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?

The most common factors driving the structure of a joint venture will be the parties’ preferred tax treatment (eg, do the parties want the joint venture to be transparent for tax purposes such that profits and losses will pass directly to the joint venture parties (see question 19)?), competition law concerns (see question 13) and accounting (eg, do the parties want to consolidate the joint venture in their accounts?).

The other key drivers of a joint venture’s structure will be:

  • whether the parties wish to limit their liability exposure;
  • the physical location of any assets to be held by the joint venture;
  • the anticipated length of the joint venture;
  • the preferred management structure;
  • whether a listing is anticipated in the future;
  • the degree of financial flexibility required by each party;
  • the ease of transferring, terminating or unwinding the joint venture; and
  • the level of publicity or public scrutiny (eg, a corporate joint venture may be subject to certain public filings that a partnership or contractual joint venture would not).

Another relevant consideration will be whether, owing to the nature of the investment or the nature of the business or asset to be operated, the joint venture parties may wish to access foreign investor protections, including those offered by bilateral investment treaties.

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?

Joint venture parties will need to consider any tax triggered as a result of their respective contributions of any assets or businesses to the joint venture. This could be in the form of a tax on chargeable gains, balancing charges with respect to capital allowances, transfer taxes if shares are transferred or land taxes if interests in UK land are transferred. Value added tax may also be an issue when contributing assets to a joint venture unless the transfer qualifies as a transfer of a business as a going concern. If one or more of the joint venture parties is not UK tax resident, the joint venture parties will also need to consider any withholding tax obligations that may be applicable (eg, on payments of interest if the joint venture is to be funded by way of loan).

There are statutory relief measures available to mitigate chargeable gains on the transfer of assets, including merger relief where there is a transfer of a company to the joint venture, rollover relief on the transfer of certain business assets, the use of losses against chargeable gains arising and, in the case of transfers of shares or interests in shares, the application of the substantial shareholding exemption, if available.

Asset contribution restriction

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

There are no company- or contract-law restrictions on the contribution of assets to a joint venture entity; however, advice on the tax (and other) consequences of the contribution should always be sought (see question 6).

For example, there may be accounting factors to consider; in particular, if the contribution of assets results in one or more parties exercising control, the controlling party (or parties) may have to consolidate the joint venture in its accounts. See also question 3 for possible restrictions on a foreign party transferring UK property if it has failed to comply with proposed registration requirements.

If assets are contributed to a joint venture such that it qualifies as an ‘enterprise’ for UK merger-control purposes, this may give rise to a ‘relevant merger situation’, which may be reviewable by the Competition and Markets Authority (CMA) (see question 13). The government’s proposed powers to intervene in any M&A transaction that may give rise to national security risks should also be considered (see question 3).

Consideration should also be given to the allocation of liabilities when contributing assets to a joint venture, particularly in relation to environmentally sensitive assets (eg, oil refinery and gas storage facilities). The joint venture parties should clearly agree how liabilities will be shared under the ‘polluter pays’ principle if the joint venture is operating an asset that may cause environmental damage.

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?

As a joint venture is not itself recognised as a distinct form of legal entity in the UK, there is no mandated priority in law between the constitution of a joint venture and the contractual agreement between the joint venture parties. Parties should therefore apply first principles in ensuring that the contractual agreement and the constitutional documents are not in conflict with each other.

It is common practice for joint venture parties to stipulate that, as between themselves, in the event of a discrepancy between the contractual agreement and the constitutional documents, the contractual agreement should prevail. The constitutional documents and the contractual agreement should also conform in relation to the approach to and approval of conflicts of interest between the joint venture entity and the joint venture parties.

The joint venture entity itself should usually be a party to the joint venture agreement. This will make it easier to seek injunctive relief against the joint venture entity in situations where it is proposing to take an action that is clearly in breach of the joint venture agreement (eg, disclosure of confidential information).

Party interaction

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

The interaction between a joint venture entity and the joint venture parties will be governed by the terms of the agreements between the parties and, in respect of a joint venture that is a company or a partnership, the constitutional documents of the joint venture entity and applicable law.

In addition, and assuming the joint venture parties and the joint venture entity are separate legal entities, there may be ongoing restrictions imposed by competition laws in respect of the flow of information either between the joint venture parties and the joint venture or between the joint venture parties that take place via the joint venture, if they are actual or potential competitors. A key area of risk is the sharing of competitively sensitive information that could influence the parties’ competitive behaviour in the market, in particular the behaviour of the parties outside the joint venture. Examples of competitively sensitive information include information related to prices, marketing strategies, customer contracts, output levels, capacity and input prices. If any such information is exchanged that is not essential to the formation of the joint venture or that goes beyond what is essential for the parties to manage their investment, this may infringe competition law.

The directors of an incorporated joint venture are required to consider their statutory duties, in particular as regards conflicts of interest in relation to transactions between the joint venture and one or more of the joint venture parties, and the duty to act in good faith to promote the success of a joint venture company for the benefit of its members as a whole. (See question 12 for further information on directors’ duties.) Such duties can be particularly significant in circumstances where there are related party transactions or disputes between a joint venture and one of the joint venture parties.

In addition, if, in the case of an incorporated joint venture, the joint venture or a shareholder is a UK-listed company, the related party transaction rules may apply in cases where the joint venture parties are transacting with one another. Depending on the size of the transaction, public disclosure or shareholder approval may be required, which could limit the parties’ appetites to transact.

Exercising control

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

In an incorporated joint venture, a 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. 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. As such, it is customary that minority investors seek additional, supplemental contractual rights, proportionate to the size of their investment in the joint venture, under the joint venture agreement, the constitutional documents or both. For example, it is common in UK corporate joint ventures for the parties to specify the right to appoint directors to the board based on shareholdings in the joint venture entity (eg, one director for every 10 per cent interest held) and to have the right to appoint a non-voting observer to the board.

Minority investors are best protected if the investors agree that certain fundamental actions cannot be taken without the consent of all investors (or at least a supermajority (eg, 90 per cent)). For example, shareholders of an incorporated joint venture can specify that no resolution to amend the constitutional documents of the joint venture company is passed unless all shareholders consent to the amendments.

In certain circumstances, minority shareholders can apply to the court on the basis of conduct that amounts to unfair prejudice by the majority shareholder.

Governance issues

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

Resolving governance issues efficiently and to the satisfaction of all parties can be critical to the success of a joint venture. The three most common governance issues are:

  • balancing management control of the joint venture company to ensure that the joint venture operates smoothly on a day-to-day basis but that key decisions that could affect the value and liabilities of the joint venture are reserved for the shareholders;
  • how to deal with deadlock situations (see question 21); and
  • how to manage conflicts between the interests of the joint venture entity and the interests of the joint venture parties (see question 12).
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?

Directors of a joint venture company will be subject to statutory duties, including duties to avoid conflicts of interest, to promote the success of the company, and to exercise independent judgement.

There are ways to manage conflict issues at the outset of the joint venture. For example, any conflicted or potentially conflicted directors could be excluded from the relevant decision-making process. Alternatively, company law provides that conflicts can be authorised via the constitutional documents, shareholder resolution or by the directors. As such, the constitutional documents could contain authorisation of conflict situations that arise by virtue of a director being a director or employee of his or her appointing shareholder, and for the directors in their board meeting to acknowledge the existence of that authorisation.

In addition, significant decisions could be reserved for approval by the shareholders, taking the ultimate decision away from the nominee directors. Such an approach can avoid issues of directors’ conflicts of interest, as the shareholders will be responsible for resolving the relevant issue and the shareholders are not subject to any duties to avoid conflicts of interest. This would not, however, absolve the directors of any breaches of their other duties. Nor is such an approach appropriate to deal with transactions and disputes involving one of the shareholders and the joint venture company (eg, if one of the shareholders is also a service provider to the joint venture company). The relevant shareholder in such a situation should not be able to prevent the joint venture company taking action against it, even if it is the majority shareholder.

Competition law

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

For UK purposes, the formation of a new joint venture may qualify as a ‘relevant merger situation’ and thus fall within the scope of the UK merger regime if the activities transferred to the joint venture by one or more parents (or acquired from a third party) are sufficient to constitute an enterprise (ie, if the activities could be carried on for gain or reward) and if the turnover or share of supply or purchases threshold is met.

There is no obligation to notify the formation of a joint venture in the UK, but the CMA may investigate transactions that fall under its jurisdiction up to four months after completion. The CMA has a discretionary power to impose undertakings suspending - and potentially reversing - integration of merging businesses, pending clearance in relation to anticipated as well as completed joint ventures.

Once the joint venture has been established, the competition law considerations outlined in question 9 will be relevant.

In relation to employee secondments into a joint venture, issues can also arise commercially in circumstances where an employee’s secondment ends (either because the joint venture terminates or the secondments are on rotation). A secondee may have had access to competitively sensitive information about the other joint venture party during their secondment and, therefore, the parties may wish to think about the constructive use of a moratorium (ie, a quasi-garden leave period) to ensure that the secondee cannot use that competitively sensitive information with their employer and such information becomes stale before they return to normal duties with their employer.

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?

The issues that arise in relation to the provision of services to a joint venture entity are not necessarily specific to the UK. 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 provision of any services with the other 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.

The joint venture parties should also agree to the allocation of any liabilities that may arise as a result of services provided to the joint venture. There are several high-profile examples of a joint venture party being adjudged liable for damage arising out of the operations of a joint venture as a consequence of inadequate contractual allocation of liability for the actions of employees of the other joint venture party who were providing services to the joint venture.

If there are any competition concerns facing the joint venture parties and entity (see question 9), these may be exacerbated if, for example, the joint venture parties provide back-office services to the joint venture. Parties may need to consider introducing information barriers or other structural safeguards to minimise the risk of problematic information sharing taking place.

A joint venture party may also find, depending on the level of control it holds in the joint venture, that the provision of services to the joint venture is considered intragroup, which may have tax (eg, transfer pricing) and accounting implications.

Employment rights

What impact do statutory employment rights have in joint ventures?

If existing businesses or assets are being contributed to the joint venture, UK law can operate to automatically transfer employees associated with the relevant business or assets. If such a transfer occurs, restrictions are imposed on the joint venture’s ability to dismiss these transferring employees or make changes to their terms or working conditions. This can make it difficult for the joint venture to harmonise its terms of employment and can cause operational issues for the joint venture by creating a two-tier workforce, with employees doing the same job but on different terms. The parties will therefore need to agree how any liabilities under the relevant employment laws should be allocated.

Intellectual property rights

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

There is no treatment of IP rights specific to a joint venture entity but the parties should agree at the outset how to address all IP issues arising from the creation, operation and termination of the joint venture.

The joint venture parties may retain ownership of their own IP rights, commonly referred to as ‘background IP’, and license these (including any IP created by them during the term of the joint venture) to the joint venture. If IP is to be assigned by a joint venture party to the joint venture then the joint venture party may require a licence back (eg, if the joint venture party wishes to continue to use the ‘background IP’).

If the joint venture is to own the IP created by the joint venture, known as ‘foreground IP’, the joint venture parties will need to agree whether this IP will be licensed to them and, if so, on what terms. The joint venture parties may require that ‘foreground IP’ is owned by either of the joint venture parties (especially if the IP created by the joint venture is derived from IP licensed to the joint venture) although these arrangements must comply with competition law.

Co-ownership of IP between the joint venture and the joint venture parties is possible but seldom advisable. Co-ownership may be cumbersome since, depending on the IP right concerned, a co-owner may not be free to use, license or dispose of the IP right without the consent of the other co-owners.

Parties should also agree at the outset how licences granted by or to the joint venture, and any IP assets held by the joint venture, should be treated upon the exit of any joint venture party or the joint venture ceasing to operate.