, etc) between some or all of the joint venture parties, due consideration needs to be given and appropriate safeguards and protections needs to incorporated to ensure the protection of disclosure, use and dissemination of all proprietary and sensitive confidential Information as well as compliance with all applicable competition or consumer protection or other applicable laws in their sharing of information or the manufacture, development or provision or sale of goods and services.

The directors of a corporate joint venture are required to consider and discharge their statutory duty to act in good faith and in the best interest of the corporate joint venture entity including to declare and avoid conflicts of interest in relation to transactions or actions between the joint venture entity and the joint venture party they represent (in addition of course to any personal conflict). These duties often arise in circumstances where there are related-party transactions or disputes between a joint venture entity and one of the joint venture parties. Limited partners of a limited partnership should also not be actively involved in the management and control of the limited partnership joint venture (hence the general partner).

Exercising control

How may the joint venture parties exercise control over the joint venture entity’s decision-making?

In a contractual joint venture structure, the decision-making function is strictly contractual among the various joint venture parties. Therefore, the contract itself will govern all decision-making requirements (including any minority investor approval). There is an unlimited number of potential thresholds and provisions to deal with contractual decision-making, including weighting to a notional voting right among joint venture participants based on an agreed criteria, or specific enumerated activities or matters that require either all or specific joint venture party approval, as well as veto or other rights in favour of joint venture parties.

In an incorporated joint venture, absent a shareholders agreement or a legal governing law requirement for special approvals (ie, special approval for fundamental matters of two-thirds shareholder approval) any shareholder with an interest of more than 50 per cent will be able, effectively, to control the joint venture, including through the power to appoint and remove directors as it sees fit and to pass majority votes of shareholders on certain matters or actions. Therefore, in the absence of any joint venture agreement to the contrary, minority investors in a corporate joint venture have relatively few rights to exercise control over a joint venture entity’s decision-making. Accordingly, it is often recommended for the protection of minority investors to seek additional, supplemental contractual rights, proportionate to the size of their holdings in the corporate joint venture, under the joint venture agreement, including board representation based on holding specific percentage interest (or transparency of actions or proposed actions, or even non-voting oversight attendance at board meetings) or extraordinary approval for certain enumerated fundamental decisions.

All corporate governing statutes in Canada provide for some form of protections and shareholder rights against certain oppression and provide derivative and others rights that are intended to protect shareholders from action that otherwise is in breach of the statute or harms the investor, provided, however, in those circumstances, the minority shareholder applies to the court for appropriate relief (including injunctive relief).

Governance issues

What are the most common governance issues that arise in connection with joint ventures? How are these dealt with?

There is no shortage of potential governance issues that arise in connection with joint ventures in Canada; however, the most common governance issues that arise in connection with joint ventures in Canada are generally:

  • the ongoing obligations and responsibilities of the joint venture parties, including management of day-to-day activities, particularly if those functions are performed by a joint venture parties representative and not an independent employee;
  • decision-making powers, including thresholds and what constitutes fundamental decisions (these are particularly important in multi-party joint ventures (ie, where there are more than two equal joint venture parties)) and how to deal with deadlock situations; and
  • how to identify, manage and resolve conflicts between the interests of the joint venture entity and the interests of the joint venture parties.

 

In most joint venture arrangements, management has responsibility for day-to-day decisions and operations of the joint venture, but key decisions or fundamental actions are reserved for approval by the joint venture parties themselves through some form of approval mechanism. Obviously, this also has potential for governance disputes or stalemates where the parties are not able to decide, so a well-drafted dispute mechanism (including through various escalated processes) is often implemented in the joint venture agreement. It Is imperative to the success of the joint venture that all governance issues be resolved in a timely, efficient and transparent manner and ideally to the satisfaction of all parties.

Nominee directors

With an incorporated joint venture, what controls exist in your jurisdiction in relation to nominee directors? How should a nominee director balance the potentially conflicting interests of the joint venture company and the appointing shareholder?

In Canada, all federal and provincial corporate governance statutes (as well as common law) have strict and defined statutory duties that govern directors, including without limitation the duties to act in good faith act in the best interests of the joint venture corporate entity and to avoid and declare conflicts of interest, to promote the success of the company, and to accordingly act in the interest of the of the joint venture corporate entity and not in the interest of the nominee joint venture shareholder party. A director that finds himself of herself in a conflict must disclose the conflict and in certain circumstances must refrain from voting on the matter. There are other ways to manage conflict issues, such as by incorporating strict conflict provisions with an alternative decision-making process (ie, matters approved by balance of the non-conflicted board, or in most cases to elevate such approval to the shareholders).

Alternatively, to avoid potential conflict, fundamental enumerated decisions that have been identified as potential conflicts of interest could be removed for the decision-making function of the board and could be reserved for approval by the shareholders. This approach would avoid the director having to determine whether they are in fact in a conflict (or any perception that a conflict exists, whether declared or not) and ultimately places responsibility for such approval with the joint venture shareholders as the shareholders are not subject to any statutory duty to declare and avoid conflicts of interest that the director is subject to. Shareholders (even a majority) are, however, under conflict and other obligations where they are in unique relationships with the joint venture entity (ie, a customer or supplier or transacting with the joint venture entity). In such a situation, the relevant shareholder needs to carefully discharge its obligations and ensure that it does not act oppressively or otherwise in a harmful manner against the interest of the other joint venture shareholders.

Competition law

What competition law considerations are engaged by the formation and operation of the joint venture? Is approval needed?

Merger control in Canada is governed by the Competition Act (CA), which includes provisions for mandatory pre-closing notification and substantive merger review. The former apply only if certain thresholds are exceeded, whereas the latter can be applied to any merger regardless of whether the applicable thresholds are surpassed.

The substantive merger review provisions apply to any ‘merger’, which is defined broadly as the acquisition, in any manner, of control over, or of a significant interest in, the whole or part of the business of another person. Joint ventures are generally considered ‘mergers’ under the CA and are therefore subject to substantive merger review provisions. Joint ventures may also be subject to pre-merger notification where the relevant shareholding or percentage interest, size of transaction and size of parties’ thresholds are exceeded. Notably, however, certain unincorporated joint ventures are exempt from notification and substantive review where (among other things):

  • there is a written joint venture agreement that will govern a continuing relationship between the joint venture partners;
  • there is an obligation on one or more of the joint venture partners to contribute assets to the joint venture;
  • the transaction does not involve a change of control over either of the joint venture partners;
  • the joint venture’s range of activities is restricted through a written agreement; and
  • written provision has been made for the orderly termination of the joint venture.

 

Joint ventures may also be subject to scrutiny under other, non-merger provisions of the CA. For example, joint ventures may be scrutinised under section 90.1 of the CA, which applies to all agreements between competitors (other than those covered by the criminal conspiracy provision) that are likely to result in a substantial lessening of competition, or section 79 of the CA, which prohibits abuse of dominance (including joint abuse of dominance).

Provision of services

What are the key considerations in your jurisdiction in structuring the provision of services to the joint venture entity by joint venture parties?

It is not uncommon in Canada for a joint venture party to provide services, technology or other expertise to the joint venture entity as it is often one of the reasons for the formation of the joint venture entity to begin with. There are several issues that arise when a joint venture party provides services to the joint venture but for the most part they are commercial and tax focused. The list below is not exhaustive but should be considered in each instance:

  • Are the parties acting at arm’s length, under market terms and with competitive rates, etc, and what are the implications (tax, accounting, etc) if they are not?
  • Ensure that the service provider is acting in its capacity and not on behalf of the joint venture entity in performing such services or dealing with third parties (this may be key as it relates to liability and insurance coverages).
  • What is the consideration, is it fair market or on competitive terms, and how is that determined?
  • What happens where there is a dispute in the performance or payment for such services, and what are the liability, indemnifications and other rights and obligations between service provider and joint venture entity?
  • What are the rights to terminate and replace the joint venture service provider?
  • What if any bearing on the joint venture participation and rights and obligations of the various joint venture parties might arise from such service arrangement, the termination thereof and any relationship dispute?

 

Where services are to be provided across borders, consideration should be given to transfer pricing rules. In addition, to the extent that services are provided in Canada by a non-resident person, withholding taxes will generally be exigible. Provision of services within Canada by a non-resident will also generally give rise to Canadian tax compliance obligations for the service provider.

Employment rights

What impact do statutory employment rights have in joint ventures?

Where assets or a business or part thereof are being conveyed by one joint venture party into a joint venture entity it is not uncommon for employees to either be transferred as part of such conveyance or seconded to such business for a period of time and on specific terms. There are statutory and common law labour and employment law implications in Canada for either scenario that must be canvassed and adequately dealt with. These would include, among other things, ensuring full compliance with any and all collective or other similar agreements and adequately dealing with any successor business obligations as well as any severance and termination rights that might be triggered as a result of either scenario.

There may be ways to structure such a transfer or secondment to avoid terminations (and corresponding severance, termination and other obligations) provided the terms of such employment are on substantially the same terms of current employment and other relevant factors are considered and appropriately dealt with. Assuming no union or other association agreement, it is not a requirement in such cases to get employee permission or consent provided a mass or other termination is not triggered by such arrangement. It should also be noted that where existing businesses or assets are being transferred and contribute to the joint venture, Canadian labour and employment law can under the successor employment rules operate to automatically transfer employees associated with the relevant business or assets, or alternatively where employment is not offered or terms are materially changed can trigger a termination of employment giving rise to termination and severance and related obligations. If such a transfer occurs, legal restrictions are imposed on the joint venture’s ability to terminate these transferring or seconded employees, or make material changes to their terms of employment or working conditions without giving rise to liability and obligations. Often, the obligations and risks relating to transferred or seconded employees are contractually allocated between the joint venture party transferring the assets and business and the joint venture itself.

Intellectual property rights

How are intellectual property rights generally dealt with on the creation, operation and termination of a joint venture in your jurisdiction?

In Canada, it is very common for parties to combine resources and expertise as a joint venture structure to develop, implement or manufacture and sell technology or intellectual property. Accordingly, an important part of establishing any joint venture is addressing the intellectual property ownership and others’ rights, including the right to exploit such intellectual property or inventions derived therefrom in the definitive joint venture agreement. Initial description of any transferred or licensed intellectual property (as well as appropriate diligence and confirmation of ownership and infringement (including transfers from any inventors)), as well as ongoing detailed reporting of developed new technology during the course of the joint venture should be cornerstones of any definitive joint venture agreement that has an intellectual property focus.

Often, parties will approach a joint venture scenario already owing technology or intellectual property and such joint venture party will want to ensure that it maintains rights in such intellectual property notwithstanding the joint venture arrangement.

Although in Canada there is no prescribed treatment of intellectual property rights specific to a joint venture entity, it is prudent and incumbent for the joint venture parties to negotiate and agree prior to establishing the joint venture all material the terms relating to intellectual property (whether it be conveyed into, or used by the joint venture to develop additional technology) in respect of the creation, operation and termination of the joint venture. Such arrangements range from a joint venture party retaining ownership of any intellectual property to be used by the joint venture, whether by licence, or mutual reciprocal licence (where the owner retains rights in the technology) to all ownership and use rights in intellectual property and derivatives thereof being for the sole benefit of the joint venture to other agreed arrangements.

Where the intent is for the joint venture itself to create and own the intellectual property, the joint venture parties will need to agree whether this intellectual property will be licensed to them and, if so, on what terms. In certain circumstances, competition issues may arise where joint venture creates technology based on licensed Intellectual property from one of the joint venture parties or where it is co-owned or shared among the various parties.

Ownership of intellectual property shared between the joint venture and the joint venture parties, although possible, is rarely advisable given the potential for dispute, as well as competition and transferability issues and limitations.