Five tips for minority shareholders in joint ventures

Jonathan Cantor, corporate real estate partner at Dentons, offers some advice for minority shareholders in corporate real estate holding structures The years since the global financial crisis have seen fundamental changes in indirect real estate investment. Before 2008, investors seeking exposure to real estate but wishing to remain passive were served by the fast-developing pooled investment market. After the crash, rightly or wrongly, a view held by some investors was that if they had been “at the wheel” then their investments would not have performed so badly. Blame was apportioned to managers, often for events outside their control. Investors considered themselves tied into structures that were illiquid, involved multiple risks and in which they had little control. All these features would have been made clear in information memoranda and (lengthy) legal documents but such details get overlooked in the fog of negative returns. The response of investors involved a drive for greater control of their investment, a feature that remains apparent today. Greater emphasis is placed on increasing allocations to direct investments and joint ventures (“jvs”). Joint ventures Property jvs come in many shapes and sizes. Some involve a 50:50 ownership structure, with parties having equal rights. Others involve co-investments with existing funds. Another popular type is club deals, involving more than two and fewer than eight investors. The inflow of overseas investors and specialist managers looking to generate returns has led to a marked increase in structures involving minority and majority stakeholders. As with all jvs, perhaps the key element for corporate jvs in the real estate space is a factor that cannot be documented – trust. Even where this is present, there is always an inherent risk that a jv party may change its strategy and the parties’ interests may cease to be aligned. This makes the position of the minority party in a corporate jv somewhat vulnerable. In English companies, there are various statutory protections for minority shareholders, such as being able to petition a court for unfair prejudice under the Companies Act 2006. This is a complex and expensive process but it is nonetheless valuable to the extent that a majority party wanting to operate outside contractually agreed terms needs to bear in mind the potential for a court to make orders against it. It is also possible that a court may order that a company be wound up on “just and equitable” grounds under the Insolvency Act 1986 if a minority shareholder is excluded from management. By virtue of being a shareholder, a minority investor will, as a matter of English company law, have certain rights. For instance, and perhaps most significantly, a shareholder with more than 25% of voting rights is able to block those shareholder decisions that require the approval of shareholders with at least 75% of the voting rights. These include a change to the articles of association of the company, a reduction of its share capital and the voluntary winding-up of the company. However, these are the bare minimum of rights and, for that reason, minority shareholders look for express contractual rights and protections in relation to the company beyond those afforded by statute. Drafting these protections when the majority party is keen to ensure it is able to take control of the venture is not an easy balance to achieve. So what are the five top tips for a minority shareholder in a corporate real estate holding structure? BOARD REPRESENTATION Most jv companies typically have a board of directors who are responsible for day-to-day management. It is common for a minority shareholder to seek the right to appoint one or more directors to the board so as to be kept informed about the business and to have a voice on discussions dealing with strategic and other key issues. If board representation is secured, the minority shareholder will want to ensure that its presence is required for any board meeting to be quorate. If board representation is not possible, the minority party should insist on the right to appoint an observer and to receive board papers at the same time as the directors. The flow of information to a minority investor is an important part of being able to hold the majority shareholder to account. CONSENT RIGHTS A minority party will usually wish to ensure that it is fully involved in major management and policy decisions of the jv company. Thus, as well as having the right to appoint a board member, it will look to have consent rights over certain major decisions. Typically, these “reserved matters” include issuing shares, borrowing in excess of certain agreed limits, capital expenditure above certain thresholds, major acquisitions or disposals, dealings between the jv entity and its shareholders not on arm’s-length terms and approving an annual business plan. It is here that the relative bargaining powers of the jv parties becomes more apparent. If a minority party has strong veto rights, the majority shareholder may seek the ability to buy out the minority party if those veto rights are used persistently to block decisions. There needs to be a mechanism to allow the venture to continue if a deadlock exists. For example, if both parties need to approve annual updates to a business plan, the documents should allow, to the extent there are line items that the parties cannot agree on, for the then‑current business plan to continue with adjustments for RPI, tax and contractual commitments. For other circumstances, some form of dispute resolution mechanism may be necessary to resolve any disagreement. PUT OPTION A put option is a mechanism by which the minority shareholder can oblige the majority shareholder to buy out its investment in the jv, normally in accordance with the predetermined pricing formula and at a defined time, usually after a lock-in period. This would allow the minority shareholder to avoid being locked into a jv that it considers to be unsuccessful. Key issues to consider in this instance are the strike price for the option and the time period within which it needs to be exercised. Also, a minority shareholder will want this right to revive after a certain time if it did not exercise the option in the original option period. TAG ALONG The minority investor will want to protect itself against the possibility that the majority shareholder may sell its own stake in the company. A tag‑along right would oblige the majority shareholder to include the minority investor’s interest, at the same price per share, in any sale that the majority shareholder makes to a third party. PRE-EMPTION RIGHT While the majority shareholder will seek to control how and when the venture achieves its exit – for example, by exercising a right to call for a sale after a certain point in time (for example, two years after stabilisation) – the minority party may look to improve its position by having a right to be first in line to buy the asset by acquiring the interest of its partner. In such a case, the minority party will look to secure as much time as possible to structure the acquisition and seek to fix the pricing at no more than the then market value of the asset. • Jonathan Cantor is a corporate real estate partner at Dentons