Tackling Joint Ventures – Issues and Challenges
By Ronak Ajmera
The business rationale for a joint venture (JV) ranges from pure play financing of business operations to longer strategic partnerships for sharing of technical/business knowhow. To a large extent, the issues which need to be resolved between potential JV partners depend on the deal commercials and nature of the proposed JV and the partners themselves. However, regardless of the nature of the JV, potential partners must strive to have these issues adequately addressed in the JV documentation so as to ensure that they are prepared, in case the partnership turns sour. This article discusses certain legal issues which potential JV partners must tackle at the stage of finalizing the transaction structure and documentation.
Minority Protection Rights
Decision making rights of shareholders in companies are usually proportionate to the equity shareholding they hold. Therefore, it is important for a minority JV partner to secure an adequate say in the company’s affairs so as to avoid being mistreated by the majority. Such protection is usually obtained by way of affirmative voting rights i.e. matters which require a positive/affirmative vote of the minority partner for it to be approved. Typically, such matters would inter alia include approval of the business plan and annual budget, anti-dilution protection and raising of debt by the JV. While this has been the trend so far, we may witness a paradigm shift on account of the recently enacted Companies Act, 2013. As such rights may result in the minority partner being reclassified as a ‘promoter’ of the JV, thereby exposing it to various unintended liabilities, parties may consider other alternatives to secure such protective rights.
Parties are usually optimistic about the JV’s prospects as well as their equation with the JV partner at the inception stage. As a result, given the sensitivity around discussing a prospective deadlock between partners, it may be challenging to discuss the deadlock resolution mechanism during negotiations. All the same, it is imperative to record the understanding between parties on the way forward in case of a deadlock in decision making. While mutual discussions/mediation may, of course, be the first step towards resolution, if parties are unable to reach an agreement, the deadlock must lead to one party buying out the other. Various innovative methods may be built in to facilitate a fair valuation at such exit. JV partners should consider dealing with this aspect upfront at the time of negotiations rather than postponing the same to a more advanced stage in the life of a JV.
The JV documentation would typically provide for a mechanism by which disputes between JV partners would be resolved. For instance, parties may agree that if their senior management fails to resolve a dispute through mutual discussions, the same would be resolved by arbitration. While this may seem to be a relatively quicker mechanism vis-à-vis traditional litigation, arbitration may prove to be a costly affair. It is possible that the attitude of corporates towards litigation, as a dispute resolution method, would change once the commercial divisions of High Courts (as proposed) are established. These commercial divisions are intended to achieve speedy finality to disputes and would also award legal costs to the successful litigant. If these objectives are achieved, litigation would be an option worth considering. However, if parties are considering arbitration as a dispute resolution mechanism, they may consider institutional arbitration i.e. arbitration conducted by specialised bodies such as the Indian Council of Arbitration (ICA), Singapore International Arbitration Centre (SIAC) or the London Court for International Arbitration (LCIA), which has recently set up a body in India. As opposed to ad hoc arbitration, which could result in delays in appointment of arbitrators, conduct of proceedings, etc., institutional arbitration is governed by the rules framed by the concerned institution. This would facilitate a timely and systematic conclusion of arbitration proceedings.
Financial partners have a clear objective of exiting their investment within a pre-defined time period (usually 4-7 years) with a certain return. If such investment is received from non-residents, it must be either in the form of equity shares or instruments which compulsorily convert into equity shares, in order to qualify as FDI. All other instruments are regarded as debt and are governed by a more restrictive regime applicable to external commercial borrowings. Non-resident investors are not permitted to receive an exit at a price higher than the fair value of such instruments. Further, in accordance with Indian exchange control regulations, they cannot receive an assured return on their investment either. This makes structuring of an offshore inbound investment a bit more difficult as compared to a pure domestic investment. Financial investors would usually want to exit the JV after its listing. However, an IPO may not always prove to be a feasible option at the given time on account of market conditions. Therefore, a financial investor would insist on alternatives to be built into the documentation which facilitate a suitable exit for its investment. In such cases, parties must negotiate their respective rights carefully so that they do not end up on the receiving end of a sour deal.
In addition to the above, JVs may encounter other legal and regulatory challenges in terms of director’s liability, where the minority has nominated representatives to the board of the JV. Under the Companies Act, 2013, fiduciary duties of directors have been codified, breach of which is punishable. Further directors having knowledge of contraventions (through receipt of proceedings of the board) would be classified as officers-in-default and accordingly, would be liable for such contraventions by the company.
Given the uniqueness of the dynamics involved in each JV, there is no uniform solution which can applied while dealing with such issues. A lot depends on the nature and risk appetite of the parties involved. Financial partners tend to be more cautious and are advised to mitigate liabilities. Strategic players, on the other hand, usually have a long term approach towards such investments and are less risk averse.
[The author is a Principal Associate, Corporate Practice, Lakshmikumaran & Sridharan, Mumbai]