Navigating joint ventures

With joint ventures proving increasingly popular, Karl Bradford and Mark Holloway provide a useful reminder of the basics of how they work, and the important elements of any such agreement. The term joint venture, or jv for short, gets used a lot and can mean different things to different people. They can range from a contractual arrangement detailing how parties will work together to a more formalised corporate arrangement where the parties establish a vehicle through which they will conduct the new business or project. Joint ventures are a fundamental element of real estate development and can be instrumental in unlocking development sites that might otherwise not be brought forward. The last 24 months or so has seen a rise in parties looking to enter into jvs. There have been lots of factors at play in this trend, although it is largely driven by there being a number of investors with large reserves of capital to deploy at a time when high interest rates mean that bank finance is not as viable. Should you enter into a jv? Entering into a jv can be a tempting proposition and there can be many advantages. However, they should not be seen as a quick fix and, if not thought through properly, could ultimately end up creating more long-term headaches for all involved. Essentially a jv is the creation of a new business which is itself run by two or more existing businesses. That means there are more decision makers, more considerations and consequently more areas for possible disagreement, especially in dealing with the ever-increasing regulatory pressures. Let’s take a typical real estate jv example. One party holds land, the other is a developer that has the expertise to bring forward a residential development. The parties set up a new company, transfer the property into it, planning permission is obtained, third party finance is put in place, the site is built out without any issues, the units are sold off and the parties both receive a sizeable profit. However, in addition to the physical issues which may be identified on site, title issues which may arise, and rising cost of raw materials and labour, developments are under ever increasing regulatory pressures. This includes the planning regime, building control and Building Safety Act 2022 requirements, environmental laws and regulations, and health and safety rules. While many of these regulatory and legislative pressures are essential for the protection of the environment or the safety of workers and homeowners, they also increase the hurdles to be cleared by development projects and often increase the time projects take. This makes financial viability much harder. In addition, because of the length of time a typical jv project takes being measured in years, the regulatory landscape can change as the development progresses. This creates uncertainty and places increased strain on the jv structure, which may not have been able to anticipate how the regulatory regime could change during the course of the development. Following on our example, the landowner may have left all of these decisions to the developer (as the expert) to resolve. Suddenly, it is being asked to put in more money, costs start spiralling and the financier calls in the security it has over the property. The jv comes to an end. The landowner has lost its land. The developer has lost time, money and possibly its reputation. This is obviously an extreme example. If properly advised and if the venture has been properly considered, the parties should never find themselves in such a situation. Is it the right partnership? As highlighted by the example above, it is important to take time to plan the jv. No jv is ever the same and the parties are never equal. Even in a 50:50 jv, the parties bring different value to the venture and will have different pressures affecting them. It is therefore critical to find and understand the right partner. It is prudent to carry out detailed due diligence on any proposed partner: its track record, reputation of working in partnership with others, financial stability (including exposure to risks it has on other projects). Partner expectations are likely to include: Contributions: what are they willing to contribute? (Land is easy to value, however expertise is less so.) The parties need to be comfortable with what they put in and the ownership stake they receive to ensure they are incentivised to make the jv a success. Decisions: do they want to be actively involved in all decisions or are they content to be a passive partner? Exits: are they looking for a long-term income stream or to realise a short-term gain? Returns: is a minimum return required? Perhaps one of the parties measures success not purely by financial return and is more concerned by, for example, the provision of affordable housing? Reputation: looking for quality or quantity (basic specification versus goldplate standards)? If the parties do not align at the outset, this is a sign that the venture is likely to fail. In this case, it may be best to walk away. The parties do not need to be in total agreement, but they do need to know what the other is expecting so that everyone’s key objectives can be met. What are the key considerations when entering into a jv? Joint ventures are typically structured as a company, limited liability partnership, or a limited partnership, either incorporated onshore or offshore. Whichever the structure, it will be important to have a clear and detailed agreement in place, covering the following factors: ■ How decisions are to be made A jv needs to be flexible so that day-to-day decisions can be made quickly and easily, but determining who makes which decision is vital. The party contributing land or the funding may not be the person with the right expertise to make an informed decision. However, they would not want to allow one party to make all decisions for the jv, especially where the decision concerns a change to what was originally envisaged that could have a fundamental impact on partner expectations. An area that can often lead to a disagreement is how any cost overruns are dealt with (for example in dealing with a new piece of regulation). Should the parties be required to provide additional funding on a compulsory or optional basis? One party is likely to have deeper pockets than the other and so the position is not equally matched. ■ If there is a disagreement Having a clear internal escalation process provides an effective way to resolve a disagreement informally – saving both time and costs. It also allows the parties to work together to resolve the issue, preventing irreparable damage to the relationship caused by any perceived “win” and “lose” which could arise out of a formal dispute resolution procedure. Another mechanism to resolve a disagreement is referring the matter to an independent expert. But, before resorting to this, the parties should ask themselves: do they really want to defer to an expert? Why would the expert know better than them? Having an independent expert increases costs further and may not give the answer the parties are looking for. If the jv relationship has broken down that much already, is an expert determination really the solution? ■ If the disagreement cannot be resolved Where the nature of the dispute is such that the parties are unable to resolve the matter, the exit by one of the jv parties or termination of the jv may be the only viable option – otherwise the jv will simply run itself into the ground. Neither scenario will be ideal. One party may not have the resources to buy the other party out, or the jv may not be viable without the involvement of one of the parties. This fundamentally changes the bargaining power and whether in practice the process set out in the jv agreement would work in the way intended. Understanding is key It would be impossible to cover off every eventuality that may arise over the life of a jv. However, a strong legal framework should be put in place to ensure that the parties keep true to the originally agreed intention. In putting that robust legal framework together, the most important thing is to really understand each party, their drivers and what they are looking to achieve. If the regulatory burden were reduced and there were fewer regulatory changes, then it would be simpler for jv partners to predict and cater for the possible outcomes of a project, meaning fewer jvs would fail. While the government has laudable goals of decreasing regulation, regardless of whether this works, it will result in further change and hence uncertainty, which will be likely to place strain on existing jv structures. Karl Bradford is a principal director in the corporate real estate team and Mark Holloway is a principal director in the developer team at Foot Anstey Photo by Rock Starr/Unsplash