Understanding joint ventures

LEGAL EYE

There is a cool-down on the SEZ front, lukewarm response to the Finance Bill, revival of the Jet-Sahara deal has failed to generate the expected excitement, while the fate of the corporate controversy of 2007 "" the Hutch acquisition "" awaits FIPB determination. The focus on electoral performances and issues of judicial transgression on executive turf provides an opportunity to write about perennially fundamental issues, such as understanding joint ventures.

HUFs (Hindu Undivided Families) and partnerships are the traditional modes of joint venture, which is not a defined legal term and best described in the current scenario as a strategic alliance between unrelated persons for conducting a new business with a profit motive.

The spurt in international joint ventures (JV) is motivated by various considerations, such as establishing a new market in foreign jurisdictions, where tie-ups help in building local marketing networks and other resources.

In countries where foreign investment opportunities are lucrative yet limited, a JV may be the only opportunity available to a foreign investor. In India, where sectoral caps operate in certain industries, joint ventures are the only recourse for FDI. But even in 'automatic' sectors, joint ventures are necessitated by varying compulsions. Large inter-governmental projects, which cannot be funded by one nation alone, require funding by multi-nation consortia. In energy and infrastructure, start-up costs and projects risks are so high that even large players do not wish to shoulder huge risks, such as laying of transnational pipelines.

There are several structural options available for JVs. For short-term transactions, not requiring a separate vehicle, contractual JVs or corporate partnerships are preferred, as administrative formalities and accounting requirements are minimal. In India, however, from the tax perspective, this may not be beneficial, particularly with the disadvantage of unlimited liability. It is expected that the proposed LLP structure will lend itself favourably to JV objectives and operations.

On date, the limited liability company is the most popular structure, as it is the JV company that is exposed to financial and commercial risks, and parties are protected, in case the JV fails. In reality, very often the JV is financed through debt, and having no financial track record on account of insufficient assets, the partners have to provide security not just to lenders, but other stakeholders as well.

The process in creating a JV is kicked off with a MoU or term sheet, stating the basics for taking initiatives and fulfilling regulatory obligations. This usually addresses structural and investment options, partners' corporate governance norms and a tentative timetable. While MoUs are usually not legally binding, care needs to be exercised, particularly in EU jurisdictions, where they have been used to found claims for damages, if one party can be shown not to have acted in good faith during negotiations.

Although there can be considerable variation in structures and definitive documentation, the partnership or shareholder's agreement (SHA) between the co-venturers is the primary document which provides for standard items such as commercial understandings, business objectives, business plan, capital structure and investment pattern. It is a common practice to make the Company a party to the SHA to create binding obligations.

From the legal and regulatory perspective, the issues most deliberated and negotiated are choice of applicable law and jurisdiction, corporate governance, representations and warranties, tax issues, voting patterns, and exit options. To elaborate on some - choice of law and jurisdiction are critical, as not all provisions are equally enforceable in every jurisdiction. Non-compete clauses, provided in all JV and other relationship agreements "" are not entirely enforceable in India, as are not claims for remote damages. On non-compete, with the withdrawal of Press Note 18, bargaining with the foreign investor for the duration of the JV has emerged as the most contentious issue.

Deadlock resolution of commercial issues is another sensitive area, where several mechanisms are built in, starting with a casting vote, snaking up through intervention by CEOs of the partners, mediation, and ending in buyout. Voting patterns, often somewhat in variance with the law, which the SHA seeks to commit the company to obligations not contained the Articles, and cause exercise of voting rights in the desired manner, are all very confidential, and not entirely enforceable.

In weighing immediate commercial considerations, the end of the road tends to get missed out. Care is to be taken to avoid situations of acrimony and litigation, to meticulously craft the exit routes, and reassignment of the pooled resources. Whether the parting of ways is occasioned by failure of the partnership or amicable, it should be clean.

Kumkum Sen is a Partner at Rajinder Narain & Co. She can be reached at kumkumsen@rnclegal.com