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 No. 14 Joint ventures have attractions – but beware the pitfalls

NEW ZEALAND FARM FORESTRY ASSOCIATION - INFORMATION LEAFLET

Like a lot of other legal phrases, ‘joint venture’ is a term which is used pretty loosely to describe a whole range of relationships.

It is most synonymous with partnership but has the legal distinction that it is venture-specific, and the rights and obligations of the parties are determined by the contract between them, without the statutory and common law overlays that affect partnerships. The distinctions are often blurred, however. The most important distinction is that partners are liable for obligations or commitments entered into by other partners in the course of carrying on the partnership business, whereas joint venture parties generally are not.

Basically in a joint venture, parties come together to contribute different things and to share in the proceeds, e.g. to establish, manage, harvest and sell timber. This may involve two people forming a joint venture to buy or lease some land with each person contributing to the establishment, maintenance and harvesting costs. Both parties would then share the proceeds.

There may also be another ‘joint venture’ in that relationship if, for instance, the land is leased or a forestry right granted on a participatory basis where the landlord/grantor receives a nominal rent in exchange for a share in the proceeds when the forest is sold. These stumpage sharing or ‘deferred rental’ arrangements are, in essence, another form of joint venture where the landowner’s contribution is the land for a period of time and the rental return is dependent on stumpage returns.

The ‘joint venture’ relationship that presents the widest range of joint venture agreement relationship issues is the venture between investors. This venture can be directly between individuals or through a company where the joint venture terms are captured in a shareholders’ agreement and in the constitution of the company. Companies are most often used as a vehicle for investment in forestry when they qualify as Loss Attributing Qualifying Companies for tax purposes. Tax will, of course, be a significant factor in determining the structure of any joint venture.

Get the basics right
Exit options

Get the basics right

The issues to be covered in a joint venture agreement, though, are largely the same whether investing directly or through a company. When establishing a joint venture it is important to get the basics right. What are parties objectives? Does this form of venture enable all parties to achieve their objectives? If one party’s goals can only be achieved to the detriment of another you have a recipe for disaster.

It is also important to establish what the parties’ contributions and obligations are to be. One may be responsible for providing land or money, another may be responsible for providing management input, or carrying out work such as planting. Parties undertaking activities may or may not get paid on the way through and contributions may be accumulated and dealt with in determining profit shares.

A joint venture has to deal with its own internal administration and procedures, particularly decision making and what participants’ voting rights are - in other words, where control lies. A joint venture agreement also deals with housekeeping matters such as bank accounts, cheque signatories, financial accounts to be maintained and whether or not those accounts are to be audited.

Exit options

If a party is in a minority and if at some point it does not like what is going on, its exit options will be important. The worst possible situation in these circumstances is if a party is locked in either because it has agreed that it won’t sell it’s interest for a period of time or because it simply has an unmarketable interest and the other party or parties won’t buy it out at a fair price.

Joint venture agreements often have devices to get round those type of problems. One of them is a ‘shotgun provision’. This is where party A tells party B that A is prepared to sell for a certain price. B can either buy A’s interest at that price or sell B’s interest to A at exactly the same price.

In these circumstances, if you want out, you actually have to be prepared to end up owning the whole. These sorts of clauses tend to disadvantage minority interests because they do not have the resources to take up the other side’s shares or interest if it is put to them.

A more equitable solution may be that if the parties are unable to come to an agreement on one buying the other out within a certain period of time then the whole project is put on the market and sold.

In an equal shareholding situation it is not uncommon to simply have a deadlock situation where unanimity is required on all issues. In these situations, both parties become completely hamstrung in their ability to operate the joint venture and the agreement relies upon the incentive of commercial necessity to force the parties to a compromise.

A variation on that theme is to have somebody come in as an arbitrator or an umpire and try to resolve the dispute, but then the joint venture is in danger of being managed by a third party. In circumstances where one party simply wants to exit and there is a market, often the agreement will provide that such interest needs to be offered to the other participants first. Assessment of value then becomes an issue as minority interests can be penalised for their lack of liquidity and, as a result, sell at a discount.

There are of course many other things to look out for. However, joint ventures are a widely accepted means of pooling capital and resources, and need to be acknowledged and approached as such.

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This article by Jeff Morrison, a partner in Russell McVeagh, appeared in the August 1999 issue of the New Zealand Tree Grower.