The Lawyers Brief..Organizational Issues in Forming Joint Ventures

8/4/2019 The Lawyers Brief..Organizational Issues in Forming Joint Ventures

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THE LA WYER 'S BRIEFBUSINESS LAWS, INC.11630 CHILLICOTHE ROADCHESTERLAND, OHIO 44026

EDITOR: W.A. HANCOCKE-MAIL: [email protected]

PHONE: (440) 729-7996 FAX: (440) 729-0645

In This Issue:Organizational Issues in FormingJoint Ventures,by William H. Venema ....... 2I. General ............... 2II. What Should the Structure

of the Joint Venture Be? .. 2ID. Who Are the Venturers? .. 4N. What Is the Purpose andScope of the Joint

( "" Venture? .............. 4) V. How Will the JointVenture Be Funded? ..... 6VI. How Will Benefits andLosses Be Allocated? .... 7VII. How Will the Joint

Venture Be Governed? ... 7VID. Can the Joint Venture

Interests Be Transferred?IfSo, How? ........... 9IX. How Can a Venturer Getout of the JointVenture? ............. 10X . What Happens IfaVenturer Fails to Honor

the Deal? ............. 10Xl. How Does ItAll End? .. 11XII. Conclusion . .......... 11Checklist for the Formation of aJoint Venture,by William H. Venema ...... 11Simple Joint VentureAgreement,by William H. Venema ... , .. 15

Volume 35 Issue No. 13July 15,2005

Letter from the EditorDear Subscribers:

As many corporate counsel are well aware, setting up a joint ven-ture may be the tallest order handed down from management afterinitially setting up a company. The number of documents and negotia-tions that can be involved in a cooperative effort between two compa-nies can be staggering, as can the menu of options facing the decisionmakers. The different legal implications of choosing various forms ofjoint venture entities (i.e., partnerships, limited liability companies, andcorporations) can have a major impact on one or both parties' negotiat-ing stance. Even if the joint venturers have their preferences fairly clear,counsel still needs to anticipate potential issues and raise them in thenegotiations. Suffice it to say, this is a tough assignment to draw.

Inthis issue of THE LAWYER'S BRIEF, we hope to smooth overthat task somewhat by presenting some useful materials by William H.Venema, currently with the law firm of Epstein, Becker &Green, P.C.,in Dallas, Texas. Mr. Venema's article walks the reader through thefundamental questions that will come up in organizing a joint venture.He then provides a more specific, point-by-point look at the issues inthe form of a checklist that counsel will find useful. Finally, we haveincluded a sample joint venture agreement prepared by Mr. Venema,which should serve as a good starting point for counsel in drafting theirown agreements.

Very truly yours,

Robert A. ChaloupkaAssociate EditorOur Corporate Counsel Catalog Is Available on the

Internet: www.businesslaws.com
http://www.businesslaws.com/http://www.businesslaws.com/


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2 THE LAWYER'S BRIEF July 15, 2005

ORGANIZATIONAL ISSUES IN FORMING JOINT VENTURES* illiam H. Venema**

I. GeneralA cursory review of most any business publicationreveals that in recent years joint ventures have become apopular business form. Venturers form them for a variety

of reasons. They allow venturers to combine, and takemutual advantage of, complementary experience and ex-pertise, technologies, management talent, and fmancialresources. Accordingly, most managers see them as an ex-pedient way to enter into new markets; to gain skills,technology, or products; or to share fixed costs and re-sources. Nevertheless, the task of forming ajoint ventureis not easy. Some experienced business professionals con-tend that joint ventures are fraught with problems and allbut doomed to failure. The goal ofthis article isto help thereader avoid the most common pitfalls.For the sake of discussion, let us define a joint venture

as the development of a business opportunity by two ormore entities acting together. Joint ventures may beconducted through a variety of structures and need notinvolve the creation of a separate legal entity. Joint ven-tures can be corporations, partnerships, limited liabilitycompanies, or trusts, or they can simply be contractualarrangements between or among the parties to the jointventure.Designing an appropriate structure for a particular

joint venture will depend on a variety of factors, includ-ing tax and accounting goals, business objectives, andfmancial needs. There are, however, certain core issuesthat should be addressed at the time of formation. This

article will discuss those core issues in a general fashion.It is, however, beyond the scope of this article to attemptto explain the precise manner in which such issuesshould be addressed in every situation. Nevertheless, thisarticle should provide good "food for thought" for thosetasked with forming joint ventures.In addition, the reader will fmd, at the end of this arti-cle, a Checklist for the Formation of a Joint Venture and

a simple Joint Venture Agreement. As the remainder ofthis article will make clear, however, forming a jointventure involves accommodating a great many compet-ing considerations. The checklist and agreement are rud-imentary samples that may be useful, although they donot address every important issue that the parties form-ing a joint venture may need to consider. Accordingly,they should be used with care and due regard for theissues presented in a particular situation.II. What Should the Structure of the Joint Venture

Be?A. AVariety of Structural ChoicesThe first step in forming ajoint venture is to determinewhat "it" is going to be. There are a variety of alterna-tive structures to choose from. If the joint venture willbe operating principally in the United States, it can takethe form of a corporation, a general partnership, a lim-ited partnership, a limited liability company, or anotherform of legal entity formed under the laws of any par-ticular state. If the joint venture will be operating prin-cipally overseas, then the venturers may choose to form

Copyright 2005, William H. Venema. All rights reserved. Reprinted with permission** William H. Venema is with the Dallas, Texas lawfirm of Epstein, Becker & Green, P.e. He can be reached [email protected].

*

Copyr ight 2005, Business Laws, Inc. THE L AWYER'S B RIE F (ISSN 08989966) is published twice each month by Business Laws, Inc., 11630Chillicothe Road, P.O. Box 185, Chesterland, Ohio 440260185, (440) 7297996. The subscription price is $495.00 per year. Single issuesand back issues are available at $30.00 per copy. Thispublication is sold with the understanding that the publisher is not engaged in renderinglegal. accounting. or other professional services or advice. If legal advice or other expert assistance is required, the services of a competentprofessional should be sought. The information contained herein is based upon sources believed to be accurate and reliable - includingsecondary sources. Where cases, statutes, or other official materials have been reprinted, we have attempted to provide materials as closeto the originals as possible, but we do not purport to publish any documents verbatim. While we have exercised reasonable care to ensure the accuracy of the information presented, no representation or warranty is made as to such accuracy. Readers Should check primary sourceswhere appropriate and use the traditional legal research techniques to make sure the information has not been affected or changed by recentdevelopments.
mailto:[email protected]:[email protected].


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THE LAWYER'S BRIEF July 15, 2005 3

an entity pursuant to the laws of the country in which thejoint venture will be doing business. Finally, the ventur-ers may decide not to form an entity at all, but rather tocreate the joint venture by means of contractual relation-ships that establish the relative rights and obligations ofthe venturers.B. Limited Liability and the Structure of the Joint

VentureThere are, of course, a variety of issues to consider indeciding upon a structure for the joint venture, includinglimited liability, governance, and tax considerations. Be-ing the risk-averse creatures we are, lawyers typicallyfocus on limited liability. To achieve this result, lawyersoften recommend corporations, limited liability compa-nies, or limited partnerships. There are, however, otherways to achieve limited liability, and so this goal neednot dictate the selection of a particular form of entity.C. Governance Issues and the Structure of the Joint

VentureGovernance issues normally do not force the venturersto choose one form over another. Although differenttypes of entities use different management structures, theventurers can usually achieve their governance goals, re-gardless of the form the venture takes. If the form is acorporation, the issues can be addressed in the manner inwhich the board is selected, as well as in various provi-sions in the bylaws and, perhaps, a shareholder agree-ment. If the form is a limited liability company, mostissues can be addressed in the operating agreement. In ajoint venture based on contractual provisions, the partiesare free to fashion virtually any governance structurethey may choose.D. Tax Considerations and the Structure of the

Joint VenturePractically speaking, tax issues are at least as importantas limited liability or governance issues in determiningthe structure ofthe joint venture. Although the corporateor limited liability company forms provide limited lia-bility for venturers, venturers can also achieve limitedliability even if they opt for the general partnership orcontractual joint venture forms, which may be moreadvantageous from a tax perspective. For example, if theventurers choose the general partnership form, they canestablish new, wholly owned, special-purpose subsidiar-ies that will be the partners in the joint venture generalpartnership. If the venturers choose the contractual form,

they can form new corporate subsidiaries that will enterinto and perform the joint venture contracts. As long asthe venturers avoid circumstances that may cause a courtto "pierce the corporate veil," such as failing to ade-quately capitalize the special-purpose subsidiary orotherwise failing to adhere to corporate formalities, theventurers should enjoy limited liability protection.A key tax issue is whether the joint venture entity willbe taxed as a corporation or as a partnership. Venturers

will certainly want to avoid the double taxation problemassociated with the corporate form. Venturers may alsowant to use an entity that is taxed as a partnership becausesuch entities provide greater flexibility with regard to theallocation of gains or losses. For example, a partnershipmay provide that one venturer will receive 50 percent ofthe gains generated by a partnership but 75 percent of thelosses. Alternatively, it could provide that one venturerwill receive 80 percent of the profits even though it hasonly 50 percent ofthe ownership interests. If these specialallocations have "substantial economic effect," then theIRS will respect them for tax purposes. See 26 U.S.C. 704(b) and Income Tax Regulations 1.704-1 (b).With the advent of the "check-the-box" regulations,which became effective January 1, 1997, it is now much

simpler to ensure that an entity will be taxed as a part-nership. Any business entity having two or more ventur-ers, including limited liability companies and partner-ships, can elect to be taxed as either a corporation or apartnership, without having to satisfy previously issuedstandards for entity classifications.E. Business Issues and the Structure of the Joint

VentureProspective venturers should consider several underly-ing business concerns when they think about structure.Several questions come to mind:Should the joint venture be autonomous from theventurers?Should the venturers have significant day-to-dayinvolvement, or should the joint venture be man-aged by a governing body that operates withoutsuch involvement?What are the chances that the joint venture mayultimately be sold to one of the venturers or to athird party, or be SpWloff in a public offering?


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Do the venturers plan to make additional capitalinvestments in the joint venture?Will third parties be asked to invest in the jointventure?What are the specific objectives of the joint ven-ture?What are the circumstances under which the jointventure should be terminated?What fmancial and strategic objectives should thestructure of the joint venture accommodate?What level of control over key decisions shouldmanagement have?

F. SomeClosing Thoughts on the Structure of theJoint Venture

Before the venturers decide on an appropriate struc-ture, they should identify the liability and tax issues fac-ing the joint venture and then consider them in light ofthe business concerns that the structure must accommo-date, such as autonomous management or the possibilityof a sale of the entity.

ITI.WhoAre the Venturers?The next step in forming a joint venture is to deter-

mine who the venturers actually are. Sometimes, this canbe a little tricky. For example, if the joint venture isstructured as a general partnership, then as discussedabove, a venturer may want to form a special-purposesubsidiary in order to limit the venturer's liability. Inaddition, a venturer may want to use a special-purposesubsidiary for other business reasons, such as facilitatinga subsequent transfer of all or a portion of its jointventure interest. If a venturer uses a special-purposesubsidiary, then the other venturers should have a clearunderstanding of who is actually making a particularcommitment to the joint venture. Itmay be necessary toobtain cross-guarantees from the parent companies ofthe special-purpose subsidiaries in order to ensure thatthe commitments in the joint venture agreement arebacked up by more than a mere shell entity.

IV.What Is the Purpose and Scope of the Joint Venture?

A. The Scopeof the Joint Venture: Broad orNarrowTo determine the scope of a joint venture, the ventur-

ers need to ask several questions:Why, specifically, are the venturers coming to-gether?What will be the scope of the joint venture's bus-iness?What products, services, or technology will thejoint venture provide?What will be the geographic area in which thejoint venture will provide such products, services,or technology?

Answering these questions can be difficult, especiallyif the joint venture's business will be similar to that ofone of the venturers. The nature of the joint venture's business and the goals of the venturers may dictate thatthe scope of the joint venture's business be defmedeither broadly or narrowly.

To defme the scope of the joint venture, the venturersmust establish certain boundaries between the joint ven-ture and the venturers. These boundaries may be de-scribed in terms of geography, product categories, cus-tomer segments, technologies, and/or fixed assets. Theymust identify the activities in which the joint venturemay and may not engage. They must decide the extentto which the joint venture may use a technology thatbelongs to the venturers and who has what rights to anynew technology that the joint venture develops.A conservative approach to defining the scope of the

joint venture would be to defme it narrowly and reservefor the venturers the right to expand the activities of thejoint venture in the future. Such a cautious approachwould be justified, for example, if one of the venturersplanned to enter into an exclusive arrangement with thejoint venture for an important emerging market. Theventurer would be rightly concerned that, if the joint


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T HE LAWY ER 'S B RIE F J uly 15, 2005 5 venture failed to perform, the venturer would be unableto expand its market share or reap the anticipated royaltyfees. Accordingly, the venturer might want to limit thegeographic scope of the joint venture's business, or enterinto a nonexclusive agreement, or limit the term of theagreement, or establish minimum performance require-ments (which if not met would cause the joint venture tolose its exclusive contract).

Defining the joint venture's scope narrowly is notalways the answer, however. A narrow scope will limitthe joint venture's ability to respond to changing condi-tions and can lead to conflicts between the venturers andthe joint venture or between the venturers, concerning

how the joint venture should respond to a particularchange. Defming the scope narrowly might ensure thatthe intellectual property of the venturers is protected, butit could also interfere with the development of the jointventure. Finally, if the joint venture's scope is narrow,then the joint venture would have to depend on the ven-turers for resources, such as marketing and sales supportand manufacturing capacity. Consequently, transferpricing issues (i.e., the prices that the venturers charge thejoint venture for such items) would be an issue betweenthe venturers and possibly with taxing authorities aswell.One could also legitimately advocate an approach that

is the complete opposite of the conservative approach ofnarrowly defming the scope. Defming the scope of thejoint venture broadly would provide the joint venturewith the flexibility that most new business enterprisesneed in order to succeed.

Inan article titled "The Way to Win in Cross-BorderAlliances," which was published in the November!December 1991 edition of the Harvard Business Review,the authors reported on a study of joint ventures con-ducted by McKinsey & Company. That study confirmedthat, if ajoint venture's scope is narrowly defmed, it willlikely cause problems for the joint venture. The studyfound that most joint ventures have major conflictsduring the first several years of existence. Those thatwere successful usually needed to be substantiallyexpanded in scope in order to survive. Of the jointventures examined in the study that failed to meet thestrategic and fmancial objectives of the venturers, one ofthe most common causes of failure was that the scope ofthe joint venture was too narrow. For those who wouldsuggest that the solution is to have a narrow scope

initially and then expand it at the appropriate time, letme suggest that this is much easier said than done.To increase the chances that the joint venture will

succeed, the venturers should attempt to eliminate thepossibility of conflicts between the current business ofthe venturers, on the one hand, and the business of thejoint venture, on the other. This goal can be accom-plished by giving the joint venture a sufficiently broadscope and restricting the right of the venturers to engagein activities within that scope. There should be no sig-nificant overlap between the business conducted by thejoint venture and the business in which the venturerscontinue to be engaged.If possible, the venturers should not be current or po-

tential future competitors in the specific business to beconducted by the joint venture. Collaborating to competedoes not mean collaborating with direct competitors. TheMcKinsey study found that joint ventures between directcompetitors are more likely to fail and are more likely toterminate within the first three years than joint venturesinvolving venturers that are not direct competitors.B. Exclusivity within the Scope of the Joint VentureA related issue to defining the scope of the joint ven-

ture is the extent to which the venturers agree that thejoint venture will, as between them, have the exclusiveright to engage in a particular business activity. Tradi-tional wisdom says that(i) venturers should establish exclusive arrangementsonly when necessary; and(ii) to the extent they do establish an exclusive ar-rangement, they should link the term and scope ofthe exclusive arrangement to speciftc performance

requirements, so that the exclusivity will be lost(or the joint venture may be terminated) if thejoint venture fails to meet certain minimum per-formance requirements within a reasonable timeperiod.Applying the traditional wisdom is not always appro-

priate, however, because exclusivity provisions mayneed to address a variety of issues. For example, whathappens if the joint venture does not have the funds topursue particular prospects, projects, or opportunitieswithin its scope? Also, where the joint venture has itsown managers, and they are relatively autonomous, what


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happens ifthe managers decide not to pursue a particularproject or market?One approach to dealing with these issues is to make

exclusivity absolute. In other words, even if the jointventure cannot or does not pursue a specific opportunitythat comes within the joint venture's defmed "scope," allof the venturers are prohibited from engaging in suchactivity. For example, if a joint venture were organizedto exploit certain patents, and the patents were trans-ferred to the joint venture entity, then only the joint ven-ture could pursue them. If the venturers agreed to thisapproach in the beginning, then they would be tyingtheir interests to those of the joint venture in a very seri-ous way. Depending on the situation and the respectiveinterests of the parties, tying the interests of the ventur-ers to the joint venture mayor may not be advantageousto a particular venturer.The opposite approach would be to allow each ven-

turer to pursue opportunities that are within the "scope"of the joint venture, but are not being pursued by thejoint venture. Such an approach gives the venturers moreflexibility, but demonstrates less of a commitment to thejoint venture.A middle-ground approach would be to provide that,

ifone or more venturers, but not the required number ofventurers, vote in favor of the joint venture funding andpursuing a particular opportunity, then only those ven-turers that voted in favor of pursuing the opportunitywould be permitted to pursue it.If the venturers or their affiliates have the ability tocompete with the joint venture, then in order to effectthe agreement of the venturers with regard to exclusivityit may be necessary to have the venturers agree to refrain

from competition and to cause their affiliates to do like-wise. In addition, the venturers should consider that, aspartners in a joint venture, they are under a fiduciaryobligation to act with loyalty toward the joint venture.This duty can cause problems if the venturers fail toaddress the issue in advance because, for a variety ofreasons, they may be tempted to compete with the jointventure to the detriment of the joint venture. Restrictionson the venturers, by contract or by operation of law, areintended to ensure that a venturer does not neglect orundermine the joint venture in favor of its own, compet-ing business.

. How Will the Joint Venture Be Funded?A. Initially and During the Life of the Joint VentureThere are two aspects of joint venture funding: (i) the

respective obligations of the venturers at the time of theformation of the joint venture; and (ii) their respectiveobligations to provide funding during the life of the jointventure. The ground rules should be clearly establishedat the beginning. The joint venture agreement shouldstate the venturers' rights and obligations to make man-datory and optional cash contributions, as well as man-datory and optional loans to the joint venture.Typically, the joint venture agreement will establishprocedures whereby the venturers develop and agree up-on an annual budget for the joint venture. Thereafter,contributions that are required to fund the joint venture's

operations pursuant to the agreed budget will usually beat the call of the joint venture's managers.B. A Process for Developing ConsensusFunding the joint venture necessarily involves issues

related to value, relative capital contributions, and econ-omic interests. A lawyer representing a particular ven-turer may be tempted to negotiate aggressively in an effort to minimize the resources that his or her clientmust devote to the joint venture and to maximize theclient's share of the future profits of the joint venture.Such a lawyer will work to get as much of the ownershipinterest of the joint venture for his or her client for assmall a contribution of capital as is possible.Obviously, the lawyer will recognize that larger capitalcontributions would benefit the joint venture and therebybe in his or her client's interest. Nevertheless, most law-yers will approach the issues related to the fmancialcontributions from the perspective of his client and notas an advocate for the joint venture. Unfortunately, this

approach may interfere with the establishment of astrong joint venture.The fmancial needs of the joint venture will become

more readily apparent if the venturers first develop astrong business plan for the joint venture. Such a planshould be developed by a team of business people fromeach venturer and should include strategies for maximiz-ing the synergies among the venturers and a list of re-source requirements such as cash, assets, technology,and management. Thereafter, each venturer should es-


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THE LAWYER'S BRIEF July 15, 2005 7tablish a team to analyze the joint venture from the ven-turer's own perspective. This second team would con-sider the capital contributions that the venturer would berequired to make, assess the expected return on the ven-turer's investment, value each of the venturer's contribu-tions, and negotiate issues such as initial contributionsand distributions upon liquidation.

If each venturer adopts this approach, then each ven-turer would have a team of business persons and lawyerswho would act to protect its interests, but there wouldalso be a third team that would approach the planningprocess from the perspective of the joint venture. Thejoint-venture team would consider the constraints im-posed by the individual venturers, but would, at leastinitially, develop its plan without significant input fromthe negotiating teams of each venturer. Discussionsabout value and capital contributions are often adver-sarial and disruptive, especially if they take place beforethe benefits of the joint venture are fully understood.Such negotiations can interfere with the development ofa spirit of cooperation, which is essential to getting ajoint venture up and running. After the venture team hasprepared the initial draft of the business plan of the jointventure, the teams representing each venturer can thenbegin to provide more input.C. The Problem of Noncash ContributionsNoncash contributions to the joint venture presentspecial problems. Venturers often fund the joint ventureby contributing services, technology, products, or otherassets to the joint venture, both at the time offormationand during the operation of the joint venture. To the extenta venturer will be making any noncash contributions, aprocedure should be established at the outset of the jointventure to determine the value of such contributions.VI. How Will Benefits and Losses Be Allocated?The venturers have considerable flexibility in structur-ing the allocation and distribution of profits, losses, andother items of the joint venture. For example, if the jointventure is expected to have operating losses initially, it

would be advisable to structure the joint venture in amanner that permits the allocation of a disproportionateshare of such losses to the venturer that has incomeagainst which such losses can be offset, while allocatinga disproportionate share of any other benefits or net in-come in future years to the other venturers.

If one of the venturers is going to provide a greaterportion of the financing for the joint venture, then itmight be appropriate to structure the joint venture as acorporation or a limited liability company that has bothcommon and preferred equity interests, with specifiedliquidation, dividend, and other preferences.In summary, the venturers should structure the jointventure in a way that makes the best use of all availablefinancial benefits, regardless of whether they are income,gains, losses, deductions, tax credits, or other items.

VII. How Will the Joint Venture Be Governed?A. A Governing Board with Restricted Authority/

Key DecisionsThe joint venture agreement, whether it is a share-holder agreement, a partnership agreement, an operatingagreement, or other document, should specify how thejoint venture will be managed, both strategically and ona day-to-day basis.Joint ventures are usually managed by some sort of

board on which each of the venturers will have a repre-sentative. Often, the representation is more or less pro-portional to the respective ownership interests of eachventurer. To avoid deadlocks, the joint venture agree-ment may provide for an independent member of theboard, who would be appointed by means of a specifiedprocess, in order to address the possibility of deadlockon the board.Itis very common to provide that certain key decisionsof the joint venture must be made pursuant to the unan-imous approval, or the approval of a supermajority, ofthe members of the board. These key decisions includesuch things as

establishing an annual budget;making capital expenditures in excess of specifiedamounts;incurring indebtedness;initiating or settling litigation;making acquisitions or divestitures;establishing strategic plans;changing the joint venture's research and develop-ment effort;deciding transfer pricing issues to and from theventurers;


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appointing the top officers of the joint venture;selecting the accountants;entering into contracts involving more than anagreed sum; orentering into contracts between the joint ventureand one of the venturers or any of its affiliates.

B. The Goal: Authority Commensurate withResponsibility

Instructuring the governance provisions, the venturersshould understand that the essence of a joint venture isthat neither venturer has full control. Accordingly, oneof the most difficult aspects of structuring a joint ventureis to establish a smoothly fimctioning decision-makingprocess, while at the same time protecting the interestsof the venturers.The McKinsey study, mentioned above, concludedthat many joint ventures fail because the management of

the joint venture lacks adequate decision-making auth-ority. Ina joint venture where the ownership is equallydivided, assigning the management power is particularlydifficult. Nevertheless, the McKinsey study concludedthat such joint ventures have a substantially higher suc-cess rate and longer lifespan than those with unevenownership.C. The Fear of Letting GoMany lawyers approach the issue of governance with

the attitude that the ideal joint venture is one that theirclient controls. Consequently, lawyers often advise theirclients to seek control of the governing board of the jointventure, because this approach will accomplish two ob-jectives:(i) it will ensure a clear decision-making process (i.e.,we decide); and(ii) it will protect the venturer's interests (i.e., sincewe decide, we can easily protect our interests).

Although this attitude may be acceptable if there is asignificant disparity between the strengths or ongoingcontributions of the venturers, or if one of the venturerssees the joint venture as a possible interim step towarda divestiture and is, therefore, willing to allow the otherventurer to control the joint venture, it is normally notthe best approach.If neither venturer is willing to allow the other to have

majority ownership or control of the joint venture, thenlawyers will often attempt to reduce the risk of dead-locks and disputes by drafting detailed provisions thatspecify that both venturers will have equal seats on amanaging board. Although the joint venture agreementmay provide that the managers of the joint venture willbe given responsibility for the day-to-day operations ofthe joint venture, both venturers will have veto powerover a list of key decisions, such as those listed above.If either venturer vetoes a key decision, the joint ven-

ture agreement will usually provide for a process that re-quires the venturers to use their respective best efforts toresolve their differences, and failing that, to refer theissue to a higher level within their respective organiza-tions or to a third-party mediator or arbitrator. If all ofthese dispute resolution procedures fail, then the jointventure agreement may provide that the joint venturemay be terminated under preagreed conditions.Although this approach sounds good iin principle, care-

ful consideration of it reveals that the approach is not asgood as it initially appears. The problem is that the listof the "key issues" often incorporates most, if not all, ofthe decisions that really matter to the joint venture. Andthere are almost always conflicts about several of theseissues during the first few years of the joint venture'sexistence. Consequently, a deadlock is a very real possi-bility.

D. A Multifaceted Approach to Governance of the

Joint VentureThe likelihood of deadlocks can be reduced by em-ploying four procedures that will allow for the protectionof the interests of the venturers, while at the same timeminimizing the risk that a conflict will lead to a termina-

tion of the joint venture.First, the veto powers of the venturers should be per-

mitted only when they are absolutely necessary, Inotherwords, vetoes are appropriate only when other ap-proaches to protecting the interests of the venturers areinadequate. These limited powers would usually involvedecisions about changes in the scope of the joint ventureor legal or fiduciary responsibilities.Second, the joint venture should adopt principles thatcan be used to answer the most important questions that

the joint venture is likely to face. For example, the joint


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THELAWYER'S BRIEF July 15. 2005 9 venture should adopt policies for setting transfer prices,the criteria that will be used to recruit senior managers,the conditions under which major investments or acqui-sitions would be made, and the range of likely dividendpayments that the venturers might receive. The policiescould include alternative scenarios based on the profit-ability of the joint venture, as well as the needs of theventurers.Third, the joint venture agreement should include pro-visions that permit the joint venture to be restructured,short of termination, in a way that will avoid or resolvea conflict after it arises. For example, as describedabove, the joint venture could

provide that one venturer may fund investments,while the other is diluted;allow one of the venturers to engage in activitieswithin the initial scope of the joint venture, iftheother venturer has prohibited the joint venturefrom pursuing such activities; orallow the joint venture to buy crucial inputs or sellits output in the open market if the venturers failto reach agreement on transfer prices.

Finally, the joint venture should consider adoptingother procedures for avoiding deadlock. For example,the joint venture should have clear procedures in placeconcerning how significant decisions will be made. Suchprocedures should specify the level at which the decisionwill be made, whether the decision will require boardapproval, and whether the decision will be determinedby a majority vote of the board, or by a supermajority orunanimous vote of the board. Finally, the board shouldinclude persons from each venturer who have the powerto decide all of the issues that are likely to be raised.VIII. Can the Joint Venture Interests Be

Transferred? IfSo, How?A. A General Prohibition on Transfer with Some

ExceptionsRegardless of the form the joint venture takes, theventurers should decide whether and how their jointventure interests may be transferred and whether and hownew members may be admitted into the joint venture.Typically, a venturer will want to limit the other ven-turer's ability to transfer its interest, although frequentlyeach of them will be permitted to freely transfer its in-

terest to a wholly owned subsidiary or other affiliate, aslong as the transfer causes no adverse tax consequencesto the joint venture or any of the other venturers.B. Transfers to Third PartiesUsually, the venturers will want to restrict third-partytransfers in some fashion. Sometimes, they will want tocompletely prohibit such transfers. If that is the case,then the venturers should have the right to unilaterallywrap up the operations of the joint venture and terminateits existence. Alternatively, the venturers may want topermit transfers to third parties. only under certaincircumstances.

C. Rights of First RefusalIf the venturers want to permit, but restrict, the ability ofa venturer to transfer its interest to a third party, then theymay make the joint venture interests subject to a right offirst refusal that would permit the joint venture or theother venturers to buy the interest to be transferred. Aright of first refusal may apply either from the inceptionof the venture or after a specified number of years duringwhich no third-party transfers are permitted. To facilitatethe right-of-first-refusal mechanism, it may be helpful torequire third-party transfers to be solely for cash consider-ation without including any other transfers of property orother consideration. Other aspects of the right of firstrefusal, which are beyond the scope of this article, shouldbe considered, including but not limited to valuation ofthe interest, time limits for making decisions, financingthe purchase, and strategies for avoiding sham transac-tions that trigger the right. The venturers should alsoconsider that rights of first refusal render the joint ventureinterests virtually unmarketable because potential buyersare unlikely to investigate and negotiate such an acquisi-tion ifthe transaction can be usurped at the last minute bythe joint venture or the other venturers.D. .A Certain Kind of BuyerIn addition to restricting sales or transfers of the jointventure interests to affiliates of the venturers, as dis-cussed above, the venturers may also restrict the abilityof the venturers to make transfers, except to third partiesthat meet certain objective criteria. For example, among

other things, such criteria couldrequire the transferee to have a specified minimumnet worth;prohibit a transfer to a transferee that is a competi-tor of the nontransferring venturer; or


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prohibit a transfer to a transferee that is owned orcontrolled by foreign persons (particularly if thejoint venture has government contracts).

E. Preventing the Circumvention of RestrictionsIf the venturers decide to include transfer restrictions,

then they should also consider how venturers might cir-cumvent such restrictions, such as by making indirecttransfers by means of a change of control of the ven-turer. This risk is especially acute if the venturer used aspecial-purpose subsidiary to hold its joint venture in-terest. A change of control could be defmed in many dif-ferent ways and could include other events, such as atransfer of stock of the venturer by the ultimate parentcorporation of the venturer or a change in the manage-ment of the venturer in which specified individuals ceaseto be in control.IX. How Can a Venturer Get out of the Joint

Venture?Joint ventures are usually not permanent arrangements.

The McKinsey study suggests that the average life spanof a joint venture is about seven years. More than 75percent of the terminating joint ventures in the Me-Kinsey study were acquired by one of the venturers. Inlight of these statistics, venturers should always considerexit clauses.Exit clauses will typically list the events that will

trigger the right of a venturer to exit the joint venture.These triggers can include a change in control of one ofthe venturers or the parent of the venturer, the inabilityof the venturers to agree on a key issue, the failure toachieve an important business milestone, a breach ofcontract, or the arrival of a specified date after whicheither venturer can terminate the joint venture by deliv-ering notice to the other venturer.After the venturers decide on the triggering events,

they will need to determine how the exit will take placeafter an event occurs. Such provisions can include theright to "put" the venturer's interest to the joint ventureor the other venturers. They may also include the rightto sell a venturer's interest to a third party, either subjectto, or free of, restrictions such as those discussed above.If a venturer is going to sell its interest to the jointventure or to the other venturers, then the value of the

interest must be addressed. Often, "buy-sell" provisions

are used to solve this problem. Pursuant to such provi-sions, one of the venturers sets a price for the interests,and then the other venturer must choose either to buy orsell at that price. These provisions should be used cau-tiously, however, because they are appropriate only whenboth venturers arejust as likely to be the buyer or seller.If one of the venturers is more likely to be the acquirer,because the joint venture's business is more closelyconnected to the venturer's core business or because theother venturer lacks the fmancial ability to back up alegitimate offer, then the buy-sell provision may not workas planned. Alternatively, valuation could be establishedby a third-party appraisal by a preselected appraiser whowill be charged with determining a "fair price."X. What Happens Ifa Venturer Fails to Honor the

Deal?Venturers typically want to focus on the positive as-

pects of the joint venture, and so it is difficult to getthem to consider in advance what should happen if oneof the venturers fails to honor the deal. Nevertheless, thejoint venture agreement should clearly specify whatconstitutes an event of default by a venturer and whatthe consequences of a default will be. . Resolving DisputesIt would be very unusual if the venturers never had adispute. In all likelihood one of them will fail to honorall of the terms of the agreement. As with any contrac-tual arrangement, there are two aspects to dealing withdefaults: (i) first, it must be determined whether adefault has, in fact, occurred; and (ii) second, the appro-priate remedy must be applied. Joint venture agreementscan include a variety of dispute resolution mechanisms,including litigation in a particular jurisdiction, arbitra-tion, mediation, or other alternative dispute resolutionforms. Whatever the mechanism, the venturers shouldagree upon it in advance, in order to avoid gamesman-ship following an event of default.B. Avoiding Disputes or Limiting Their EffectTo prevent disputes from escalating and jeopardizingthe existence of the joint venture, venturers will ofteninclude a provision in their agreement that requires eachventurer, before the venturer resorts to any dispute res-olution process, to refer the dispute to certain specified

managers of each venturer for resolution. Further, theagreement would also include a provision that requires


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('$.'-':i."

THE LAWYER'S BRIEF July 15. 2005 11

the venturers to continue to operate the joint venturewhile the dispute is being resolved.The venturers may alsowant their agreement to include

disincentives to default, such as liquidated damages pro-visions or specific performance provisions. The venturerscould also include provisions that permit the nonde-faulting venturers to buy the interest of the defaultingventurer on preestablished terms, or to cause the dissolu-tion of the joint venture, in addition to being compensatedfor any damages resulting from the default. The purchaseprice for such a buy-out provision could be at a specifieddiscount from the fair market value of the interest. Alter-natively, the fair market value of the interest could bedetermined by a preestablished formula or process, by theagreement of the parties, or by a third party.

As discussed above, venturers are often special-purposesubsidiaries. Accordingly, ifthe joint venture obligationsof a venturer are guaranteed by a parent or other affiliateof the venturer, then the agreement should addresscircumstances or events with respect to such parent oraffiliate that would also be deemed to constitute a defaultby the venturer under the joint venture agreement, such asthe bankruptcy of a venturer's parent or affiliate.XI. How Does ItAll End?As difficult as it is to get venturers to focus on provid-

ing a dispute resolution mechanism in their agreement,it is even more difficult to get them to focus on how thejoint venture will end. The joint venture agreementshould specify what events, if any, will cause the jointventure to terminate. In addition, the venturers shouldconsider whether they want to include a "termination forconvenience" provision, pursuant to which a venturercan force a termination of the joint venture. Termina-tions for convenience can be fashioned so that theyapply only after a set period of time has elapsed follow-ing the formation of the joint venture.Normally, it is not in the best interests of the venturers

to terminate the joint venture by terminating its businessand winding up its affairs. Instead, it is usually prefera-ble for one of the venturers to purchase the interests ofthe other venturers. The buy-sell provision discussedabove can facilitate this process.xn. ConclusionA joint venture can be a valuable and flexible method

of pursuing a business opportunity. To be effective,however, it must be designed in a way that enables it tohandle the many issues that it is likely to encounter. Theforegoing discussion provides a sampling of what thoseissues might be.

CHECKLIST FOR THE FORMATION OF A JOINT VENTURE*WilliamH. Venema**

The following checklist includes many issues that theventurers should usually consider in forming a domesticjoint venture and drafting the relevant documents. Nev-ertheless, no checklist is complete. Each situation mustbe considered in light of the issues facing the venturersin that particular situation.1. ANTITRUST REVIEW. The venturers should con-

*

sider antitrust issues early in the process becausethere may be delays involved if a premerger clear-ance is required.a. Will a Hart-Scott-Rodino tiling be required?b. If so, are the venturers aware of the cost and de-

lay involved in making a Hart-Scott-Rodino filing?

Copyright 2005, William H Venema. All rights reserved. Reprinted with permission* * William H Venema is with the Dallas, Texas law firm of Epstein, Becker & Green, P.C. He can be reached [email protected].


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12 THELAWVER'S BRIEF July 15, 2005

c. Does the joint venture agreement address whowill pay for the Hart-Scott-Rodino fil ing?d. Have the venturers been warned about engag-

ing in legal conduct of the joint venture that"spills over" into illegal conduct such as pricefixing?

2. REVIEW UNDER THE FEDERAL AND STATESECURITIES LAWS.a. WII the venturers be issuing anything that might

be defined as a "security" under either the fed-eral or state securities laws? [General partner-ship and limited liabil ity company interests maybe securities depending on the circumstances.The test used for determining whether theseinterests are securities in a particular case is theHowey test. Generally, interests in general part-nerships and similarly structured limited liabil-ity companies are not considered to be securitiesbecause the partners (and venturers) are in-volved inthe activities of the entity and do notrely on the efforts of others. Alternatively, inter-ests in limited partnerships and similarly struc-tured limited liability companies are securitiesbecause investors rely on the management ef-forts of others.]

b. If the venturers are receiving securities, is anexemption from registration available at both thefederal and state level?

3. FORM OF THE JOINT VENTURE.a. Should there be a separate legal entity?b. If there is no separate legal entity, how will the

venture be financed and staffed?(i) WII either venturer "loan" employees to the

joint venture?(ii) Wlo will be responsible for the staff work ofthe joint venture, such as legal, accounting,tax, etc.?(iii) How will the noncash contributions of the

venturers be valued? How will the venturersproviding such noncash contributions becompensated?

~..r" f.(iv) Is there a need for separate agreements


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THE LAWYER'S BRIEF July 15, 2005 13 6. SCOPE OF THE JOINT VENTURE.a. Do the venturers want to describe the scope ofthe joint venture broadly or narrowly?b. If the scope will be broad, the documents

should state that the joint venture is formed toconduct "any legal operation."c. If the scope will be narrow, the documents

should state that the venture is formed to con-duct a specific business endeavor only.

d. A middle ground approach is to state that theventure is formed to conduct some specific bus-iness endeavor and then follow that with" ... orany other legal operation approved by the [boardof directors, management committee, etc.]."

7. RELATIONSHIP OF THE VENTURERS TO THEJOINT VENTURE.a. Can the venturers deal with the joint venture? If

so, on what terms, and who is responsible forensuring that such dealings are fair to the jointventure? b. Wlat about competition? Is there any restrictionagainst the venturers partiCipating in othercompetit ive joint ventures, or engaging in com-petit ion with the joint venture? Have these beenapproved by antitrust counsel?

8. ADDITIONAL CAPITAL REQUIREMENTS ORLOANS TO THE JOINT VENTURE.a. How will the joint venture address the possible

need for additional capital?(i) Must there be a unanimous agreement or a

supermajority?(ii) Can a manager or executive committee is-

sue calls for additional capital?b. What happens if some venturers either cannot

or will not make additional capital contributions?c. Can the venturers make loans to the joint ven-

ture - either in addition to, or in place of, cap-ital contributions? Are there any restrictions onthe terms of such loans?

9. MANAGEMENT OF THE JOINT VENTURE.a. If the venturers use a corporation, then:

(i) deSignate a "board of directors";(ii) elect "officers": and(iii) note that the day-to-day operations of thejoint venture will be managed by the offi-

cers, subject to the overall direction of theboard of directors.b. If the venturers use a limited liability company,

then decide whether it will be member managedor manager managed. If it will be managermanaged, decide whom the managers will be.

c. Will the joint venture have one individual who hasthe authority to handle most day-to-day manage-ment responsibilities, subject to various approv-als of the board or management committee?

d. Will the joint venture have one venturer who isthe main one to manage the joint venture, whilethe other one takes a secondary role? [Thisapproach might be appropriate, for example, ifthe joint venture were formed to submit bids ona contract, and one of the venturers is the primecontractor, while the other one is a subcontrac-tor. The venturer that is the prime contractorwould be in charge of most of the day-to-dayoperations of the venture.]

e. Will the joint venture be run by a managementcommittee? [This approach might be appropri-ate, for example, if the joint venture wereformed to develop a new product. This approachwould involve, among other things, the forma-tion of subcommittees, the adoption of proce-dures for. having meetings and submitting re-ports, and the establishment of milestones.]

10. KEY DECISIONS. What are the key decisions thatrequire either unanimous approval or a superma-jority?a. establishing an annual budget;b. making capital expenditures in excess of speci-

fied amounts;c. incurring indebtedness;d. init iating or settling lit igation;


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14 THE LAWYER'S BRIEF July 15, 2005. . . . .,t ,e. making acquisitions or divestitures; (iii) Who pays for the insurance? v

f. establishing strategic plans;g. changing the joint venture's research and de- (iv) Could the venturers have the joint venturevelopment effort; named as an additional insured on their

h. deciding transfer pricing issues to and from the policies?venturers; b. Warranties and Indemnification.i. appointing the top officers of the joint venture;j. selecting the accountants; (i) What should the venturers warrant to thek. entering into contracts involving more than an joint venture and/or each other?agreed sum; orI. entering into contracts between the joint venture (ii) Should the venturers have any indemnifi-and one of the venturers or any of its affiliates. cation obligations? [For example, theventurers could agree to indemnify the

11. INTELLECTUAL PROPERTY/CONFIDENTIALITY. joint venture and the other venturers if thea. If the venturers are contributing intellectual intellectual property they contributed in-

property, and it is also anticipated that the joint fringes someone else's copyright or patentventure itself wil l develop intellectual property, or ifother representations they made in thehow should the venturers sort out who owns the agreement proved to be untrue.]various rights? Should there be a force majeure provision? If.

b. Usually, though not always, intellectual property so, who should be excused from what? Andcontributed by the venturers remains with the under what circumstances?venturers. d. Books, Records, and Audits.

c. What about intellectual property developed by (i) What books and records will be kept? .he joint venture? This is often the subject ofextensive negotiation. V\lhat are the standards (ii) V\lho is responsible for maintaining thefor determining what was developed by the joint records?venture, as opposed to minor modifications or (iii) V\lhat rights do the venturers have to auditimprovements of what was contributed by theventurers? V\lho decides? V\lho has what rights the books and records?in that jointly developed intellectual property? (iv) What security measures will be taken and

d. V\lhat are the venturers' rights and obligations what backup of the records will be re-regarding confidentiality in relation to intellectual quired?property, or other data relating to the joint ven- e. What other aspects of the deal might requireture? Should that be addressed in the joint additional documents?venture agreement, or should the venturershave a separate confidentiality agreement? (i) licenses;

(ii) supply agreements;12. VARIOUS ADMINISTRATIVE MATTERS. (iii) distribution agreements;a. V\lhat insurance should the joint venture be (iv) technology transfer agreements;

required to have and maintain? (v) confidentiality agreements;(vi) consulting agreements;(i) V\lho should be responsible for arranging (vii) employment agreements; andthe insurance? (viii) leases.

(ii) V\lhat proof of insurance should be submit- 13. APPRAISAL AND VALUATION.ted to the venturers? a. In connection with the possible termination of


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THE LAWVER'S BRIEF July 15, 2005 15 the joint venture, or the buyout of any of theventurers, how is the value of a venturer's in-terest to be determined?b. If there is to be an appraisal, what are the pro-

visions that describe the way in which that ap-praisal should be conducted, including whoshould conduct it, based on what input from theventurers, etc.?

14. DISPUTES AND DEADLOCKS.a. What are the procedures for dispute resolution

and/or for the resolution of deadlocks?

b. Will there be "put" and "call" rights to resolvedeadlocks? Will there be a buy-sell provision?

15. TERMINATION.a. How should the joint venture terminate? Whatare the rights of the venturers upon termina-

tion?

b. Will there be a right-of-first-refusal if one of thejoint venture venturers wants out of the ven-ture? If so, what are the parameters?

SIMPLE JOINT VENTURE AGREEMENT*William H. Venema**

This Joint Venture Agreement (this "Agreement") isentered into this __ day of , 2005, byand among XYZ, Inc., a corporation("XYZ"), and ABC, Inc., a corporation("ABC"), (collectively, the "Venturers").WIT N E SSE T H:WHEREAS, the Venturers are desirous of forming a

joint venture (the "Joint Venture"), under the laws of thestate of by execution of this Agreement;

WHEREAS, the Joint Venture would be for the pur-poses set forth in this Agreement;

WHEREAS, the Venturers are desirous of fixing anddefining between themselves their respective responsi-bilities, interests, and liabilities in connection with theJoint Venture; and

NOW, THEREFORE, for and in consideration of thepremises, the mutual covenants and promises containedin this Agreement, and other good and valuable consid-eration, the receipt and sufficiency of which the Ventur-ers hereby acknowledge, the Venturers agree to consti-

tute themselves as a Joint Venture, for the purposes setforth in this Agreement, and intending to be legallybound by this Agreement, the Venturers, after first beingduly sworn, do covenant, agree, and certify as follows:1. DEFINITIONS."Affiliate" shall refer to (i) any person directly or indirectlycontrolling, controlled by or under common control withanother person, (ii) any person owning or controllinq 10percent or more of the outstanding voting securities ofsuch other person, (iii) any officer, director, or otherpartner of such person and (iv) if such other person is anofficer, director, joint venturer, or partner, any business orentity for which such person acts in any such capacity."Distributable Cash" shall mean all revenue of theJoint Venture, from whatever source, less the amount ofexpenses of the Joint Venture and the amount ofreserves."Venturers" shall refer to XYZ and ABC and any sue-cessor(s) as may be deSignated and admitted to theJoint Venture.

Copyright 2005, William H Venema. All rights reserved. Reprinted with permission** William H Venema is with the Dallas, Texas law firm of Epstein, Becker & Green, P.e. He can be reached [email protected].*


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"I.R.C." shall refer to the current and applicable InternalRevenue Code."Net Profits" and "Net Losses" mean the taxable in-come and loss of the Joint Venture, except that the"book value" of an asset shall be substituted for itsadjusted tax basis if the two differ, but otherwise NetProfits and Net Losses shall be determined in accor-dance with federal income tax principles."Project" shall refer to _"Treasury Regulations" shall refer to those regulationspromulgated by the Department of the Treasury withrespect to certain provisions of the I.R.C."Percentage of Participation" shall refer to that figureset forth in 5.1.2. FORMATION, NAME, AND PRINCIPAL PLACEOF BUSINESS.2.1 Formation.(a) The Venturers do hereby form a joint venture pur-

suant to the laws of the state of , in order for theJoint Venture to carry on the purposes described in thisAgreement.

(b) The Venturers shall execute such certificates asmay be required by the laws of the state of or ofany other state in order for the Joint Venture to operateits business and shall do all other acts and thingsrequisite for the continuation of the Joint Venture as ajoint venture pursuant to applicable law.2.2 Name.The name and style under which the JointVenture shall be conducted is: _2.3 Principal Place of Business. The Joint Venture

shall maintain its principal place of business at:____________ . The Joint Venture mayrelocate its office from time to time or have additionaloffices as the Venturers may determine.3. PURPOSE OF THE JOINT VENTURE. The busi-ness of the Joint Venture shall be to _and all such other business incidental to the generalpurposes set forth in this Agreement (the "Joint Ven-ture Purpose'l

. TERM; DISSOLUTION.4.1 Commencement and End of Term.The term ofthe Joint Venture shall commence as of the date of thisAgreement and shall be terminated and dissolved uponthe earliest to occur of:

(i) completion of the Project and receipt of all sumsdue the Joint Venture;

(ii) December 31, 20_;(iii) the unanimous agreement of the Venturers; or(iv) the order of a court of competent jurisdiction.4.2 Dissolution. Upon dissolution, the assets of the

Joint Venture shall be divided among the Venturers, inaccordance with their respective capital accounts, asdescribed in 5.8(c) of this Agreement.5. PERCENTAGE OF PARTICIPATION.5.1 Percentage of PartiCipation. Except as other-wise provided in 6 and 9 of this Agreement, the in-

terest of the Venturers in any gross profits and theirrespective shares in any losses and/or liabilities thatmay result from the business of the Joint Venture, andtheir interests in all tangible and intangible propertyacquired and all money received in connection with theperformance of the business of the Joint Venture shallbe as follows:

Name of VenturerPercentage of ParticipationXYZ, Inc. 60%ABC, Inc. 40%5.2 Payment of Losses. The Venturers agree that in

the event any losses arise out of, or result from, theperformance of the Project, each Venturer shall assumeand pay the share of the losses that is equal to theVenturer's Percentage of Participation.5.3 ExcessPayment of Losses. If for any reason, a

Venturer sustains any liabilities or is required to pay anylosses arising out of or directly connected with theconstruction of the Project, or the execution of anysurety bonds or indemnity agreements in connectiontherewith that are in excess of its Percentage of Partici-pation, then the other Venturer shall promptly reimburse


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THE LAWYER'S BRIEF July 15, 2005 17 such Venturer this excess, so that each member of theJoint Venture will then have paid its proportionate shareof such losses to the full extent of its Percentage ofParticipation.5.4 Indemnification for Excess Payment of Losses.The Venturers agree to indemnify each other and to hold

the other harmless from, any and all losses of the JointVenture that are in excess of such other Venturer'sPercentage of Participation; provided, however, thatthe provisions of this 5.4 shall be limited to losses thatare directly connected with, or arise out of, the perfor-mance of the Project and/or the execution of any bondsor indemnity agreements in connection therewith andshall not be related to or include any incidental, indirect,or consequential losses that may be sustained orsuffered by a Venturer.

5.5 Bonds and Indemnity Agreements. The Ventur-

ers shall from time to time execute such bonds andindemnity agreements, including applications therefor,and other documents that may be necessary in connec-tion with the performance of the Project; provided, how-ever, that the liability of each of the Venturers under anyagreements to indemnify a surety company or suretycompanies shall be limited to the percentage of the totalliability assumed by all the Venturers under such indem-nity agreements that is equal to the Venturer's Percent-age of Participation.5.6 Initial Contribution of the Joint Venturers.(a) The Venturers shall contribute to the Joint Venture

the property listed on Schedule A, attached to thisAgreement [omitted] and incorporated into this Agree-ment by this reference, and their respective capitalaccounts shall each be credited with the agreed-uponvalue of such contribution.

(b) Except as otherwise required by law or this Agree-ment, the Venturers shall not be required to make anyfurther capital contributions to the Joint Venture.5.7 Return of Capital Contributions.

(a) No Venturer shall have the right to withdraw itscapital contributions or demand or receive the return ofits capital contributions or any part thereof, except asotherwise provided in this Agreement.

(b) The Venturers shall not be personally liable for thereturn of capital contributions or any part thereof, exceptas otherwise provided in this Agreement.

(c) The Joint Venture shall not pay interest on capitalcontributions of any Venturer.5.8 Allocations of Net Profits and Losses; Distri-butions. Subject to the provisions of this 5, the Ne

Profits and Net Losses of the Joint Venture (includingany net "book" gains of the Joint Venture resulting froma capital event) shall be allocated to the Venturers in thefollowing priority:(a) Net Profits:

(i) First, to those Venturers with negative capitalaccounts, between them in proportion to theratio of their negative capital account bal-ances, until no Venturer has a negative capi-tal account.

(ii) Thereafter, to the Venturers, pro rata, basedon their respective Percentages of Participa-tion .

(b) Net Losses: Subject to the provisions of this 5Net Losses of the Joint Venture (including any net"book" loss of the Joint Venture resulting from a transac-tion resulting in a capital loss) shall be allocated to theVenturers, pro rata, based upon their respective Per-centages of Participation.

(c) Adjustment of Capital Accounts. For purposesof this 5.8, capital accounts shall be established andmaintained as provided for in 1.704-1(b)(2)(iv) of theTreasury Regulations. Adjustments to the capital ac-counts shall include a qualif ied income offset set forth in 1.704-1(b)(2)(ij)(d).

(d) Distributions. Distributable Cash of the JointVenture shall be distributed to the Venturers, pro rata,based on their respective Percentages of Participatlon,6. POLICY COMMITTEE.6.1 Establishment. The management of the JointVenture shall be conducted pursuant to policy estab-lished by the Venturers acting through a "Policy Commit-

tee," which is hereby established .


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18 THE LAWYER'SBRIEF July 15, 2005

6.2 Voting. Except as provided in 6 and 9, eachVenturer shall have a voice in the Policy Committeeequal to its Percentage of Participation. For such pur-pose, each Venturer is assigned the following number ofvotes and hereby designates the following representa-tives to exercise such votes:Venturer Votes RepresentativesXYZ, Inc. 60ABC, Inc. 406.3 Venturer Representatives. Each Venturer may, at

any time, substitute an alternative in place of any of itsabove-named representatives by serving written notice toall the other Venturers. Each Venturer's representative oralternative representative on the Policy Committee ishereby granted and shall hereafter possess authority toact for such Venturer on all matters of interest to it withrespect to its participation in the Joint Venture.6.4 Majority Vote. The Policy Committee shall deter-

mine the policy for the management of the Joint Ventureby majority vote and, as used in this Agreement, a "ma-jority vote" is defined to be any figure greater than one-half of the authorized votes.6.5 Policy Committee Powers. The Policy Commit-

tee shall have the following powers:(a) To determine the time and place of holding its

meetings and the procedures for conducting PolicyCommittee affairs.

(b) To determine and act upon the various matters, ex-pressly or impliedly contained in other sections of thisAgreement, which require decision by the Policy Commit-tee.

(c) To determine and act upon any other matters ofjoint interest to, or requiring prompt action by, the JointVenture.

(d) To determine insurance reserves and reserves forother potential liabilities that may result from, or arise outof, the Project work.

(e) To consider all claims and disputes of any kindbetween the Joint Venture and the subcontractors and/or third parties and to authorize negotiation, arbitration,litigation, and/or any other process for their resolutionand to authorize the settlement thereof.

6.6 Notwithstanding any other provisions to the con-trary herein, insurance coverages and limits shall besubject to approval of all of the Venturers.6.7 Meetings. The Policy Committee shall generally

perform its duties at a meeting at which all designatedrepresentatives of the Venturers are present, but wherecircumstances warrant, telephone communication be-tween all representatives of the Venturers or their altern-atives is authorized.6.8 Salaries and Expenses. The salaries and ex-

penses of each of the representatives on the PolicyCommittee shall be borne by the Venturer whom therepresentative has been designated to represent andshall not be an expense to the Joint Venture.7. DELEGATION OF AUTHORITY.7.1 Division of Authority. The Venturers agree to a

split of authority between themselves as follows:(i) XYZ shall be the Administrative Managing Part-

ner responsible for all bookkeeping and payrollof the Joint Venture, and

(ii) ABC shall be the Project Managing Partner incharge of the Project Work.

7.2 Project Managing Partner.The Project ManagingPartner shall appoint a General Manager through whomit shall manage all matters necessary and connectedwith the performance of the work of the Joint Venture,with the exception of the work performed by the Admin-istrative Managing Partner.7.3 Delegation of Authority. Authority to act for and

bind the Joint Venture in connection with the perfor-mance of any work related to the Project or otherwisemay be delegated in writing by unanimous vote of theVenturers to any designated individual(s).8. JOINT VENTURE BANK ACCOUNTS.8.1 Establishment of Account. All funds received bythe Joint Venture in connection with the performance of

the Project shall be deposited in a checking account, setup especially for the Joint Venture. Said account shallbe kept separate and apart from any other accounts ofthe Venturers.


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THE LAWYER'SBRIEF July 15, 2005 1

8.2 Withdrawals. Wthdrawals of funds from the JointVenture's checking account will require the signatures ofboth representatives of the Venturers for any withdrawalin excess of $ .Wthdrawals of funds from theJoint Venture's checking account in amounts less than$ may be made by such persons as areauthorized in writing by unanimous vote of the Venturers.9. ACCOUNTING AND AUDITING.9.1 Separate Books; Inspections. Separate books

of accounts shall be kept by the Administrative Manag-ing Partner of the transactions of the Joint Venture. AnyVenturer may inspect such books upon reasonable no-tice and at any reasonable time.9.2 Audits. Periodic audits may be made upon said

books at such time as authorized by the Policy Commit-tee by persons designated by the Policy Committee.Copies of any such audit shall be fumished to all Ventur-ers. Upon completion of the Project, a final audit shall bemade and copies of such audit shall be furnished toeach of the Venturers.9.3 Accounting Method. It is understood and agreed

that the method of accounting used by the Administra-tive Managing Partner and for state and federal incometax purposes shall be the cash based method and thatthe accounting year shall be the calendar year.9.4 Payments toAdministrative Managing Partner.The Administrative Managing Partner shall receive ad-

ditional compensation in the amount of 3 percent of thetotal Project amount for the use of its data-processingsystem and for accounting, payroll, and tabulating work.Work performed by the Administrative Managing Part-ner's in-house counselor executive secretary on behalfof the Joint Venture shall be charged separately to theJoint Venture's account at a rate agreed upon by theVenturers.10. RESOLUTION OF DISPUTES. If any disagreementarises between the Venturers concerning any mattersset forth in this Agreement, related to this Agreement, orarising between the Venturers as a result of this Agree-ment, and the Venturers are unable to resolve the dis-agreement by negotiation, then either Party may submitsuch disagreement to arbitration. The procedures forsuch arbitration are as follows:

10.1 Such proceedings are initiated when a Partserves a written notice of arbitration on the other Partywhich notice shall include the name of the arbitratoappointed by the Party sending such notice (the "Initiating Party"). Wthin thirty (30) days after the date thasuch notice is given, the Party to whom such noticegiven (the "Receiving Party") shall either agree witthe arbitrator appointed by the Initiating Party or shasimilarly appoint an arbitrator b~'giving like written noticto the Initiating Party. If the Receiving Party fails eitheto agree with the arbitrator appointed by the InitiatingParty or to make such appointment within such periodthen the arbitrator appomted by the Init iating Party shabe empowered to act as the sole arbitrator and to rendea binding decision.

10.2 If the Receiving Party agrees with the arbitratoappointed by the Initiating Party, then such arbitratoshall act as the sole arbitrator. Alternatively, if theVenturers duly appoint two arbitrators pursuant to subsection 10.1 above, the two arbitrators so appointedshall, within ten (10) days after the appointment of thlatter of them to be appointed, select a third arbitratowho shall act as the sole arbitrator. If said arbitrators arunable, within said ten (10) days, to agree on the seection of said third arbitrator, either one of them marequest that the American Arbitration Association seleca third arbitrator, and the selection of such third arbitrator by such Association shall be binding. The arbitratoselected in accordance with the procedure set forthabove shall set a time for the hearing of the dispute thashall be within sixty (60) days following the date theInitiating Party gives notice of arbitration. The finadecision of the arbitrator shall be rendered in writing tothe Venturers not later than sixty (60) days after the lashearing date.

10.3 The place of any arbitration shall be , oat such other place as agreed to by the Venturers.

10.4 The arbitration shall be c:onducted in accordancewith the rules of the American Arbitration Association thenprevailing, and the decision of the arbitrator shall befinaand binding on the Venturers, and shall be enforceable ithe courts of the United States. To the extent necessaryto carry out the decision of the arbitrator, the Venturersshall enter into a confession of judgment, with a court ocompetent jurisdiction, in form and substance adequateto effect the decision of the arbitrator.


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11. MISCELLANEOUS PROVISIONS.11.1 Governing Law. This Agreement, and any

claims arising out of the relationship between the Ven-turers, including but not limited to claims arising undertort law as well as contract law, shall be governed, en-forced, and construed in accordance with the laws of thestateof _11.2 EntireAgreement;Amendments. This Agree-

ment represents the entire agreement of the Venturerswith respect to the Joint Venture and supersedes allprevious agreements by and between the Venturersconcerning the Joint Venture Purpose. This Agreementmay only be amended in a writing executed by bothVenturers.11.3 Notices.Notices hereunder must be in writ ing,

and (except for the notices described in 2 of thisAgreement) will be effective upon delivery, postage pre-paid, by certified mail, return receipt requested, ad-dressed as follows:

If to XYZ, to:

If to ABC, to:

11.4 Waiverof Compliance; Consents. Except asotherwise provided in this Agreement, any failure of eitherVenturer to comply with any obligation, representation,warranty, covenant, agreement, or condition herein maybe waived by the Venturer entitled to the benefits thereofonly by a written instrument signed by the Venturergranting such waiver, but such waiver or failure to insistupon strict compliance with such obligation, representa-tion, warranty, covenant, agreement, or condit ion shallnot operate as a waiver of, or estoppel with respect to,any subsequent or other failure. Wlenever this Agree-ment requires or permits consent by or on behalf of anyVenturer hereto, such consent shall be given in writ ing ina manner consistent with the requirements for a waiver ofcompliance as set forth in this 11.4.

11.5 Force Majeure.Neither Venturer shall be liablefor failure to perform or for delay in performance arisingout of causes beyond its reasonable control and withoutits fault or negligence, including but not limited to fire,flood, strike or other labor difficulty (except those involv-ing employees of the Venturer), act of God, war (de-clared or undeclared), embargo, blockage, legal restric-tion, riot, insurrection, act of any governmental authority,fuel or energy shortage, wreck, or delay in transporta-tion. In the event of delay of performance due to anysuch cause, the date of delivery or time of completionwill be extended by a period of time reasonably neces-sary to overcome the effect of such delay.11.6 Severability. If any provision of this Agreement

or the application thereof to any person or circumstanceshall be invalid or unenforceable to any extent, theremainder of this Agreement and the application of suchprovision to other persons or circumstances shall not beaffected thereby and shall be enforced to the greatestextent permitted by law.11.7 Counterparts. This Agreement may be exe-

cuted in several counterparts, and by the Venturers onseparate counterparts, each of which shall be anoriginal; but such counterparts shall together constituteone and the same instrument. 11.8 Benefit and Binding Effect. Neither Venturerhereto may assign this Agreement. This Agreement

shall be binding upon and inure to the benefit of theVenturers and their respective successors.

IN WITNESS WHEREOF, the Venturers have causedthis Agreement to be executed by their duly authorizedrepresentatives as of the day and year first writtenabove.XYZ, INC.By:Name:Title:ABC, INC.By:Name:Title: - - - - _ .

Documents

The Lawyers Brief..Organizational Issues in Forming Joint Ventures