Home Companies Act 2013 Joint Venture Agreement vs. Memorandum of Understanding

Joint Venture Agreement vs. Memorandum of Understanding

October 25, 2021

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This article is written by Yamini Jain, pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho. The article has been edited by Prashant Baviskar (Associate, LawSikho) and Smriti Katiyar (Associate, LawSikho).

Introduction

In order to make a comparison between a Joint Venture Agreement and a Memorandum of Understanding (“MOU”), it is essential to understand the fundamental nature of the two of them. Any arrangement among two or more parties to cooperate so as to run a business or achieve a commercial aim is commonly known as a JV. On the other hand, an MOU is a formal written agreement between two or more parties outlining the aligned intentions of the parties. The niceties under the abovementioned concepts have been discussed in detail below.

What are Joint Venture Agreements?

Its nature majorly depends on its own underlying characteristics and facts upon the resources and desires of the involved parties. It is a symbiotic business alliance between multiple companies wherein the complementary resources belonging to the partners are shared mutually for their due perusal. The most significant features of a JV would include its effective business strategy for the enhancement of marketing, positioning, and acquisition of clients that has stood the test of time.

Why create a Joint Venture Agreement?

There are a few reasons why two parties might decide on a joint venture agreement:

It allows them to share the reward and risk, which is ideal for minimizing losses.
It helps them each grow as a separate company without seeking capital from other sources.
It gives them access to wider markets.
It permits them to share resources with each other.
It allows them to develop new products.
It provides them with greater skills and expertise.
It helps them diversify their interests and products.
It offers more flexible control over a relationship as opposed to stricter agreements.

Some of the primary purposes of establishing a JV include leveraging resources such as labour, capital and technology to aid in the achievement of economies of scale. JVs can limit individual exposure by enabling sharing of liabilities and thereby offers an opportunity to the parties to jointly manage the risks associated with setting up new ventures. Further, it provides greater market access and is heavily utilized by companies to expand their businesses in other consumer segments, geographies and product markets. This, thereby, enables flexibility in diversifying business by allowing companies to enter into non-core businesses while maintaining an easy exit option.

What is a Memorandum of Understanding?

An MOU is a document that sets out the intent of a common line of action of the parties. It indicates that the parties to it have reached an understanding with a common notion and are prepared to proceed for the next action. Although it does not legally bind the parties, it serves as a firm declaration of the imminence of a binding contract. Such documents are frequently used to facilitate negotiations in commercial transactions as well as in international relations. Thereby, MOUs are generally pursued by the partners of a JV Agreement in the early stages of a negotiation, essentially serving as the foundation of a JV in the future.

Steps involved in drafting MoU

Step – 1: Planning Phase: each party expresses its requirements, objectives, goals, and negotiable points.

Step – 2: Drafting Phase: parties then draft the initial MoU

Step – 3: Negotiating phase: the MoU typically outlines guidelines that govern the mediation process.

Step – 4: Timeline negotiation: on completion of negotiations, parties establish a timeline for the MoU to take effect, when it shall expire and any rules regarding termination.

Step – 5: Restrictions: finally, each party adds any restrictions, disclaimers, privacy statements, etc., and signs the final MoU.

Important Clauses of Joint Venture Agreements and MOUs

Though a JV is usually beneficial, there exist certain concrete drawbacks to it if not drafted in a clear fashion. Further, since a MOU marks the starting point of the establishment of a JV, it is best to have clarity in jotting down the clauses under it to avoid any conflict at the stage of executing a contract in furtherance of such MOU. Some of the key clauses have been described hereunder for both JVs and MOUs:

Joint Venture Agreement

Recitals and definitions

It is crucial that the parties and their business address are mentioned and the purpose of execution of such agreement is clearly specified at the beginning of the document. Following the recitals, the first and most important cause of any agreement shall be the ‘definitions’ clause that ought to define all key and unique terms in the agreement in clear and specific words to avoid any ambiguity in its meaning at any point during the term of the agreement or post its termination if in dispute.

Structure of the Joint Venture

Since there is no stringent criteria upon which the structure of a JV may be determined, it is generally upon the parties to ascertain the same in this clause. They may enter into either of the two kinds of JVs, contractual or a separate legal entity established under the Companies Act, 2013 for the purposes of the JV. It is pertinent that this clause lists the details of the formation of the JV along with the registered office and business address of such JV.

Contribution of parties

The quantum and nature of the investment to be made by the parties in the joint venture is decided by them at their discretion. It can be in the form of intellectual property, equity, debt, capital, or distribution channels, management skills, machinery, goodwill, or any other non-monetary consideration. It can also be determined on a pro-rata basis or otherwise.

Distribution of shares

The proportion of ownership of any company is dependent on the proportion of shares distributed amongst parties. It may be determined on the basis of capital contribution or mutual agreement, and its ratio further has an impact on the decisions of the JV.

Management and financial arrangements

The representation of the parties in the company is dependent on the criteria set out in this clause. It may depend on the shareholding proportions or a management committee may be appointed for short term projects. Along with the internal functions of the company, the parties also contemplate their financial arrangements in respect of the profit-loss sharing ratio or the expenditure to be borne by each.

Deadlock resolution

A deadlock is a situation where parties holding equal powers cannot arrive at a common ground in respect of a particular decision. The various ways in which such deadlock could be resolved include a casting-vote method, an independent manager, gin and tonic method, the third-party swing vote, Russian roulette, or Texas shootout, etc.

Other standard clauses

A JV Agreement shall stipulate various other conditions highlighting the rights and obligations of the parties, their representations and warranties, a covenant to keep each other indemnified of any losses, non-compete, confidentiality, dispute resolution, force majeure, termination, exit mechanism, etc. so as to avoid conflict on its terms in the future, as far as possible.

Memorandum of Understanding

Purpose of the arrangement

This clause shall provide for the exact intent of the parties behind the execution of an MOU and the nature of the commercial transaction that they wish to enter into. It may be for the purposes of a sale, investment, consultancy, etc. thereby setting out the basic terms for it.

Intent to make the MOU legally binding, wholly or partially

As noted above, it is the intention of the parties which determines the binding nature of a MOU. The language of the document is crucial in identifying such intent, whereas, a clear or specific mention of the same aids in avoiding multiple interpretations of the same.

Obligations of the parties or the commercial understanding

This clause states what the parties are intended to do or refrain from doing as per the conditions stipulated in the MOU. Such obligations could vary from the time of performance, payment preconditions, encumbrances, etc. on account of each party individually and simultaneously.

Confidentiality

Often MOUs are entered into with an intention to get the parties to commit to the transaction before actually consummating it. Commercial transactions often have implications on the market movements, especially when these are entered into between two entities that hold a significant market share. In some cases, there may be an ‘announcements’ clause permitting the sharing of the deal, if that benefits the parties to gather momentum or market traction.

At the stage of entering into an MOU, the process of due diligence has not begun, and therefore, a lot of confidential information isn’t shared. However, it is possible that the deal itself or the possibility of the transaction itself is likely to have implications, and therefore, it is required to be kept confidential.

Term/termination

MOUs may not have a definite term and may last up to the time when a definitive agreement is entered into or up to specific work is done or up to the time when something is delivered. It may also have a specific term indicated in it. Together with the terms, it may also have a termination clause that provides either of the parties a right to terminate the MOU at convenience.

Stamping of a MOU

MOUs may not be stamped, particularly if they are not intended to be binding on the parties. However, where the intention is to create legally binding covenants and obligations through such MOU, it ought to be duly stamped in a manner as is applicable to any other agreement of like nature.

Conclusion

A wide range of investments has positively impacted the participation of corporations, especially in the fields of infrastructure, energy, construction and mining, so as to combine their forces and employ their specialities and financing routes, together. The exchange control liberalizations, in the recent past, on payments to foreign technology providers has further spurred activities pertaining to JVs in the country. JVs and MOUs are two such distinct documents that are mistaken to have a similar purport. However, the major difference in the two lies in the intent and timeline of their execution. As has been highlighted hereinabove, MOUs act as a precursor in the stratification of the execution of a JV while the negotiations for the same are under process.

References

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