1. Shareholdings and foreign ownership restrictions
One of the key decisions which parties need to make prior to entering into a JV is the percentage shareholding which each party will hold. Often, in order to ensure an equal division of power, where there are only two parties, they will elect to have a 50/50 JV. However, before such a decision is taken, the parties need to consider, in conjunction with local counsel, whether there are any foreign ownership restrictions (Restrictions) in the jurisdiction in which the JV will be incorporated. For example, foreign ownership restrictions might be applicable in Bermuda, Canada, India, Indonesia, the People’s Republic of China and Vietnam, depending on the type and size of the JV and the sector which it will participate in. Where such Restrictions apply, a foreign investor will need to partner with a local party in order to be able to operate within the relevant jurisdiction.
We are increasingly seeing jurisdictions amend their Restrictions in order to address prevailing economic and/or political conditions. For example, in Vietnam, legislation has been proposed that could see the 49 per cent cap on foreign ownership removed in certain sectors later this year. In light of the potential for legal or regulatory changes affecting Restrictions, parties should always consider inserting a mechanism which allows the flexibility to modify the JV structure without the need to renegotiate. For example, the use of a put/call option mechanism in a shareholders’ agreement (the Agreement) which is triggered by a change in Restrictions can allow for a rebalancing of the parties’ shareholdings in a manner that both (a) ensures ongoing compliance with the law and (b) enables the foreign party to increase its holding when the Restrictions become more permissive with respect to foreign investment. In the event that the Restrictions are abolished altogether, this will allow the relevant party to either acquire the entirety of the JV company or to sell its entire shareholding in the JV company.
2. Business plan
We see business plans being dealt with in a number of different ways. The optimal approach is to append an agreed version of the business plan to the Agreement. However, due to commercial practicalities, this is often not possible at the time that the Agreement is entered into. In such circumstances a number of alternatives can be used.
Firstly, the parties may set out the key parameters of a future business plan, for example, that the business plan, once finalised, will contain projected cash flow statements, monthly projected profit and loss accounts, management reports, etc. for the JV company. Such a clause could also include a long stop date by which time the parties should have put the business plan into place.
Parties may also wish to give the JV a lead in time prior to putting any formal business plan into place. For example, the parties may agree that a business plan will not be put into place until six months after the incorporation of the JV company. In such a case, it may be useful to include detailed provisions in the Agreement with regard to how the parties will agree upon the final business plan. Such provisions could include the date and location at which the parties will meet, the personnel from each of the parties who will be involved in the development of the business plan and the dispute resolution mechanism which will be applied in the event that the parties are unable to agree upon a final business plan (for more on this please see paragraph 4, below).
3. Duration of the JV
Another factor for the parties to consider is the length of the JV and consequently how the JV will be terminated. The parties may intend that the JV will be short or long term in nature or for an indefinite period. This will depend upon their respective strategic objectives and the purpose of the JV.
If the original commercial intention is that the JV will continue indefinitely, we would advise that the parties still carefully consider the termination provisions as JVs, for a number of reasons, can often end unexpectedly. Such reasons can include a change in market conditions, irreconcilable differences between the parties, the insolvency of one of the parties, amendments to Restrictions or a change in the strategic direction of one or both of the parties.
Some key points to consider upon termination occurring are whether a put/call option, as discussed in paragraph 1 above, will apply or whether the JV will be wound up. The parties will also need to consider how the assets of the JV will be divided; if one of the parties initially contributed an asset will the whole of that asset be returned to the said party? Will it be possible for seconded employees to transfer back to their original employer?
At the point of the termination of a JV, relations between the parties may have deteriorated. Therefore, it is important to have provisions in place which clearly specify the process which will apply – this should help to avoid any further disagreements between the parties or any unnecessary delay in the termination process.
4. Dispute resolution mechanisms
Parties should carefully consider the dispute resolution mechanisms which they wish to apply in the event that there is a dispute between them. The most likely final scenario in the event of a dispute of a fundamental nature will be the winding up of the JV or, subject to any Restrictions which may apply, one party purchasing the shares of the other. Prior to this situation arising, the parties may wish to implement a waterfall process – the specific details will depend upon the commercial rationale of the parties; however, it could be along the following lines:
- the parties’ chairmen/CEOs meet to try and resolve the dispute;
- a mediation process is commenced;
- an expert is appointed in order to determine the fair market value of the JV company; and
- either party is entitled to make an offer to purchase the other party’s shares at the fair market value.
Again, depending on the relative bargaining power of the parties, it may only be one party which is entitled to buy the other out, and in the event that the relevant party does not make such an offer the dispute can be deemed to be resolved in favour of one of the parties.
5. Regulatory consents for JV operations
Prior to embarking on a JV, the parties should also consider whether any regulatory consents are required for the JV to operate. In the energy and natural resources sector, local governments tend to safeguard production and licensing rights for resources located within their jurisdiction. Therefore, the JV or parties may need to enter into certain contracts with, and/or obtain licences from, the relevant regulatory body in the country where the relevant resources are located. The parties and their legal advisers will also need to work closely with local counsel in relation to such matters.
Parties should also consider whether having a JV in its ownership structure will lead to any increased regulatory obligations. If an entity is deemed to be a parent undertaking under EU or UK law then it may affect the regulatory obligations which apply to it, for example, in relation to applying position limits and calculating compliance with EMIR clearing limits.
The parties must also consider anti-bribery and anti-money laundering legislation. They need to ensure that the JV and the parties will be able to operate effectively and efficiently while also adhering to the anti-bribery and anti-money laundering legislation which is applicable to them. We would always suggest that parties specify in the Agreement that the JV will comply with all relevant international laws, for example, the UK Bribery Act 2010 and the US Foreign Corrupt Practices Act 1977, as amended from time to time.
6. Merger control issues
Prior to embarking on a JV, parties should always carefully consider whether any competition clearance will be required. Competition regimes are in place in over 140 jurisdictions worldwide and many of them have comprehensive rules in respect of JVs. We are seeing JVs coming under an increasing amount of scrutiny from competition authorities.
JVs with an EU dimension and created in any of the ways set out in the EU Merger Regulations (EUMR), constitute a concentration in the context of competition law and therefore fall within its scope. Nearly half of all concentrations notified under the EUMR have been JVs.1
Where EUMR thresholds are not reached, the different thresholds of the 28 EU member states need to be considered. Different member states take different views of full function and non-full function JVs, thereby leading to uncertainty as to when and when not to file. The complexity of this area in fact underscores the importance of a case-by-case assessment. For further guidance on when to file and when not to file in relation to JVs, please visit www.reedsmith.com.
JVs that do not fall within applicable merger control regimes are advised to comply with self-assessment regimes, in which they should undertake a formal self-assessment to demonstrate compliance in case of any subsequent competition investigations. In the UK, the CMA has published a short checklist of dos and don’ts for businesses to consider when setting up and managing JVs or other forms of collaboration. The CMA guidance provides businesses and their advisors with useful insights, which will help them assess the legality under competition law of any collaboration with a competitor. Further details on this checklist can be found at www.reedsmith.com.
7. Shareholder and board reserved matters
It is common for an Agreement to set out certain matters which the management of the JV cannot undertake without the approval of all or a majority of the shareholders. An Agreement may also specify certain matters which require approval by all or a majority of the board. Such matters will depend on the commercial rationale of the parties and the level of insight which they wish to have at board and shareholder level.
For example, if a shareholder has a senior member of its management team appointed as a director of the JV board, it may require certain decisions to be board reserved matters and only very high level decisions to be shareholder reserved matters, whereas if a shareholder has a relatively junior person appointed to the board of the JV, it may want a large number of matters to be shareholder reserved matters, rather than board reserved matters, in order for there to be sufficient visibility of the JV and its operations at a senior level within the shareholder.
Matters which are often deemed to be shareholder reserved matters include the winding up of the JV, material acquisitions or disposals by the JV, the entering into of any financing arrangements over a certain value, or any amendment to the name of the JV, the articles of association of the JV, the business plan for the JV or the employment terms of key individuals.
Board reserved matters include amending the tax residency, accounting reference date or auditors of the JV company, the making of a loan by the JV company, any licensing or transfer of any intellectual property which the JV company owns, or the JV company entering into any related party transaction.
Shareholder and board reserved matters may also extend to any subsidiaries of the JV.
8. Dividends
The dividend policy of a JV depends upon the purpose of the JV and the commercial rationale of the parties.
For example, the parties’ aim for the JV may be to simply generate profits for shareholders and not to grow or expand. In such a case, the dividend policy of the JV will be to distribute all available profits of the JV, subject to applicable company laws. By contrast, where the parties intend to grow the business of the JV, or expand and invest in new property or machinery, the JV will likely want to retain a considerable portion of the profits which can be reinvested into the business.
Shareholders commonly do not feel in a position to be able to decide on the dividend policy at the date that the JV is incorporated or the shareholders’ agreement is entered into. In such a case, the shareholders may make any decisions on the implementation of or any amendment to the dividend policy a shareholder reserved matter.
Any dividend policy will also need to take into account any loan repayments which the JV is required to make, either to third party providers or the shareholders, and which are likely to take priority over any dividend payments.
- John Cook and Christopher Kerse, EC Merger Control (Sweet & Maxwell: 2005), para. 1-008.
Client Alert 2019-130
