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?

Two primary drivers in determining how a joint venture is structured (contractual versus legal entity) are tax regulation and accounting rules. Depending on the structure, the joint venture parties will need to address issues such as gain recognition in connection with contributions of assets, consolidation issues and the possibility of subjecting a foreign person to US taxes and jurisdiction. Additionally, if forming a legal entity, the type of legal entity chosen by the joint venture parties may have a significant impact on the tax implications for such parties. In general, a corporation will be subject to corporate income tax and its shareholders will be subject to a tax on the dividends they receive (ie, double taxation), whereas a partnership or limited liability company, in general, will not be subject to an entity-level tax and will pass through its tax attributes to the owners for their payment (ie, a single level of tax). See question 6 for a more detailed discussion of tax considerations in connection with creating and operating joint ventures.

Other drivers in determining how a joint venture is structured include governance and operational control. The parties should expect to spend considerable time discussing how the joint venture will be managed. In comparison to M&A transactions, where one party will emerge as the controlling entity, in a joint venture, the joint venture parties will need to define governance control (ie, board-type decisions) and operational control (ie, day-to-day operational activities) of the joint venture. These discussions will play a large role in determining how to structure a joint venture. It is important to understand that joint venture parties often have competing interests and agendas, and in a long-term relationship, it is imperative that the joint venture structure and documents appropriately address how decisions are made.

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?

As noted above, tax considerations will play a major role in determining how to structure a joint venture. Accordingly, parties will want to engage tax counsel and accountants very early in the process. The ultimate structure of the joint venture will want to address each of the following:

  • tax consequences of forming the joint venture;
  • what is the most efficient structure during the operations of the joint venture to achieve the most tax-efficient flow of earnings for the joint venture parties; and
  • what type of structure will achieve the most tax efficient exit or termination at the end of the alliance.

It is important for the joint venture parties to consider tax consequences over the life of the joint venture at the onset. Additionally, foreign investors may prefer a corporate joint venture structure to avoid falling into the US tax net for the operational life of the joint venture.

Asset contribution restriction

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

Generally, there are no restrictions on the contribution of assets to a joint venture entity. However, there are some consequences of contributing assets that should be considered when determining how and what types of assets are contributed. For example, an investor in a joint venture that contributes services in return for an ownership interest in the joint venture may have to include the value of such ownership interest received as taxable income. Additionally, there may be regulatory restrictions that are triggered by the contribution of assets to a joint venture. For example, if two entities that are otherwise competitors in a market contribute specialised assets to the joint venture that previously enabled them to compete, such contribution may raise antitrust issues if it inhibits competition going forward and may require regulatory approval. And depending on the applicable industry in which the joint venture participates (eg, energy, healthcare, etc), there may be restrictions based on applicable industry-related regulations.

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?

While the laws of each state vary, in general, most statutory governance requirements may be waived by the joint venture parties in their governing agreement. These even typically include the ability of joint venture parties to waive certain fiduciary duties that may otherwise be imposed by state law. In most states, including under Delaware limited liability company law, the members of a limited liability company have substantial freedom to determine the business and legal relationship of the members. Accordingly, the joint venture agreement will typically take precedence over the controlling state statute. In most states, when a joint venture entity is formed, a charter document must be filed with the state. The charter document may include - but is typically not required to include - the particular terms of the parties’ agreement regarding governance of the entity. However, an entity is generally not required to publicly file the document, which typically contains most of the relevant provisions regarding how an entity is managed (for a limited liability company, this is often referred to as the LLC agreement or operating agreement).

Party interaction

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

Depending on the form of the joint venture entity and the specific state whose laws govern the joint venture entity, the joint venture parties are typically free to contractually establish the parameters governing how they interact with the joint venture entity. However, the joint venture parties should consider the statutory framework that governs the joint venture entity. For example, if the parties choose to form a limited partnership, the statutory code of the jurisdiction of formation may restrict the limited partner’s interaction with the joint venture entity, and if the parties choose to form a corporation and officers or employees of the joint venture parties serve as directors of the joint venture entity, such individuals will owe certain fiduciary duties to the joint venture, unless such duties are waived. If the joint venture parties choose to establish a joint venture contractually - rather than via the formation of a new legal entity - in many cases, there will not be an underlying legal framework setting forth how the parties may interact and, unless contractually established, the joint venture parties will not owe fiduciary duties to each other.

Exercising control

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

Parties to a joint venture can allocate control over the joint venture entity through negotiating provisions in the entity’s governance documents. For instance, the structure of a board of directors or board of managers can be established, including which joint venture parties are empowered to appoint individuals to those board seats. This can be especially beneficial to minority investors, as provisions in the governance documents can ensure that minority investors have control over the joint venture’s decision-making or, at least, with regard to certain major decisions. In addition, it is common for joint venture agreements to include certain routine decisions that may be made by the controlling members of the joint venture, as well as provisions that require certain material and fundamental decisions (ie, large investments or capital expenditures, acquisitions, dissolutions, etc) to be made by a super-majority or by all members of the joint venture in order to protect the interests of minority investors.

Governance issues

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

Some of the most common governance issues include:

  • who will govern the joint venture entity or the contractual alliance (ie, manager or board, etc);
  • how decisions affecting the joint venture will be made;
  • what fiduciary (or similar) duties apply to the governing members or other controlling persons; and
  • how the joint venture parties address a situation where a mutual decision cannot be made (ie, deadlock).

Each of these issues is related and must be carefully and deliberately discussed by the joint venture parties; in many ways, this is what makes a joint venture unique. How these issues are decided will depend greatly on the types of parties involved, the extent of their investment in the joint venture, the expertise each party brings to the joint venture, and the nature and purpose of the joint venture. The governance issues are typically one of the most discussed topics in forming a joint venture.

In 50/50 joint ventures, the parties will often form a board of directors or managers that include equal board seats. With equal board seats, so long as the parties’ interests are aligned, the decision-making process is frequently not an issue. However, if interests are not aligned, the parties will need to have provisions that address deadlock situations. See question 21 for a more detailed discussion of deadlock provisions commonly used in joint ventures in the US.

For joint ventures that are not 50/50 and include minority investors, the joint venture parties will most likely be discussing minority investor protections, such as providing board seats for minority investors or different approval thresholds for certain decisions by the joint venture, as discussed above.

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 an incorporated joint venture, the joint venture parties (eg, the shareholders) may generally establish the framework by which directors of the corporation are nominated and elected via the bylaws or other organisational documents of the corporation. Generally, the directors of a corporation owe certain fiduciary duties to the corporation that may be incongruent with the responsibilities or duties the director owes to the joint venture party. If the parties desire that certain individuals serve as directors of the corporation and such individuals have conflicting duties, the joint venture parties should consider forming the corporation in a jurisdiction that permits the modification or waiver of such duties, or forming a different type of entity that would not require such individuals to comply with certain typical fiduciary duties. For instance, the General Corporation Law of Delaware permits corporations to waive the director’s fiduciary duty of loyalty. In addition, certain types of entities - in particular, limited liability companies - do not require their members or managers to observe the same fiduciary duties as directors of corporations. In addition, under many state statutes that govern limited liability companies, members may expressly agree that they may compete against the joint venture.

Competition law

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

US competition or antitrust law is governed by several sources, including federal and state statutes, case law interpreting and applying these laws, and various agency regulations. The most important federal antitrust statutes are the Sherman Act and Clayton Act, which generally promote competition and aim to protect consumers from anticompetitive business practices. The Hart-Scott-Rodino Act (the HSR Act), which Congress passed in 1976 and which amends the Clayton Act, is particularly relevant to parties looking to form a joint venture. The HSR Act’s requirements to file notifications with the Federal Trade Commission and the Antitrust Division of the Justice Department for certain transactions may apply to joint ventures, depending on the size and structure of the transaction and the joint venture parties themselves. If a filing is required, the HSR Act establishes waiting periods that must elapse before such a transaction may be consummated, and authorises the enforcement agencies to stay those periods until the joint venture entities provide certain additional information about the likelihood that the proposed transaction would substantially lessen competition in violation of section 7 of the Clayton Act.

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?

There are several key considerations in structuring the provision of services to the joint venture entity. One consideration is determining what expertise and skills the joint venture parties bring to the joint venture. For example, joint ventures often form based on one party being the industry expert (eg, a developer of energy projects) and another party providing the funding for the purpose of the joint venture (eg, an investor providing capital to support the development and construction of new energy projects). In these scenarios, each party’s role in the joint venture will govern how the services to the joint venture are provided.

Another consideration, if applicable, will be where the employees performing the services for or on behalf of the joint venture are employed. The parties will need to decide if the joint venture will have its own employees or if employees of one of the joint venture parties will provide services to the joint venture entity (often through a separate services agreement with the joint venture entity).

Third, there are tax considerations that will be implicated in deciding how services by the members are provided to the joint venture entity. For tax purposes, careful attention will need to be given in determining how funds generated by the joint venture entity flow to the joint venture parties (ie, as distributions from the joint venture entity or as compensation for services by a joint venture party). These decisions may have a significant impact on the overall tax consequences to the joint venture parties.

Employment rights

What impact do statutory employment rights have in joint ventures?

As discussed above, statutory employment rights will generally apply to a joint venture entity only if it has its own employees. As noted above, the joint venture parties often enter into a services agreement with the joint venture entity to provide certain services that would otherwise typically be provided by an entity’s employees. If a joint venture entity has its own employees, the joint venture entity will need to comply with applicable statutory employment rules, such as rules relating to hiring and firing employees, safe workplace environments and any applicable employee benefits and reporting obligations. If a joint venture is formed contractually, rather than via forming a new entity, the joint venture parties should be clear in such documentation how employment obligations, etc, are allocated and can contractually agree to have the intended employer protect the other joint venture party if it becomes statutorily liable to an employee of the intended employer.

Intellectual property rights

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

Typically, certain intellectual property (IP) rights are licensed to the joint venture entity by the joint venture parties upon the creation of the joint venture entity. However, parties must be careful to specifically state what they are licensing to the joint venture, the terms and conditions governing such a licence and what they are not licensing or contributing to the joint venture. In addition, at the creation of the joint venture, the joint venture parties typically determine how the joint venture will treat jointly developed IP, derivative IP and the ownership thereof. In particular, joint venture parties are often particularly focused on jointly owned IP, as joint ownership can result in future conflicts with regard to enforcement and commercialisation of such IP and with regard to the exit of the joint venture.