What You Need to Know About Joint Ventures
Joint Venture is two or more companies that come together for a common purpose. Usually a joint venture is formed for one specific purpose which lasts for a finite amount of time or until the project is finished. A joint venture does not necessarily have to be a separate formal business entity such as a limited liability company or corporation. Often a joint venture is a contractual relationship between the parties. However, if the parties will be engaging in activities that encompass the joint venture business activities they should consider the formation of a formal business entity for their joint venture.
Joint Venture can be a single project or a series of projects. The key to a joint venture is that the parties are joining together for the single purpose of accomplishing that project and agree to share the profits and losses of the project. For example, two companies may join together in a joint venture to build a hospital or road. In that situation the joint venture parties would work together to build the hospital or road . When the hospital or road is built the joint venture generally is dissolved or ends. In that scenario the joint venture was for a specific project.
Joint Ventures can be a series of projects. For example, assume a manufacturer wants to enter the automotive parts industry. That manufacturer may partner with a second company to joint venture into the automotive parts industry. The joint venture may build multiple automotive part manufacturing facilities. However, the joint venture does not end with the completion of the projects, it continues for a term of years or until the joint venture partners decide to dissolve the joint venture.
Joint Ventures are different from other forms of businesses such as partnerships or corporations because the business activities it engages in are presumably separate from the joint venture partner organizations. Joint Venture partners do not seek a joint venture business entity to manage other aspects of their business. Instead, the joint venture business entity’s purpose is limited to executing the joint venture projects.
What You Should Know About Partnerships
"A partnership is the voluntary association of two or more persons for the purpose of conducting a business and sharing its profits." A partnership may be formed for any business or venture that is not illegal or that does not require a license (such as distributing liquor or insurance) if a partnership isn’t authorized and regulated by statute. Partnerships are automatically dissolved by the death of any general partner or are subject to judicial ordered dissolution on application by a partner or creditor.
Partnership agreements describe in detail how the joint venture will operate and how profits will be divided. In addition, partnership agreements commonly include language specifying what happens upon a partner’s death, incapacity or withdrawal from the partnership.
The two most common types of partnerships are general partnerships and limited partnerships. General partnerships are the most common form of partnership and include all partners as general partners. General partners share in the unlimited liability of the partnership and all participate in controlling and managing the activities of the partnership. Limited partnerships include at least one general and one limited partner. The limited partner(s) does not participate in the control and management of the partnership and their liability is limited to the capital invested in the venture.
Partnerships are taxed as pass-through entities or "pass-throughs." That means the profits of the partnership pass through to the partners who are then taxed individually. Pass-throughs are very popular because they avoid double taxation and generally provide the partners with greater flexibility in allocating income and appreciation among themselves and their families.
Comparative Legal Forms
When it comes to the legal framework governing joint ventures and partnerships, clear distinctions can be found in their treatment by the law. Parties to a joint venture are generally bound by a contract and any specific statutory frameworks that might apply depending on the nature of the undertaking. Joint ventures are permitted under competition law provided they do not raise competition concerns. There are also applicable laws, such as the Companies Act 2013, which provide a legal framework and establish rules for the formation, conduct and dissolution of companies but not joint ventures. If two companies come together to undertake a project, this will generally be done in a manner which does not affect the legal identity of the two companies so they will not be treated as partners.
A partnership between two or more individuals is an association of persons that forms a separate legal entity different from, and distinct from, each partner. The subject matter of a partnership is the carrying on of a business in common. Partnerships are governed by the Indian Partnership Act (1932). This Act has been amended several times but its basic principles have remained unchanged, and its provisions are applicable only in relation to persons.
Unlike joint ventures, limited liability partnerships (LLPs) are a hybrid model of a partnership and a limited liability company. Partners have limited liability in an LLP. An LLP is a legal entity in its own right but its legal status is different from other forms. If a person becomes a partner of an LLP, then they will become a partner of the LLP and will be jointly and severally liable for the debts and liabilities of the firm under the Partnership Act.
Taxes and Profits
Financial arrangements for joint ventures are almost always laid out in a joint venture agreement. That is where the investing parties typically agree to the terms of their capital contributions, how profits and losses will be allocated and how the capital accounts will be preserved. The internal accounting usually follows many of the complex rules that apply to joint ventures taxed as partnerships.
The capital accounts and allocations of losses and profits typically will track those of the individual partners, but a joint venture may choose to allocate income and losses according to their own needs because it is not a separate entity for federal income tax purposes. The joint venture agreement likely has very detailed provisions on the allocations and distributions, which may be more complex than those in a partnership agreement due to certain tax and business considerations. These can include how the outlay of cash will affect capital contributions before and after the term of the investment, how the gains and losses will be allocated to the investors based on their respective capital accounts, and whether there are special allocations for windfalls based on common practices or negotiated with respect to the joint venture.
Profits, losses and distributions are typically shared according to the proportionate capital contributions of the parties. Joint venture agreements also contain provisions for buy/sell arrangements, these enable a party to sell its interest in the joint venture to the other parties at an agreed-upon price. If one of the parties wishes to exit the agreement, the other parties can choose to acquire the interest of the departing party at a specified price. Such buy/sell arrangements are common in corporations (these "call options" enable a party to buy the collective interest of the other parties at a predetermined price if one of the parties departs). An "exchange call option" enables a party to purchase the interest of the departing party at the same price that it would have received if it had retained its interest. Joint venture agreements also contain "tag-along rights" such that if the joint venture has a third-party offer to buy the interest of one of the parties, the other parties can accept or reject but if it accepts then it has to purchase the interest on the same terms as the third party. Such "put options" are common in joint ventures where the parties have large capital obligations (for example, risky investments in resources) and do not want their capital to be tied up indefinitely if the venture goes south (in other words, if the parties decide to leave ExtractCo, they can put their interests to the other parties and the other parties must purchase those shares).
Decision Making and Control
In assessing the difference between a joint venture and a partnership, the decision-making process by which the parties operate jointly is critical. The very nature of a joint venture transaction – that parties are coming together for a single, specific purpose such as completing a particular project or achieving a goal – allows each party a significant level of control in the venture. Partners, on the other hand, have much of their decision-making authority transferred to the partnership itself and might be left with limited involvement in more day-to-day operations, especially if the partnership is formed among a large group of individuals, such as a law firm .
By virtue of the definitive agreement outlining the terms of the joint venture (that each party drafted and negotiated with direct help from outside counsel), the requirements for decision making, voting and control are clearly laid out for the parties to follow. Decision making for a joint venture might also differ from that of a partnership in that it could require "super majority" votes (often any vote over 51 percent) as well as the vote of the managing member, partner, shareholder, etc., of each of the entities that make up the joint venture.
In its simplest form, control among parties of a joint venture is fairly easy to determine, as control primarily lies with the manager(s) or managing partner(s) of the venture, meaning the CEO or COO of the entities that make up the venture. In a partnership, the authority of partners in decision making and control depends on the type of partnership that has been created.
Length of Existence and Goals
The duration and objectives of the entity will set it apart from a partnership. A partnership is intended to exist between the partners indefinitely until it is dissolved. A joint venture is created for a limited time and for the accomplishment of a specific purpose. For example, when two or more entities join together to open a single retail location, develop a single residential or commercial community, it is a joint venture. Much like the formation of any type of business entity, it is critical to have an appropriate operating agreement as well as the involvement of an attorney in both the formation of the entity and its operation. The operating agreement will contain the specific purpose of the joint venture just as a partnership agreement would. Additionally, the operating agreement will include the length of the joint venture.
Liability and Risks
A potential lurking disadvantage of a joint venture is that the participants may be separately and equally liable for each other’s actions. This is especially true in closely held business settings where states impose fiduciary duties among business participants. Potential liabilities, therefore, include tax liability, contract liability, labor law liability and liability for tortuous activity.
Assets of the joint venture may be attacked by third-party individuals as well as participants if the requirements for liability by a participant are met. Therefore, for example, assets of a general partnership may be attacked if the assets of the partnership are insufficient to cover all claims against the partnership under the alter ego theory if the claim meets the test for piercing the corporate veil (that is failure to maintain adequate capitalization, failure to observe corporate formalities, commingling of corporate and personal assets, fraud, etc.).
Potential assets of a partnership as well as assets of participants can be reached under various creditor theories, such as the theory of constructive trust, fraudulent conveyance, equitable lien, equitable or actual subrogation, and equitable recoupment. A remaining issue is whether a contract entered into between participants after formation of the partnership binds the trust and liability created by the participants in the absence of a pre-formation agreement. A principal case is Magnan v Anaconda Indus. Inc. 71 AD2d 118 (1979).
The most frequent circumstances giving rise to alter ego liability include the absence of corporate formalities (such as commingling of assets, failure to maintain corporate records and undercapitalization), as well as fraud and a single group of shareholders in control of two businesses. See, e.g., TNS Holdings Inc., v MKI Securities Corp., 92 NY2d 650 (1999).
Although not clear, parties can probably limit their liability to non-participants (vendors, customers, etc.) through contract language which (1) indemnifies and releases each party from the effect of the actions of others, (2) provides that information learned of the venture is confidential and (3) provides that the obligations created by the venture are limited to the company assets.
Which Business Structure to Choose
When considering whether to form a joint venture or a partnership, businesses must first closely evaluate their current and future business needs. As with many legal issues, one size does not fit all when choosing the type of business entity with which to proceed. There are a plethora of factors to consider. First, entities must closely evaluate the range of options. Then, they must look at the goals of each business and how they will use the entity which they consider forming. For example, how long do they need the entity? Is ease of formation key? Will it need to attract investors at some point? Is limited liability vital? By analyzing the goals of the initial and future involved entities, the appropriate entity type may become apparent.
Most businesses commonly choose between a partnership or a corporation; however, there are some features of a joint venture entity that are beneficial and which would otherwise be unavailable to companies that choose corporation or partnership entities. For example, a joint venture entity provides limited liability to its shareholders. In addition, a joint venture entity is not required to be governed by corporate law . In contrast – a partnership, which is governed by partnership law, does not provide the same level of liability protection to its partners, particularly in the case of general partnerships. Although limited liability partnerships and limited liability companies also provide similar levels of protection to limited partners and members, respectively, these entities still remain as "pass-through" entities. Thus, all profits and losses are attributable to the shareholders’ K-1 and may be subject to taxation at each shareholder’s personal tax rates. With a joint venture — although the entity is a pass-through for tax purposes — an entity pays its own taxes. Accordingly, aside from the limited liability aspect of a joint venture entity, an important consideration for some businesses would be the ability to control the actual tax payment of the net income derived and retain after-tax revenues within the joint venture as opposed to being subject to the tax payment for each shareholder — as is the case in most forms of partnerships and limited liability companies.
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