Back to Basics: Forming a 50/50 property joint venture

Richard Hepworth takes a look at some of the key contractual provisions to consider in a 50/50 property joint venture. Company A holds a disused site in a prime location. It has expertise for the required demolition phase. It wishes to de-risk part of the financial costs of the project. Company B has funds and expertise to project manage and build a warehousing development on the site. The parties agree that Company B will acquire 50% of the special purpose vehicle (a private limited company) holding the land for an agreed price, covering half the land acquisition, planning and other costs to date. Company B has satisfied itself regarding title to and other property law-related matters regarding the project.  The parties are happy from a tax point of view and sit down to discuss key commercial terms for the running of the project and the jigsaw of contractual arrangements needed to reflect the commercial intentions of the parties. Before diving into drafting a detailed joint venture agreement, articles, project management agreements, funding agreements, demolition and building contracts, and so on, the parties agree key issues in heads of term form (see table). Heads of terms: issues to resolve Shares Economic rights and voting rights. Funding the project The obligations to fund on the parties and the remedy for failure. The board Constitution of the board, voting rights, alternates, frequency, etc. What matters are subject to shareholder scrutiny/veto? How does the board interact with other stakeholder contracts (project agreements) with the project manager, demolition contractor, builder, etc? Exit What does exit look like? What happens if one party wants to sell shares early or is insolvent? Should any party have a drag-along right? Shareholder veto Key matters where unanimity is required and is not left to the board or the project agreements. Project agreements Ensuring clear lines of authority/delineation of decision making, and detailed commercial terms (including pricing) – the detail of this is outside the scope of this article. Deadlock What is a deadlock and what are the stages for resolution? Guarantees Is group guarantee support required for each party’s jv obligations or under the project agreements? Breaches In our scenario, does a breach by Company A of any warranties in the initial sale agreement of 50% of the shares to Company B lead to consequences in the jv arrangements? Shares A typical position for a simple 50/50 jv would be for Company A to hold 50% of the shares as A shares and for Company B to hold 50% of the shares as B shares, with all economic and voting rights matching each other. It is of course possible to mix a combination of rights attributable to the A shares and the B shares to cater for more complex arrangements where perhaps initial contributions are uneven. For example, you could see 50/50 shareholdings rank equally for all purposes but that the A shares get a priority return (by way of dividend or return of capital) relative to an additional contribution into the jv at the outset. Funding the project After the initial contributions, the jv will set out how the development is funded. This could be as simple as a general obligation on the parties to seek third-party finance for the SPV (perhaps with guarantees from A and B) or A and B might agree to provide funding and, if either fails to put in their loans, then the other can top up the breach in return for a pre-agreed priority return. The financing arrangements could, be more sophisticated and aligned to particular phases of the project development. They may require priority and subordination arrangements between the SPV, any third-party funders, Company A and Company B. The board The matrix of contractual arrangements outside the jv agreement can be many and varied depending on the complexity of the project. These may involve specialists within Company A’s group (eg a specialist demolition contractor), Company B’s group (a building contractor/project manager, etc) and/or third-party contractors. The key here is for this contractual matrix to dovetail together itself, but be aligned with the key decision processes within the SPV. The jv agreement will then have different strata of decision-making parameters, from day-to-day management of the SPV, to what requires board approval and the levels of veto the two companies have as shareholders. Different projects will have different strata for decision-making processes. For example, in our case, Company A’s demolition company and Company B’s contractor may have a small percentage of cost increases flex before any overrun is escalated upwards. The jv agreement and articles of association will also detail administrative matters for board meetings, such as how many a year are held, whether the chair rotates, whether directors can appoint alternates, and so on. Exits • Planned exit The jv agreement will normally include expected time frames and sources/types of exit/sale. Where there might be sales of part, the jv agreement might make provision for interim returns. One of the parties may wish to have first option to negotiate a property acquisition out of the SPV before going out to the market (sometimes at a discount to full market value). • Early exit When it comes to a shareholder seeking an early exit, 50/50 jvs can often be fairly rigid because they are predicated on the (hopefully) good relationship between the parties and the particular expertise each brings to the table. Often an exit is completely prohibited in the early period of a development project life (unless of course the other shareholder consents).  Once beyond this initial period, a shareholder wishing to sell to a third party must generally offer the shares first to the other shareholder and, even if it declines to buy, there are often restrictions on the terms of the sale and identity of a third-party buyer, including the obligation to adhere to the terms of the jv agreement.  In many cases, the difficulty of this means shareholders need to be in the project for the long-haul as an early exit (other than to the other party, often at a negotiated discount) will be hard. • Drag along This is a provision whereby if one shareholder obtains a third-party buyer for the whole SPV then the other party must also sell at the same price. These are often unusual in a 50/50 jv, unless there are special reasons for one party to have this right. In such cases, the drag along is usually not permitted in the initial phase of the development project’s life (either measured in time or the achievement of milestones) and can often specify a minimum return to be achieved. It may even include prohibited potential purchasers. • Forced exit This typically involves an insolvency event of one of the shareholders but can also involve a material breach by a party. In such instances, the other shareholder will usually retain a right (not an obligation) to buy the insolvent party’s shares in the SPV out of the insolvency process at fair value confirmed by an appropriate expert (often at a discount). Shareholder veto Above the layers of decisions made day-to-day and at board level, most jvs contain a list of sacrosanct matters which require written consent from both shareholders. These will include generic veto items common to most jvs, for example not changing the project agreements, not incurring borrowing over certain levels and not engaging new professionals, as well as other issues which might be more project specific. For example, in a demolition and rebuild arrangement, the parties might wish a shareholder veto on the terms of any technical milestone arrangements required before building starts. Deadlock Many jv agreements contain provisions on how deadlocks are resolved, for example where a matter on the shareholder veto list hits an impasse. The rationale is to provide a contractual resolution procedure, which is often stark in operation to focus the parties to negotiate properly when a dispute arises. However, a number of jvs do not include deadlock provisions, usually on the basis that it is hard to predict how issues will play out and the fear that parties will feel backed into a corner.  Where a jv agreement does include a deadlock resolution procedure, it usually encapsulates two phases. The first is defining the circumstances leading up to and the procedures to follow before a formal deadlock arises and the resolution process starts. These are many and varied but usually see an escalation from board impasse to shareholder review and ultimately referral to the chairs of the two shareholders. This process is aimed at finding a negotiated solution, with the looming threat of chair intervention and, thereafter, formal dispute resolution. If a deadlock is unresolved, there are a number of different resolution options, which can be used separately or as a series of gateways to get to resolution: The deadlock is resolved by reference to an appropriate expert. This could be feasible in certain circumstances, but many deadlocks involve commercial decisions/judgment calls which may not be appropriate to refer to an expert. An obligation to mediate in good faith and, if no resolution is achieved, move to another level of resolution. A winding up of the jv and sale of the assets. This is typically used as a final measure once all other forms of resolution have been tried and is not that frequently seen as the first point of call. A mechanism where one party buys out the other’s shares. These can take various guises. Two well-known ones are: • Revolver resolution (previously known as Russian Roulette) The party who serves the first deadlock notice states it will buy the other’s shares at a certain price per share or sell its shares to the other at the same price. The party receiving the notice has then a defined period to choose whether to buy or sell at that price. The theory is that the party starting the procedure will set a “fair” price because it is agreeing to buy or sell at the same price. • The stand-off One party offers to buy the other out at £X per share. The other then has a certain period either to agree to sell at £X or to offer to buy at a higher price (the jv agreement could specify the increase has to exceed a particular percentage above £X). If the higher offer is made, then each party then sends its final sealed best buy bid to an appointed expert and the party with the highest bid becomes the buyer at that price. Breaches If a party materially breaches the jv agreement or the share sale agreement under which Company A transferred 50% of the SPV to Company B, then sometimes, in addition to any ordinary claim for breach of contract, jv agreements include this as a trigger to buy out the breaching party in whole or in part. This is seen as a draconian option and therefore either kept specifically drafted and limited to a small category of breaches or not included at all. Key takeaways  Take time to agree headline commercial terms. Make sure project agreements dovetail and with the jv agreement. Do not impose too draconian provisions on the other side – in a 50/50 jv they will inevitably ask the same of you. Make sure all parties are clear that you are in it for the expected project length. Do not paper over any cracks by relying on deadlock provisions. These can be clever and complex but are by their very nature adversarial and costly. Better to address issues early in negotiations and tackle them head on. Prevention is better than cure. Richard Hepworth is a corporate partner at Brabners Photo by Sora Shimazaki/Pexels