Business 2K Blog Place

If one or more of the participants or any part of the joint venture business is based outside Northern Ireland, it may well be desirable to form a vehicle company (or companies) in an overseas jurisdiction. In this case it is important to consider the interaction of the law governing the contractual arrangements between the parties and the law governing the incorporation of the joint venture vehicle. The difference in legal tradition and rules between common law countries (such as Northern Ireland and the UK) and civil law systems (such as those of most of the members of the European Union) can give rise to real difficulties. It is also relevant to remember that the legal relationship between participants in an international joint venture may be characterised differently in several jurisdictions.
Anyone considering a cross-border joint venture should seek legal advice from professionals qualified in the relevant overseas jurisdiction. Various law firms in Northern Ireland (including several of Invest NI’s panel of solicitors) and numerous law firms worldwide are members of Unilaw (an international group of independent law firms). Unilaw provides valuable contacts with law firms in other jurisdictions and enables clients to obtain legal advice on cross- jurisdictional issues quickly, efficiently and from reliable sources.
This guide is provided to give an overview of the principal areas when considering Joint Ventures. Detailed legal advice should always by sought.

The provisions of the shareholders’ agreement will vary from case to case but any such agreement should at the very least cover issues such as:
• the object and scope of the joint venture;
• the capitalisation and financing of the company;
• the composition of the board and management arrangements;
• provisions for distribution of profits;
• transferability shares in different circumstances;
• provision for protecting the minority;
• provisions for remedying a deadlock;
• provisions relating to the termination; and
• restrictive covenants on the company and the participants.
The articles of association should generally include:
• the rights to appoint and remove directors; quorum provisions at both director and shareholder level;
• procedures for shareholders’ meetings;
• pre-emption provisions on share issues;
• possibly pre-emption provisions on the transfer of shares;
• division of shares into separate classes to which the parties’ respective rights can attach;
• chairman’s casting vote (or its exclusion);
• appointment of alternative directors, flexible provisions for resolution by agreement and notices
Resource:

It is important to identify at the outset any events which it is agreed will terminate the joint venture.
Events which terminate the joint venture commonly include the following:
• the expiry of the definite term;
• insolvency of either party (although it may be more appropriate in such circumstances to grant the other party a call option to allow that party the opportunity to buy the insolvent party’s shares in the joint venture company);
• a change of control of one of the joint venture parties;
• a material breach by the other party of any terms of the shareholders’ agreement which the innocent party elects to treat as a terminating offence.

It is usual for the parties in establishing a joint venture to each transfer a number of employees with relevant expertise into the joint venture. Whether or not the joint venture will be bound to take on those employees on the existing terms and conditions of employment or whether it will be free to renegotiate largely depends on the purpose for which the joint venture has been established. If they take on parts of the existing business of the participants, it is likely that the Transfer of Employment Undertakings (Protection of Employment) Regulations 1981 (”TUPE”) will apply which means that employees will automatically transfer to the joint venture and that the joint venture must honour their existing terms of employment.
If the joint venture is to set up a new business, TUPE is unlikely to apply and so the joint venture must obtain the relevant employees’ consent to the transfer. In order to ascertain the risk involved in setting up any joint venture it is important that employment advice is sought

Particularly important in the event of a transfer of a party’s shares or early termination of the venture is the need to establish what happens to the technology and other intellectual property rights of the joint venture company.
Points to consider for a shareholders’ agreement include:
• Should foreground rights assigned initially by the venture parties to the joint venture company be assigned to them respectively on termination?
• Should the joint venture be required to give up or change its corporate name or other trademarks if they incorporate house names or marks of the outgoing party?
• Should each party be free upon termination to use and exploit any arising intellectual property generated during the course of the joint venture?
• On the transfer of shares, should the outgoing party lose the benefit of any licence of intellectual property from the joint venture company or lose the benefit of any rights to use it in the future?

It is important for joint ventures to establish a mutually acceptable policy regarding the transferability of shares. The parties entering into a joint venture do not normally expect the other party to dispose of its shareholding to a third party since the result could well be that two incompatible parties are thrown together. It is therefore common for joint ventures to adopt legal arrangements restricting free transferability typical of providing that:
• the transfer of shares without consent of the other parties to the joint venture is either forbidden indefinitely (which is not acceptable in some jurisdictions) or is prohibited for a stated period or is made subject to board approval; or
• the transferability of shares is not prohibited as such but the other shareholder is given a pre-emption right (that is, a right to first refusal). It is also common, whatever rules govern the transferability of the shares, to permit only the disposal of the party’s entire holding so that small shareholdings do not arise

If a minority shareholder holds more than 25% of the voting capital in the joint venture company, under the law of Northern Ireland it will have the power to block the passing of special or extraordinary resolutions covering a limited selection of matters such as resolutions to reduce share capital, resolutions to disapply the statutory pre-emption rights on a new share issue or to alter the articles of association. However, a minority shareholder cannot block ordinary resolutions which will be decided by a majority vote. Ordinary resolutions cover, for example, appointment or removal of directors, sanctioning the issue of shares or declaring dividends.
A minority shareholder in a Northern Irish company may, in extreme circumstances, be able to apply to the court on the basis of conduct which amounts to unfair prejudice of a minority shareholder but the remedy is limited. Accordingly, a minority shareholder is usually advised to seek its best contractual protections beyond those afforded by statute.
A minority shareholder will often seek the right to appoint a director, supported perhaps by the requirement that its representative is a necessary part of the quorum. A party with a shareholding in excess of, say, 30% might wish to have veto rights over certain major matters such as changes in the joint venture’s articles of association, issue of shares, capital expenditure or contractual commitments in excess of previously agreed limits, borrowing powers and/or major acquisitions or disposals.
An additional protection is for a minority shareholder to establish a put option whereby the majority shareholder can be obliged to purchase the shares of the minority shareholder often in accordance with a pre-determined price at an annual buying stage. This will provide an opportunity for a minority shareholder to review its position and prevent it being locked in if the joint venture is unsuccessful from its view point.
A minority shareholder shall often seek a tag-along right under which it can require the majority shareholder to include the minority stake on the same terms in any sale it makes to a third party.

A further issue to consider is how the joint venture company is to be funded both initially and in the future. The choice of funding method will be influenced by the existing and future cash requirements of the joint venture company and by tax considerations.
The following factors should be considered:
• Straightforward subscription of ordinary shares or possibly of different classes is the simplest and most common method for new ventures coupled usually with the appropriate level of loan capital.
• Consideration for the initial issue of shares by the joint venture capital may be cash but can also be a non-cash consideration - for example, the transfer of assets to the joint venture company.
• Complex funding techniques can emerge where a joint venture involves outside investors who are not involved in the management of the company and are more concerned with the security term and capital growth. Equally this can lead to some form of preference share capital, ordinary share capital or possibly loan stock convertible into shares.
The parties may decide that the initial finance for the joint venture company should be injected substantially as loan capital as shareholding loans from the joint venturers or from lending banks.
The parties must also consider the manner in which any future finance is to be provided. Participants should agree in advance as far as practicable whether or not they are willing to be committed to provide further finance and if so, the time periods and monetary limits for any further finance as well as the conditions under which they are required to implement these commitments. These should generally be spelt out in the shareholders’ agreement and factors to be borne in mind include:
• If there is to be no commitment on a joint venturer to provide future finance, this should be expressly stated.
• In international joint ventures the possibility of exchange control in one or other country affecting the execution of these commitments must be properly considered.
• Banks may require guarantees from shareholders and there should normally be provisions in the shareholders’ agreement governing the scope and extent of any such guarantees and stating whether or not they should be given severally. If future financing commitments are central to the joint venture, for example in a start up venture involving significant planned capital expenditure, appropriate default procedures should be considered.

Deadlock can arise either in a 50/50 joint venture where the shareholders’ appointed directors take opposing views or where a director appointed by a minority shareholder exercises the right to veto.
Similarly, deadlock can arise at shareholder level in relation to matters which require shareholder approval. There are various ways in which deadlock situation can be dealt with. These include:
• Chairman’s casting vote – although this may unlock a deadlock, it gives one party the advantage which effectively negates the concept of joint control.
• Outsider – an independent third party for example, a non-executive director, could be appointed to assist in the decision-making process. However, it is often difficult to find somebody with appropriate business expertise wishing to take on significant risks and responsibilities in return for limited rewards.
• Reference to shareholders – often the most practical method is for an unresolved deadlock to be referred to the chairman or chief executive of the shareholders. This often concentrates the mind of the venture and ensures that it finds a solution for itself.
It is helpful to have a policy to revert to when an insoluble deadlock arises. The aim of the policy should be to ensure that a sensible compromise is reached before the deadlock occurs. When there is an insoluble deadlock, the following options are usually available:
• Transfer of shares – a deadlock could serve as a trigger leading one party to transfer its shares to a third party subject to pre-emption rights. This avoids winding up and it allows it to continue in business.
• “Russian Roulette” or “Texas Shootout” – under a Russian Roulette clause either party can serve notice on the other to value the others shares or sell its own shares to the other party at a specified price. The other party can either accept the offer or reverse it at the same price. This risk of reversal acts as an incentive to the offering party to put forward a fair price. A “Texas Shootout” occurs where the party who is seeking an offer to sell its shares decides that it would like to buy out the other party instead, then both parties can submit sealed bids, the highest winning. Although both options terminate the relationship between the parties, they do ensure the business of the venture continues.
• Voluntary liquidation – the assets of the venture will be sold and the venturers will share the proceeds according to their equity interest. Liquidation may be unattractive because it involves the disposal by the company of assets with potential liabilities to corporation tax or capital gains and the disposal by the partners of shares in the company with possible capital gains tax consequences.

An important function of the shareholders’ agreement and articles of association is to reflect the agreed arrangements for managing the joint venture vehicle. Different considerations will apply if it is a 50/50 joint venture where there is likely to be equal representation on the board as opposed to a joint venture involving a minority shareholder who requires special protection.
Board of the joint venture company
Firstly it should be established whether the board of the joint venture will have an executive role or whether there will also be an executive body with a secondary supervisory body consisting of shareholder representatives who approve the strategy and important decisions.
There will be some matters that the venturers will regard as crucial to protect the value of investments. It is not unusual for these to be subject to shareholder approval rather than board approval.
It is not essential for the management rights and responsibilities to correspond with equity ownership. Therefore, a party may be given greater management rights, for example, rights over decisions affecting technical and management areas.
A director may face a conflict between the interests of the venture and interests of his appointing company. There is a balance to be struck between his duty to exercise his power for the benefit of the venture as a whole and his duty to protect the shareholder who appointed him. In practice, the appointee can exercise his powers in accordance with the wishes of the appointing shareholder provided that, in doing so, he does not act blindly, but considers the venture as a whole. To the extent that there are areas for conflict, it may be better for these to be dealt with at shareholder level

Joint venture transactions call for clear well drafted documentation. Basic legal documents for establishing a joint venture are likely to be:
• a joint venture/shareholders’ agreement; and
• the memorandum and articles of association of the joint venture company.
The purpose of a shareholders’ agreement will be to establish the basic rights and obligations of the parties and to ensure the company and its business are established and run in accordance with the participants’ objectives. A further purpose is to prescribe, as far as possible, for what will happen if difficulties occur. (For guidance on what should be contained in joint venture documents please refer to the text box at Appendix 1).
In the case of non-corporate joint venture structures, the basic objectives of any formal arrangement between the participants will be substantially similar to that of a shareholders’ agreement with essential differences reflecting where appropriate the absence of a separate legal vehicle and the fact that the joint venture may relate to a project of finite duration.