Joint Venture Agreement: Structure, Governance, Financing and Exit

What is a joint venture agreement?

A joint venture agreement is the contractual basis for a business partnership in which the partners pursue a common goal whilst remaining legally and economically independent. It allocates contributions, opportunities and risks amongst the parties involved and sets out the terms of the cooperation. The term is not a statutory type of contract, but rather a collective term developed in practice. Depending on its structure, it may be governed by the law on civil law partnerships, the law on limited liability companies (GmbH) or the law on commercial partnerships.

Typical reasons for forming a joint venture include entering a new market, the joint development of a technology, the pooling of production capacities, or the development of a distribution channel for which none of the partners has the necessary reach on their own. The common thread is always that the partners wish to achieve more than either could on its own, without relinquishing their independence. This intermediate position between a mere supply contract and a full merger makes the contractual structure challenging.

A sound contract must first describe the purpose and scope of the joint venture as precisely as possible. The more clearly the business mandate is defined, the easier it will be later to assess which activities are still covered by the common purpose and where one of the partners might be competing with their own business interests. All other provisions – from financing and managing directors to the exit strategy – are based on this definition of purpose.

Equity joint venture or contractual joint venture?

In an equity joint venture, the partners establish or acquire a joint company. This company holds assets, employs staff, enters into contracts and operates on the market in its own right. This model is suitable for long-term collaborations with their own business plan, their own financing and clearly definable operational risk. In a contractual joint venture, by contrast, the collaboration is limited to contractual agreements. It may be appropriate for individual projects, development collaborations, consortia or distribution partnerships. A separate limited company is not strictly necessary.

In an equity joint venture, a separate company is formed. Liability is generally pooled at company level, whilst staff and assets are held by the joint venture. Governance is provided by the bodies established under company law, supplemented by the shareholders’ agreement. Funding is provided through equity, shareholder loans or third-party financing. The venture ultimately results in the sale of shares, liquidation or restructuring. A contractual joint venture does not necessarily require the formation of a new company. Liability must be allocated between the partners by contract; staff and assets generally remain with the partners or are allocated on a project-by-project basis. Management is carried out through contractual bodies and a project organisation. Contributions and cost allocation are governed by the partners in the contract. The arrangement is terminated by notice, completion of the project or winding up.

A contractual JV may, in legal terms, constitute a partnership in its own right, even if the parties did not intend to establish a company. The purpose, external presentation, joint decision-making and distribution of profits should therefore be structured in such a way that the intended classification remains clear.

The decision on the structure must also take into account tax, competition law, foreign direct investment (FDI), liability, balance sheet treatment and financial reporting. It should be made before the detailed clauses are negotiated.

How is a joint venture GmbH set up?

In an equity joint venture, two levels of documentation work together. The articles of association of the joint venture GmbH govern the company’s external structure, i.e. share capital, shares, governing bodies and representation. The shareholders’ agreement governs the internal relationship between the partners and contains the actual joint venture clauses relating to governance, financing, competition and exit. This distinction is intentional: the shareholders’ agreement remains confidential, whilst the articles of association are publicly available in the commercial register.

With regard to capitalisation, in addition to the share capital, it is particularly important to regulate further financing. The agreement should specify whether and to what extent the partners are obliged to make further capital contributions or provide shareholder loans, what applies in the event of future capital requirements, and what the consequences are if a partner fails to participate in a financing round. Dilution rules and guidelines on the valuation of new shares prevent one partner from quietly sidelining the others through capital measures.

Likewise, the contributions made must be clearly documented. If a partner contributes assets in kind, licences or personnel instead of cash, the contract must specify the scope, valuation and legal classification of these contributions. Where assets are transferred to the company, a distinction must be made between a transfer of ownership and a mere grant of use, as this determines what reverts to the original owner in the event of the company’s dissolution.

What form of governance prevents deadlock and one partner overriding the other?

Governance must strike a balance between the ability to act on an ongoing basis and the protection of both partners. In a 50/50 structure, not every operational decision needs to be unanimous. Conversely, fundamental strategic issues should not be decided by a managing director or partner alone. A typical model consists of three levels:

Management: This team manages day-to-day operations within the framework of the business plan, budget and rules of procedure. Responsibilities, reporting lines, signing authorities and rules on representation must be clearly defined. If each partner appoints a managing director, rules are required to address conflicts of interest and the chairmanship.

Advisory Board or Shareholders’ Committee: This body oversees the management, approves major measures and serves as the first level of escalation. Its composition, voting weights, quorum and chairmanship must not be left to chance.

Shareholders' meeting: Fundamental decisions such as capital measures, changes to the business model, acquisitions, disposals, dissolution or amendments to key contracts are reserved for the shareholders. Reserved Matters should be accompanied by thresholds, deadlines and a rule on urgency. A list of matters requiring approval that is too long paralyses the company. A list that is too short may devalue a partner economically. A deadlock should only arise in the event of a significant, specifically defined impasse.

Precise and economically viable dispute resolution provisions are also essential. A robust procedure begins with the written identification of the point of dispute and its escalation to the partners’ management teams. If this does not resolve the matter, mediation or a specialist expert determination follows. As far as possible, the joint venture continues to operate in accordance with the existing budget during this process. Only as a last resort should buy-outs, sales or termination be considered. Pure ‘buy-or-sell’ mechanisms without prior dispute resolution stages can force the joint venture into a compulsory sale at the first sign of a strategic disagreement.

How can intellectual property and know-how be brought into a joint venture securely?

In technology-driven joint ventures, the treatment of intellectual property and know-how is often crucial to the value of the venture. The agreement must clearly distinguish between what belongs to a partner and remains with them, what is contributed to the joint venture, and what is newly created during the collaboration. These three categories – existing IP, contributed IP and IP developed within the joint venture – each require their own set of rules.

For existing intellectual property rights and know-how that a partner merely grants for use, a licence with a clearly defined scope is recommended rather than a full transfer. The licence specifies the purposes for which, the territory in which and the duration for which the joint venture may use the intellectual property, and sets out what happens to this right of use upon termination of the joint venture. In this way, the valuable existing IP remains in the hands of the contributing partner, whilst the joint venture is granted the rights of use necessary for its purpose.

Particular attention should be paid to intellectual property created during the collaboration. The agreement should specify in advance to whom inventions, further developments and the results of joint work are attributable, and how the partners may use them following a separation. In the absence of such provisions, there is a risk of protracted disputes over the exploitation of jointly created assets following the end of the joint venture. This is complemented by confidentiality obligations which restrict the transfer of know-how to the respective parent company and its subsequent use there.

Competition law, merger control and FDI

Joint ventures touch upon two aspects of competition law.

Co-operation control: The co-operation between the parent companies may be subject to scrutiny under Section 1 of the German Act against Restraints of Competition (GWB) and Article 101 of the Treaty on the Functioning of the European Union (TFEU). The exchange of information, the allocation of customers or territories, joint procurement and non-compete covenants must not go beyond what is necessary for the purpose and proper functioning of the joint venture. Information that is not required for the joint venture and which allows inferences to be drawn about the partners’ competing core businesses is particularly sensitive. Clean teams, tiered access rights and clear reporting rules may be necessary.

Merger control: The establishment or acquisition of joint control may constitute a concentration. At EU level, the focus for joint ventures is on full functionality. German law also covers further types of acquisition, in particular the acquisition of shares and the acquisition of control. A notification requirement arises only if the applicable turnover or transaction value thresholds and the required domestic connection are met.

Investment screening: If a foreign investor participates in a German joint venture or is granted special control rights, German investment screening may apply. This applies in particular to security-related activities, critical infrastructure, defence or sensitive technology. Even a minority stake or atypical governance rights may be subject to scrutiny.

Antitrust and FDI analyses must be included in the timetable prior to signing. The joint venture agreement should set out conditions for approval, obligations to cooperate, risk allocation and a long-stop date.

How is the exit arranged?

A joint venture requires an orderly process for voluntary sale, breach of obligations and a permanent deadlock. The mechanisms should not attempt to cram different situations into a single clause.

• Ordinary exit: After a minimum term, provision may be made for transfer windows, pre-emption rights, a right of first offer or a structured sale process. It must be clarified whether only shares may be sold or whether the entire joint venture may also be disposed of.
  
• Event-based exit: Call or put options may be linked to serious breaches of duty, the insolvency of a partner, a change of control, the risk of sanctions, failure to meet financing obligations or regulatory obstacles.
  
• Deadlock exit: Russian Roulette, Texas Shoot-out or Sealed Bid can resolve a deadlock. They only work if both partners are financially capable of acting as either a buyer or a seller. Where resources are unevenly distributed, minimum price thresholds, financing guarantees, longer timeframes or an alternative sale process are required.
  
• Valuation: The purchase price rule is usually more important than the name of the option. The valuation date, method, net financial debt, shareholder loans, minority or control premiums, synergies and the treatment of ongoing disputes must be defined. In the event of breaches of duty, any discount should be clearly defined and proportionate.
  
• Form and execution: In the case of GmbH shares, the obligation to transfer and the transfer itself generally require notarisation. This regularly applies to call, put, drag and buy-or-sell clauses. Powers of attorney, duties to cooperate and an enforcement mechanism should be structured in such a way that a blocking partner cannot prevent the agreed exit.
  
• Follow-up agreements: Upon exit, licences, supply contracts, trademarks, staff, IT and know-how must also be addressed. A transfer of shares alone does not terminate the partners’ economic dependence.
  

How are disputes within the joint venture resolved?

Dispute resolution is one of the provisions that a joint venture agreement should mandatorily include, precisely because the partners assume the venture will be successful when the agreement is concluded. In cross-border and high-value joint ventures, an arbitration clause is usually preferable to dispute resolution before the state courts. Arbitration offers confidentiality, which is important in sensitive technology and competition matters; it allows for the selection of expert arbitrators; and it results in awards that are more easily enforceable internationally than court judgements.

An arbitration clause is only as good as its drafting. The contract should clearly specify the arbitral institution and the applicable rules of arbitration, the place of arbitration, the language of the proceedings, the number of arbitrators and the law applicable to the merits of the case. In addition, provisions must be made regarding how the arbitration proceedings relate to deadlock and exit mechanisms, so that there is no ambiguity as to whether a deadlock is to be resolved via the buy-or-sell clause or through arbitration proceedings. The selection and drafting of the appropriate dispute resolution clause is a specialist area of advice which we take into account from the outset when drafting the joint venture agreement.

What else needs to be taken into account in the case of international joint ventures?

An international joint venture involves at least three legal levels: the law governing the joint venture itself, the contractual provisions of the shareholders’ agreement, and the mandatory rules of the countries in which the joint venture operates.

Particular attention must be paid to company law and the requirement for notarisation at the joint venture’s registered office, the choice of law and dispute resolution provisions in the shareholders’ agreement, as well as merger control and investment screening in multiple countries. In addition, the tax structure, transfer pricing and withholding taxes, export controls, sanctions and foreign exchange regulations, as well as employment law and the posting of workers, must be examined.

Furthermore, data protection and international data transfers, IP registration and licensing restrictions, as well as compliance, anti-corruption and whistleblower schemes, must be examined. Finally, the language, translation and hierarchy of multilingual documents must be reviewed.

In the case of cross-border structures, an arbitration clause is often advisable. It should specify the institution, seat, language, number of arbitrators and applicable law. Supplementary provisions may be required for interim measures, company law registration procedures and expert determinations.

Local advisers should not work in isolation. A lead counsel must consolidate the documents, approvals and tax assumptions and ensure that the articles of association, joint venture agreement and operational contracts are not contradictory.