This article is written by M.S. Bushra Tungekar from the University of Mumbai Law Academy. In this article, the author discusses important clauses to be mentioned in a joint venture agreement.
Table of Contents
Introduction
India is a lucrative destination for investment having commercial incentives and a vast market for various sectors. India has a lot to offer right from skilled and unskilled labor to advanced technology and manufacturing industry.
Joint ventures are a preferred form of investment for foreign investors who intend to do business in India. Joint ventures facilitate foreign entities to gain quicker market access and a better understanding of the Indian market with the help of the Indian entities.
Indian entities can gain a competitive advantage by entering into a joint venture with a foreign entity possessing better and advanced technology and processes.
Setting up a joint venture can be really simple if done with efficient planning, assessment of viable joint venture partner, format, target market study, and structure.
What is a joint venture?
Joint ventures are a strategic partnership undertaken by companies for running a business or a project or to obtain a commercial objective. Joint ventures can be of various types and forms, it can be based on a contract or it can be equity-based.
The duration for which the joint venture had been established may also vary. It can either be based on the perpetual running of the business or for a short period of time, at the end of which the Joint venture ceases to exist.
A joint venture is a malleable concept. The nature of the joint venture depends on the wishes of the parties and the resources along with other facts. It is completely upon the parties to decide the purpose, duration, and structure of the joint venture.
It is not unknown that synergies of two or more companies, allow them to thrive in a market, which they wouldn’t have been able to do on their own. Major resources such as technology or intellectual property are the backbone of any organization same applies to joint ventures.
The pooling of resources, easy access to the market, easy access to technology, synergy, sharing of risks and knowledge, etc are some of the reasons why companies prefer joint ventures as a form of a corporate structure.
Important clauses
Establishing a joint venture involves a series of steps starting with identifying and assessing a viable joint venture partner to enter into an agreement. Joint venture transactions require efficient documentations and other allied/ ancillary agreements.
Before entering into the joint venture a memorandum of understanding (MOU ) or a letter of intent (LOI) is signed by the parties, in order to express the intention of the parties to enter into such agreements.
A joint venture agreement is the heart and soul of any joint venture. It lays down the object and purpose of the joint venture. Not only that it also provides for the structure, rights, and obligations of parties, the manner in which the business is to be conducted, the profit-sharing ratios, dispute resolution, etc.
An ideal joint venture agreement should contain all the relevant clauses that have been agreed upon by all the participating parties. It should not be ambiguous and must try to cover all possible scenarios that might arise. As the smooth functioning of any joint venture depends on the joint venture agreement, ambiguity in the agreement will hamper the functioning.
A joint venture agreement can be said to be the constitution of the joint venture. It is crucial that important clauses are efficiently incorporated into a joint venture agreement. Although the clauses in a joint venture agreement may vary from one venture to another, the following clause will find its place in a joint venture agreement almost always.
Definitions
First and foremost it is important to have a clause that defines all the relevant terms in the joint venture agreement. This is done so as to avoid any misunderstanding and ambiguity in the agreement. Certain words or terms are given restrictive definitions for the purpose of interpretation of the agreement.
It ensures that there is a mutual consensus between the parties as to what a certain term means. It is highly recommended in joint venture agreements especially if the venture involves a high level of technical work.
This clause may also define various acronyms used in the joint venture agreement. For example, the Civil Procedure Code of 1908 may be referred to as “the code” in the agreement.
Parties to the Joint venture
Identification of the parties involved in a joint venture is important. As there may be cases wherein the original party is not the investing party, and the investing party may be the parent company of the original party. Therefore to ensure that the joint venture agreement is binding to the investing parties as well as original parties, the parties to a joint venture must be defined.
The parties defined under this clause shall set the terms for the rights and obligations, the profit-sharing ratio, thereunder. The clause shall contain names of the pirates, their registered office, their place of conducting business, etc.
Business object and Purpose of the Joint Venture
This is one of the most important clauses in the joint venture agreement. This clause lays down the purpose for which the joint venture is being entered into. This clause must be elaborate a very small definition of the business or object that may give rise to disputes in the future.
The clause should explain in-depth as to what is the object of the joint venture and the territory in which the business is to be carried. Technical details are also to be mentioned under this clause.
The language of this clause must be clear, precise and unambiguous. If a joint venture is to be terminated on the accomplishment of a particular goal then the means to measure the accomplishment of such a goal is to be mentioned under this clause.
The Structure of the Joint venture
The parties to the joint venture are free to mutually decide the structure. There are no hard and fast rules as to the structure of a joint venture. Under this clause, the structure shall be laid down. The parties may enter into a contractual joint venture. The pirates may even create a new entity by registering the company under the Companies Act of 2013 for the purpose of the joint venture.
This clause shall also contain the details of the formation of the joint venture thereof. It shall also mention the registered office and the location where the joint venture shall be conducting its business.
Contribution of parties
The parties to the joint venture decide the quantum and the nature of the contribution they are willing to make. The parties decide how much capital they want to invest in the venture. The nature of contribution by the parties can be in the form of capital or intellectual property or debt or equity, it can also be in the form of distribution channels or management skills, or machinery, or goodwill, or any other non – cash considerations.
The capital ratio contributed by the parties is not necessarily 1:1. Therefore the details of the contribution by the parties are to be explained under this clause.
Distribution of shares
The shareholding of all the partners shall be laid down under this clause. The distribution of shares is an essential aspect as the shareholdings determine the proportion of ownership among shareholders.
The distributions of shares need not be 50:50, it can vary. The shares can be distributed by a mutually agreed ratio or on the basis of the capital contribution of the parties.
The shareholding ratio affects the decisions of the joint venture. An equal i.e 50:50 ratio would mean that both the parties involved would be considered on an equal footing.
Therefore it is important that the distribution of shares is spelt out in the joint venture agreement.
Management
This clause lays down the representation of the parties on the board. The ratio of representations may depend on shareholding positions. As we know that in India not all decisions require the approval of shareholders, certain decisions are taken by the board of directors.
The parties may also agree upon establishing a management committee instead of appointing the board of directors where the joint venture has been entered into for a particular short-term project.
The board of directors or the management committee is responsible for conducting the day-to-day business of the joint venture. It is essential that all the parties involved in the joint venture nominate their representative and agree upon the functioning of the management.
This clause will lay down as to the composition of the Board of directors, how a director is to be appointed, or removed, provisions for alternate directors, their remuneration, etc. What will be the composition of the board in case of a change of shareholding ratio? The clause shall also lay down the procedure for the appointment of the CEO or a managing director.
Usually, the decisions are approved based on the vote of the majority of the board of directors. There should be a balance of power, neither party would want to get outvoted. However equal representation may also result in a deadlock situation.
This clause will also lay down the conduct of the board of directors or the managing committee such as:
- Frequency of meetings;
- The quorum for the meetings;
- Voting majorities;
- Special resolution;
- Setting of agenda.
Financial arrangements
Profit-loss sharing
This clause shall set out the ratio of profit and loss sharing, and capitalization. The ratio in which the profit shall be distributed must be laid down in the joint venture agreement. This clause should also lay down the profit distribution policy and the amount of profit to be transferred to reserves. It should also lay down the provisions for bearing the losses
The tax implications should be considered as well when establishing a dividend policy. Fund allocation method and procedure for purpose of research and development.
The procedure to be followed in case there is a need to raise additional capital. The terms and situations upon which the additional capital is to be raised.
Bearing of expenses
There are various expenses such as legal fees or travel of the employees and other expenditures that are necessary for the smooth functioning of the joint venture. There should be a provision pertaining to the dealing of such expenditure. these expenses can be deduced from the profits or the parties can agree to share the expenses in a mutually agreed-upon ratio.
Rights and obligations of the parties
The contributing parties have certain rights that they can exercise and certain obligations. The clause should lay down in detail as to what is expected from the parties. This is done so in order to avoid future disputes and misunderstandings
For example, if a party has agreed to bring in raw cocoa and the other has agreed to provide for the processing facility. Then these functions would come under the obligations of the parties. As they are the key functions of the joint venture. The details as to the quality of products bought by any party must also be listed under this clause. This helps in freeing the agreement of any ambiguity.
Their rights and the manner in which they can exercise such rights. Also, the extent to which they can exercise such rights should be listed in the joint venture agreement. The rights of parties can consist of the right to vote, the right to information, the right to inspect the books of accounts, so on, and so forth.
Representation and warranties
Representations and warranties are often found in business contracts. They are statements of fact made by the parties entering into the joint venture. Representations and warranties are usually made before entering into an agreement such representations and warranties are also mentioned in the joint venture agreement.
Representations and warranties are made so that the parties have sufficient information about each other such as financial standings of the parties or the loans taken by the parties, pending litigation, etc.
Many such statements along with relevant documents are exchanged between the joint venture parties during the due diligence process. It helps the parties to make an informed decision and later on there no surprises.
Misrepresentation of facts can be used as a ground for termination and the aggrieved party can claim damages as well. Warranties can be affirmative or can be promissory in nature.
These statements are essential as they facilitate the parties in deciding whether they want to enter into the joint venture or not. Therefore they are to laid down in the joint venture agreement as well. Not only that the steps to be taken in case of misrepresentation or in case of breach of any such warranty is also to be mentioned in the agreement.
Indemnity clause
Indemnity is a legal obligation on the parties to compensate the other party in case of breach of any contractual obligation. The representations and warranties clause is often accompanied by an indemnity clause.
The party who suffers due to a breach of representations and warranties is entitled to be indemnified for the losses. The right to be indemnified is in addition to the right to receive damages under the law.
The indemnity clause must be fair, mutually agreed upon, and well balanced. The language and scope of this clause should be clear and precise.
Non-compete clause
The non-compete clause of the joint venture agreement is very useful in conducting the business of a joint venture. In India, there cannot be an absolute non compete agreement between parties. The Indian constitution and the Indian contract law prohibits absolute restriction on the free practise of any trade or profession.
A non-compete clause can be mentioned provided the restriction is reasonable otherwise it shall be treated as a violation of a person’s fundamental right to trade, which has been guaranteed under Article 19(1) (g) of the Indian Constitution. Not only that it shall also violate Section 27 of the Indian Contract Act, 1872, wherein the agreement would be held void.
A reasonable restriction is permitted so that the joint venture does not have to compete with any of the company of the owners in the same business. The reasonable restriction can be in terms of the geographical limit of conducting business or the duration.
Confidentiality
While entering into a joint venture during the due diligence stage the parties tend to disclose critical information with respect to the company.
The information can be related to technology, or trade secrets, or intellectual property. The information that is not available in the public domain and the ancillary documents are also disclosed. The information in the wrong hands would cause the party to suffer losses. This is why this clause is very crucial.
The clause may also provide that the information disclosed for the purpose of the joint venture shall not be used for personal gains. Furthermore, confidentiality is to be maintained even after the termination of the joint venture, or a stipulated time can be mentioned for maintenance of confidentiality after the termination of the joint venture.
The clause also put an obligation on the parties to ensure that the information disclosed to any of the employees are also bound by the confidentiality clause of the joint venture agreement.
This clause must mention what information would come under the ambit of confidential information. This can also be defined under the definition clause of the joint venture agreement.
Dispute resolution
The parties in a joint venture are bound to have disagreements and conflicts. Not every time it would lead to full-blown litigation however it is always advisable to have a mechanism in place to deal with such situations.
The parties in a joint venture can be from different jurisdictions and governed by different laws. Therefore the mechanism to be followed in case if a dispute arises must be mutually agreed upon by the parties and must be laid down in the agreement.
This clause should mention the following things:
The governing law
It is upon the parties to mutually agree upon the law that would govern in case of a dispute. Once the governing law is decided the pastries have to abide by that law only.
The jurisdiction
In the case of multiple jurisdictions, the parties must agree upon one jurisdiction.
The parties can consider the benefits of laws and legal systems for better protection of their rights. As some jurisdictions are faster or more stringent when it comes to the violation of intellectual property rights. The quantum of damages that are awarded by various jurisdictions is also to be taken into consideration.
Arbitration
It is not unknown that arbitration is a popular and preferred mode of dispute resolution. It is popular due to various reasons in spite of it being a little expensive. The clause should lay down the procedure of appointing the arbitrator, the place of conducting the arbitral proceedings, the jurisdiction where the award would be entered, etc.
Enforcement
Judgments passed by all courts of law or awards passed by international arbitration are not always enforceable in India. To put in simpler terms the jurisdiction where the Indian Judgements are not enforceable, decrees and awards passed by such jurisdictions are not enforceable in Indian.
International treaties and conventions signed by India also play a role in the enforcement of the awards and judgments. Therefore the clause must have a provision for such scenarios as well.
Deadlock resolution
A deadlock usually arises when the parties involved in the joint venture have equal powers and are unable to come to a common conclusion. A deadlock arises when the parties are in disagreement and neither party is ready or willing to surrender their powers or accept the other parity’s decision.
A deadlock cannot be completely avoided as there will be disagreements. Therefore is advisable to establish a mechanism that will help the parties to come to a common agreement or to resolve the deadlock.
Deadlocks affect the functioning of the joint venture therefore the mechanism should be efficient and quick. The joint venture agreement must clearly mention what would constitute a deadlock and how it is to be dealt with.
Given below are the common ways in which deadlocks are resolved in a joint venture agreement.
Casting vote method
To give a casting vote to the CEO or the Managing director or the chairman of the company. However, the issue with this resolution is that the parties would then want to appoint the Chairman, or the managing director, or the CEO such a person who would favor them.
Independent manager
Where in the emergence of a deadlock a casting vote is given to an independent director or member of the board. This person should cast a vote keeping in mind the best interest of the joint venture and not any individual party.
The third-party swing vote
Similarly, the casting vote can also be given to a third party altogether. However, the parties may find it a little difficult in agreeing to a third party that is suitable for both. The third party is usually an expert in the field. Who has sufficient knowledge and can make a decision that would suit the best interest of the joint venture
Gin and tonic method
Under this method, the casting vote is passed to the representatives of both parties on a rotation basis. For example, for 1 year the representative of party A shall have the casting vote, and then for the next year, the representative of Party B shall have the casting vote.
The drawback in this system is that important decisions may be made in only one party’s term.
Texas shoot out
This mechanism involves sealed bids. Under this method, the parties are required to send to independent third parties, their sealed bids. The parties send their highest bids to purchase the entire share of the other party.
After receiving the sealed bids the third party discloses the highest bid and the party who made the highest bid has to purchase the shares of the other party at the said price.
Buy or sell also known as “Russian roulette”
In this method, there is compulsory buying or selling of shares by the parties. A party will offer to either buy the shares of the other party or will sell their shares. For example, Party X will offer to purchase the shares of party Y or will have to sell his shares to party Y. Now it is up to party Y whether to sell his shares or make a counteroffer to purchase the shares of X.
This method, however, starts a financial strength game. The company that is weaker than the other company in terms of financial strength would eventually have to sell out its shares. It can be a good method when both companies are near equals in terms of financial capacity.
Force Majeure
This clause provides for relief and protection to a party in case they are unable to fulfil some of their obligations. The inability to fulfil obligations is due to the events that take place which is beyond the control of the parties. The event could be a flood or an earthquake or a fire so on and so forth.
It is crucial to mention which type of events shall be covered under this clause. This clause may cover the events under the head of “Act of God” and other events such as thereat of war or terrorism, strikes, medical pandemics, etc.
The force majeure clause is interpreted in a narrow sense by the courts. Therefore langue of this clause must not be vague but specific and clear.
Exit mechanism
During the course of the joint venture, there can be many reasons where the parties would want to exit the joint venture. It could be short of funds or the joint venture going in losses for a period of time. It is not unusual for a party to want an exit from the joint venture.
Another common cause for exit by parties in cases where the deadlock isn’t resolved between the parties leading to an exit of one party or termination of the joint venture. Therefore the exit mechanism must be provided for in the joint venture agreement.
Again it is upon the parties to choose an exit mechanism, however, given below are few exit mechanisms that are commonly used:
- Initial Public Offering;
- Liquidation;
- Employee buy out;
- Sale of venture;
- Sale between parties;
- Notice;
Termination
Many joint ventures do not survive in the long and are often terminated. This clause is different from the exit mechanism clause. The termination clause provides for instances or breaches on the occurrence of which the joint venture will be terminated. Whereas the exit mechanism clause provides for ways in which the parties can exit from the joint venture.
Both the clauses are equally important. The following list of events may be included in the termination clause:
A material breach of agreement
When any party breaches any material provision or any specific provision that has been provided for in the agreement, the aggrieved party can seek for the joint venture to be terminated.
Representation
A false representation of facts and warranties can render a joint venture to be void and can lead to the termination of the joint venture.
End of period or objective
When a joint venture is undertaken for a short or a specific period of time or when the joint venture is undertaken for a specific project, then on completion of such time or project the joint venture will automatically come to an end.
Conclusion
The joint venture agreement is one of the most important documents in a Joint venture. It lays down the structure, the rights and obligations of parties, the functioning of the joint venture, confidentiality clauses, and most importantly the distribution of profits, etc.
All the clauses mentioned above in the article may or may not be added to the agreement. However, these clauses are essential to ensure that the agreement is free of any ambiguity. Further additional clauses depending on the nature of the joint agreement should be added.
The joint venture agreements are very flexible in nature and can be modified as per the needs of the joint venture and the parties
It is important to keep in mind that a joint venture agreement like any other agreement is legally enforceable. Therefore the parties while entering into such an agreement must ensure that they’ve completely understood the terms and that the agreement covers all aspects of the relationship between the parties.
Reference
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