Contractual Joint Ventures Explained
Contractual joint ventures (CJV) are arrangements where parties contractually agree to undertake a specified business project, together with their respective ownership of the results of that project. A key characteristic of the CJV model is the limited duration of the relationship between the parties. A CJV typically is for a limited duration, and the CJV will terminate at the end of the project. The practical result is that the CJV is not a natural person (and not entitled to registration as a foreign investment), but rather is a contract between the parties as to certain rights and obligations.
The CJV business model differs from the equity joint venture model in that a CJV does not require the creation of a new legal entity. Parties engaged in a CJV only need to enter into an agreement, and they are only subject to rights and obligations spelled out in the CJV agreement. In addition, the CJV does not require parties to contribute equity, and one or both parties may not contribute all of the capital required to conduct the project , which is a typical requirement for forming a WFOE joint venture entity. A CJV is "closed" meaning that neither party can transfer its interest in the CJV to a third party without the consent of the other party.
Because a CJV is a contract among the parties, its primary purpose is to establish the terms of the relationship between the parties, particularly the sharing of profits and losses and the use of intellectual property contributed by the parties. Under a CJV, the parties are "free to negotiate their own terms, determine their own rights and obligations, divide their responsibilities, and therefore allocate their risks and profits." A CJV is a partially registered joint venture business model, because there may be aspects of a CJV that require the parties to notify the Ministry of Commerce. For example, if a CJV involves importing/exporting goods, the parties may need to register with the relevant customs authorities.
A CJV can be a good vehicle for parties to minimize risk and obtain the benefits of complementarity, joint marketing, and resource sharing. These are very attractive benefits for market entry into China.
What to Include in a Joint Venture Agreement
A contractual joint venture agreement can take many forms, but a comprehensive agreement should have certain key elements to clearly delineate the rights and responsibilities of the contracting joint venture parties. Of course, the particulars of each joint venture will depend on the nature of the business and the anticipated goals of the joint venture. However, certain basic terms are generally present in most agreements.
The agreement should describe the roles and responsibilities of each party with regard to the management and operations of the joint business. This may include the manner of decision-making and the allocation of risks and benefits among the parties. One of the major reasons for entering into a contractual joint venture agreement is so that the parties can share risks and benefits. The terms of how those risks and benefits are distributed should be detailed in the agreement.
One important element would include the contribution of each party to the joint venture. The parties may contribute cash, inventory, developments, equipment, expertise, or other tangible or intangible assets. The agreement should also state how long the parties’ contributions will be used, whether or not they may be withdrawn, and how they will be accounted if the relationship ends. For example, it may be a term of the agreement that neither party may withdraw its financial interest until the joint venture has brought in a certain amount of profit.
Terms regarding the allocation of the profits or losses generated by the joint venture is another key element. Again, this will vary according to the nature of the business and may even be affected by the role of each party in the joint venture. Terms of financing the venture and/or sharing financing obligations may be included. Typically, the profits and losses will be shared in proportion to the initial contributions of each party, but the parties may agree on a different formula.
The agreement may also discuss exit strategies or termination provisions. A strong contractual joint venture agreement will include a mechanism for resolving any conflicts that arise. It should also provide procedures for how the business will wind up and how the assets will be distributed.
Legal Issues When Preparing Agreements
As with any written agreement, legal implications loom large in drafting a contractual joint venture agreement. For example, while the parties to the agreement are often dissuaded by the prospect of drafting a finite and legally enforceable contract, proper legal counsel proves invaluable when drafting a contractual joint venture agreement. Most of the requirements imposed on a contractor are significant and can even turn the tide for or against one of the parties. Common examples of the implications of proper legal counsel are employment law violations, violation of competition laws, and compliance with any laws requiring business licenses and permits. Additionally, a contractor who begins to operate before obtaining the required licenses or before the incorporation of the new company may be subject to fines and liability for improper operation. Finally, a business that does not incorporate can be held liable for all debts and injuries of its constituents. While it is impractical for a joint venture to remain active without revenue, and therefore without any labor force, the contractor must take the appropriate measures to make sure their labor force is treated and classified in accordance with the law. To this end, a contractor attempting to implement a joint venture must be sure to observe and comply with employment law in terms of wages, hours, overtime and workers’ compensation claims. Similarly, compliance with competition law must guide the contractor’s joint venture agreement in order to avoid inadvertent limitations on freedom to trade. In addition, the contractor must ensure that the new company complies with the various tax code requirements. While the IRS typically will not impede the operations of a private contractual joint venture, it is always prudent to file the appropriate documentation in order to receive the appropriate tax identification number.
Pros and Cons
When considering whether to enter into a contractual joint venture, the principal advantages and disadvantages are as follows:
Advantages
A contractual joint venture can be implemented quickly and without red tape. A contract is easier to draft and negotiate than other alternatives, particularly when intellectual property is being contributed to the joint venture.
As it can often be cost prohibitive to establish a stand-alone joint venture company, a contractual joint venture can be the more affordable form of collaboration.
It can be the least risky form of joint venture. In comparison with shareholders of a company in which their interests are diluted, the parties’ interests in a contractual joint venture are not diluted. There is less risk of personal liability.
Disadvantages
A contractual joint venture does not create a separate legal entity. Because of this the parties must rely entirely on the contractual documentation to establish their rights. In certain situations this may create a disadvantage – for example, the concept of fiduciary duties does not apply to a contractual joint venture and therefore the parties may be less protected than if the collaborative effort was structured as a company.
Examples and Case Studies
To see contractual joint venture agreements in action, a handful of case studies provide insight. Two examples come from the Southwest region of the U.S. and the Canadian market. In both scenarios, cities entered contractual joint venture agreements with companies to expand infrastructure within their borders. For example, in 2015, Phoenix formed a joint venture with Paloma Partners II to develop a 108-acre neighborhood beneficial to the Arizona State University community and other developments including an urban mural project. Paloma Partners II specializes in unfairness claims resolution, capital recovery and litigation financing. The joint venture created an improvement district in the 5th Avenue and Van Buren Street areas in central Phoenix called the Roosevelt District. The district, in two phases, proposes to use 61 acres of the land to build a multi-story, live-work-play community with a library, landscaped commons, market-rate units and a light rail stop. The surrounding area not only includes ASU but also three art galleries and the Phoenix Art Museum . Similarly, Calgary city officials signed a joint venture agreement with developer West Campus Development Trust (WCDT) to support and create new jobs and businesses in the city’s downtown core. The agreement calls for WCDT to turn a parkade block into an office tower topped by a 224-unit condo complex. The residential portion of the project plans to be eco-friendly and features interiors by international designer Cecconi Simone. The joint venture agreement stipulates that construction of the residential portion would begin after the construction of the office tower and the two projects would be built simultaneously, pending financing. Mayor Naheed Nenshi said the "large office development project had the potential to create 7,000 jobs and $300 million in business income within downtown Calgary." Although the entity holding responsibility in a contractual joint venture can transfer its own interests to another party, the contracting parties remain jointly and severally liable under these types of agreements.
Negotiating a Joint Venture Agreement
Negotiating a Contractual Joint Venture Agreement
The negotiation process for establishing a contractual joint venture agreement begins with open and honest dialogue between the parties to assess the feasibility of entering into this type of agreement. Once the parties have agreed to a joint venture, it’s important that you ask the following questions: Establishing a contractual joint venture agreement requires strategic consideration because the business and legal implications will have a long-term impact. In the negotiation process, there are certain proposed strategies that may be utilized to ensure that this process is done correctly: (i) Ask open-ended questions throughout the negotiations process to allow all parties an opportunity to express their thoughts, if any; (iv) Close all discussions to maintain continuity, so all aspects of the agreement have been addressed, i.e. all capital contributions discussed before closing the deal; (v) Review and revise contracts together to ensure sufficient legal protection; and (vi) Draft a final agreement that reflects all negotiations. If issues arise during the negotiation process, it’s helpful to have a strategic plan in place for conflict resolution. A few ways to resolve these issues include: (i) Use active listening skills to de-escalate tension, if any, between the parties; (ii) Discuss potential options to see if there’s an opportunity for a win-win situation; and (iii) Alter agreements to reach creative solutions.
Trends for the Future
Emerging trends and sectors to watch
As the economy continues to evolve, so too will the practices of contractual joint ventures. Considering the global nature of modern business, trend watching may begin outside of the US.
Internationally, a considerable move towards inter-regional collaborations has already started. This trend will also be seen at a national level. Already, more and more regional development organizations form partnerships with neighboring or near neighboring regions (see an example here). As industries migrate, regions will need to work together to keep their economic engines going, and in turn strengthen their relationships through joint venture agreements.
Industry-wide, the technology sector is always on the lookout for the next best innovation. In our current climate where major technology players are developing robots that mimic human workers, a contractual joint venture would allow the sharing of research between traditional competitors to cut down costs while maximizing output.
For technology-focused contractual joint ventures, the sharing of information has both encouraged further development and has made it accessible to a wider audience through increased transparency. The only thing holding back the business and social pressures for the emergence of this type of joint venture is the POETIC problem—pressure of equal or greater size, on equal terms, of higher importance, of equal term, of a collective interest . As technology continues to evolve, especially with the development of apps and other open-source systems, the tensions created by unequal POETIC will continue to lessen.
One industry that will see an upshot due to contractual joint venture agreements is impact investing. Investors increasingly see corporate social responsibility as a consideration in investment decisions. Corporate social responsibility offers a method for addressing common societal problems through multiple routes while seeking a direct or indirect financial return. Because there is so much focus on aligning impact investing with traditional investments, contractual joint venture agreements are in the spotlight. For instance, the charitable arm Solar Aid uses contractual joint ventures with local solar equipment sellers to establish its solar microfranchises that empower entrepreneurs in Africa. One outcome of this arrangement is that, after a sale, both the seller and Solar Aid receive a share of the profit and the Solar Aid franchisee receives the cash to off-set the cost of the solar panel for their customers. Solar Aid uses its share of the profits to train the entrepreneurs to provide high-quality customer service and business skills. After training, these young entrepreneurs are then certified by Solar Aid, which markets them to diverse clients.