A joint venture is a kind of business arrangement created jointly by two or more parties to form a separate legal entity while the joint venture partners retain their distinct identities. A joint venture might be ideal where two or more companies have complementary strengths which can be combined for maximum effect or in case of cross border joint ventures where one company intends to explore the foreign markets with industry and local regulatory knowledge of the foreign partner.
Some of the advantages of entering into a joint venture include:
- Allowing the parties to share industry knowledge, technological capabilities and share costs.
- Opportunity to access new markets that they would not otherwise have access.
- Sharing collective tangible and intangible assets.
The nature of the legal entity to be incorporated for establishing a joint venture in India, depending upon other commercial considerations, may either be a company incorporated under the Companies Act, 2013 or limited liability partnership established under Limited Liability Partnership Act, 2008. Foreign entities contemplating to set up their business operations in India can start their business either by way of incorporating a company in India which may either be a joint venture with an existing Indian entity or by way of incorporating a wholly owned subsidiary of a foreign entity. Such body corporate may either be a private company or a public company or a limited liability partnership. A contractual joint venture can also be used where the establishment of a separate legal entity is not needed or the creation of such a separate legal entity is not feasible.
Technology is an attractive reason for organizations to enter into a joint venture. Entering into joint venture agreements to take access of advanced technology already created by one entity to produce the products. For this purpose, the entities usually enter into a technology/brand licensing agreement which lays down the terms and conditions regarding licensing of technology and/or brand name and the terms of payment of royalty to the licensor. It may be noted that in case of joint venture where foreign partner is involved then any investments by a foreign partner by way of consideration other than cash (such as technical know-how) must comply with the exchange control regulations. Further, it may be noted that in case of involvement of a foreign partner, the foreign exchange regulations lay down the sectoral limits upto which a foreign investment can be brought into India into different sectors/industries. Not all sectors are allowed for 100% investment from a foreign investor and the investment limits and approval requirements from RBI should be adhered to while bringing in monies from a foreign partner into India.
Another important consideration is approval requirements under the Indian Competition Act, 2002. The definition of combinations as mentioned under Section 5 of the Indian Competition Act, 2002 does not have mention to joint ventures and therefore the circumstances in which joint ventures were required to be notified under Section 5 was unclear. However, a recent FAQ issued by Competition Commission of India clarifies this uncertainty to a certain extent. It clarifies that if one or more enterprises transfer its assets to a joint venture company, then the formation of joint venture is treated as a notifiable combination, provided that thresholds are met after applying the principle of attributability. Since the FAQs only provide that where one or more of the joint venture parties transfer its assets to the joint venture company, it may be implied that where no asset transfer is involved, joint ventures may be formed without seeking approval under the Competition Act, 2002.
In this article, we have herein-below touched upon few basic deal points which must be appropriately negotiated and agreed upon by the partners in the joint venture agreement for the joint venture to work for the maximum benefit of all partners.
A. Selecting the right partner and setting the contributions to be made by each partner clear:
The first and foremost important consideration is choosing the ideal partner, based on the strategic objectives, which goes a long way in establishing a successful joint venture. Also, there should be a clear and distinctive demarcation of each partner’s contribution to the joint venture and their respective roles and responsibilities. It is important that the partners share similar cultural norms and have similar operating philosophies and risk appetites. All material components and strategic objectives should be negotiated before the deal is signed which will ensure that the joint venture goes smoothly for a longer period.
B. Contribution of Capital:
It is important that the joint venture partners have clarity on the capital contributions, both initial and additional, required to be made by them from time to time to fund the joint venture company. Therefore, the parties to the joint venture agreement, must as a condition precedent agree and approve a business plan of the joint venture company to determine the specific circumstances under which capital contributions must be made, including the timing and amounts of such contributions. The agreement should also clearly lay down the procedure which the parties need to follow as and when such contributions are to be made by the parties. Such clauses should additionally provide for any consequences which may arise if a joint venture party fails to make any required contributions in the future which may inter alia be dilution in the shareholding of the defaulting joint venture partner and consequent reduction of rights of the joint venture partner.
If any capital contributions are in the form of assets, the joint venture agreement should provide the manner in which, and the values at which, such non-cash capital contributions will be converted into cash.
C. Management Structure of the Joint Venture:
For a joint venture to be successful the management related provisions in the joint venture agreement should be appropriately drafted. The management rights of a partner would be typically dependent on the capital contributions made by a partner in a joint venture. Usually one partner has day-to-day operating responsibility, subject to the other participant’s veto over critical matters. Reserved matters are important for the partner which holds minority stake as the minority partner shall have a say on important matters through these matters and therefore the list of matters which shall require consent of the partner should be appropriately decided. Further, it is important to clearly lay down the provisions pertaining to composition of the board of directors, their appointment and removal procedures, how the meetings of the board and the shareholders would be conducted etc. The voting mechanism should be properly laid down and depending on the capital structure of the joint venture entity, consideration needs to be given as to whether a deadlock could arise and in case of a dead lock how the same shall be resolved. The parties should negotiate the agreement in such a manner which lays down deadlock resolution mechanism which may include acceleration of a buy/sell provision or dispute resolution mechanism in the form of mediation or arbitration to avoid any dissolution of the joint venture.
D. Restriction on transfer of shares:
Under a joint venture agreement, consideration should be given as to whether a joint venture party may transfer its interest in the joint venture entity and if such right is given to the partners, what are the restrictions that should be applicable on the partners. It should be properly thought through and negotiated, depending on the circumstances, whether a Right of First Refusal “ROFR” or a Right of First Offer “ROFO” should be given. A ROFR entails the party offering any shares for sale to the other partner first, and if the other partner refuse to purchase the shares at the stated price, only then can the selling partner sell the shares to a third party, and not at a price below that was offered to the other partner. A ROFO helps in the price identification process. Further, it should be evaluated whether the shares of a partner should be under lock-in for certain period. The partners can negotiate on, (i) period of lock-in; (ii) fall-off of the lock-in within a specified period. The partners may also want the flexibility to transfer shares to affiliates but the definition of an “affiliate” should be carefully drafted.
E. Deadlock Resolution:
In a joint venture it is very important to have a deadlock resolution mechanism in the event that the partners are unable to agree on an important matter. These may include acceleration of a put/call provisions of a joint venture agreement. Ideally, levels of deadlock resolution mechanism should be clearly mentioned, involving firstly, negotiations involving senior officers on both sides, then secondly, mediation, but if still it cannot be resolved, then third-party resolution or triggering the exit mechanism may well be the final alternatives.
F. Exit/ Termination Mechanism:
An exit strategy should be defined in detail as part of the transaction agreements and the exit clause should be properly negotiated because generally, joint ventures are created for definite time and purpose or even if it is for a longer term, a very small percentage of JVs continue successfully for years, and in most cases, one of the JV partner exits by selling its stake to the continuing partner or other mechanism as laid down in the agreement. It is very important in such scenarios to negotiate in such clauses the agreed prices or formula provisions or deferred payment terms. While drafting the exit clause, it is important that exit triggers, valuation/pricing approach, process to initiate and execute the exit is properly documented. Upon termination of the joint venture, the exiting party usually has non-compete obligations to ensure that the exiting partner does not carry on competing business for a certain period of time.
G. Other critical points to be considered in the joint venture agreement:
Frequency and the basis of distribution of dividend to joint venture partners;
Fall away of the rights of the JV Partners in the event their shareholding in the JV falls below a specified percentage;
Approval of a business plan;
Applicability of non-compete covenants to the joint venture parties and their affiliates; and
Indemnity by the joint venture partner for their own breaches of the joint venture agreement or for losses due to negligence or misconduct by any of the partners.
Authors: Prashant Jain, Co-Founder & Partner; Anita Dugar, Senior Partner.
Disclaimer: The content of this article is intended to provide a general guide to the subject matter. For any queries, the authors can be reached at (i) firstname.lastname@example.org (ii) email@example.com.
Updated as on April 10, 2020
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