Buzz

Joint Ventures

Joseph W. Bartlett, Founder of VC Experts.com


One of the most mysterious of legal organisms is the joint venture. However, for a variety of structural reasons, there remains a large element of mystery, ambiguity and lack of understanding concerning this amorphorous term and its implications ... and for some very specific reasons.

First, there is no specific definition of what is and what is not a "joint venture," legally (or economically) speaking. The relationships which bear that label include any number of quite different regimes. A license agreement is often labeled a joint venture, particularly if a small entrepreneur wants to claim, after licensing her software to Microsoft, that she is engaged in a "joint venture" or "strategic alliance" with a giant multi-national. A turnkey construction contract can be a joint venture ... a venture between the owner of the property, the contractor and the subcontractors to build a building. The term can be used to mask a disguised sale, wherein Party A contributes property and Party B contributes cash to the venture. The venture sits on the assets for five years and then the parties unwind, with A taking the cash and B taking the property, all tax free. There are any number of other examples, but I think the point is made.

Secondly, there is no joint venture statute, either federal or state; there is no analog of the Delaware general corporation law, for example, which specifically addresses the legal rules governing joint ventures; no Revised Uniform Limited Partnership Act; no Limited Liability Company Act and not a wealth of court decisions interpreting specific rules in part because there are no specific rules labeled "joint venture rules."

A joint venture has to be something in the law, but that something can range from a simple contractual relationship to a structure which is deemed to be a general partnership. It can be a limited partnership subject to the Revised Uniform Limited Partnership Act; a limited liability company subject to the Limited Liability Company Act; or in fact, it can be several entities ... a limited partnership, for example, with a limited liability company as the sole general partner and its assets consisting of shares in corporations.

The point is that there are no standard models and little or no boilerplate for the drafts people to fall back on. Consequently, this all leads to a classic 'good news, bad news,' scenario. The good news is that the drafters of a joint venture agreement have close to ultimate flexibility in writing up the relationships of the parties and covering all the contingencies they can anticipate. The bad news is the same as the good news; the freedom and flexibility means that the constituent language has rarely stood the test of time ... and differences of opinion can (and indeed often do) arise about the meaning of specific phraseology.

I can continue to recite additional uncertainties. Thus, most joint ventures are private companies; however, it is not clear whether the interests in the joint venture are "securities" for U.S. law purposes. (Using a broad generalization, general partnership interests are not securities and limited partnership interests are.) The tax treatment of joint ventures can be arcane because the tax provisions of Subchapter K (governing the taxation of partnerships and, therefore, most joint ventures) are amongst the most complicated in the Internal Revenue Code.

Most importantly, the governance standards are often very much in doubt. In fact again referring to the case of Meinhard v. Salmon, Judge Cardozo introduced the phrase 'fiduciary duty' into the law in considering what amounted to a joint venture (versus a corporate entity); thus, the notion of 'partnership' implies high standards of fiduciary duty in the relationship. However, looking at the Uniform Limited Partnership Act and the Limited Liability Company Act, the drafters of those rule sets have given brand flexibility to the parties to define their own governance standards, and in the process to "restrict," if not to curtail, the application of fiduciary duty standards, in favor of substitute standards, crafted by the parties, which hew to some basic ideas of fairness. Questions then arise in a variety of contexts, such as:

  • Is the "corporate opportunity" doctrine to be imposed on joint ventures? Thus, does each venture partner have to show to the joint venture any opportunities which come to its attention, even if the opportunity appears on the screen of employees who are far removed geographically and bureaucratically from those in charge of the operation of the joint venture?

  • Is a basic obligation of 'good faith and fair dealing' imposed on the parties? If a joint venture involves a manufacturer of refrigerators contracting with a entrepreneur contributing a new method for making ice, does the manufacturer have an obligation to stay in the refrigerator business, even though it is losing money, in order enhance the exposure of its partner?s products?

  • Can a joint venturer compete with its partner in remote areas of the world?

All these issues can be governed, case by case, by contract; but, often they are not. And in that case, the question is what is the default standard. Is there, indeed, any default standard ... Cardozo's notion of very strict 'fiduciary duty?'

Adding to the complexity matrix, joint ventures are now called on to perform a variety of quite complex functions, for example, in this era of globalization, cross border joint ventures are very common. Assume one has to figure out what rules apply to a joint venture between a company domiciled in the United States and one in the Republic of China; choice of law issues become quite imposing for those in charge of writing up, and counseling upon, the resultant structure ... particularly competing rules governing the ownership and administration of intellectual property. In addition, joint venture are becoming popular as substitutes for mergers, as noted below.

Joint ventures often involve untested products and processes and works in progress. This fact can complicate the chore of putting together the all-important prenuptial agreement (i.e. what happens in the case of divorce?) A treatise could be written on how to unwind a joint venture including one that involves intellectual property which in the course of the joint venture is subject to enhancements, improvements, and significant modifications. Who gets it back, the original contributor or the parties equally? How, in the case of enhanced IP, do you unscramble the omelet ... purge the knowledge base of the party allegedly surrendering all rights to the IP?

The divorce issue is more prominent these days as joint ventures are now standing in for mergers ... and for this purpose I am coining the phrase "mezzanine mergers," meaning the parties electing to live together without the benefit of the sacrament in a joint venture relationship, as a prelude to a merger. The aversion to mergers is driven by the fact that evidence is mounting in support of a remark made years ago by my friend, Warren Helman ... all mergers should be entered into under a presumption of failure. Ironically, there is a good deal of evidence to the effect that most joint ventures in fact fail to meet the parties' expectations. However, a joint venture is deemed to be a less final, dramatic and irrevocable act than a merger for obvious reasons. What happens when a joint venture partner withdraws particularly in a case where there are more than two joint venturers? Does the venture continue, and if so, what are the rights of the withdrawing party?

How is one to construct the minimum standards for "best efforts," "reasonable best efforts," or "commercially reasonable best efforts" of each of the party to contribute to the progress of the joint venture? If the commercial enterprise being pursued involves products in their early stages, it is difficult to quantify in terms of dollar revenues what each of the parties must accomplish. One has to think of proxies for revenue numbers, when there are no revenues at the inception of the joint venture, like requiring each party to spend some amount per year in order to maintain its place at the table.

In short, joint ventures have given rise to a good deal of academic research, most of which I find very difficult to apply in practical real world situations. However, I do not denigrate the effort, and this is the point of this Buzz. There are any number of good reasons for continuing to encourage both practitioners and academics to write on this subject. There is a good deal of elegant drafting remaining to be accomplished, and equally an heroic amount of analysis and annotation to cover the wealth of contingencies.


joe@vcexperts.com