Risk Management

Joint Ventures: Proceed with Caution

Things can go wrong in any business combination, but risks are often more acute with joint ventures.
Jonathan Cogan and Will RosenzweigOctober 10, 2016
Joint Ventures: Proceed with Caution

As joint venture agreements gain in popularity, corporate executives should be aware of the legal challenges and pitfalls that present themselves in these unique commercial arrangements.

Jonathan Cogan

Jonathan Cogan

The benefits of joint venture (JV) agreements are clear: They provide a framework for deeper collaboration and protections than a standard arm’s-length contractual relationship without the entanglement of a merger, acquisition, or partnership agreement.

Yet, the risks are potentially greater with a JV, depending on the type of relationship between the parties and the contractual details. Difficulties can arise due to uneven financial or operating power within the relationship or because of the misguided assumption that abuse is less entangling in a JV arrangement.

As any senior executive instinctively knows, unanticipated problems can arise and basic assumptions can go awry in the planning or execution of any business combination or contractual relationship, whether through unforeseeable third-party developments or intentional malfeasance. But such issues can often be more acute in joint ventures.

A managing partner, for example, might be enticed to compete with the venture by taking corporate opportunities — like third-party contracts, availability of real estate, or opportunities to invest in new businesses or products — for herself individually rather than on behalf of the venture. In more extreme instances, a managing partner may divert or misuse the venture’s assets for his own benefit, sometimes even moving those assets offshore in an attempt to shield them from the venture’s creditors and other equity holders.

It is therefore critical for partners to have an understanding of the steps they can take to protect their interests and maintain leverage if and when their relationships with their venture partners become strained. That’s particularly true for minority partners and/or partners who do not have control of the venture’s finances.

Getting comfortable with the full range of available legal rights and options can often be vital in deciding whether entering a joint venture is the right approach, and in maximizing the recovery of its invested monies and other assets, should a company go forward with a JV that indeed turns sour.

Among other things, companies should keep in mind three considerations when pursuing joint ventures.

First, companies should plan for disagreement and a potential exit by thinking through, and negotiating in advance, provisions that make clear how partners/members can “cash out” of the venture. Significant, time-consuming, and risky litigation can result when parties to a venture have not planned in advance for how they will deal with a separation.

Second, companies should be aware of the menu of rights available to them in the event that internal disputes develop or suspicions arise. For instance, a JV member is usually entitled to inspect the books and records of the venture.

Members may also be able to petition a court to dissolve the venture and seek to recoup their investment if they find evidence of wrongdoing or otherwise show that conducting business under the venture is no longer reasonably practicable or that they are being oppressed. This dissolution power can include court appointment of a neutral receiver to handle the dissolution.

In addition, various U.S. jurisdictions hold that a joint venture partner owes a duty to the other partners not to pursue other business opportunities that could compete with or otherwise harm the joint venture. A managing partner could be held liable to the other partners for breaching this duty, with courts possessing a broad array of potential remedies.

Third, a company should ensure that the joint venture agreement provides for dispute resolution in a locale with laws that will provide effective resolution of any potential disputes. Many non-U.S. countries will complicate not only dispute resolution but also judgment enforcement.

On the other hand, if assets are substantially in a non-U.S. jurisdiction, the advantages of a local forum may outweigh the downsides of litigating away from home.

A prominent example of the danger in ignoring these principles presented itself in a recent Texas state court case from Dallas captioned Energy Transfer Partners, L.P. v. Enterprise Products Partners L.P. In that case, two parties involved in prospective joint venture negotiations expressly disclaimed the formation of a partnership in three written agreements signed at the outset of the exploratory process.

The agreements expressly limited the obligations the contracting companies owed to one another and made any formal joint venture contingent on the meeting of certain conditions. Nevertheless, a Texas jury concluded that the subsequent conduct of the parties established a legally binding partnership — and with it, stronger obligations to each other.

As a result, one party’s subsequent deal with a third company concerning similar interests to the potential JV constituted a breach of the implied partnership, although the conduct was consistent with the written agreement. This left the breaching party liable for more than $500 million in damages for breaching a partnership it had no reason to believe existed. (The case is now pending appeal.)

The devastating consequences of the joint venture in the Energy Transfer Partners case underscore several points made above. For one, the purportedly limited nature of a JV did not effectively limit the parties’ obligations to each other as intended.

Next, an understanding of Texas law and the laws of other potential jurisdictions could have avoided the unintended partnership. And on the other side, the aggrieved party’s knowledge of its rights and remedies led to a beneficial resolution when its interests were threatened.

In sum, while joint ventures can be incredibly effective tools for securing business, attention to the legal benefits and dangers they present is crucial to actually achieving their intended results.

Jonathan Cogan is a partner, and Will Rosenzweig an associate at the litigation firm Kobre & Kim.