1.0
TYPES OF BUSINESS ARRANGEMENTS
An international joint venture is only one of a
variety of means by which a domestic owner of a technology can exploit or
develop that technology in a foreign market. Before embarking upon a joint
venture, a technology owner should examine the relative advantages and
disadvantages of the other vehicles for foreign market entry. In addition to
joint ventures, the methods of exploiting a technology in a foreign market
include exports, licensing and other contractual arrangements, and direct
investments
It
is important at the outset to distinguish a joint venture from other types of
business arrangements so that the advantages and disadvantages of a joint
venture can be viewed in proper perspective. Certain business arrangements
often are incorrectly referred to as joint ventures.
A
joint venture is not merely a contractual undertaking by two or more parties to
collaborate on and perform a specific task or one-time project. The sometime
reference to such arrangements as "contractual joint ventures" is the
source of some of the confusion surrounding the nature of a true joint venture.
A joint venture also is not merely a contractual arrangement by two or more
parties to cooperate in the pursuit of a particular contract and, if
successful, to perform such a contract by dividing the prescribed tasks in
accordance with the respective qualifications of the parties. This kind of
association is sometimes called a "consortium" or a "teaming arrangement."
Furthermore, a joint venture is not merely a patent and technology agreement
calling for the conveyance of rights and the physical transfer of technology.
A
joint venture often contains some or even all of the foregoing contractual
ingredients, but it also possesses one other essential characteristic: a joint
venture must embody a separate legal entity jointly owned and jointly managed
by the venturers. Regardless of the scope of the undertaking, the nature of the
joint venture entity, or the respective degrees of equity or management
involvement, there must be (1) a separately identifiable joint venture entity,
(2) an ownership interest in such entity by each joint venturer, and (3) an
active management involvement, or deliberate abdication of the right to such
involvement, by each joint venture partner.
A
joint venture is neither suitable nor appropriate for all purposes. In
circumstances where there is little or no interest in management involvement or
in long-term earnings, a straightforward contractual arrangement is frequently
preferable. There may be no justification for the complexity and collaborative
effort of a joint venture if the receipt of royalties for rights in technology
is sufficient. Similarly, if the proceeds of a single contractual effort can be
fairly divided among the parties performing discrete and identifiable portions
of the work, there is no need for a more comprehensive business relationship.
On the other hand, a joint venture contemplates a pooling of resources, a sharing
of risks, a blending of expertises, and a uniting into a common entity for the
achievement of objectives that would be exceedingly difficult, if not
impossible, for any one of the joint venturers acting alone.
2.0
THE NATURE OF A JOINT VENTURE
1.
A
company may not have sufficient resources to undertake a particular project and
may need the financial resources of another company with similar needs or
interests to share the business risks and reduce the burden of investment
costs. Research and development activities that require a substantial initial
cost outlay may best be carried out through such a joint venture operation.
2.
The
parties may wish to pool technology and expertise, thereby expanding the
capabilities and business opportunities available to each.
3.
A
company may desire to enlarge its market power or to expand into a foreign
market with which it has no familiarity. A joint venture partner
("JVP") that is well-established in the locale, knowledgeable in the
local business customs, and equally at risk, may provide the most satisfactory
mechanism for establishing a viable foreign presence.
4.
Parties
may wish to share the risks of new ventures.
5.
Easier
to obtain project financing.
6.
Investment
Spread.
7.
Government
Policies
There
are two types of joint ventures, the equity joint venture and the contractual
joint venture. Joint ventures are frequently characterized by a 50/50
participation in which each partner contributes 50 percent of the equity in
return for 50 percent participating control. The relative contributions, as
well as degree of ownership and control, are largely matters for negotiation.
They relate to the value each party places, and the other party accepts, on the
contributions, and reflect the objectives of the venturers. Such a valuation frequently
can be a difficult and tedious exercise, particularly where contributions
involve technology. If the joint venture is to be located in a country with a
controlled economy, valuation may be quite problematic, especially if the JVP
from that country is contributing land or goods in kind that may not have
readily ascertainable free market values.
The
50/50 arrangement is common in joint ventures. Such equal participation has a
number of advantages. Each JVP is equally at risk, and is not subservient to
the other partner, as would be the case where majority control is vested in one
party. Such a sharing of interest and control raises the possibility, however,
of deadlock and early termination of the joint venture before its objectives
have been accomplished. Many corporations nevertheless subscribe to this form
to ensure an equal commitment by the other partner, while retaining maximum
control over the conduct of the enterprise.
It
should be noted that joint ventures are characterized by extreme flexibility,
so that if one partner is uncomfortable with coequal status in one phase of the
business enterprise, the joint venture can be structured to accommodate the
particular need. For example, if a JVP is concerned that the joint venture may
expand its product line beyond the initial parameters of the joint venture and
thereby threaten that JVP's already established product lines, the JVP may
insist upon more than a coequal role in that phase of the joint venture's
business. Such objectives can be reconciled by careful planning at the
inception of the joint venture.
2.1 Equity Joint Ventures
The equity joint venture in its most basic form
arises where the two legal entities for a joint stock company in order to
engage in a common commercial enterprise.
Basic
features are:
1.
Free
transferring of shares, exclusively to companies owned by the partners, with
preferential right to purchase shares vested in the respective companies.
2.
Management
by a Board of Directors.
3.
Cash
Injection
Advantages
A
U.S. corporation is basically a creature of state statute. Because of this,
incorporation generally involves greater expense and formality than other forms
of association and, during the existence of the corporation, requires adherence
to continuing statutory obligations and formalities. However, provided the
statutory formalities are followed, innumerable variations are possible in
setting up and operating the corporation.
Under
general corporate law principles, a corporation is deemed to be an entity
legally separate from its incorporators, shareholders, and officers. Many
consequences and advantages logically follow from this attribute.
1.
Advantages
The
primary advantage of the corporate form of association is the fact of limited
liability. Except in the unusual case in which the "corporate veil is
pierced" (e.g., for inadequate capitalization, failure to follow corporate
formalities, or use of the corporate form to perpetrate a fraud), those who
invest in a corporation are not personally liable for corporate debts. Their
risk is generally limited to the value of their stock. This is an important
advantage in the context of the inherently speculative nature of many
technology joint ventures, and such limited liability may be a critical factor
in attracting a JVP.
2.
A further advantage of the corporate form is that a corporation's stock may
normally be freely transferred. Although affecting voting power and control,
such transfers do not affect the corporation's existence. Conversely, and of
more importance in this context, reasonable restrictions can be placed on the
transferability of the stock, thereby preventing unknown third parties from
entering into the joint venture.
3.
Through issuance of different classes of stock, the corporate form also
provides a simple method for differentiating among the rights of its
shareholders. A corporation can issue different classes of stock (e.g., Class A
common and Class B common, common and preferred, or common and different
classes of preferred), with different rights and preferences, including
different voting, dividend, redemption, and liquidation rights. Accordingly,
the corporate form has built into it a simple and flexible mechanism for
allocating such rights, which may be as complex or straightforward as the
situation demands. In the event disparate treatment of shareholders is not
necessary, the capital structure may be simplified to one class of common
stock. On the other hand, if
called for, several classes of common and preferred may be used to
differentiate among the rights of the shareholders.
4.
Another attribute of a corporation is that it has a generally recognized
management structure. Centralized management is provided by a corporation's
board of directors, which is charged with overseeing the general management of
the corporation's business and operations. The shareholders of a corporation
exercise control over the operation of the business through their power to
elect the board of directors. Formal shareholder approval is normally necessary
only for fundamental or extraordinary corporate actions, such as amendments to
the corporate charter, mergers, and dissolutions. Accordingly, the corporation
can raise money by selling its stock to many shareholders without fearing that
they will directly interfere with the management of the company.
5.
A further advantage of doing business as a corporation is the availability of
fringe benefits for corporate employees. Some such benefits receive
advantageous U.S. tax treatment, thereby serving as an inducement for attracting
top level management personnel. These benefits may include qualified pension
and profit-sharing plans, stock options, and group insurance plans. However, a
partnership format may offer comparable tax-benefited plans.
Disadvantages
1.
Suspicions
as to liability implications
2.
Duplication
of Resources
3.
Taxation-
Profits could be subject to tax at the joint venture and shareholder levels.
4. A second significant tax disadvantage
associated with corporations is that the shareholders have less flexibility in
transferring assets into and out of the corporation with minimal tax effect
than in the case of a partnership. Careful planning is required to deal with
this problem.
5.
To the extent a corporation intends to offer its securities to the public, the
corporation may be required to comply with the state securities ("blue
sky") laws, as well as the federal securities laws, at a substantial cost.
6.
As compared to some other forms of organization, a corporation also is subject
to greater governmental regulation both at the state and federal level, and is
subject to greater difficulties in transacting business across state lines. A
corporation must conduct its business with greater formality than other forms
of association. Such corporate formalities include incorporation formalities,
capitalization requirements, the maintenance of appropriate books and records,
the scheduling of meetings of shareholders and directors, notice requirements,
minutes and other record-keeping requirements, and the compliance with quorum
and majority rules. In the event these corporate formalities are not strictly
followed, it is possible that the corporate form will be disregarded. For
example, state laws generally vest in the board of directors the authority to
manage the affairs and operations of the corporation. To the extent the
shareholders attempt to "usurp" control of the business operations, a
court may determine that the corporate form is merely a sham and "pierce
the corporate veil," thereby subjecting its shareholders to unlimited
liability.
2.2 Contractual Joint Ventures
Generally,
U.S. courts have defined a contractual joint venture as an association of two
or more persons (whether corporate, individual, or otherwise) combining
property and expertise to carry out a single business enterprise and having a
joint proprietary interest, a joint right to control, and a sharing of profits
and losses.
Although
joint ventures normally are governed by the substantive law of partnerships
under U.S. law, they differ from partnerships in that partnerships contemplate
the operation of a general business, not a specific undertaking. The joint
venture need not be formally organized as a corporation or other business
entity, but in more substantial undertakings, it is customary to do so. What
form the association takes—partnership, general business corporation, or close
corporation—depends on several factors, including the objectives of the
parties.
The
motivations for forming a joint venture are several and often overlapping.
Basic
Advantages
Regardless
of the motivating force, the joint venture provides a means of achieving
business and economic objectives potentially beyond the capabilities of either
JVP acting alone. This is the primary advantage and hallmark of the joint
venture form of association—the ability to combine the strengths, expertise,
technology, and know-how of separate businesses with the concomitant benefit of
sharing investment costs and risks.
In
deciding whether a joint venture is the appropriate vehicle to implement the
intent of the parties, it is important to weigh the relative advantages and
disadvantages of this form of business association.
One
of the primary advantages of the joint venture is that it can allow the
participants to undertake potentially speculative and high-risk endeavors
without exposing assets to unlimited liability. Accordingly, a company can
experiment with larger projects or enter into new areas without making a
permanent commitment or risking capital beyond its means. The JVPs can define at
the outset the extent to which each will be liable for costs and will share the
risks associated with the endeavor. Moreover, the financing arrangements of the
new joint venture entity may not appear on the balance sheets of the parent
companies. A joint venture further provides a substantial degree of flexibility
in distributing operational responsibilities and authority between the JVPs and
thus allows the parties to utilize effectively the particular strengths of
each.
However,
there are also certain disadvantages in the joint venture form of organization.
First, a joint venture involves co-ownership and co-management and thus creates
a risk that problems will develop in the decision making process. This is
particularly true in the case of 50/50 ownership where there is an increased
probability of management deadlocks that can effectively stalemate all
activities. Second, a joint venture may have its effectiveness undermined by
negotiated compromises between JVPs replacing the certainty of a single management.
Although recognition of this problem at the outset allows the JVPs to provide
for dispute resolution mechanisms, the disruptive potential remains the JVPs at
the commencement of their economic "marriage" may not, without
guidance, consider realistically or give sufficient credence to, this serious
problem.
Given
the close cooperation necessary for effective operation of the joint venture, a
substantial unity of interest between JVPs is a prerequisite for success.
Unlike merger or acquisition transactions which necessitate agreement of the
parties only for a short period of time and after which only one of the parties
will control the enterprise, a joint venture requires continuing agreement
between the JVPs as to the nature and scope of the enterprise. If the basic
objectives of the individual JVPs are incompatible at the outset or if they
change over time, these differences can create significant problems and bring
about the premature termination of the venture.
3.0
PLANNING THE JOINT VENTURE
The
formation of an international joint venture can be an extremely complex
process. The goals of the enterprise must be defined, the structure must be
negotiated, numerous legal issues must be recognized and resolved, and
potential areas of conflict between the JVPs must be identified and reconciled.
Careful planning is required at all stages.
The
planning stages essential to the formation of a joint venture are outlined
below. The important considerations relevant to each stage are discussed in
detail in later chapters of this book.
3.1 Identifying Objectives
At
the outset of every proposed joint venture, it is necessary to have an
understanding of the basic objectives of the proposed enterprise. This includes
identification of the nature and scope of the proposed undertaking, as well as
the company's expectations and goals. For example, if a company is seeking a
short-term arrangement to measure the potential market for a product in a
foreign country, a licensing or straightforward contractual arrangement might
be preferable to a joint venture, which generally contemplates a longer term
and more substantial commitment.
3.2 Selecting a Partner
If
a joint venture is deemed desirable, one of the first considerations is the
selection of a compatible partner. A concern may initially seek a co-venturer
of equal business stature and with comparable corporate policies, philosophies,
and financial resources. Through the process of active negotiation, involving
business people as well as lawyers, the JVPs should determine whether their
objectives are compatible. This process may be difficult, but it is important,
particularly in the context of multinational joint ventures, given the
cultural, linguistic, political, and social differences between the parties.
Similarly, there may be legal, accounting, and tax differences between the
countries of the JVPs. Since all of these differences may give rise to
misunderstandings, they must be reconciled.
3.3 Choosing the Business Form
The
next step is to choose the basic structure of the business venture. A variety
of complex legal and practical considerations are involved at this stage. It is
necessary to identify the respective contributions of the parties and the
proposed financing arrangements in order to measure the compatibility of the
potential JVPs and to determine the appropriate organizational form.
Frequently, one JVP looks tor a capital infusion and, in return, shares its
technology expertise, and know-how.
3.4 Identifying Legal Problems
At
the beginning of the process, counsel must identify and resolve major legal
issues and potential problem areas, including governmental regulatory matters.
3.5 Identifying Conflicts Between
Partners
It
is also important to identify potential areas of conflict between the JVPs so
that they can be reconciled prior to making an irrevocable commitment. For
example, the parties may have to deal with differing tax objectives resulting
from fundamentally different business goals or, more commonly, from different
constraints of the tax laws and accounting practices of the home country. Early
recognition of these issues may allow the parties sufficient flexibility to
structure the joint venture to avoid these problems.
3.6 Drafting the Joint Venture Agreement
Finally,
after the goals, structure, and legal issues have been identified, it is
necessary to draft the joint venture agreement. As will be seen in later
chapters of this book, international joint ventures often involve unique
features, and careful draftsmanship is required.
1.0 TYPES OF
BUSINESS ARRANGEMENTS
1.1 Joint Ventures
1.2 Exports
1.3 Licensing & Other Contractual Arrangements
1.4 Direct Investments
2.0 THE
NATURE OF A JOINT VENTURE
2.1 Equity Joint Ventures
2.2 Contractual Joint Ventures
3.0 PLANNING
THE JOINT VENTURE
3.1 Identifying Objectives
3.2 Selecting a Partner
3.3 Choosing the Business Form
3.4 Identifying Legal Problems
3.5 Identifying Conflicts Between Partners
3.6 Drafting the Joint Venture Agreement
4.0 A HYPOTHETICAL JOINT VENTURE
5.0
INTERNATIONAL JOINT VENTURES
5.1 Identifying a Suitable Partner
5.2
Information Exchange Agreement
5.3 Letter of Intent or Memorandum of Understanding
5.4 Important General Provisions
¨
Prefatory Clauses
¨
Definitions
¨
Currency Provision
¨
Management & Control Provisions
¨
Disputes Resolution Procedures
¨
Disputes Resolution Forum & Choice of Law
Designation
¨
National Security Restrictions
¨
Termination Provisions
¨
Representations & Warranties
¨
Force
Majeure Clause
5.5 Tax Planning
5.6 Ancillary Agreements
¨
Patent, Technology & Technical Assistance
¨
Real Estate Transfer Agreement
¨
Supply Agreement
¨
Equipment & Machinery Agreement
¨
Administrative Services Agreement
¨
Marketing Agreement
¨
Trademark/Trade Name Agreement