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 two primary driving factors for structuring a joint venture usually are governance and tax considerations. With respect to governance, parties often opt for a structure such as an LLC, which provides the benefit of limited liability for the joint venture parties as well as substantial contractual flexibility to establish governance arrangements. For example, unlike a corporation, which is managed by a board of directors, an LLC can be managed either through a board of directors (technically known as managers), or by one or more of its members. In addition, unlike a corporation in which directors have fiduciary duties as a matter of law, an LLC agreement can modify or even eliminate the duties of its managers (other than the implied covenant of good faith and fair dealing, which is relatively narrow). Although not necessarily appropriate in every case, limiting fiduciary duties may be preferable in certain joint ventures where the parties are sophisticated and are willing to rely on contractually specified governance rights without full fiduciary protections.

The form of organisation of the joint venture entity will affect the tax consequences to the parties (and the entity itself). A US corporation will be treated as a corporation, and an entity other than a corporation (eg, an LLC or a partnership) that has two or more owners will, absent an election to treat such entity as a corporation, be treated as a partnership. Generally, an unincorporated joint venture through which the parties conduct a business and share profits and losses will be treated as a partnership. The consequences of this tax classification are further discussed below. Both the tax classification of the entity (or arrangement) and the structure through which an interest in the joint venture is held will have a significant impact on the tax consequences to the parties and the joint venture, including with respect to formation transactions, income or loss generated by the joint venture, distributions to the parties, redemptions and sales of interests in the joint venture, future investments and liquidation or termination.

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?

Often, the most significant tax consideration is the tax classification of the joint venture (ie, determining whether to use an entity (or arrangement) that would be treated as a partnership or a corporation). A partnership is not subject to income tax at the entity level. Rather, its profits and losses are reported on the income tax returns of its partners, regardless of actual distributions. For tax years beginning before 1 January 2026, a non-corporate partner may be entitled to an income tax deduction of up to 20 per cent of certain qualified business income allocated to such partner from certain US trades or businesses conducted by a partnership, but several limitations apply. A distribution to a partner that is not in excess of the partner’s tax basis in its partnership interest is generally not taxable, subject to certain exceptions. Generally, neither partnerships nor contributing partners incur tax on contributions of assets in exchange for partnership interests, with certain exceptions (eg, those related to assumptions of liabilities).

A corporation is a separately taxable entity subject to corporate income tax (currently, at a 21 per cent federal rate, plus applicable state and local taxes). Additionally, distributions to shareholders are generally taxable to shareholders and are not deductible by the corporation. Corporate shareholders are generally eligible for a dividends-received deduction. A contribution of assets in exchange for stock in a corporation is generally not taxable to the corporation. However, such a contribution is taxable to the shareholder, absent the application of certain rules, for which certain foreign parties may not be eligible, providing tax-free treatment in the case of transfers of assets to a corporation in exchange for at least 80 per cent of its stock. Foreign parties will also need to consider special tax rules (eg, those applicable to transfers by foreign corporations of US assets to a US corporation).

Other tax considerations may be relevant for foreign parties to a joint venture conducting a US business. For example, because a foreign partner in a partnership conducting a US business will generally be subject to US tax (including withholding tax) on its share of partnership income, foreign parties may prefer a corporate structure, where only dividends would attract US withholding tax (subject to an applicable income tax treaty). Foreign parties should also consider the rules relating to foreign investments in US real property and the impact of the joint venture structure on eligibility for tax treaty benefits.

Asset contribution restriction

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

There generally are no restrictions on the contribution of assets to a joint venture other than restrictions that apply generally to the transfer of assets. For example, the contribution to, or acquisition by, a joint venture of US assets or businesses may require competition clearance under the Hart-Scott-Rodino Act (the HSR Act). In addition, if one or more of the parties operates in a regulated industry, such as telecommunications, energy or the financial sector, regulatory approvals similar to those that would apply to a sale of such contributed business may be required.

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?

The interaction of the joint venture’s governing documents depends on the entity form of the joint venture. For example, for an LLC in Delaware, the key organisational document is the LLC agreement (also referred to as the operating agreement), which would normally contain all of the specifically negotiated governance and exit mechanisms. On the other hand, a corporation, another potential form of joint venture entity, is governed by a certificate of incorporation (or articles of incorporation, depending on the state of incorporation), by-laws and, most likely, a shareholders’ agreement. Of these documents, the certificate of incorporation must be filed with the Secretary of State in the state of organisation, but the by-laws and shareholders’ agreement do not need to be filed. Including a provision in the certificate of incorporation (where appropriate to do so) is generally viewed as stronger than including it in the shareholders’ agreement, although in some cases, a provision is included in both in order to maximise potential remedies for its violation. In any event, care should be taken to avoid any conflict between the joint venture’s various governing documents.

Party interaction

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

Interactions between the joint venture entity and the parties themselves are generally governed by the contractual relationship established between the parties. Parties are often concerned about a joint venture party using its influence over the joint venture to enter into an arrangement that may be unfavourable to the joint venture. For this reason, joint venture governance arrangements often provide some mechanism for approval of related-party transactions, such as a supermajority vote at the board or an equity holder consent right. Joint venture agreements may also include provisions regarding the sharing of information and related confidentiality obligations owed to the joint venture entity by the joint venture parties (and by the joint venture entity’s directors and officers, who may have been appointed by an equity holder). In addition, fiduciary obligations (to the extent applicable) may also constrain interactions between the joint venture entity and the joint venture parties, and may also include obligations of confidentiality.

Exercising control

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

There are various ways to allocate control rights with respect to a joint venture. For example, if the joint venture entity has a board, the parties can be given board-designation rights. There may also be additional directors on the board aside from the parties’ designees (eg, the CEO or independent directors). In addition, joint venture arrangements will often include veto rights at the board or equity holders’ level for various matters. The parties may also provide for certain members of the joint venture’s senior management team to be appointed by individual joint venture parties (possibly on a rotating basis).

Governance issues

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

The most common governance issues in joint ventures relate to the level of control that joint venture parties have over the joint venture’s decision-making. Parties must balance the need to ensure that the joint venture can function with their desire for control over its management. These issues are generally dealt with by creating various tiers of decision-making authority. Daily operation of the joint venture is generally vested in its management, subject to oversight by the board, the composition of which is determined in an agreed manner. Certain decisions, such as significant transactions or the issuance of equity to a new investor, may require the approval of a supermajority of the board or of the equity holders.

The level of control that each party has in a joint venture is highly variable based on the purpose of the joint venture, the number of parties in the joint venture, whether one party is expected to have greater influence because of its level of ownership or expertise, and other factors. For example, in a joint venture that is designed principally for financing purposes, the operating partner may retain most of the control, while the financing partner may have consent rights over fundamental decisions (eg, changing lines of business or a liquidation of the company). In 50:50 joint ventures, in which the parties expect to run the joint venture business together, it is common to have a fairly substantial list of actions that require board or equity holders’ approval; in practice, this means that the two partners must agree on a course of action, or a deadlock will ensue (see below).

In joint ventures where there are multiple partners with ownership stakes of varying sizes, it is not uncommon to see approval rights set at different thresholds. For example, purchasing or disposing of a substantial asset may require a low supermajority vote of the board. More fundamental matters may require a unanimous vote of the board or of the equity holders. A minority equity holder also will often have a basic set of protections against unfair treatment by the majority.

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?

A joint venture may, through its governing documents, establish the method by which directors are nominated or appointed. The duties of nominee directors of a joint venture are related to the entity form of that joint venture. In a joint venture that is organised as a corporation, a director of that corporation, even if appointed by a specific shareholder, has legally prescribed fiduciary duties to the corporation and not solely to that shareholder, and may not, for example, delegate decision-making to that shareholder. However, the parties can provide for a waiver of the ‘corporate opportunity’ doctrine (which would otherwise restrict a director from diverting certain opportunities away from the corporation). On the other hand, if the joint venture company is organised as an LLC, the parties can provide for corporation-like fiduciary duties but may alternatively provide that directors’ duties are modified or limited, as discussed above. A director of a joint venture should be cognisant of the extent of his or her duties in that capacity.

Competition law

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

In the US, formation of a joint venture may be subject to the HSR Act in the same manner that generally applies to the transfer of, or investment in, voting securities and assets. For example, the contribution to, or acquisition by, a joint venture of US assets or businesses may require competition clearance if the size of the investment exceeds the thresholds set forth in the HSR Act. Under the HSR Act, transactions may be subject to notification and waiting obligations. The reviewing agency (the US Department of Justice or the Federal Trade Commission, depending on the sector) may, within an initial 30-day period, make a request for additional information and documentary material, which is called a ‘second request’. In the event that a second request is made, the waiting period under the HSR Act expires in 30 days following the date that the parties certify substantial compliance with the requirements of that second request. If applicable, the parties may not consummate the proposed transaction until those notification and waiting period obligations are satisfied.

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?

An agreement pursuant to which one joint venture party provides services to the joint venture typically would be put in place when the joint venture is formed (so that the parties are comfortable with its terms), or, if it is put into place afterwards, typically would be treated as a related party transaction (discussed above). Joint ventures also present particular issues regarding the provision by a joint venture party of health and welfare benefits and equity incentive awards that require careful consideration and planning at the structuring stage. In addition, in some cases, a foreign joint venture party may be required to accept certain restrictions on its involvement (governance, operational or otherwise) with the joint venture for regulatory reasons (eg, in connection with obtaining CFIUS approval for its investment in the joint venture).

Employment rights

What impact do statutory employment rights have in joint ventures?

The treatment of employees of a joint venture is dependent upon both the structure of the joint venture and the parties’ desires for structuring. Where the parties intend to actually transfer employees to a new joint venture entity, the form of contribution of assets by the parties to the joint venture affects how those employees can be moved. If a joint venture party is contributing the equity of an entity to the joint venture, then that contributed entity’s employees will move with the entity without further action by either party or the joint venture. If, on the other hand, assets and liabilities are being transferred directly by a party to the joint venture, then employees cannot be transferred directly and the joint venture must make the employees of such party new offers of employment. It is also possible to structure the joint venture so that minimal employees are actually employed by the joint venture. This can be accomplished by a joint venture party providing services for a fee through transition or long-term service agreements, or employee leasing or seconding from the joint venture parties.

Intellectual property rights

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

Upon formation of a joint venture, the parties may either transfer or license relevant intellectual property (IP) rights to the joint venture. Joint venture parties should be careful in their structuring to avoid weakening IP rights. Parties also should consider the tax consequences of any IP transfers or licences.

With respect to the time period during which the joint venture is in operation, parties have substantial flexibility to address the treatment of newly created IP. For example, the joint venture can retain ownership of such newly created IP, and license it to the joint venture parties. Parties also have flexibility to determine how IP is treated upon termination of the joint venture (eg, they might agree to long-term, royalty-bearing or royalty-free licences to a party that is not receiving the IP upon termination).