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INTERNATIONAL JOINT VENTURES, A PRACTICUM By Paul Ehrlich and Milton R.

Stewart

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In Brief
More companies are doing business globally, but only the largest have the resources to overcome the legal and cultural barriers on their own. Smaller companies often turn to an international joint venture (IJV). Learn about the advantages and disadvantages of IJVs, including key contract provisions, practical aspects, andcommon mistakes to avoid.

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The Basics

how of the local marketplace. This information substantially enhances the ventures probability of success. Consider, for example, the joint venture between the Polish rm PAUL EHRLICH is vice Pezetel and Rockwell, who jointly pursued president and general the US market for low-ying aircraft. Rockcounsel of adidas North America. He was a well had access to marketplace information, corporate nance and and when Rockwell abandoned the project, transactional lawyer in private practice before Pezetels solo pursuit of the market ended in joining adidas. failure. Reputation. The reputation of the resident partner gives the IJV credibility in the local marketplace, especially with existing key supMILTOn STeWART is a pliers and customers. partner in the Portland, Legal prerequisites. The formation of an OR, law rm of Davis Wright Tremaine LLP, the IJV can be a legal prerequisite to establishing Lex Mundi member rm a presence in the local market. For example, for Oregon. His practice focuses on domestic and in certain industries, Chinese law requires the international mergers and acquisitions and joint formation of an IJV with a Chinese company ventures. in order to have access to the Chinese market. Advantages of IJVs Thus General Motors formed a joint venture IJVs offer signicant advantages as comwith Shanghai Automotive Industry Corpopared to direct entry into a foreign market. ration (SAIC), called Shanghai General Motors Corp., Faster access. IJVs often allow much faster access to allowing GM access to the Chinese market for the manuforeign markets. The local partner to the joint venture may facture and sale of Buicks. Similarly, Volkswagen joined have already established itself in the marketplace and ofwith SAIC to form Shanghai Volkswagen Automotive ten will have already obtained, or have access to, governCompany for the manufacture of the Santana. Without ment contacts, lines of credit, regulatory approvals, scarce these partnerships, the foreign automakers would not supplies and utilities, qualied employees, and cultural only lack credibility in the Chinese market, they simply knowledge. Upon formation of the IJV, the nonresident would not have access. partner has access to the local partners preestablished ties to the local market. Disadvantages of IJVs Lower cost. For these same reasonsthe local partners Of course, IJVs also have their share of disadvantages. preestablished tiesIJVs are usually far less costly than a Dilution. IJVs, like all partnerships, dilute future profde novo entry into the foreign market or buying an existits because the prots are shared among the contributing ing company in the jurisdiction. The principal costs of partners. They dilute equity for the same reason. a de novo effort have already been incurred by the local Opportunity cost. IJVs can foreclose other opportunipartner. Moreover, the benets of a presence in the local ties for entry into a foreign marketplace. jurisdiction are obtained through association without the Financing problems. It can be difcult for IJVs to demand on capital required for an outright acquisition. independently obtain nancing, particularly debt nancAdditionally, an IJV creates synergies that are lacking in ing. That is, in part, because IJVs are usually nite in their an acquisition. duration and lack permanence. Thus, the parents of an Distribution ease. IJVs often provide rapid access IJV should expect either to adequately capitalize the entity to distribution channels. The local partner will already up front or to guarantee loans made to the IJV. have an established supply and distribution network in Competition. Another potential disadvantage of an IJV the host country, and have in place the marketing and is the possibility you might wind up turning your own sales contacts, expertise, market efciency, and cultural joint venture partner into a competitor. However, this understanding to ensure efcient distribution in complidanger can be ameliorated by noncompetition, nonsoliciance with the laws of the host country. tation, and condentiality provisions in the joint venture Local knowledge. Most importantly, IJVs give the agreement. nonresident partner access to the knowledge and knowWhat is an IJV? It is a joint undertaking among two or more business entities from different jurisdictions. A company forming an IJV will often partner with one of its customers, vendors, distributors, or even one of its competitors. These businesses agree to exchange resources, share risks, and divide rewards from a joint enterprise, which is usually physically located in one of the partners jurisdictions. The contributions of joint venture partners often differ. The local joint venture partner will frequently supply physical space, channels of distribution, sources of supply, and on-theground knowledge and information. The other partner typically provides cash, key marketing personnel, certain operating personnel, and intellectual property rights.

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Getting Started:
The preliminary IJV agreement
An IJV should begin with at least a term sheet, if not an agreement in principle or memorandum of understanding. It is vital that some document be the foundation for assuring that the parties agree on all of the primary business and legal issues before a denitive agreement is drafted. Such agreements serve several purposes: they force the parties to concentrate on understanding their business goals and objectives at an early stage; they force the parties to determine early on whether the relationship is feasible and likely to succeed; they can smooth the process of drafting the documents for the venture, which require a lengthy negotiation period and can be highly complex; and

at the very least, they can serve as an estoppel agreement. The parties should consider including binding condentiality terms in the preliminary agreement to protect each partys condential business information and intellectual property. Of course, it is up to the parties how detailed the preliminary agreement will be. If negotiating exibility is your aim, a general preliminary agreement is preferable. Even though some terms are nonbinding, the preliminary agreement has moral force, and can illustrate the intention of the parties. Also, in some countries (e.g., the United States) there is a duty to negotiate in good faith, even where the agreement is expressly nonbinding. Each companys management and legal counsel should have an active role in creating the preliminary agreement.

The denitive IJV agreement


The denitive agreement will contain many of the terms from the preliminary agreement (such as continued condentiality and capital contributions), with greater detail. It will also contain additional negotiated provisions covering various operational activities through to termination of the venture. The denitive agreement can include documents such as: a condentiality agreement; a letter of intent; an exclusivity agreement; a primary joint venture agreement (may include shareholders' agreements, partnership agreements, or similar agreements depending on the entity type); and/or any other agreements required for operation of the joint venture, such as intellectual property sharing agreements, loan instruments, management agreements, leases, services agreements, or guarantees. There are many matters that the denitive IJV agreement should cover. Management. It is critical that senior management be chosen early, be independent, have a clear charter and authority, and have clear reporting lines. Independent managers will be more likely to ensure that disputes are resolved and avoid termination of the venture, as they have a more vested stake in the success of the venture. Consider tying managements bonus at least partially to the overall performance of the joint venture, rather than the ventures contribution to the parent entity. Governance. The agreement should specify the structure of the board of the joint venture entity (or the committee which will provide management oversight, in the case of a contract joint venture). The board should be composed of an odd number of directors, unless impasse is contemplated and dealt with elsewhere in the agreement. It is not uncommon for the two joint venture partners representatives to agree upon the odd-numbered director.

An IJV Must: Working with Your Partner


An IJV cannot succeed unless the partners can and do work well together. You should be cautious if the partners dont have a track record of good relationships with each other. Partners in the joint venture may have different reputations and histories, share dissimilar corporate practices and cultures, or have different goals. To overcome these differences, the parties can establish a transition team to deal with potential trouble areas. Another set of problems can arise if the partners do not share expectations and needs. Before they enter into an IJV, the parties must identify their respective business purposes and conduct due diligence to ensure that they can collaborate on making the IJV successful. Partners should approach the joint venture with a goal of understanding each partners individual expectations and should address how each party will contribute to meeting the others objectives. Having different objectives is not always bad; one partners focus on prot will not necessarily be at odds with the other partners focus on, for example, access to technology or training. But clarity about the differences is critical. We recommend: Discussing the differences early in the negotiations, to help ensure that the joint venture is tailored to the individual needs of each party; Spelling out specic expectations or benchmarks in the contract; and Ensuring that all partners are exible enough to accommodate the evolving needs of the IJV.

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The partners should also allocate board-level decision-making authority on certain issues and agree on arbitration provisions. In case one party fails to fulll its obligations to the IJV, the agreement should contemplate a provision that allows a sole contributor to dilute the other partys equity. The parties to a joint venture are held to a standard of good faith. Ofcers and directors may simultaneously owe

duciary duties to the joint venture and the parent. Contributions of partners. The agreement should set out in as much detail as possible the respective contributions of the parties, both tangible and intangible. Depending on tax considerations, it may be appropriate to specify values for the respective contributions of the parties. The form of entity (pass-through versus corporate-level

ACC US and International Resources on . . .

Joint Ventures
ACC Committees:
More information about ACCs International Legal Affairs Committee is available on ACC OnlineSM at www.acca. com/networks/committee.php, or you can contact Staff Attorney and Committees Manager Jacqueline Windley at 202.293.4103, ext. 314, or windley@acca.com. Michel P. Cloes, Hanno Hinzmann, Michelle Thomas, "Basic Contract Law Principles in Europe, course 103. Sabine Chalmers, Stephen Faciszewski, Cheryl Fackler Hug, Sally March, Joint Ventures in the International Marketplace, course 403. Peter Herbel, A Comparative Review of Multinational Compliance Programs, course 509. Christopher Crowder, Richard Hansum, Lisa Phelan, and Ann Rappleye, Perspectives on Competition and Antitrust Compliance in the US and Europe, course 703. A. Patricia Marcucci, Adolfo Millan, Paige Navarro, Veronica Pastor, Francisco Velazquez, An Introduction to Business Practices in Mexico and Latin and South America, course 803. John Hogan, Alexandre Montagu, Judith Powell, International License Agreements, course 901.

Docket Articles:
Nelson A. Blish, Isabel M. Davies, and David P. Owen, Securing Global Patent Protection, ACC Docket 22, no. 4 (April 2004): 4259. www.acca.com/protected/pubs/ docket/apr04/patent.pdf. Marc Brotman and Tony Reeves, The EUs 26-Headed Hydra? The New European Competition Enforcement Regime, ACC Docket 23, no. 6 (June 2005): 2845. www. acca.com/protected/pubs/docket/jun05/hydra.pdf. Alan Greenwood and Steven Lauer, The Global Compliance Landscape: A Resource File, ACC Docket 23, no. 9 (October 2005): 3248. www.acca.com/protected/pubs/ docket/oct05/scratch.pdf. Toolkit, Crossing the Pond Without Drowning, ACC Docket 23 (September 2005): 106116. www.acca.com/ protected/pubs/docket/sept05/toolkit.pdf.

Virtual Library Sample Forms and Policies:


Sample forms and policies available via ACCs Virtual LibrarySM ( www.acca.com/vl ) include the following: Joint Venture Agreement (Philippines, 2006). www.acca. com/resource/v6715 . Joint Venture Investment Term Sheet (US, 2005). www. acca.com/resource/v7056 . Joint Venture Checklist (China, 2004). www.acca.com/ resource/v424 . For more information on compliance, see ACCs Compliance Portal at www.acca.com/practice/compliance/index.php.

InfoPAKs:
Doing Business Internationally (2006). www.acca.com/ resource/v6087. Drafting and Interpreting Contracts (2005). www.acca. com/resource/v6023 .

Annual Meeting Course Materials:


Program material from these courses at ACCs 2005 Annual Meeting is available at www.acca.com/am/05/material.php :

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taxation) is highly relevant, and the contribution of debt and services may be treated differently for tax purposes. The partners will also seek to maximize their utilization of foreign tax credits and benecial tax treaties. Future capital needs are often difcult to predict, but the agreement can include provisions for prospective debt nancing with guarantees by the partners. If contributions are to be made solely by the parties, they may agree that each party will have the option to require all the parties to make additional capital contributions up to a certain annual or formula-driven limit. The parties should be careful to see that their contributions are properly reected in their respective ownership and voting percentages. Allocation of risks and rewards. In as much detail as possible, the agreement should delineate who gets what, where, when, why, and how. Dividend distributions, capital calls, and allocations of losses (including special tax allocations, if permissible) should be covered. Dispute resolution. It is always possible that the IJVs parents will nd themselves in disagreement on some important matter, and the denitive agreement should specify how any such dispute will be resolved. Most partners would prefer not to resolve such disputes through litigation. Thus, the agreement should contain detailed procedures for mediation and/or arbitration. These provisions should delineate the method for selecting an arbitrator, the binding or nonbinding nature of the arbitration (arbitration awards are enforceable in most countries pursuant to the New York Convention), and allocation of fees associated with arbitration. Generally, the agreement should not contain a provision permitting the arbitrator to revise or restructure the venture, because the arbitrator is not likely to be the person in the best position to assess the relevant risks of a revised venture. You should also consider impasse provisions that attempt, short of mediation or arbitration, to resolve deadlocks that are not fatal to the joint venture. The partners may wish to allocate control on certain issues to the partner best equipped to manage the issue, or alternate decision-making authority according to a schedule. (For more information on this subject, see HandsOn: The Neutral Zone, also in this issue.) Regulatory issues. The agreement should address all regulatory issues affecting the joint venture, such as compliance with: export and import controls, foreign corrupt practices acts (and their equivalent), companies acts (and their equivalent), and competition law (antitrust). In a few jurisdictions, currency repatriation must also be addressed.

An equity venture is often preferable, as it results in fewer limits on respective liability and allows for more exibility if the business environment changes.
Governing law. The agreement normally species that the IJV and the related activities of its parents are to be governed by the laws of the jurisdiction in which the joint venture will be principally located. However, it is not uncommon to provide for a choice of law from a neutral jurisdiction. Also, venue is often placed in a neutral jurisdiction that is mutually convenient to both parties. Choosing a neutral jurisdiction and venue is a good idea when the laws of the respective jurisdictions vary, resulting in uncertainty regarding the outcome of a dispute. A neutral jurisdiction and venue clarify procedure and law and allow the parties to more accurately measure the risk and predict outcomes. Termination provisions. The contract should contain detailed provisions regarding when and how the contract and joint venture terminate. If either party is to have an opportunity to buy the interest of the other party, that mechanism should be both well thought out and set forth in detail. For example, the parties may wish to include a put-call provision whereby one party sets the ventures sale price and the other has the option to buy or sell at that price. Governing language. IJV agreements are often written in two languages, particularly for joint ventures between American and Asian companies. One or the other of the language versions should be designated to prevail if there is an alleged inconsistency between the documents and their translations. Noncompetition, nondisclosure, nondisparagement, and nonsolicitation. Whether an IJV is dissolved or ends by one party purchasing the interest of another, noncompetition provisions may well be appropriate. In addition, parties commonly seek covenants of nondisparagement, condentiality, and nonsolicitation of IJV employees. These covenants should contain language preventing current and former employees and members of the IJV from certain activities. They should not disparage: the IJV or its products and services; the IJV partners or their ofcers, directors, shareholders, members, employees; or the dissolved IJV.

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They should not use or disclose condential information learned through association with the IJV for any purpose other than the business of the IJV. They should not solicit the employees of the IJV or any IJV partner. Intellectual property. The IJV agreement (or a separate attached document) should clearly delineate all rights to IP, technology, software, and the like. In addition, an appropriate licensing agreement should be executed in respect to those knowledge items. The IJV agreement should clearly delineate ownership of intellectual property upon dissolution or termination of the joint venture.

The IJV agreement should clearly delineate ownership of intellectual property upon dissolution or termination of the joint venture.
situation. You should keep in mind that IJVs are generally formed for a dened purpose or specied project. You will therefore usually want a vehicle that permits you to limit the IJV in purpose, scope, and duration. Other considerations include: the motivations of the parties, access to technology, access to scarce resources, synergy of operations, and (lastbut not least) sharing of risk and liability. You will nd that an equity venture is often preferable, as it results in fewer limits on respective liability and allows for more exibility if the business environment changes. (See Equity or Contract? Strategies for IJV Formation, below.)

Structuring the IJV


Joint ventures can be created through a variety of structures: as a contractual relationship, for example, or as an equity relationship. And of course, you can sometimes reach similar results through alternatives to joint ventures, such as: a licensing arrangement (with or without equity investment, although an equity joint venture generally results in greater protection against liability); a distribution arrangement; or a management assistance or consulting arrangement. Which strategic vehicle should you employ? Your decision should be based on the circumstances of each

Equity or Contract? Strategies for IJV Formation


An IJV can be created by a contractual arrangement among the joint venture partners, but it is more common for the parties to create an equity joint venture by forming a new entity owned, in agreed proportions, by the respective parties. An equity joint venture is often more advantageous, especially JOiNt VENtURE StRUctURE when complex regulatory issues are to the fore. For instance, the United Kingdom requires that all applicants for wireless 3G licenses be a body corporate. By forming an equity venture, this requirement is easily met without the need to change corporate structure to meet multi-jurisdictional demands. DisadvaNtaGEs May be more expensive May expose nonresident partner to local problems

AdvaNtaGEs Offer parties a mutual interest Encourage parties to work together to adapt the enterprise to changes in business environment Result in fewer limits on respective liability of joint venture partners Tend to be less expensive Are less likely to involve nonresident partner in local problems

Equity Ventures
(More suitable for long-term, multitransaction projects with complex regulatory issues)

Contractual Relationships
(More appropriate where each partys contribution is easy to dene)

Do not provide nonresident partner with local presence Less exible if business environment changes

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Avoiding the Novice's Mistakes


The return on a successful IJV can be very high, but many IJVs are far from successful. Our clients and business strategists advise us that as many as two-thirds of cross-border alliances encounter signicant nancial and operational problems during their rst years of operation. And in the end, according to some industry analysts, approximately half of all IJVs fail. Why do so many IJVs run into trouble?

ers, perhaps because of the balance of terror and the need for collaboration and cooperation. Similarly, joint ventures between equally strong partners tend to work better than those between partners of unequal strength. Ventures between partners with complementary strengths work better than ventures between partners with overlapping strengths.

Poor planning
Even if a good business plan is developed, it will need to be revised as the IJV develops and encounters the challenges of the market place. Experience tells us that as many as half of all joint ventures end up modifying their scope by expanding the proposed business or entering into new businesses not contemplated when the joint venture was formed. Thus, exibility and evolution are key for successful IJVs.

Greed
A common mistake is for one party in the venture to cut itself too good a deal. A joint venture is a partnership and, like all partnerships, it functions well only if it is structured from a win-win perspective. The parties need to focus on jointly making money from customers, instead of from each other. Although lawyers tend to abhor 50/50 relationships, the data suggest that 50/50 joint ventures work better than oth-

Failure to reality check


A related problem is negotiating from the ivory tower.

For Additional Information


Explore information related to this topic:
Erin Anderson, Two Firms, One Frontier: On Assessing Joint Venture Performance, 31(1) Sloan Mgmt. Rev. 1929 (1990). James D. Bamford, et al., Mastering Alliance Strategy (Jossey-Bass 2002). David J. BenDaniel, Arthur H. Rosenbloom, et al., International M&A, Joint Ventures, and Beyond: Doing the Deal (Wiley 2d ed. 2002). Peter J. Buckley and Marc Casson, An Economic Model of International Joint Venture Strategy, 27 J. of Int l Bus. Studies 849903 (Dec. 1996). Farok J. Contractor and Peter Lorange, Why Should Firms Co-Operate? The Strategy and Economics Basis for Co-Operative Ventures, in F. Contractor and P. Orange, eds., Co-operative Strategies in International BusinessJoint Ventures and Technology Partnerships Between Firms (Lexington Books 1988), pp. 328. Robert F. Cushman, et al., The Handbook of Joint Venturing (McGraw-Hill Professional Publishing 1989). Deepak K. Datta, International Joint Ventures: A Framework for Analysis, 14(2) J. of Gen. Mgmt . 7890 (1988). J. Michael Geringer and Louis Hebert, Control and Performance of International Joint Ventures, 20(2) J. of Int l Bus. Studies , 235255 (1989). J. Peter Killing, How to Make a Global Joint Venture Work. 61(3) Harvard Bus. Rev. 120127 (1982). Bruce Kogut, A Study of the Life Cycle of Joint Ventures, in F. Contractor and P. Lorange eds., Co-operative Strategies in International BusinessJoint Ventures and Technology Partnerships between Firms (Lexington Books 1988), pp. 169185. Gregory E. Osland and S. Tamer Cavusgil, 38(2) Performance Issues in US-China Joint Ventures, 38(2) Cal. Mgmt. Rev. 106130 (1996). Arvind Parkhe, International Joint Ventures, in B.J. Punnett and O. Shenkar, eds., Handbook for International Management Research (Blackwell 1996). Ana Valdes Llaneza and Estaban Garcia-Canal, Distinctive Features of Domestic and International Joint Ventures, 38(1) Mgmt. Int l Rev. 4966 (1998). Alex Wilmerding, Venture Capital Term Sheets & Valuations (Aspatore Books 2005). Ronald Charles Wolf, Effective International Joint Venture Management (M.E. Sharpe 2000). Aimin Yan and Barbara Gray, Bargaining Power, Management Control, and Performance in United StatesChina Joint Venturesa Comparative Case Study, 37(6) Academy of Mgmt. J . 1478-1517 (1994).

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One of the biggest mistakes a joint venture partner can make in negotiating an IJV is to be unwilling to walk away from a bad deal. As in every business transaction, there should be a point beyond which a joint venture partner will not go in respect to critical business and legal issues.
Sometimes executives and counsel structure a joint venture without adequate input from operational managers or complete understanding of eld-level conditions. If you are negotiating and structuring a joint venture, its critical that you communicate with the operational managers who will have to live with your decisions. Those managers can often provide valuable input early in the process and save the venture from signicant cost and possible failure. Remember, they know things you dont and cant know. It is much easier to get this important on-the-ground feedback if the parties have preliminarily chosen the IJVs management. Experienced managers can be very helpful to both sides in making sure that the important business issues are attended to in the negotiation and documentation of the joint venture agreement.

Lack of management autonomy


As discussed above, management autonomy is also critical for successful IJVs. A joint venture whose management is dominated by either party, or whose hands are tied unless both parties agree on operational issues, is unlikely to succeed.

No exit strategy
The lack of an exit strategy is an oft-cited problem for IJVs. Such a strategy is vital, given the fact that most IJVs are nite

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in duration and a step toward a more permanent solution to the market needs of one or both parties. Lack of an exit strategy can result in signicant and unnecessary nancial loss due to inefciency, reorganization costs, antitrust liability, or worse. Creating an exit strategy can be tough. It is difcult at the inception of a partnership to plan for its end. There can be many unseen barriers to efcient dismantling of an international venture, including legal, economic, political, and social obstacles. A common way of handling this issue is for the joint venture agreement to provide that one or the other of the parties can acquire 100 percent of the venture at the close of the ventures initial term.

The Right Deal at the Right Time


The top tip for ensuring the success of your IJV? Avoid the fatal triangle of wrong deal, wrong partner, and wrong reasons. Do your homework and due diligence; know whether an IJV is the right approach to the marketplace; nd the right partner; and negotiate a win-win deal. Then document the deal with a nite and comprehensive agreement that allows management to make good decisions and implement them, and allows the organization to evolve and change as the marketplace itself does. If you do all of that, you will be well on your way to IJV success. The authors extend their thanks and appreciation to Davis Wright Tremaine LLP associates Brian Buckham and Sean Malcolm for their invaluable research and editing assistance.
Have a comment on this article? Email editorinchief@acca.com.
Paul Ehrlich and Milton R. Stewart, International Joint Ventures: A Practicum, ACC Docket 24, no. 6 (June 2006): 52-67. Copyright 2006, the Association of Corporate Counsel. All rights reserved.

Chasing the deal


One of the biggest mistakes a joint venture partner can make in negotiating an IJV is to be unwilling to walk away from a bad deal. As in every business transaction, there should be a point beyond which a joint venture partner will not go in respect to critical business and legal issues. Chasing the deal almost always results in a bad deal. One cannot negotiate a good deal unless one is willing to walk away from an unacceptable one.

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