Joint Ventures (JV) refer to the technical and financial collaboration through a strategic alliance between two or more existing business entities. An agreement to effectuate and enforce such a collaboration is known as the Joint Venture Agreement (JVA). The parties to a JVA combine their business resources to generate shared profits. The JVA lays down the rights and obligations of each party, the extent of equity contribution, the manner for sharing of revenues, expenses, control over the enterprise, etc.
Upon execution of a JVA, a new entity is created based on the mutual efforts of the parties to the JVA. However, the legal status of the respective pre-existing business entities is not affected by the JV.
Part II of the Series on Joint Ventures discusses the important clauses and definitions to be kept in mind while drafting a JVA and the potential issues faced in Joint Ventures.
The JVA necessitates proficient legal drafting. The agreement should be inclusive of all the relevant clauses that specify the consensus of both the Parties with regards to the formation and operations of the JV. A complicated and vague documentation can be fatal to the JV and hamper the interests of the Parties involved.
There is no defined format for such agreements, however, some of the important clauses in these types of agreements are as follows:
- Object and Scope of the JV;
- Cost and Pricing;
- Participation of local and foreign investors in equity and agreement for the future issue of capital;
- Obligations of the Parties;
- Composition of the board and management, and procedure of meetings;
- Procedure for shareholders meetings;
- Transferability and sale of shares;
- Technical know-how/brand name/ confidentiality from the other Party;
- Remedies for deadlock;
- Voting provisions;
- Non-Compete Clauses;
- Indemnity Clauses;
- Dispute Resolution; and
- Applicable Law.
The Definitions clause is inculcated in an agreement in order to facilitate easy and concise interpretation. In the JVA, the following terms, to the extent not inconsistent with the context thereof, generally have the following meanings assigned to them as below:
“Act” refers to the Companies Act, 2013, and its Rules, including any subsequent amendment or enactment.
“Affiliate(s)” or “Associates” in relation to any Party, means any firm, concern or company or entity, which controls the said Party or is controlled by that Party, either on its own or together with one or more affiliates.
“Agreement” means the JVA and shall include all the Exhibits annexed to the JVA.
“Applicable Laws” means all laws, brought into force and effect by Government of India or the State Government including Rules, Regulations and Notifications made thereunder, and Judgments, Decrees, Injunctions, Writs and Orders of any Court of record, applicable to this JVA and the exercise, performance and discharge of the respective rights and obligations of the Parties hereunder, as may be in force and effect during the subsistence of this JVA.
“Articles of Association” means the articles of association of the JV.
“Board” or “Board of Directors” means the Board of Directors of the JV.
“Business Day” means a day on which banks are generally open for normal business in the respective state in India.
“Control” means, in relation to either Party, the right to, directly or indirectly, control the affairs of any third party either by holding (i) more than 50 per cent of the total voting rights in such Third Party concerned or (ii) of the composition of the Board of Directors of such Third Party concerned.
“Financial Year” means the financial year of the JV, which shall end on March 31 of each calendar year.
“Force Majeure Event” means:
- War (whether declared or undeclared), invasion, armed conflict or act of foreign enemy in each case involving or directly affecting India;
- Revolution, riot, insurrection or other civil commotion, act of terrorism or sabotage in each case;
- Nuclear explosion, radioactive or chemical contamination;
- Strikes, working to rule, go-slows and/or lockouts which are in each case nationwide or state wide in the State of Maharashtra;
- Any Act of God, such as, effect of the natural elements, including lighting, fire, earthquake, tidal wave, flood, storm, cyclone, typhoon or tornado;
- Epidemic or plague;
- Change in Applicable Law;
- The act or omission or delay of any Governmental Authority, not caused due to reasons attributable to the party claiming Force Majeure, which prevents or causes a delay in the implementation of the Project;
- Expropriation, creeping expropriation, requisition, confiscation, nationalization, export or import restrictions;
Provided that each of the event is beyond the reasonable control of the Party claiming Force Majeure, which could not have been prevented by exercise of reasonable care on the part of such Party (including its Affiliates or any of their respective employees, servants, or agents) and which could not have been reasonably foreseen, and directly affects the Project or the ability of a Party to perform its obligations under the JVA.
“Memorandum of Association” means the memorandum of association of the JV.
“Person” includes an individual, an association, a corporation, a partnership, a joint venture, a trust, an unincorporated organization, a joint stock company or other entity or organization, including a government or political sub-division, or an agency or instrumentality thereof and/or any other legal entity.
“Shares” means the equity shares of the respective Currency and value of the JV.
“Shareholder(s)” means any Person who holds shares of the JV.
“Technology” means all knowhow, confidential technical data, drawings, designs and information relating to the manufacture, assembly, testing, servicing and sale of a Licensed Product and Licensed Parts now or hereafter becoming owned by or known to the other company, including Improvements and which the other company has the right to disclose to others, and includes (without being limited to) prints as well as engineering, manufacturing and assembly information necessary and advantageous for the manufacture and assembly of Licensed Products and Licensed Parts, such as assembly drawings, material specifications, technical specifications, parts lists, drawings of tools and of special machines and assembly instructions for Licensed Products.
“Transfer” means and includes any direct or indirect sale, assignment, lease, transfer, pledge, gift, or other disposition of or the subjecting to an Encumbrance of, any property, asset, rights or privilege or any interest therein or thereto.
POTENTIAL ISSUES AND SAFEGUARDS
The process of establishment of a joint venture is laden with complexities. To ease out such issues, certain considerations are highlighted below:
1. Due Diligence: Due diligence is an essential step in the process of forming a joint venture. It gives an appropriate assessment of the fact whether the Partner entity has the capability of carrying out the business that is being undertaken by both the Parties.
Furthermore, it is important to know about the existing and/or new liabilities of the Partner; care should be taken that the liabilities are not transferred to or borne by the other Partner.
Hence, the scope of due diligence should be clarified at the outset. The process is very similar to that which is carried out during other corporate transactions. Depending on the terms of the JV, the scope of due diligence should be determined.
2. Intellectual Property Issues
- Ownership of Intellectual Property: These form the backbone of JVAs. After a JV is founded and an entity created, it has an identity of its own and the issue of ownership of the brand created is of prime significance. In a JV, either of the Partners to the JVA can contribute to any kind of Intellectual Property (IP) for the JV. In order to prevent either of the parties from claiming rights to its use for personal gain, it becomes important to clearly define who would own the IP and to what extent can it be used beyond the scope of the JV at the outset itself.
- Post term use of Trademark: It may so happen that the Licensor exits the JV, and the term of the license has expired, and the other Party continues to use the Trademark for reference purposes or as a part of the corporate name. To minimize the risks that could arise from such a litigation; the Trademark License Agreements which are common to all the JVAs, should be carefully drafted.
- Licensing or Assigning: It is important for the Licensor to ensure to not grant exclusive rights to use the mark to more than one person, for similar types of goods or services that are likely to cause confusion or deception.
3. Enforcement of Foreign Judgment/ Arbitration Award: When it comes to commercial transactional disputes, Arbitration is the preferred mode of Dispute Resolution. However, there are complications in enforcing a foreign award in India. Despite being a signatory to the New York Convention of 1960, India has only notified about 45 countries as reciprocating territories; implying that the award can only be enforced in India when the seat of Arbitration is in the reciprocating territory.
Similarly, India recognizes approximately 12 countries for the enforcement of judgments. Even if a judgement is credible, it cannot be directly enforced as a decree if it is passed in a non-reciprocating territory. Hence, this would further slow down the process of resolving disputes.
4. Corporate Governance Clauses: Tangible and intangible consequences of corruption not only harm a company’s ability to grow and compete, but it also hampers its reputation, public and consumer trust; not to mention the legal consequences that follow.
It is also important to get the accounts and financial statements audited periodically, to prevent fraudulent practices. Ethical business practices can be maintained through internal control mechanisms such as stringent anti-corruption provisions as is seen in foreign documentation, or incorporation of specialized committees to investigate specific aspects of the venture or provisions for periodic internal audits, etc.
5. Taxation Issues in Unincorporated JV: Contractual arrangements with even one non-residential participant may be taxed at a maximum of 40% if they qualify as ‘association of persons‘ under the Income Tax Act, 1961 (IT Act). This term is not specifically defined under the IT Act but is rather interpreted via case laws. As a result, in order to avoid paying such high taxes, the JV arrangements must be structure with utmost care.
Definitive drafting of the JVA is critical to the success of the JV. It is crucial in order to determine the scope of the JV, to demarcate the relationship between the Parties, the method of setting up a JV, duties and obligations of the Parties and addressing areas of conflict. Clearly defining each of these clauses goes a long way towards preventing the Parties from entering into future disputes and ensuring a smooth operation of the JV, along with the following benefits:
- The Parties to a JVA are bound only by a temporary arrangement;
- The Parties can share all the risks and costs;
- The Parties can gain access to additional resources while pursuing a mutual goal;
- The Parties can access increasing opportunities with respect to growth, etc.
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