Key considerations for property Joint Ventures
Entering into a joint venture with another party in respect of the development of a property continues to be a popular way of sharing risk, pooling knowledge and expertise, and potentially making a project more attractive to third party funders.
In this article, Ben Brayford and Christine Dubignon, consider the fundamental issues which should be considered when entering into a property joint venture arrangement.
I’ve been in talks with a proposed joint venture partner for some time, and we’ve now agreed to go ahead with the project. What should I do next?
Discussions up to this point are likely to have focussed on the potential of the underlying project and the broad contributions of each party, so it’s now time to consider the specifics of the joint venture arrangements. It’s not always necessary for a formal heads of terms to be entered into (and in some cases this can actually delay matters), but the key commercial issues should be agreed in principle before any legal documents are prepared. Not only will this make the legal process more efficient and cost effective, but it will also identify any key stumbling blocks at any early stage. These would include matters such as:
- What legal structure is to be used (a company, LLP or limited partnership for example) and does either of the parties have any tax considerations that need to be addressed?
- What are the ownership shares of each party?
- How will decisions be made?
- How will the project be funded?
- Who is doing what in respect of the project (e.g., running any planning process, assuming any development management role etc.)?
- When can new parties be admitted/ the existing parties exit?
- How will disputes be dealt with?
We’ve agreed to fund the initial costs on a 50:50 basis, although once we achieve planning permission, we intend to borrow from a third party. Is there anything else that we need to consider in relation to funding?
If there is a cap on the amount the parties can be obliged to fund, this should be documented – ideally by reference to a budget or project appraisal. Project costs, even in the preliminary stages can be unpredictable and a contingency element should be included. Consider also what should happen if one party is unable/ unwilling to fund for some reason. Should they be forced to leave the venture or instead face some kind of financial penalty? Importantly, consider including an ability for one party to fund unilaterally where the other fails to do so. If all funding requires the consent of both parties, then one party could find themselves “blocked” from contributing much needed cash – where needed to secure the viability of the project generally as well as to protect any previous investment. This can be of particular importance where a dispute arises between the parties.
You should agree in principle what should happen if you fail to secure funding for the project on acceptable terms. Should the parties be allowed/ forced to fund it themselves, should the site be sold, or should another third-party investor be introduced? As these are all key decisions, it is helpful to agree a roadmap at this stage.
As we’re funding on a 50:50 basis, should we both be involved in all decisions?
Not necessarily. The starting point is to understand what each party is contributing to the project. If one of you has particular commercial expertise, it might be appropriate to delegate overall responsibility for certain functions to them - provided they operate within agreed parameters outside which you both must be in agreement.
Having an agreed business plan is crucial as this will clearly identify the objectives and milestones and can again be used to assist with delegation of responsibilities.
Fundamental issues, such as the introduction of new parties, disposing of the site, and entering into unusual or onerous contracts should be subject to the consent of both of you. However, care must be taken to not create an unwieldly operating model or a risk that one party could create a deadlock over something relatively trivial.
If certain decisions do require unanimous consent, you will need to agree what happens if you are unable to both agree to a particular proposal.
The other party is suggesting that we have a “buy out” mechanism in the case of any dispute. What would this involve?
A dispute is most likely to arise where you fail to both agree to a matter which requires unanimous consent and there are various ways this can be addressed.
It might be appropriate not to have any formal resolution mechanism as this can effectively force the parties to negotiate to achieve an appropriate commercial agreement. However, this does create uncertainty, and depending on the nature of the decisions which could give rise to a deadlock, could be unsatisfactory especially if the project is of different commercial significance to the parties. If it constitutes a major investment, a party is unlikely to want it to stall if a decision can’t be reached, but a larger participant who may have concluded that the project is not going to be as profitable as anticipated may be happy for it to be “mothballed”.
Many decisions requiring unanimous consent will have important commercial consequences, so whilst expert determination provides certainty, it will rarely be appropriate.
A buy out mechanism gives one party the right to buy out the interests of the other and tends to favour the party in a stronger financial position. It needs to be considered carefully as it can be exploited if a party wants to force an exit of the other and can also be used as commercial leverage in discussions about matters requiring unanimous consent.
It can be “softened” by imposing time restrictions on when it can be used, setting minimum prices to be paid (e.g. objectively determined "fair value", or a premium on fair value), or by allowing it to be reversed on the party who has instigated the process. As any buy out mechanism can potentially lead to one party exiting the venture it will need to be extremely carefully negotiated.
The other party will be acting as development manager but has said that we don’t need a separate DMA as we will have a shareholders’ agreement. Is this correct?
The key issue here is to identify exactly which services you are expecting them to perform and the specific remuneration structure. If they completely fail to perform the services, or don’t do so to an appropriate standard would you be happy with them retaining 50% of any profits regardless?
It is often helpful for a separate development management agreement to be entered into – even if on an abbreviated basis. It should identify the relevant services, the basis on which they are to be performed, any fees payable, and termination rights. Structuring the arrangement like this means that an appropriate weighting can be given to the fees payable for the development management services and the profit entitlement arising by virtue of the parties' initial funding of the project. It also allows the opportunity for the development management arrangements to be terminated if required.
It’s also worth considering how the joint venture and DM roles are connected. If the DM was in default, should this have any impact on its profit share or other rights as a member of the joint venture? Additionally, if a termination right does arise under the DMA, should the non-DM party be able to terminate the DMA without the DM blocking the termination at joint venture level?
How will the sale of the development be dealt with and will I have the ability to sell my interest in the joint venture before then?
The parties should be clear at the outset as to the exit strategy envisaged for the development and whether (outside of a dispute scenario) there will be the ability for either party to sell its interest at an earlier stage.
Typically, a completed development will need to be let and then sold. If one party has assumed the development manager role, then it may make sense for it to take on primary responsibility for putting together the letting strategy and disposal strategy, albeit with oversight from the other party. How this will work should be documented as part of the DMA and joint venture arrangements.
However, a party may wish to withdraw from the joint venture and sell its interest prior to completion and disposal of the development – perhaps because the development has become unexpectedly protracted or because financial pressures mean that party wishes to extract its investment at an earlier stage than anticipated.
Generally, a joint venture agreement will contain restrictions and controls around how (and when) this can be achieved. Some element of protection will often be necessary to limit the circumstances in which the other party can be saddled with a partner not of its choosing. This can be particularly relevant if one of the parties is performing the development manager role, and they will often be subject to ‘keyman’ provisions design to ensure that key personnel remain involved in the project.