What are the elements of a successful JV, and what contractual omissions can lead to failure?
Joint ventures between contractors are common, especially on very large infrastructure projects such as Crossrail. The perceived commercial benefits include the ability to share risk and increase bargaining power. Sometimes it is essential to form a JV to demonstrate the skills and/or experience required to win the work. Or local law may require the use of local labour, and joining forces with a local contractor is a way to meet that requirement.
Despite their popularity, JVs do not always succeed. Indeed, they often fail. Why does that happen, and what can be done to reduce the risk of failure? JV partners face important choices at the outset, and during the partnership, which they need to consider carefully, to maximise the prospects of success.
How should the JV be structured? Will it be an unincorporated alliance or an incorporated JV company in which all parties invest? If the latter, where will that company be registered? The local jurisdiction or somewhere else?
These decisions are fundamental because they affect the contractual structure and operation of the JV, including what happens if the relationship turns sour. There is no one-size-fits-all approach, as much depends on the particular circumstances of each project, but there are some common factors that experience tells us are important considerations. These include control of the JV, the level of integration, potential liability, operational concerns, tax consequences, duration and, crucially, the resolution of disputes. In the initial honeymoon period of the union it can be easy to overlook some of these factors, but partners do so at their peril.
Control and decisions
The key considerations may be how control is to be exercised, and what happens when disagreements arise between partners. In practical terms, this means considering how the board will be constituted and how decisions are to be made. Will some types of decision require a higher majority than others, even perhaps unanimity? What happens if there are conflicts of interest? How will those be resolved?
To resolve disagreements, a number of internal and external mechanisms may be used as a first step to avoid (or swiftly resolve) stalemates. One is the appointment of a temporary independent director to resolve stand-offs between the partners. This can be achieved by giving the chair of the board the casting vote and providing for rotation of the role at set intervals to maintain the balance of power.
An external mechanism is independent expert determination. This allows the parties to refer disputes or differences to confidential and binding expert determination, which can be a cost-effective and swift means of resolution, avoiding the time and costs involved in going to arbitration.
A mechanism for the most serious disagreements is the use of compulsory sale and purchase provisions, sometimes called “Russian roulette”, “Mexican” or “Texas shout out” clauses. Whatever the label, their effect is the same: the termination of the JV when the parties can no longer work together.
These mechanisms can all help to avoid or resolve disagreements, but a failure to build them into the contract may well have the opposite effect. They are not, however, a panacea and will not be suitable for every case. Sometimes formal dispute resolution, in court and/or arbitration, is almost inevitable, and early and prompt legal advice should be sought.
Culture harmony and vision?
The structure of the JV may not be the cause of failure. More fundamental factors can be at play in its operation, management and execution, which can be traced back to a mismatch between the different expectations, cultures and ways of working of the JV partners.
These soft factors cannot be ignored. Deep-rooted cultural differences between teams can lead to fundamental misunderstandings that, left unchecked, lead to a lack of trust. Once gone, it is hard to restore. Such issues are not easy to address, but failing to do so can incur serious time and costs consequences.
Successful JVs demand strong leadership and operational management built on solid foundations. Research indicates that success hinges on a clear, shared vision, as well as commitment to agreed ways of working and the ability to anticipate and respond positively to change. Appropriate internal procedures for managing conflict when it arises are also key.
A clear, well-led and well-managed strategy enables JV partners to move forward together, which, to paraphrase Henry Ford, is when success takes care of itself.
James Morris is a partner with Mayer Brown International