JV,Takeover Notes PDF

What are joint ventures 1. Not legally defined in Singapore a. “joint venture” is not a technical one with a settled meaning. As a matter of ordinary language, it connotes an association of persons for the purpose of a particular trading, commercial, mining or othe...

What are joint ventures 1. Not legally defined in Singapore a. “joint venture” is not a technical one with a settled meaning. As a matter of ordinary language, it connotes an association of persons for the purpose of a particular trading, commercial, mining or other financial undertaking with a view to mutual profit, with each participant usually (but not necessarily) contributing money, property or skill” (United DOminions COrporation LTd) 2. Represents a wide range of Collaborative business arrangement 3. Involves a Significant integration between parties Rationale to entering into joint ventures 1. Cost savings through sharing og employment, fixed, costs, capital intensive programmes 2. Risk savings a. Save risks because both companies can undergo projects of considerable size with speculative risks eg Natural resource and infrastructure projects 3. Access to technology a. Learn from their co-venture technology and skills to accelerate entry into a certain technology market 4. Expansion of customer base a. Establish economies of sale and global customer reach, purchasing power, capital investment resources necessary to meet international competition 5. Entry into developing economies 6. Entry into new markets a. Financing an acquisition and venture which will otherwise not be affordable 7. Subsequent exit eg IPO or trade sale Lawyers in joint ventures 1. Alert client to important business issues and options to deal with the issues 2. Structure the joint venture in light of business objectives and interests of the clients 3. Carry out due diligence in other legal investigations eg if assets are being contributed into a SPV or iff client is investing into an existing business 4. Identify and obtain clearances and consents from 3P 5. Ensure proper documentation by ensuring JV arrangements are clearly documented, safeguard client’s interests 6. Establish joint venture vehicle  a. What are teh legal steps needed, advise construcitively to establish according to client’s wishes and interests Forms of joint ventures 1. Difference between a corporate joint venture and a contractual alliance: Former has a legal entity, business assets are held by that legal entity. But contractual alliances involve hte parties that are unincorporated 2. Corporate joint ventures a. Create a jointly owned corporate vehicle as a separate legal entity. This legal entity holds business assets of joint venture b. Appropriate legal form for most equity joint ventures for continuing business c. Available in most jurisdictions 3. Contractual alliances a. Basically an unincorporated JV, arrangement based on a separate contract Unincorporated alliance based on simple contract b. Does not involve creation of a separate legal entity Legal documents for a joint venture company 1. Constitution of teh company and joint venture agreement (Aka shareholder’s agreement- shareholders being the shareholder of the JV company ) 2. What is the JV Agreement? a. It is the principal commercial agreement between the parties b. This shareholder agreement supplements the constitution 3. Difference between Shareholders’ agreement and constitution a. Constitution are regulated by Companies Act and bind all shareholders, including current shareholders and future shareholders. Amended by shareholders passing a special resolution (75% voting rights) b. But shareholders’ agreements are governed by contract law and they bind the parties to the shareholder agreement. c. Constitution and SHA are drafted hand in hand where the constitution replicates certain governance provisions in teh SHA to ensure that both documents are fairly aligned Key issues in shareholder’s agreement Key issfues to consider when drafting shareholders’ agreement 1. They are complex to negotiate and draft. They depend on the terms of the transaction, structure, relevant bargaining position, power and specific intents towards the transaction  2. Parties 3. Purpose and scope 4. Conditions precedent to formation 5. Share capital & equity interests 6. Governance/Board & Management structure 7. Additional financing 8. Financial matters 9. Reporting and information 10. Inter-party relationship issues 11. Transfers of shares 12. Insolvency, default and change of control 13. Governing law 14. Dispute resolution Key issue: Parties to the shareholders’ agreement Key parties to the SHA: shareholders of the joint venture company Optional parties: - Parent companies of the shareholders - Because sometimes shareholders are shell companies or are not entities of substance and it is important to have parent companies involved as SHs so they can guarantee the obligations under the SHA - Joint venture company - BENEFIT and DISADVANTAGES of having the JV Company as shareholder - BENEFITS - The JV Company can directly undertake obligations to observe certain restrictions and procedures such as non compete or confidentiality undertakings which can make enforcement of obligations easier - Also help if there is a risk that the director of the JV company may not observe constraints or undertakings contraactualy agreed between shareholders - - Easier to enforce obligations, particularly if: - Directors have little regard for wishes of shareholders - Even if directors are likely to have regard to wishes for shareholders, they will not be bound by the obligations in the SHA unless they are a party to the SHA. - There are multiple parties to JV where the cooperation of several shareholders is required to give effect to an undertaking relating to the conduct of the JV company. Hence, having the actual JV company as a party to the SHA increases teh enforcement of the agreed term - DISADVANTAGES  - In event of dispute between parties, JV company’s consent may be required - When one party thinks that the terms within the JV agreement should not involve the JV Company so that in teh event of dispute or variations, any wider relationshi issues can be taken into account without the acknowledgement of the JV company and its management - Terms that fetter JV company’s exercise of its statutory powers might be unenforceable - Eg term in the SHA that restricts JV company for passing resolution regarding a specific right to shareholders given by statute - However it is possible to contract around this by phrasing it as a restriction on shareholders where shareholders exercise their voting rights to ensure that certain resolutionsare not passed unless certain contractual approvals have been obtained Key issue: Rights and protections that should be considered and negotiated for minority protection To begin with, Underlying statutory and corporate rights limited because they do not provide any realistic s safeguard or influence in relation to JV companies - It isthe counsel’s job to negotiate for stronger rights!! The minority protection rights negotiated vary depending on: Proportion of minority shares - Should be differences between the rights to be negotiated by a minority party in a 60-40 joint venture where the minority party provided substantial management eand t echnical expertise and in a 80-20 joint venture where the minority SH is a strategic partner but hte majority sharehodler has day to day operational control and maangemetn rights Role of minority shareholder - Is the minority shareholder a principal of finance Whether JV is a multi-party JV - It is a multi party JV where each party has small but passive shareholding interest especially in a lot of start up SHA - The appropriate protection should be put in place to prevent undue control Before considering typical minority protection, what are the statutory remedies for minority shareholders - These apply in relatively narrow and extreme circumstances - Minority shareholders holding >25% shares can block certain decisions requiring 75% shareholder approval - Statutory rights to call for meetings, information or investigations in certina lmited circumstances - Right to intiitate action against the party (Statutory derivative actions for breach of directors’ duties) - Right to seek winding up on just and equitable grounds - Remedy for unfair prejudicial conduct by the majority WHat should counsel note in negotiating for minority SHs - Typically minority shareholders want to ensure representation on the board of joint venture company - They will negotiate for certain info rights like budgets, periodic financial statements to be provided on a regular basis - Involved in major business decisions where its consent is required on important matters - these are called “RESERVED MATTERS” - Protect against the dilution of their shares (their equity stake) by subsequent share issues and ensure that they receive a proper distribution of profits from their JV company - Establish safeguards so they can assert their claims when necessary against breaches by majority shareholders if the majority shareholders are in breach of obligations ot the joint venture - Has an ability to exit the joint venture in the worst case scenario without being trapped in a situation where the relationship between teh shareholders have broken down Key issue: Governance / management rights of the JV Company These arrangements cover board coposition, key management appointments and aboard and shareholder proceeding Board composition - Appointment and removal of directors: refer to the number of directors each party can appoint and the manner that each party can remove board nominees. Include provisions to adjust for the number of directors that can be appointed by parties if there is a change in shareholding proportions - Adjustments on change in shareholding Proportions Eg if party A holds 60% shareholding and party B holds 40% shareholding, party A can appoint 3 directors and partyu B can appoint 2 directors. To provide more rights to teh minority shareholders, can include provision stating that if there is a change in shareholder proportions, the  umber of directors that each director can appoint can be adjusted such that with every 10% shareholding it is equivalent to one board seat - Key management - For example CEO, CFO appointment rights. - Can decide upfront in the contract which party gets to appotin the persons to these positions Board and shareholder proceedings Quorum and notice requirements especially when acting for a minority shareholder or a more passive investor. Typically quorum requirements can include stating that more of their directors to be present at the general meeting or shareholder representative to be presnet at the sharohlder meeting in order for there to be a quorum Notice requirements to follow the same notice requirements in the companies act unless contractually agreed otherwise Provide for different Approval thresholds depending on the matters being decided by the board or shareholders. ○ Day to day matters will be simple marjoiy vote ○ Prescribed matters, “reserved matters” are mattes which will require prior written consent of minority shareholders or both shareholders depending on the balance between the two Key issue: Financing arrangements for the joint venture company - Are there any specific funding obligations on the part of the shareholders? - Typically if JV is established for a specific project eg property tender or infrastructure project, there may be specific funding obligations and funding schedule attached to the shareholder agreement where shareholders are committed to fund minimum amounts upon achieving certain milestones How should funding be obtained for JV company? Sometimes there is a priority of methods of funding - First, must head to banks to seek external funding - Secondly, shareholder loans - Thirdly, sharehode’s equity when they subscribe for additional shares to fund companies When can the company trigger funding arrangements? - If shareholders are contractually obligated to fund the company, which are these circumstances? Provision of security? Sometimes banks require provision of security by shareholders of the JV company if external funding is obtained by shareholders of the joint venture company. The shareholder agreement will contain provisions as to how liability under any security granted by the shareholder should be apportioned  What happens if there are specific funding obligations upon the shareholder and one shareholder fails to raise funding? Can the other shareholder raise funds on behalf of that shareholder. If htat is the case, can raise funds on behalf, there will be penalties in place such as default interest or the funding will take place by issuance of shares at a dlutive issue price When and HOw are shares in a JV can be transferred Almost all joint venture agreements consist of a restriction on share transfer. This is because transferring of shares without constraints opposes the basic nature of joint venture. Thre is a Spectrum of restrictions on share transfer The range of restrictions include completely free transferability -> Free transferability with a few constraints (e.g. transfer can be refused in a few limited situations) -> Pre-emption (giving other member(s) a right of first refusal) -> Prohibition on transfer except in very limited circumstances, usually with the other shareholder’s consent -> to an absolute prohibition of transferability on the other end. Where on this range should the ability to transfer as stated in the JV agreement be pitched? ○ [little restriction] In certain JV especially in multi party joint ventures where many parties have a largely passive investment like start ups, a regime of relative freedm of transfer may be appropriate to enable parties to transfer their interests to a 3rd party ○ [high restriction] But in many corporate JV where teh personal relationship between parties is crucial to the JV continuing, the simple route is to prohibit transfer except in very limited circumstances usually with the other shareholder’s consent for an intiial lock up period If this is a operational joint venture where parties are leveraging on specific assets and know-how of the other parties and it is important to the identity of the relevant parties involved then there will be additional transfer restrictions imposed In most JV, parties choose the solution of permitting transfers but subject to pre-emption procedure WHat is the pre-emption procedure - This entails a procedure where  - Tsfr price is given to another party setting out the selling prty’s wish to transfer shares of the J company at the proposed price. The other JV party is given on a period to decide whether to exercise pre-emption rights aon thee terms stated in the transfer notice. In a case of multi party JV, each party is offered selling party’s shares pro rata based on their respective existing shareholding percentage in the joint venture company together wti hte opportunity to take up shares not acquired by the other shareholders. - If pre-emption rights are not exercised, selling party can sell shares to third party within a defined period at a price that is not less than that offered to the existing JV party Examples of pre-emption rights: Right of first offer, right of first refusal Difference between right of first offer and right of first refusal - The price of selling shares to the third party, must the third party purchaser be identified before offering the shares to the sahrehodlers - Right of first offer - Selling party wishes to sell but not obliged to first identify a third party purchaser - The non selling shareholder has 1 st opportunity to take up that offer or negotiate. This right arises at the front of the selling process - If not accepted, selling party is usually free to sell to 3rd party at price not less than previously offered price. If a JV party wishes to exit by selling shares, it is right for the other JV Party to acquire the shares at a fair price - (+) for selling party, avoid the initial cost and effort of marketing to or negotiating with third parties - (-) for non selling parties are forced to participate and have to make a decision to buyout selling party’s shares even when it is not a real possibility to sell shares to the third party, - hence the non selling party is forced to buy the shares even when it just wants to ensure that a third party they are not familiar with to come in and even when is not likely for a third party buyer to be identified in the first place - RIght of first refusal - Selling party obliged to identify bona fide 3rd party purchaser before preemption right exercisable by the non selling party. THis pre-emption right arises at the back end of the selling process. - Non-selling party has 1st opportunity - If not exercised, selling party can only sell to specified 3rd party at price - specified in transfer notice - (-) Difficult for selling JV party to identify a purachser because not feasible to obtain a firm offer from 3rd party in advance since a third party will prefer to wait and NOT negotiate before that it is confirmed whether the pre-emption rights will be taken up or exercised. More on transfer price (Key issue when negotiating pre-emption rights - Price that the non selling party can buy the shares by selling party under pre-emption provisions can buy at the price offered by the third party purchaser, price set by selling party or price determined by independent valuation - Price determined by independent valuation -> the formula and procedures to identify the price requires external accountants and financial advisors, requires detailed mechanics and timeline to be set out, assumptions of the valuer, timelines to prepare valuation report and the procedure to be in place if parties disagree with the valuer or each others valuation. - Most appropriate basis for price valuation will depend o nteh transaction at hand and parties’ commercial preferences - Different basis for parties’ valuation - Market value - Fair value - (More formulaic basis of valuation - Net asset value - Earnings basis (e.g. P/E ratio) - Discounted cash flow - Start-up cost - Dividend yield - Two issues on JV Parties’ right to transfer shares Whether tag along rights or drag along rights are appropriate Tag along rights (piggy back on majority SH’s tsfr price) “Tag-along” or “piggy-back” right preserves exit for other party when one party wishes to sell to 3rd party ○ The other JV parties may want the opportunity to exit as well. Hence, to preserve the other party’s right to exit, give the other party tag along rights. With this right the selling party is obliged to ensure that any 3rd party purchaser of its shares must extend offer to include the other JV party’s shares on the same terms Sensible precaution for minority to ensure that upon sale by majority shareholder, it can get the same price for its shares and does not get locked in as minority with newcomer Difference? - Even though for both rights, the shares are being sold at the same price that are being negotiated between the joint venture party selling their shares to the third party, Drag along rights force the other minority shareholders to sell their shares but tag along rights  just extends the terms of the third party offer to minority shareholders who wish to exit? Is there any consent sought by the majority shareholders of the minority shareholders before the majority shareholders exercise the drag along rights? Also the tag along rights are given to the other JV party tagging along but the drag along rights are given to the initial JV Party selling their shares? Would a third party entering into share transfer agreements with JV parties who have drag along rights be at a disadvantage since mirnotiy shareholders can give them limited representations and warranties? Drag along rights - Appropriate for majority party - The selling party is given a right if it is selling to a third party purchaser to oblige each other shareholder to sell its shares in the JV company to the third party at the same price per share as negotiated by the selling party. This enables the majority shareholder to sell its shares without being blocked by the minority shareholder - (+) enables majority party to deliver entire interest in the JV company to the 3rd party Purchaser - Drag along rights are usually structured so they can only be exercised if the sael involves all of the shares in the company or the majority of the shares in the company - They usually provide that the dragged shareohlders (other shareholders that are compelled to sell their shares) will only be required TO GIVE limited representations and warranties for eg in relation to their title of shares, authority and capacity to enter into the sale agreement and will not be giving detailed or business operation reps and warranties in relation to the joint venture company. This is especially where the minority shareholders are silent investors that do not control and are not involved in the management and the day to day operation of hte joint venture company How can parties exit a JV? Typical considerations when negotiating when and how parties can exit from a JV Key issues when designing the exit provisions => Methods provided for in the contract for one JV party to EXIT - Established for a Fixed term unless parties agree to renew? This is more common for non-equity joint ventures but rarely seen/joint renewal - Termination for convenience - Should the party have the right simply by notice to terminate the joint venture irrespective of any cause attributable to the other party? If yes, What should be the exit mechanism following such notice - Termination for cause (default)  - Should the party have the right to terminate the venture in the event of specified cirucsmtnaces (For cause in a default scenario)> What are these scenarios? - Agreed put or call options - Would the party have the right of direct option to put its shares in the joint venture company to the other party ie require the other party to buy its shares - Would the party have the right to call for the other party to sell its shares (Call the other party’s shares) at specified times as part of a pre-agred commercial deal - Sale or public offering of joint venture company - Should the party have the right to initiate the sale of the JV Company as a whole either through an IPO or through a trade or secondary sale? Such a route may be specifically contemplated as an objective or possibility when the JV company is established - Deadlock - Should there be a right to trigger a deadlock resolution mechanism which will terminate the joint venture if tere is a breakdown in the JV relationship Key issue 1: exit when there is a Deadlock Definition of a deadlock Inability of the parties to agree on strategy or other important decisions affecting the venture due to: Genuine disagreement on a business dispute or Fundamental breakdown in relationship The existence of strong minority rights can lead to a higher risk of deadlock How do deadlocks arise - Management Deadlocks can arise at a Board level where directors appointed by 2 or more shareholders are at a deadlock with one another have opposing views because the votes cast are equal - Or if there is a minority shareholder where the board appointee exercise a veto right a similar deadlock can arise at shareholder level - Boycott of meetings: One of the party refuses to attend in meetings which makes it impossible to pass resolutions or conduct affairs of the JV company - for eg in the governance provisions where if the quorum requires an appointee of the minority shareholders to be present at the shareholder and general meetings and the appointee fails to turn up at those meetings Dealing with deadlocks Should parties include provisions in the JV company to help with deadlock? Do deadlock meahcnisms relay help Actively establish clear resolution procedure if a deadlock arises VS those who prefer to negotiate an appropriate resolution at the time of any deadlock rather than anticipate in advance what the deadlocks might be, so no provision of deadlock procedure It is common to not have a formal, pre-set deadlock procedure, many pracititoners have doubt to their usefulness unless parties have a strong desire to confirm a definite exit route in the case of a breakdown If deadlock breaker provisions are included but no t operated in full, they can establish an important background for parties to establish its tactical strategy and provide a fall back scenario if parties cannot reach an agreement to break the deadlock 3 basic ways to deal with deadlocks: - 1. Design management structure to avoid deadlock arising in the first place - Structural measures can include agreeing at the outset that one party has clear voting and management control - 2. Mechanisms enabling joint venture to continue - 3. “Divorce” mechanisms Way 1: Design management structure to avoid deadlock arising in the first place What are some structures - agreeing at the outset that one party has clear voting and management control - A particular party will have control or leadership over a particular area -> this makes sense when each party controls a distinct skill or resource to the venture - Most decisions are made at executive level instead of referring to the full board of directors - Parties to the JV can choose to restrict matters that require board or shareholder approval Because these measures go to the management structure within the particular venture so it depend on the wishes of the JV parties. Most likely each JV Party will be unwilling to give up their ability to decide on matters so it will still give rise to deadlock Way 2: Mechanisms enabling the JV to continue and resolve the deadlock - Possible mechanisms include: - Additional vote in event of a tie - Independent director’s swing vote - He is appointed externally without any allegiance to any joint venture party.  - Internal escalation - Deadlock is referred in stages of escalation up to the chairman or the chief executives of the joint venture parties itself for resolution at the highest level within each parties’ organisation - Dispute review panel established to be available throughout the joint venture to exist with resolution of disputes especially in a long running joint venure - Reference of the deadlock disputes to mediation or expert determination - Arbitration or court proceedings are NOT appropriate because deadlock disputes relate to a business disagreement or a breakdown in relationship rther than a breach in contract Way 3: “Divorce” mechanisms Useful when there is a major breakdown between the parties. Itis not because of a minor reason that could result in a divorce mechanism being triggered. The measures will usually involve a buyout of one party’s interest or a winding up of the joint venture company Examples of divorce mechanisms: special divorce measures to be provided for when there is a insoluble deadlock or breakdown as provided in the JV agreement Winding up -> this is when parties are given the express right to terminate by notice by calling for a winding up Sale of joint venture company as a whole Put/call options - Exercise a put option or exit from the JB Commence various buy or sell “Shoot-out” procedures between the parties “Multi-choice” procedures When should the deadlock mechanisms be referred to? - The JV agreement can specify a defined deadlock event for a party has a contractual right to initiate the relevant divorce measure - When the TERMINATION provisions do not provide an adequate solution then parties need to consider whether special divorce measures should be introduced to provide for a deadlock situation Divorce mechanisms may or may not be provided in a equity JV agreement - The strongest reasons why these mechanisms are included is that they act as a nuclear deterrent because the threat of their implementation puts pressure on parties to agree on a commercial solution. - Sometimes, can limit divorce mechanisms to a KEY DEADLOCK where hte deadlock must relate to something critical to the continued operation of the joint venture. For eg if no resolution is not reached either the JV company has to cease operation or be in breach of its financing covenants breach of laws etc => not a minor disagreement to trigger divorce mechanisms Timing break when the divorce mechanisms are exercised  - If the measures are adopted, it is highly advisable for sufficient timing breaks during the formal deadlock procedure before the strict provisions of the JV agreement are finally implemented. This allows parties an opportunity to agree on a commercial solution in the interim even if they are reluctant to do so THese divorce mechanisms are the last resort Divorce mechanisms recognise that in these deadlocks, it will inevitably lead to a breakdown of the joint venture which cannot realistically be solved by the sale of one party’s interest to a third party. These measures usually result in a buyout of one party’s interest or winding up of the JV company None of these divorce mechanisms are an ideal solution where very few divorce solutions are implemented and completed in accordance with their contractual terms. The inbuilt potential deadlock of JV companies in itself provides the strongest structure for encouraging parties to reach a commercially agreeable solution. The severe commercial consequences to the business of the joint venture of a deadlock ensures that a sensible compromise will be agreed between parties. If there is a prolonged deadlock and no satisfactory termination procedure can be triggered, the residual legal remedy is for parties to seek a winding up of the joint venture company. Any such process is timely, costly and winding up is a last resort. Because JV requires parties to agree on certain matters such as setting up the venture, parties will need to agree when to terminate the joint venture Key issue 2: Exit when there is a default (Termination FOR cause) Parties can wish to negotiate for the right to terminate the joint venture on teh corruence of certain specified events or for cause What are the trigger events? Default Events Insolvency of one of the joint venture partners ○ Upon the insolvency of one of the joint venture partners, the party may trigger a default mechanism and buy out the insolvent JV Party’s shares instead of waiting for the insolvency process to be triggered where the assets of the insolvent party including the shares of the JV company to be distributed to other third parties that the remaining JV parties are not familiar with Breach of Shareholder agreement ○ -> commonly requested by minority shareholders on the basis that most of the obligations and the responsibilities under the shareholder agreements require the majority shareholder to comply with ○ Breach of certain specified provisions rather than just any breach of minor provisions (eg confidentiality which should not be severe enough to warrant a dissolution of the whole joint venture relationship ) Cross-default  ○ Where the JV company entered into various ancillary agreements with all or some of its shareholders like licensing agreements and management agreements, a default or termination of ancillary agreements can trigger a cross default under the shareohlder agreements Change in control ○ Parties are engaging with each other on the basis that they belong to a certain wider group of companies and the other shareholder JV entity ceases to remain within that grop of companies, it allows party to rely on the default mechanisms Default mechanisms - Depend on the relative bargaining power and shareholding proportions of the parties involved as well as the terms, specific structure of the joint venture company Put/call options - The non defaulting shareholders will be entitled to put their shares to the defaulting shareholder which requires the defaulting shareholder to acquire their shares or - To have a call option over the defaulting shareholder’s shares where they will be entitled to acquire shares held by the defaulting shareholders. - Proportion of shareholding matters: Where there is a clear majority shareholder responsible for running the group or the JV is clearly part of the majority shareholder’s operations, the majority shareholder may want to ensure that regardless of defaulting or non-defaulting shareholder, the majority shareholder will always be the party buying out the minority shareholder to ensure that the JV company will always be within its control and group Pricing of buying or selling shares for the put/call options - Pricing is based on a valuation mechanism. The pricing is based on fair value where the valuation is set out in the shareholders agreement and the discount is applied to the purchase of the shares depending on whether the put or call option is beng exercise - For example there is a buying out of the non defaulting shareholder’s shares, have to buy the shares at a PREMIUM to fair value - But if the non defaulting shareholder is buying the shares from the defaulting shareholder, entitled to buy at a discount - The amount of discount and premium is to be negotiated between parties Unwinding arrangements apply to any termination or exit under the joint venture agreement - If there are many ancillary agreements between the joint venture company and specific shareholders, these ancillary agreements need to be terminated or alternative agremenets must be put in plae if the shareholders party to the ancillary agreements are exiting. If any or both parties have contributed specific assets to the joint venture, there may be arrangements for assets to be returned to the exiting shareholders