Q&A: setting up and operating a joint venture in South Africa

Setting up and operating a joint venture

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

The most common factors driving the structure of a joint venture will be the parties’ preferred tax treatment of the joint venture, competition law concerns and accounting (eg, whether the parties want to consolidate the joint venture in their accounts).

Apart from the above reasons, limited liability is generally the driver determining the type of joint venture. It is not possible under South African law to have an incorporated or limited liability partnership, and common law partnerships expose partners to joint and several liability for the partnership debts. For this reason, incorporated joint ventures are more common. There are also other legal issues with partnerships that parties must consider in determining the structuring of a joint venture. For example, partnerships, not being separate legal entities, generally come to an end if one of the partners leaves. This is not the case with companies that have perpetual succession and changes in membership do not affect the existence of the company.

There are also practical considerations that may play a role in determining the structure of a joint venture – partnerships are established and operated by contract, and are, therefore, easier to establish and operate than companies.

An additional important consideration in South Africa in structuring joint ventures is black economic empowerment. There may be certain instances where a joint venture would need to be structured with a particular shareholding that qualifies as a ‘black shareholding’ in terms of the broad-based black economic empowerment measures applicable in South Africa. In addition, there may be certain requirements for directors on the board or management of the company that qualify under the black economic empowerment measures.

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?

There are generally no tax costs in setting up a joint venture as a company or a partnership. If the joint venture is set up as a company, the company is generally the taxpaying entity and there will only be tax on distributions to shareholders. Because a partnership is not defined as a person for normal tax purposes, it is not a taxable entity. For certain other purposes (for example, value added tax), however, the partnership is regarded as a body of persons, but only for those purposes. Since a partnership is not a taxable entity and its individual partners are liable for normal tax on their portion of the partnership’s profits, the income that has been received by a partnership is deemed to have been received by the partners individually on the same date as the receipt of the book by the partnership, in accordance with their profit-sharing proportions as set out in the partnership agreement.

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

There are no general restrictions on the ability of joint venture participants to contribute assets to the joint venture. If the joint venture is an incorporated joint venture, the contributions would take the form of subscriptions for shares. The consideration for the shares can be money, property, labour or anything else undertaking a promise or an agreement.

If the joint venture is a partnership, contributions take the form of money, knowledge, experience, expertise or labour, or their equivalents. Because the partnership does not have separate legal existence (distinct from the partners composing it), its property is owned in common by the partners in undivided shares.

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

This depends on the type of joint venture. The position under the current South African Companies Act differs from the position that had prevailed in South Africa prior to the commencement of the South African Companies Act in 2011. Previously, it was possible for the shareholders in a joint venture company to enter into a shareholders’ agreement and provide that the shareholders’ agreement prevails in the event of a conflict between the shareholders’ agreement and the company’s articles of association. Under the current South African Companies Act, this is no longer possible. The South African Companies Act provides that a shareholders’ agreement must be consistent with the South African Companies Act and the company’s memorandum of incorporation (its constitution), and any provision of such shareholders’ agreement that is inconsistent with the South African Companies Act or the company’s memorandum of incorporation is void to the extent of the inconsistency. This has resulted in joint venture parties including more provisions in the memorandum of incorporation to remove any inconsistency and the risk of such provision being void.

The memorandum of incorporation must be filed (registered) with the Companies and Intellectual Property Commission. There is no requirement for the shareholders’ agreement to be registered, but sometimes parties file the shareholders’ agreement together with the memorandum of incorporation and incorporate its terms by reference to avoid any inconsistency between them that may result in the shareholders’ agreement being void.

Partnerships are not regulated by statute and are governed by contract. The partnership agreement serves as both the constitution of the partnership and the agreement regulating the partners’ relationship. A partnership agreement does not have to be registered.

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

The rules differ depending on the type of joint venture.

In the case of companies, interaction between the joint venture parties (shareholders) and the company is regulated by the South African Companies Act and the company’s memorandum of incorporation. Generally, such interaction takes place at shareholders’ meetings. Matters such as information sharing are regulated by the South African Companies Act and the company’s memorandum of incorporation (and, to a lesser extent, the shareholders’ agreement). Information given to directors nominated by a specific shareholder can generally not be shared with the shareholder nominating the director. Sometimes the memorandum of incorporation will include a specific provision allowing such sharing of information, but it will be subject to the directors’ fiduciary duties, which will generally allow the sharing of the information by the director.

Partnerships in South Africa are not legal entities. In other words, a partnership is not recognised under South African law as a legal person. The interaction between the partners is purely contractual. Partnerships are largely unregulated and information sharing between partners is unrestricted. Partners have a duty to observe good faith, which includes a duty to guard against a conflict of interest. The duty to guard against a conflict of interest means that a partner may not place itself in a position where such a partner’s private interests may conflict with the partner’s duty towards the partnership. It also means that a partner may not use information that it obtained for its own benefit if such action would conflict with the partnership’s interest. The general principle underlying the fiduciary duty of a partner is that it may not acquire, or retain for itself, any benefit or advantage that falls within the scope of the partnership’s business and that it is the partner’s duty to acquire for the partnership.

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

South African incorporated entities transact the majority of their business by a simple majority decision of the board of directors or by majority votes of the shareholders. Therefore, in the absence of any agreement to the contrary, minority investors have relatively few rights by operation of law to exercise control over a joint venture entity’s decision-making process. This is particularly the case in an incorporated joint venture where a majority shareholder with an interest of more than 50 per cent will be able to effectively control the joint venture, including through the power to appoint and remove directors. As such, it is customary that minority investors seek the additional ability to block controls by a majority shareholder in these circumstances and this additional protection should be included in the memorandum of incorporation.

In the case of a company, the joint venture parties, as shareholders, generally exercise control of the joint venture through reserved matters, which are matters that cannot be undertaken by the company without a specified majority of shareholders approving such matters. Shareholders may nominate directors to the board, but directors owe fiduciary duties to the company when they make decisions and cannot generally act on the instructions of the shareholder who nominated such a director. Having said this, it is also possible to provide that certain board decisions can only be made with the consent of all of the directors.

In a partnership, control of the partnership by the partners is exercised by including reserved matters in the partnership agreement that cannot be undertaken by the partnerships or the partners without the consent of a specific majority vote.

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

The most common governance issues that arise in connection with joint ventures relate to the split between the daily operations of the business and the overall supervision of the daily operations. Generally, whether the joint venture is operated through a company or a partnership, there would be an operating or management committee that would be responsible for the daily operations of the partnership or the company. This body would have some sort of delegated authority to make certain decisions on behalf of the company or the partners. There would generally be oversight of such an operating or management committee, either by the board or by the partners themselves. In the case of a company, certain decisions may also be reserved for decision-making by the shareholders of the company.

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?

Generally, directors – whoever nominates them – owe fiduciary duties to the company and must act in the best interests of the company. This means that directors are not allowed to act in the best interests or on the instructions of the shareholder who nominates them. The director should always act in accordance with this fiduciary duty, and cannot balance the conflicting interests of the joint venture company and the appointing shareholder. This generally means that the director considers only the best interests of the company and only where those interests coincide with the interests of the nominating shareholder can the director take into account the interests of the nominating shareholder. The fiduciary duties owed to the company are paramount.

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

The formation of a joint venture may require merger approval from the competition authorities if it results in a direct or indirect acquisition of, or an establishment of direct or indirect control over, the whole or part of a business of another firm and if it meets the financial thresholds for a notifiable merger. There is no exclusion in South Africa in respect of non-full-function joint ventures. Instances in which there may be an acquisition or establishment of control include the following:

• a transaction where two or more firms acquire joint control over an existing entity or the whole or part of a business in circumstances where at least one of the firms did not previously have control; and
• a transfer of interests, assets or the whole or part of a business to a joint venture entity resulting in an acquisition of control by the joint venture entity over those interests, assets or business.

A transaction where two or more firms create a new entity over which they exercise joint control and contribute, for example, funds and know-how is unlikely to require merger approval, provided there is no transfer of interests, assets or the whole or part of a business to the joint venture entity.

Joint ventures are often pro-competitive and efficiency-enhancing; for example, a joint venture may facilitate entry into a market that may not have been possible to enter independently. However, joint ventures between competitors may present competition law risks. It is imperative that any joint venture between competitors has a legitimate purpose and only places restrictions on the joint venture parties that are commercially necessary for the operation of the joint venture. In addition, agreement between competitors on issues such as price, quantity and quality should only be reached if it is ancillary to the legitimate purpose of the joint venture. Information-sharing protocols should be put in place to prevent the sharing of competitively sensitive information that goes beyond that which is required for the operation of the joint venture.

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 common for joint venture parties to provide services to the joint venture entity. The key considerations in structuring these provisions are tax issues and the rules relating to conflicts of interest under the South African Companies Act.

Commercially, joint venture parties will want to assess whether the provision of services will be at arm’s length and whether they will need to negotiate the provisions of any services with the joint venture parties.

It is also important to consider the nature of the services being provided or whether the joint venture is carrying out regulated activities, as this may lead to additional regulatory scrutiny over the contractual arrangements and may also require specific mandatory terms to be included in any contract.

What impact do statutory employment rights have in joint ventures?

South African employment law is generally favourable to the employees, with specific statutory rights given to employees in various labour laws. For example, employees have a statutory entitlement to paid leave, the right to strike and statutory protection against retrenchments. Generally, these would apply to a joint venture in South Africa and employees who are employed in the joint venture would enjoy these statutory protections. If there is a transfer of the employees from the joint venture parties to the joint venture, in certain circumstances the joint venture entity would be responsible for recognising certain employment protections prior to the transfer of the employees to the joint venture (mainly, if there is a transfer of the business of the joint venture parties to the joint venture entity as a going concern). Secondments from the joint venture parties to the joint venture entity itself should be considered carefully, as some of the statutory rights may attach to the joint venture entity.

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

This depends on the circumstances. Very often, intellectual property (IP) rights are held by the joint venture parties and licensed to the joint venture. Sometimes, a separate IP entity is created that holds the IP and this entity licenses the IP to the joint venture. The IP rights of the joint venture itself are normally vested in the joint venture entity and would be dealt with in the same way as other assets upon termination.