Corporations
and
Cross Border Transactions
Visiting Prof. John W. Reboul
September 2009
Course Overview
• Introductions
• American Corporations
• Cross Border Transactions
– International Mergers and Acquisitions
– International Component Supply Agreements
– International Distribution Agreements
– International Joint Ventures
• Manufacturing
• Natural Resources
Introductions
• Who is Visiting Professor Reboul?
• Class Introductions
• Questions
Who is Professor Reboul?
Education
• 1964, Doctorat de l’Université, Faculté de Droit et des
Sciences Économiques
• 1963, LL.B., Harvard Law School
• 1959, A.B., Harvard College
Practice
He co-founded Reboul MacMurray with John MacMurray
in 1973 and is a corporate lawyer with extensive
experience in international corporate, finance and
securities, joint ventures/strategic alliances, and private
equity law. He joined Ropes & Gray in 2003 when
Reboul MacMurray Hewitt & Maynard combined with
Ropes & Gray.
Who is Professor Reboul? (cont’d.)
Professional Experience
He has advised clients on multinational transactions
centered in Europe (France, Germany and The
Netherlands) and Asia (Japan, Korea, Malaysia and
Thailand).
He represented Mitsubishi Motors Corporation for many
years, including in its alliance with Volvo Car Corporation to
develop and produce a car to be assembled at the
Netherlands Car B.V. (NedCar) plant.
He has worked on cross-border joint ventures, acquisitions,
distribution arrangements and other agreements involving
many countries in Europe and in Japan.
Who is Professor Reboul? (cont’d.)
Professional Experience (cont’d)
• He represented a South African private equity fund
borrowing from Overseas Private Investment
Corporation.
• He represented the Democratic Republic of the Congo in
the renegotiation of certain mining contracts entered into
with international mining companies.
Class Introductions
• To give me an idea of your backgrounds
and interests, I would appreciate it if
several of you would stand up and inform
me of your:
– Name
– Program in which you are enrolled and year in
program
– Home city
– Why are you taking this class?
Questions
• This is an open class, as such questions and
comments are both encouraged and welcome.
• I will ask questions about some of the situations
described. There are frequently no “right” or
“wrong” answers and the purpose of the
questions is to encourage discussion of the
issues raised.
• You may ask questions in any way related to
the subject matters being presented but suggest
that questions about current events and politics
be raised after the class.
• Raise your hand if you do not understand
anything discussed or if you cannot hear me or if
I speak too fast.
Characteristics of a Corporation
– General
• Created by law
• Can exist indefinitely
– Legal
• Can sue or be sued
• Can own property
• Shareholders not personally liable for actions of
corporation, except to prevent abuses
How does a Corporation compare to
other legal business relationships?
Individual Proprietorship
Partnerships
Corporations
Persons Required
One
At least two people
Only need one adult to
form
Formation
No formalities
No paper work required.
This may be a default
business structure.
Formal filing required
Liability
Full liability
Each partner responsible Shareholders not
for all actions of the
personally liable, except
partnership
to prevent abuse.
Control
Individual Control
Each partner equally
unless specified
otherwise
Board of Directors and
Officers
Tax
Included in Individual's
tax responsibility
Flows through to
partners
Separate taxpayer
Note:
There are also limited partnerships (where the general partners run the business and are
responsible for the partnership’s debts and the limited partners are primarily investors) and limited
liability companies combining some or all of the characteristics of a limited partnership.
Taxation Concepts
$$$
Partnership
100% Profits
Partners
$
Partners pay
income tax,
proportionately,
on 100% of the
profits
Pass Through Taxation (money only taxed once)
$$$
Corporation
$$$
Corporation pays
Expenses and
taxes
Net Profits
Corporate Taxation (money taxed twice)
Net profits
distributed to
Shareholders as
Individuals, who
pay income tax
HOW TO CREATE A
CORPORATION
Where to Form the Corporation
• Multi-state corporations
– Most are formed in Delaware
•
•
•
•
Over 50% of U.S. publicly traded corporations
Over 60% of Fortune 500 companies
Certainty of results if litigation
Management-friendly
• Offices/operations in only one state
– Delaware or state where corporation will be physically
located
– Formation extremely simple by signing a Certificate of
Incorporation and causing it to be filed with the
Secretary of State or other official in the state in which
the corporation will be incorporated.
General Characteristics of Delaware
Corporation
• Share capital. Delaware does not impose minimum or
maximum limits on share capital.
• Non-cash consideration. A corporation's shares can
be issued for non-cash consideration.
• Rights attaching to shares. The rights, powers and
preferences of shares must be set out in a corporation's
certificate of incorporation.
• Foreign shareholders. Delaware does not impose
restrictions on foreign shareholders.
• Management structure. Unless the certificate of
incorporation provides otherwise, a Delaware
corporation is managed by, or under the direction of, its
board of directors. There are no co-determination rules
or citizenship requirements for management.
Certificate of Incorporation
NAME AND ADDRESSES
• Name must not be the same as another
corporation incorporated in the same state
• Must include word “corporation”, “corp”,
incorporated” or similar
• Must include address of each incorporator
CAPITAL STRUCTURE (STOCK) MUST INCLUDE :
• Number of authorized shares
• Number of classes of stock
• Information on par value, rights, preferences or
limitations of each class
• Information on any series (structures) of preferred
stock.
CORPORATE PURPOSE:
• Must include corporate purpose, but purpose can be very general
• For example: “The purpose of this corporation is to engage in
any lawful act or activity for which corporations may be
organized under the General Corporation Law of the State of
Delaware”
Governance
Governance
– State Law
• Certificate of Incorporation
• By-Laws
–
–
–
–
Not filed with the state
Outsiders to corporation not bound by By-Laws
Incorporator adopts initial By-Laws
Shareholders and Board of Directors (if so provided) can
adopt By-Laws
Management Structure
• Management Structure
– A Board of Directors elected by the shareholders
manages the corporation. Officers appointed by the
Board take care of day-to-day operations
• Board of Directors
–
–
–
–
Acts by Board of Directors
Meeting; or
No meeting with unanimous written consent
Meeting may be held outside state of incorporation
– Conference call acceptable, if directors can hear all
participating directors simultaneously
Management Structure (cont’d.)
• Notice
– Regular meetings are specified in the By-Laws, no notice
– Special meetings require notice with method set in By-Laws
– If Director not given notice, any action taken at meeting is void,
unless director waved notice by:
• Attending the meeting without objection; or
• Writing and signing a waiver of notice at anytime
• Quorum Requirements
– Must have quorum at meeting (generally majority of all director
seats)
– Can lose quorum if director leaves meeting before voting
– At meeting, only need majority present to pass resolutions
Duties of Board
• Directors of corporations owe a fiduciary to the
corporation and can be held liable for breach of
this fiduciary duty. Directors can also be liable
for the unlawful payment of dividends or
unlawful share purchase or redemption.
– Liability can arise for breaches of the duty of
loyalty (this deals, for example, with conflicts
of interest).
– Breach of duty of care:
• Failure to discharge duties in good faith and with that degree
of diligence, care and skill that an ordinarily prudent person
would exercise under similar circumstances.
Officers
Officers are generally named by the Board of
Directors and are the persons who run a
Corporation. Generally, officers include:
– President
– Secretary
– Treasurer
but, may include:
– Chairman
– Vice Presidents, and many other titles
Mergers & Consolidations
A
+
C
B
Consolidation
Merger
• The Board of Directors of each
corporation must generally adopt plan
of merger or consolidation
• Each corporation must generally have
shareholder approval
• No shareholder approval in “short form”
merger: B owns 90% of each class of
stock of A
• Deliver certificate of merger of
consolidation to Dept. of State for filing
• Right of Appraisal for shareholder of
Corporation that disappears
B
• includes dissenting shareholder in
short form merger
A
• Surviving corporation succeeds to all
rights and liabilities of the constituents
“successor liability”
Transfer of Substantially All
Assets/Share Exchange
• Fundamental change for selling corporation only
–
–
–
–
Each corporation's Board of Directors must authorize deal and
Approval by selling corporation’s shareholders
Buying corporation generally does not vote
Department of State for filing
•
•
Only if share exchange
Does not apply to asset transfer
– Selling corporation shareholders may have right of appraisal
• Only successor liability if:
1. Deal provides otherwise;
2. Purchasing company is mere continuation of the seller; or
3. Deal was entered fraudulently to escape such obligations
Dissolution
• Voluntary: By vote of board and shareholders or
by all shareholders without board vote.
• Involuntary: Judicial
– Board Resolution or resolution of majority of
shareholder entitled to vote
• Insufficient assets to discharge liabilities or
• Dissolution beneficial to shareholder
– Under Delaware law, in the case of a corporation
having only 2 stockholders owning 50% of the stock
engaged in a joint venture and such stockholders are
unable to agree on discontinuing the joint venture
either one may petition the Court of Chancery to
dissolve the corporation.
Dissolution (cont’d.)
• Dissolution does not end corporation’s
existence. Requires winding up:
–
–
–
–
Gather all assets
Convert to cash
Pay creditors
Distribute remainder to shareholders
• Shareholders are never paid before creditors.
Cross Border Transactions
• This is a very broad topic and can involve almost any
business arrangement involving parties in different
countries. My lectures will address the following
categories of transactions:
Cross Border Mergers and Acquisitions
- Includes situations in which a company (Company A) in one country
buys a company (Company B) in another country or combines with
Company B
- Also includes Company A buying an interest in Company B of less than
100%
- The acquisition of an interest of less than 50% is frequently part of
a larger relationship, for example, a joint venture
Cross Border Transactions (continued)
Cross Border Supply Agreements
-
A product made in one country is a component in a final product
made in another country
- For example, an engine made in Japan may be incorporated in an
automobile finally assembled in the United States
Cross Border Distribution Agreements
-
A product manufactured in one country by Company A is
distributed in another country by Company B
- For example, many automobiles are distributed by unrelated distributors in
countries other than the country in which they were made
Cross Border Transactions (continued)
Joint Ventures
- A very broad term which may include one or more of the following: the
acquisition of an interest by Company A in Company B, a component
made by Company A being included in a final product made by
Company B or a product made by Company A being distributed by
Company B in another country
- A characteristic of Joint Ventures is that Company A and Company B
are carrying out some business together over a period of time
- We will examine two types of joint ventures
- Manufacturing joint ventures, and
- Natural resource join ventures
These lectures will focus on the issues arising in connection with the
categories of transactions listed above but note that, in the case of any
joint venture, the laws of each country touched by a cross border
transaction must be considered
- A manufacturing joint venture located in say The Netherlands between a
Japanese and a German company will involve the laws of The Netherlands,
Japan, Germany, the European Union and maybe other countries, for example
England if English law is chosen to govern the interpretation of the joint venture
agreement and Singapore law if arbitration is to take place in Singapore.
INTERNATIONAL
MERGERS AND
ACQUISITIONS
International Mergers and Acquisitions
In the first part of this course, we looked on some of the provisions of U.S. Corporate
Law which apply to mergers and acquisitions. In the following discussion, we will
consider some of the agreements that are typically involved and some of the issues
that need to be addressed. One point to be noted is that a merger or acquisition is a
transaction which results in one company acquiring another company or a
combination of two or more companies and that distinguishes such transaction from
the International Component Supply Agreement, International Distribution Agreement
and International Joint Venture in which companies maintain their separate existence
and agree to work together for specific purposes.
TYPICAL AGREEMENTS
• Typical Agreements at Signing:
– Stock Purchase Agreement or Merger Agreement
– Debt Commitment Letter(s)
•Types Additional Agreements by Closing
–
–
–
–
Stockholders Agreement
Employment Agreements
Stock Incentive Plan and Awards
Management Agreement
Business Issues
• Identify assets and liabilities to be transferred
• Set payment terms
• Allocate risks (known and unknown) between the buyer
and seller(s)
• Obligate parties to take specific steps to get the deal
closed
• Establish degree to which parties are bound (e.g.,
closing conditions)
• Establish rights in the event that assumptions are not
correct (e.g., right to terminate; breakup fee;
indemnification)
• Establish terms of any continuing relationships (e.g.,
component supply, IP licensing, transition services)
Basic Perspectives of Sellers and Buyers
• Sellers want:
–
–
–
–
Best price
Quick closing
Minimal risk of non-consummation
Minimal continuing obligations
• Buyers want:
– Exclusive opportunity to analyze the business
– Substantive and procedural opportunities to reset the price or exit the
deal if Buyer’s assumptions are wrong
– Time and process to obtain financing
– Minimal exposure if Buyer doesn’t close
– Where feasible, indemnification if Buyer’s assumptions are wrong
Transaction Structure
• Types of transfers:
–
–
–
–
Stock sale
Asset sale
Merger
Recapitalization
• Types of consideration:
–
–
–
–
Cash
Stock
Debt
Contingent payments and earnouts
• Tax consequences differ depending on:
– Type of transfer
– Type of consideration
– Jurisdictions in which Buyer, Seller and Target are located
• Local law issues:
–
–
–
–
–
Limitations on financing
Diligence risks
Limitations on allocation of risks and responsibilities by contract
Procedural issues
Sometimes counterintuitive
• Examples of legal issues:
– US
• State corporate law limits breakup fees that may be paid – generally
2 ½ to 3 % in Delaware
• Shareholder merger approval thresholds vary by state
– Majority of outstanding shares in Delaware
– 2/3 in Texas
– Germany
• Criminal penalties for financial assistance and failure to timely declare
insolvency
• German statue ensures good title--title warranties unnecessary
• German state limits purchaser recovery if purchaser knew of the
breach of warranty – explicit language needed to remove limit
• Difficult to enforce employee non-competes
• Real estate taxes due on stock transfers
– UK
•
•
•
•
Financial assistance limitations on financing
Limits on warranty claims and proof of damages vs. indemnity
Post-closing pension liabilities
Limitation on break-up fees (e.g. 1%)
Purchase Price Adjustments
• Picking the right measure
– Net assets
– Net working capital
– Other
• Picking the right target
– Historical
– Projected
– Average
• Mechanics
– Closing vs. most recent month-end
– International Financial Reporting Standards (“IFRS”) vs. “Company
Accounting”
– Consistency with IFRS vs. consistency with baseline
– Locking certain variables (such as how to calculate reserves and
whether to permit reversal of reserves)
– Treatment of cash, foreign cash, debt and debt-like liabilities
– Preparing calculation vs. objecting to calculation
– Preventing manipulation through the operation of the business
Representations and Warranties
• Overview
– These are the Seller’s promises to the Buyer as to what the Buyer will
receive when the transaction is completed.
– Provide basis for closing condition (bring down)
– Provide basis for indemnification (allocation of risks)
– Materiality and knowledge
– Essential although not always included
• Key Representations Often Negotiated
–
–
–
–
–
–
–
–
–
–
Accuracy of securities law filings
Financials (IFRS)
Undisclosed liabilities (going beyond IFRS)
No material adverse change (“MAC”)
Intellectual property
Noncontravention; material contracts
Compliance with law
Customers and suppliers
Transactions with affiliates
Sufficiency of assets
Material Adverse Change
•
Possible Inclusions
– Forward looking element
• Prospects
– Language that aggregates problems
– Adverse effect on timely performance of agreement
•
Possible Exclusions
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
Changes in the economy
Changes in political conditions
Changes in industry
Changes in IFRS or interpretations thereof
Changes in law or regulation
Acts of war or terrorism
Natural disasters
Suspension of trading in securities
Changes in market price or trading volume of target securities
Failure to meet projections
Fluctuations in sales or earnings consistent with past practice
Changes in analyst recommendations
Changes in ratings of target securities announcement or performance of deal
Identity of buyer
Litigation related to the deal
Covenants
•
Promises as to the pre-closing conduct of business
–
–
–
–
•
Preserving business
Restricting new long-term commitments
Restricting equity issuances
Avoiding manipulation of purchase price adjustments
No shop/Go shop
– Limit seller's ability to solicit or facilitate alternatives
– Procedural protections to preserve first mover advantage
•
Approvals and Consents
– Allocation of responsibility for obtaining approvals and consents
• Shareholder approval
• Antitrust and regulatory approval
• Third party consents
– Providing for failure to obtain consents
•
•
Confidentiality and non-competition (pre-and post-closing)
Post-closing matters
– Transition services
– Cooperation re tax returns and tax audits
– Employee matters
Closing Conditions
•
•
•
•
Updating representations
Absence of material adverse change (MAC”)
Absence of injunction
Approvals and Consents
– Stockholder approvals
– Regulatory approvals
• Key agreements
– Transition services
– Leases, licenses, etc.
Termination Arrangements
• By material consent
• By buyer or target if not closed by a “drop dead date”
• By buyer or target if target shareholders reject deal
Post-Closing Remedies
• Anyone to sue?
– Public company
– Private company or subsidiary
• Types of remedies
– Fraud
– Claims under securities laws
– Contractual indemnification
Indemnification
• General indemnity for breaches of representations, warranties and
covenants
– Thresholds, baskets, caps
– Length of survival by category
– Exceptions to limitations
• Special indemnities
– Taxes, environment, employee benefits
– Known or partially known problems
• Making the indemnity work
–
–
–
–
Solvent seller
Holdback, escrow and set-off mechanics
Providing for seller representative
Suing estates
Schedules
• Effects of listing items on disclosure schedules
– E.g., representation will say no litigation, no employment agreements,
no tax claims, etc. except as listed in a particular schedule.
– Disclosure
– Allocation of risk
• Updates to schedules between signing and closing
– Buyer’s remedies
– Pre-signing occurrences
– Post-signing occurrences
INTERNATIONAL
COMPONENT
SUPPLY
AGREEMENTS
Manufacturers of products from computers to
automobiles are dependent on components made in
countries other than their own and the component
supply agreements governing such sales are
essential for both the manufacturer of the
component (the “Component Manufacturer”) and the
manufacturer of the finished product (the “Product
Manufacturer”). What will be addressed in this part
of the course is the relationship between
independent contractants.
The vast majority of sales are transactions between independent parties
and are covered under simple purchase orders.
- The U.N. Convention on Contracts for the International Sale of Goods
(CISG) provides that, in the absence of an express provision specifying
that it is not to apply, the CISG is deemed to be incorporated into (and
supplant) any otherwise applicable domestic law(s) with respect to a
transaction in goods between different contracting states.
-
As of July 1, 2008 ratified by 71 countries including Hungary
Brazil, India and UK only major trading countries that have not ratified
- Battle of the forms
- A purchaser may send a purchase order with detailed terms printed on the
reverse specifying the purchaser’s responsibility and electing the law of the
purchaser’s country
- The seller may return a form also with printed conditions which may specify
a different law and may specify arbitration in the seller’s country.
- Different results under CISG and the Uniform Commercial Code (UCC) in
effect in 49 states of the United States
- CISG a rejection and counter offer
- UCC tries to avoid battle by saying that any acceptance conditioned on
offeror consenting to additional terms
- We will look especially at two of the relationships indicated on The
Supply Chain diagram below, which are the contractual arrangements
between the Component Manufacturer and the Product Manufacturer
and between the Product Manufacturer and the Distributors:
Sales
Reps/Agents
Raw Materials
Component
Manufacturer
PRODUCT
MANUFACTURER
Retailers
and Dealers
(PLANT, INVENTORY,
SHIPPING)
Distributors
including Wholesalers
Technology
And IP
Definition of the component
– Does is currently exist?
– Is it being developed?
• What will be the specification of the components to be sold?
– output, e.g., horsepower for an engine
– fuel efficiency
– performance
• Evaluation testing to determine
– whether technical objectives are attained
– whether new regulations are complied with
• Is the price fixed or is there a procedure for price
adjustments?
Purchase Obligations
• Maximum and Minimum quantities
• Protections for Component Manufacturer against obligation to
furnish quantities which it cannot produce or which would require
unplanned investment to increase capacity
• Protections for Component Manufacturer for Product Manufacturer’s
failure to purchase an agreed minimum
– Need to agree on amount of investment relating to a particular
program
• How much capacity already exists
• Calculation may be subject to difficult negotiations
– Reimbursement for unamortized investment
– Liquidated damages
• can protect the Component Manufacturer’s Profit
• fixed amount or a percentage of the price; may be
reimbursable based on future excess purchases
• Limitations of liability
– Direct vs consequential
– Liability caps (e.g., US $x)
Prices
• Most favored nation clause
• Adjustments for:
– Changes in components
• Voluntary changes
• Changes to update components or to meet regulatory requirements
• Calculation of price adjustments
– Currency
• What currency does Component Manufacturer usually want?
• What currency does Product Manufacturer usually want?
– Currency fluctuations and whether risk is to be shared
• E.g., no adjustment if the exchange rate is between 85 yen = US$1 and
105 yen = US $1 and 50/50 sharing outside that band
– Inflation formulas may be crafted for particular components, e.g.,
respective weighting for steel prices and wage rates
– An example of a formula:
P1 = PO (S1 x .18 + C1 x .09 + L1 x .17 +
(SO
CO
LO
M1 x .16 + W1 x .20 + .20)
MO
WO
)
P1 = Adjusted Engine Price
PO = Engine Price Prior to Adjustment
The other letters refer to indexes related to steel (S1 & SO), cast iron
products (C1 & CO), light metal ingots (L1 & LO), wholesale prices (M1 &
MO) and a wage index (W1 & WO).
– Would a 10% increase in the cast iron index result in a greater increase in
the Engine Price than a 10% increase in the wage index?
– Why is the last item in the index “.20” without being multiplied by a fraction
comparing two indices?
Payment
• Advance cash payment
• Letter of credit
• Payment after a period of time
– Exposure could be large, e.g., a Component Manufacturer could be one
of the largest creditors in the event of the bankruptcy of the Product
Manufacturer
• Currency of payment
– Distinguish from adjustments for fluctuations in exchange rates
Shipping Terms
• What is included?
– Handling
– Packaging
– Freight
– Insurance
– Export taxes
– Import duties
Standardized terms may answer many of these
questions and some of the most common are
the following as defined in Incoterms:
EXW: “Ex works” means that the seller delivers when
he places the goods at the disposal of the buyer at
the seller’s premises or another named place (i.e.,
works, factory, warehouse, etc.) not cleared for export
and not loaded on any collecting vehicle.
FOB: “Free on Board” means that the seller delivers
when the goods pass the ship’s rail at the named port
of shipment. This means that the buyer has to bear
all costs and risks of loss of or damage to the goods
from that point.
Incoterms (cont’d):
CIF: “Cost, Insurance and Freight” means that the
seller delivers when the goods pass the ship’s rail in the
port of shipment. The seller must pay the costs and
freight necessary to bring the goods to the named port
of destination BUT the risk of loss of or damage to the
goods, as well as any additional costs due to events
occurring after the time of delivery, are transferred from
the seller to the buyer. However, in CIF the seller also
has to procure marine insurance against the buyer’s
risk of loss of or damage to the goods during the
carriage.
DES: “Delivered Ex Ship” means that the seller
delivers when the goods are placed at the disposal of
the buyer on board the ship not cleared for import at the
named port of destination. The seller has to bear all of
the costs and risks involved in bringing the goods to the
named port of destination before discharging.
INCOTERMS
Chart of Responsibility
The following chart summarizes the responsibilities of both the buyer and seller for each of four INCOTERMS
described above.
SERVICES
EXW
FOB
CIF
DES
Ex Works
Free Onboard Vessel
Cost Insurance &
Freight
Delivered Ex Ship
Warehouse Storage
Seller
Seller
Seller
Seller
Warehouse Labor
Seller
Seller
Seller
Seller
Export Packing
Seller
Seller
Seller
Seller
Loading Charges
Buyer
Seller
Seller
Seller
Inland Freight
Buyer
Seller
Seller
Seller
Terminal Charges
Buyer
Seller
Seller
Seller
Forwarder’s Fees
Buyer
Buyer
Seller
Seller
Loading On Vessel
Buyer
Seller
Seller
Seller
Ocean/Air Freight
Buyer
Buyer
Seller
Seller
Charges On Arrival At
Destination
Buyer
Buyer
Buyer
Buyer
Duty, Taxes & Customs
Clearance
Buyer
Buyer
Buyer
Buyer
Delivery to Destination
Buyer
Buyer
Buyer
Buyer
Why Do We Care?
• Seemingly small amounts can have a
significant impact on the profitability of an
agreement. A US $0.50 handling fee on a US
$ 1.000.00 component seems insignificant but
not if the profit on the component is $10.
• Who bears the risk if the components are
destroyed or damaged?
• Who bears the risk if the seller or buyer
becomes insolvent?
Schedules of production and shipment
• Forecasts
• Firm orders and modifications permitted
• Obligations of Component Manufacturer to expedite shipments and
allocation of the related costs
Quality Control
• Inspections
• Cost of repair of defects not included in warranty allowance
– When should there be a recall, voluntary or governmentally required?
Further Development and Changes to Components
• To meet legal requirements
• To reflect normal product improvements
• Allocation of costs of legally required and other changes
Technical Assistance and Information
• Warranty
– Obligations of Component Manufacturer and how is this
obligation paid for
• Warranty allowance or reimbursement of actual expenses
• Patent Rights
– Responsibility for infringement
– Confidentiality
• Product Liability
– indemnity
• Other Provisions
– Do not overlook provisions at the end of an agreement
– Force Majeure
– Term and termination
• post termination obligations e.g., continued supply of parts
– Governing law
– Arbitration
INTERNATIONAL
DISTRIBUTION
AGREEMENTS
• Reasons for a Distributor
– Use local knowledge about market
– Reduce initial investment
• Distinguish distributor from sales agent which
– Does not take title
– May or may not be able to take orders
– Usually paid a commission
• Define Product
– Does it include successor products and replacement parts?
• Non-Exclusive or Exclusive
– Non-Exclusive
• Is the distributor one of many in the country?
• Benetton has more than 6000 stores in 120 countries.
• More costly products will have fewer distributors or even only one in a
particular country.
– Exclusive distributor’s rights and obligations in designated country
Non-Exclusive or Exclusive (cont’d.)
• Exclusive Distributor may work harder but will want to be
protected in market it develops.
• Is there a minimum purchase obligation?
• Does the product manufacturer have a right to terminate if
designated volume not purchased?
• Distributor “will actively promote and develop the sale of
products distributed by distributor under this Agreement”
– How much protection does this give the manufacturer?
• Risks of saying nothing
– When a distributor is also a manufacturer of similar
products
• Why? A distributor in a particular country may want to
complete its line of products and prefers to buy, for example,
a small car rather than build it.
• Particular problems if the manufacturer is also selling directly
or through a subsidiary in the same country.
Manufacturer
Independent
Distributor
Affiliated
Distributor
Independent
Distributor’s
Retail Dealers
Affiliated
Distributor’s
Retail Dealers
Retail Customers
• Allocation of volume. Independent Distributor will want a
guaranteed minimum but will resist minimum commitments.
• Manufacture will want minimum commitments from the
Independent Distributor.
• Choice of products will all products be made available to
both distributors?
• Pricing
– If Manufacturer can determine price unilaterally, it can squeeze the
margins of Independent Distributor.
– Agreement among Manufacturer, Independent Distributor and
Affiliated Distributor fixing the price to dealers or to the public would
be illegal.
– If Distributors in a particular industry establish a single price at which
they sell products to their dealers, does this suggest a solution for
the case of the same product being sold to the Independent
Distributor and the Affiliated Distributor? Assume that a reasonable
margin for a distributor is 15%.
• Adjustments for physical differences between similar products
• Adjustments for differences in terms of sale, rebates, allowances etc.
• Manufacturer’s obligations
– Minimum supply obligation
– Meet legal requirements of country into which product is shipped
including indemnity for failure to meet such obligations and for
product liability claims
– Warranty
– General and Repetitive Defects
• When is a defect normal wear and tear, when is it to be covered by
a warranty, when is it a general and repetitive defect
– Windshield wipers need replacing?
– Door handle falls off in 1% of cars, in 20% of cars?
– Engine fires?
– Transfer of intellectual property rights (both patent and trademark
rights) and allocation of responsibility in the case of infringement
• Who is responsible Component Manufacturer, Product Manufacturer
or Distributor?
– Delivery delays
• How does this differ from situations of a component supply
agreement?
•
Orders
– Planning volumes
– Lead times
– Assurance of payment
• Advance payment or letter of credit
– Passage of title
• FOB port of shipment
• DES delivered ex ship
• Why does it make a difference?
– Freight and insurance
• Confidentiality
• Governing Law
– Obligations imposed on all entities operating in the applicable
jurisdiction
– Interpretation of joint venture agreement and rules for operation
of joint venture entity
– UN Convention for International Sale of Goods
• Force Majeure
• Choice of forum or arbitration
• Termination
– Fixed term
– Termination for a default or failure to achieve certain minimum
volumes
• Effect of termination
– Obligations arising before the termination continue, for example,
paying for products already shipped, indemnity for product
liability claims for vehicles already sold
• Effect of termination (cont’d.):
Assume that the Independent Distributor has a network of dealers which sold the
products and will want these dealers to make repairs under the warranty granted by
the manufacturer both during the term of the warranty and thereafter. What does the
following clause do? Which important issue does it fail to address?
“The parties recognize that Independent Distributor has assumed a warranty
obligation under this Agreement and that this obligation to third parties will continue
for some time after the termination of this Agreement. Notwithstanding termination of
this Agreement, Manufacturer agrees to supply Independent Distributor with a
sufficient supply of replacement parts for Products and any required technical
information for Independent Distributor to meet its warranty obligation to third parties
and to comply with all applicable laws and regulations until arrangements for
assumption of Independent Distributor’s warranty obligation have been made
between Manufacturer and a new distributor. The prices for such parts will be the
same as if this Agreement were still in effect. Delivery, passage title and the terms of
payment will be as specified pursuant to clauses __ and __ of this Agreement.”
• What types of product could this apply to?
– Motor vehicles?
– Computers?
– Appliances?
– Food products?
INTERNATIONAL
JOINT VENTURES
Joint Ventures frequently start with a great deal of
enthusiasm without a careful analysis what each
Party hopes to achieve and what conflicts are likely
to arise.
– Why a Joint Venture? Is a Joint Venture the
best way for a company to achieve its
objectives? Could a simple component supply
or distribution arrangement or a merger achieve
the same commercial objectives?
– Basic Questions
• What is the business?
• What is the likely turnover and market share?
Basic Questions (cont’d.)
•
•
•
Where will the business be based?
What are the Parties’ objectives?
Will it work, feasibility study?
–
–
–
–
–
due diligence
identity of Joint Venture Parties
long term aims and corporate culture
expected financial regulatory or business problems
likelihood of change in control
Studies indicate that where there is little overlap
between the businesses of potential Joint Venture
Parties, a Joint Venture will be more likely to succeed
than a merger but conversely where there is a
reasonable degree of overlap between the Parties’
businesses, a merger is significantly more likely to
succeed than a Joint Venture.
Will a Joint Venture succeed?
Minimal overlap
14%
Moderate/high overlap
24%
25%
62%
Success
38%
37%
Mixed results
Failure
Alliances are more likely to be successful where each Party brings something different.
Source: “The way to win in cross-border alliances” Bleeke and Ernst.
November/December 1991 issue of Harvard Business Review and the McKinsey
quarterly 1992.
The report studied 49 strategic alliances established by top companies in the US, Europe
and Japan.
•
Structure
– There is no common template and the structure must be
designed to fit the particular situation.
– Can be in the form a joint company, partnership or contract
Varying interests may be accommodated in a
Joint Venture.
•
N. Car
– Government looking to sell its interest in the automotive
industry
– Auto Manufacturer V looking for the design of a new model
– Auto Manufacturer M looking for sufficiently large potential
sales volume to make production of cars in Europe
economically feasible.
•
Natural Resources Joint Venture
– Government looking to develop its mineral resources
– Mining companies looking for a source of a particular mineral
• What will the Parties contribute to the Joint
Venture?
– Cash: purchase of stock of Joint Venture or loans to
Joint Venture or guarantee of loans to the Joint
Venture. Is there a continuing obligation to provide
financing?
– Non-cash:
• Technology, e.g., the design of a new product, manufacturing
processes for a new production facility
• Components, e.g., an automotive engine essential for the
production of a new car
• Existing manufacturing plant or the site for a new plant
• Market for the products made by the Joint Venture
– Protect ability of Party to receive a minimum quantity
– Protect the Joint Venture against short falls in orders
• Source for minerals
• Verify contributions
• What will the Parties take out?
– Royalties for Party contributing technology or
resources
– Dividends (What earnings will be paid out and
what amounts will be retained?) interest on
loans, management fees
– Ability to sell products to Joint Venture
– Products produced by the Joint Venture
– Can initial losses be used by either Joint
Venture Party to achieve tax savings
MANUFACTURING
JOINT VENTURES
Many of the issues are the same for Manufacturing Joint
Ventures and Natural Resources Joint Ventures, but I will
address in this section those questions arising frequently
between two manufacturers and in the next section those
particular issues which arise between mining companies and
the governments of the countries in which they are operating.
• Management
– The McKinsey Study referred to above indicates that Joint
Ventures are most successful if they have a strong independent
management in place
– Not just a representative of one of Joint Venture Parties but
mindful of interests of Joint Venture itself
– If all questions are referred back to the head offices of the joint
venture participants, operations will become impractical.
– Procedures to keep Joint Venture Parties informed
– Business plan and annual budgets
•
Management Issues
– If the manager is a director of the Joint Venture Company,
then he or she may face conflicting legal duties.
– He or she may also be subject to obligations of confidentiality
in relation to the information he or she learns as manager.
– The manager that a Party appoints may eventually identify
more strongly with the Joint Venture than the appointing Party
and face conflicting loyalties.
•
The reporting of information and confidentiality issues
should be addressed in the documents.
Employees
A number of employment issues will arise, particularly
if employees are to be transferred to the Joint Venture
by the Joint Venture Parties.
Key questions will include:
– Is employee consultation/consent required prior to the
establishment of the Venture?
– Will redundancies be necessary? If so, what
procedures should be followed? How much will it
cost and who should bear the ultimate cost?
– Will it be necessary or commercially desirable to
harmonize terms and conditions of employees in the
Joint Venture? Local laws may restrict the ability of
the Parties to do this.
Key questions (cont’d.):
– If managers are to be transferred or seconded to the
Joint Venture:
• what is their tax position?
• how difficult might it be to obtain work permits for
them?
• what is their potential liability as managers or
directors of the Venture?
If an existing business located in the European Union is
transferred, the Acquired Rights Directive (as
implemented by member states) will apply. Broadly this
provides for the automatic transfer to the Joint Venture
entity of the conditions of employment of employees
engaged in the business.
Control
Even split of Ownership. A study carried out in 1993 found that
success is more likely where there is an even split of ownership
30
61
10
8
60
31
Even split of ownership
(sample of 20)
Uneven split of ownership
(sample of 13)
Failure
Mixed results
Success
An even split of ownership is more likely to result in a successful Joint Venture.
Source: “Collaborating to Compete”.
Bleeke and Ernst, 1993
Unequal Ownership Percentages,
Minority Protection
Identify areas where the interests of the Joint
Venture Parties may diverge.
For example:
–
–
–
–
–
–
–
–
Business plan
Access to profits
Expansion of business
Future investment requirements
Future finance (share issues/loans)
Acquisitions/disposals
Change of business
Access to intellectual property and research and
development
Unequal Ownership Percentages,
Minority Protection
• Divide the areas into three categories
– Matters over which the minority would require a veto
– Matters over which the minority should have a
positive right of action (for example, to appoint and
remove a quota of directors)
– Matters on which a majority vote will be acceptable
Unequal Ownership Percentages,
Minority Protection
• Divide board and shareholder powers
Who should have control over each matter: the board or
the shareholders? (Most countries recognize a division
between board and shareholder powers but this is not
universal.)
The documents can detail the division of power between
the management and shareholders of the Joint Venture
Company or alternatively, in a 50:50 Venture, the
structure may be such that the deadlock provisions will
require that appropriate decisions are made at the Joint
Venture Party level. It is best practice even in a 50:50
Venture to define the extent of each Party’s control
because of the independence (at least as a matter of
law) of the company’s management.
Directors
– Appointment and removal. What power does each
Party have to appoint and remove directors? What
proportion of the board is appointed by the respective
Parties?
– Veto. What powers of veto do those directors have
and when? What happens when any veto is used?
– Quorum. Is there a requirement for directors
appointed by all Parties to be present for a quorum?
Care is needed with the quorum provisions. For
example, if one of the directors that a Party wants to
appoint to the board of the Joint Venture Company is
often abroad, it is important to ensure that notice must
be given to directors abroad on a timely basis.
– Chairman. Who appoints the chairman? Is he/she to
have a casting vote?
Shareholders
What rights will the Parties have as shareholders? In a 50:50 Joint Venture the
rights of the shareholders will be based on the division of control between the
Joint Venture Company board and the Joint Venture Parties. The extent of
shareholder rights will be more of an issue where there is a minority
shareholder.
Documenting Minority Protection
Methods of Minority Protection
• The method of protection will depend on the law of the Joint Venture
Company. Few jurisdictions allow a company to establish the rights
and obligations of the shareholders without regard to the corporate law
applicable to the entity through which the Joint Venture is operating.
For example, in Brazil and The Netherlands. But there may be other
forms of business organizations which could accomplish the Parties’
obligations.
• It may also be possible to give an effective veto right in some other
way. For example, the shares of a company can be divided into
different classes. It is possible to provide that certain matters (such as
amendments to the by-laws) are deemed to be a variation of class
rights and therefore require the approval of that class of shareholder.
• Set forth below is an example of a provision giving minority
shareholders rights in a Joint Venture among three Parties owning the
same number of shares two of which were manufacturing companies
owning Class A Shares and the third of which was the government of
the country in which the plant was located owning Class B Shares.
Veto Rights
For each of the actions set forth below in items
(i) through (vii) (other than any action expressly
required to be taken by the Joint Venture
Company pursuant to the Shareholders
Agreement or any of the Business Agreements)
approval of a majority of the issued and
outstanding Class A Shares [held equally by the
two Manufacturing Companies] and a majority
of the issued and outstanding Class B Shares
[held by the Government] shall be required:
i.
ii.
amend the Articles of Association and adopt or
amend the Management Board Regulation;
change the outstanding share capital;
Veto Rights (cont’d.)
iii. enter into a merger;
iv. appoint auditors to examine the annual accounts,
adopt the annual accounts and distribute profits;
v. approve the filing of a petition for bankruptcy or
moratorium, a voluntary agreement with creditors,
or a dissolution or liquidation of the Joint Venture
Company;
vi. substantially change the business of the Joint
Venture Company, bring about major changes in
the organization of its business enterprise or amend
or terminate any of the Business Agreements; and
vii. enter into or amend any agreement between the
Joint Venture Company and either of the
Manufacturing Companies.
[Question: How many of these veto rights limit the day-to-day
operations of the Joint Venture Company?]
Veto Rights (cont’d.)
For each of the actions set forth below in items
(viii) through (x) (other than any actions expressly
required to be taken by the Joint Venture
Company pursuant to the Shareholders
Agreement, or any of the Business Agreements)
approval of a majority of the issued and
outstanding Class A Shares shall be required but
not a majority of the Class B Shares:
viii.
approve the Long-Term Plan, the Annual Budget
and any amendments thereto;
[Questions: What type of things should be included in the longTerm Plan and/or the Annual Budget? Why not include these
in the agreement creating the Joint Venture?]
Veto Rights (cont’d.)
ix.
x.
make any departure from an Annual Budget,
including any loan or guarantee to, or borrowing
from, a third party, and any asset acquisition or
disposition, and any commitment or expenditure, in
each case not included in an Annual Budget; and
make any grant of license for any patent, knowhow or other intellectual property of the Joint
Venture Company.
For each of the actions set forth above, with the
exception of the actions set forth in item (iv), the
approval of the Supervisory Board, acting by a
simple majority vote, will also be required.
Shareholders Agreement
It is also possible to list the matters over which the Parties are to have
a right of veto in a shareholders agreement providing that the company
cannot do any of the things listed without the consent of all Parties.
Again this may be limited by the laws of the country where a Joint
Venture is established.
Conflicts of Interest and Assuring that Parties do not Avoid
their Obligations
– Arrangements for the audit of transactions between the Joint
Venture and any of the Parties.
– Non-compete clauses seeking to prohibit the Parties to the Joint
Venture from competing with the Joint Venture Company during the
life of the Joint Venture.
– Confidentiality agreements requiring each Party to keep information
about the Joint Venture and each other confidential.
If it is intended that the Parties should have
access to confidential information in the Joint
Venture Company, this should be expressly
stated. Parent companies do not automatically
have this right.
• This can be an extremely difficult issue. Each
Joint Venture Party will have certain unique
things to contribute to the Joint Venture.
Consider issues raised by the following:
– Intellectual Property: scope of intellectual property
being contributed and royalty payment.
– Components
• Which components, e.g., everything to be contained in the
final product other than listed items?
• Prices/and price adjustments. Does a replacement
component call for a price increase?
• Services provided
– premises, management, workforce
• Sales to and Purchases from Joint Ventures
– A Joint Venture Party selling to a Joint Venture keeps
100% of any increase in selling price but only its pro
rata shares (e.g., 50%) of any increased profits
earned by the Joint Venture.
– If one Party is looking for products made by a Joint
Venture and other is looking for a share of a Joint
Venture’s profits -- a conflict.
– If one Joint Venture Party is reselling products
manufactured by the Joint Venture, such Party has
every reason to buy cheap and resell at the highest
possible price.
• How can other Joint Venture Party protect itself?
– cost plus?
– market price less a discount?
– competitive price?
Duration Exit and Termination
Duration: Most Joint Ventures do not have a long
life span, other than natural resource Joint
Ventures where many years may be required for
the development and exploration of a mine or
other natural resource.
– Joint Venture Parties are joining for a specific reason,
e.g., to make a new product and after a period of time
one Party or the other may want to make such a
product under its sole responsibility and control.
– Other than natural resource Joint Ventures, most last
less than 10 years.
Duration Exit and Termination (cont’d.)
Exit and Termination:
– The fact that a Joint Venture will have a limited life
should be recognized from the outset and the
bargaining position of the Parties may change, e.g.,
one Party may become dependent on the production
of a Joint Venture company and the other may want
to walk away.
• Alternatives
– Make no provision: “If we make no arrangements for
termination, that will encourage us to work together.”
• that particular Joint Venture was terminated in less than 5
years
Duration Exit and Termination (cont’d.)
Situation to Deal With:
• Consensual Termination
– Both Parties agree in advance that the Venture should end. For
example:
• The Joint Venture is for a fixed term and the Parties agree in
advance that the Venture will terminate at the end of the term.
• The Joint Venture is established for a specific purpose and the
Parties agree in advance that the Venture will end once the purpose
has been satisfied.
In each case the agreement will need to deal with the transfer of
shares (if it is a corporate Joint Venture) or the distribution of the
Venture’s assets on termination/winding-up.
Disposal of an Interest
•
The Parties may have picked each other for particular reasons and want a veto
over any transfer of the interest of the other Joint Venture partner. Joint
Venture Party #1 may have picked Joint Venture Party #2 and neither would
want a transfer to Company #3 which is a competitor .
•
The Parties may be willing for one of their number to leave the Joint Venture,
but for the Venture to continue either with the introduction of a new Party or
under the control of the remaining Party or Parties alone.
In such case, the documents may provide each Party with pre-emption rights in
respect of a proposed transfer of shares by the other Party, either at the price
that the third party purchaser (if identified) is willing to pay or at an independent
valuation. There is often an exception for intra-group transfers so that preemption rights will not be triggered if one of the Parties transfers its shares in
the Joint Venture to another company in its same group.
Most agreements prevent each Party from selling only a part of its
shareholding. This prevents the shareholdings splitting up into many parts.
The discussion so far on disposal of an interest pre-supposes the existence of
a third party buyer.
What happens if the Party having the right to buy the interest of the other Party
is not able to finance such a purchase?
Disposal of an Interest (cont’d.)
DEFAULT/TRIGGER EVENT
The Parties may agree that on the happening of a defined event of default (or
certain other trigger events) the Party in default will be required to sell its
shares in the Venture.
Common trigger events are:
– Insolvency of either Party to the Venture.
– Change in control of either Party.
– Material breach of the shareholders agreement or by-laws (possibly limited to
specific provisions).
– Material breach of any other agreement between the Parties.
On the happening of an event of default, the Party that is not in default is
commonly given a right exercisable by notice to buy the shares of the other or,
sometimes, to require the other to buy its shares. This normally follows a
cooling off period. This may be a long period. For example, one Party only
exercised its buy out rights two days before the end of a twelve-month option
period.
The value of the shares will usually be determined according to a formula
specified in the agreement or by an expert on the basis of specified guidelines.
Disputes and Deadlock
Whether the Joint Venture is a 50:50 Venture or
one with a minority Party with veto rights, the
Parties need to address the possibility of dispute
or management deadlock. The documents should
define the matters that are serious enough to start
a dispute resolution process and set out the
process itself.
Normally, any formal resolution process will not be
initiated unless and until informal negotiations
between the Joint Ventures’ directors/managers
fail to settle the dispute.
Disputes and Deadlock (cont’d.)
Common dispute resolution procedures which have been
suggested:
– Chairman’s Casting Vote. In a corporate Joint Venture, the
board chairman can be given a casting vote.
– Outsider’s Swing Vote. This refers to the decision of an
identified outsider.
– Arbitration or Expert Resolution. This is really only suitable
for a limited range of disputed matters, which are more factual in
nature (for example, a dispute over the valuation of intangible
contributions to the Venture by either Party).
– Escalation. This is where disputes are referred to the chairmen
or chief executives of the Joint Venture Parties. The threat of
enforcing this provision is often enough to encourage managers
to agree before the process is instituted.
None of these are likely to work except in limited
circumstances. If the Joint Venture Parties think that
they may be deadlocked over an issue essential to the
Joint Venture (e.g., a decision to double the production
of the Joint Venture), they are unlikely to be willing to
turn that decision over to any third party.
In practice, the only resolution is for one Joint Venture
Party to buy out the other through negotiation or various
procedures, including “Russian Roulette” and “Texas
Shoot-out”, described below. Although I have
participated in discussions of such arrangements when
negotiating Joint Venture Agreements, I have never
seen them actually included in a final contract.
Russian Roulette:
• Either Party can serve notice on the other
requiring the other Party to buy its shares at a
set price or to sell its own shares to the Party
giving notice at the same price. The other Party
then has a period in which to accept the offer to
buy or sell its shares at that price. This seems a
fair solution and likely to establish a fair price
since the Party setting the price does not know
whether it will be a buyer or seller. But it only
works if both Parties are confident that they will
be of similar financial strength when the
deadlock occurs and will be able to replace
whatever product the Joint Venture is making
from another source.
An example of how such a mechanism may be drafted is set forth
below:
“(d) Final Impasse. Within forty five (45) days after notice of a Final Impasse,
the notifying Shareholder (the “First Shareholder”) may offer to the other
Shareholder (the “Other Shareholder”) a cash price per share (the “Offer
Price”), fully payable sixty (60) days after such notice, for the Other
Shareholder’s shares in the Company. Within (30) days after such notice, the
Other Shareholder may notify the First Shareholder in writing that it will
purchase the First Shareholder’s shares in the Company for an amount equal
to the Offer Price, multiplied by the number of shares then held by the First
Shareholder, on said sixtieth (60th) day. If the Other Shareholder fails to so
notify the First Shareholder of its intent to purchase the First Shareholder’s
shares, the Other Shareholder shall be compelled to sell its shares to the First
Shareholder for the Offer Price, multiplied by the number of shares then held by
the Other Shareholder on said sixtieth (60th) day. If no offer is made by any
Shareholder on or before the forty-fifth (45th) day after notice of Final Impasse,
the status quo shall prevail and no further action may be taken with respect
thereto. If either Shareholder notifies the other Shareholder of its intent to
purchase the shares but fails to tender the required cash on the required date,
the process shall continue as if such notification had not been provided, and
the defaulting party shall be liable for damages under Applicable Law.”
However, the Parties may not be willing to run the risk of a “Russian Roulette” and
such a version is set forth below:
“Deadlock Situation
(a)
Presidents’ Meeting. If the Parties cannot come to an agreement as to a question
as to which Parties are required to agree to pursuant to this Agreement and in
either case the failure to reach any such agreement seriously prejudices the
operations of the Joint Venture Company and the production of the [product] as
provided in this Agreement, then one of the Parties may give a notice of a
deadlock, specifying the nature of such deadlock in reasonable detail. If such a
notice of deadlock is given, the Presidents of the Parties will meet within sixty (60)
days after the date on which such notice of deadlock has been given. The
Presidents of the Parties will endeavor to resolve in good faith the matters which
are the subject of such notice of deadlock.
(b)
Offer Rights. If the Presidents of the Parties do not both resolve the deadlock and
enter into a memorandum confirming that the deadlock has been resolved, within
one hundred and twenty (120) days after such notice of deadlock is given, then
either Party (hereinafter referred to as the “Offeror Party”) may deliver, no later
than ninety days after the expiration of such one hundred twenty (120) day period,
a notice (hereinafter referred to as a “Notice of Offer”) to the other Party
(hereinafter called the “Offeree Party”) making an irrevocable offer to sell for cash
all the Shares held by the Offeror Party at the price per Share set forth in the
Notice of Offer. Such Notice of Offer may be accepted by the Offeree Party during
a period of sixty (60) days after the Notice of Offer has been given by giving
written notice to the Offeror Party and will thereafter expire.”
Texas Shoot-out:
• A variation on Russian Roulette, if the Parties
both wish to buy, is for both Parties to submit
sealed bids, the highest winning. Alternatively,
there can be provision for bidding by auction.
This raises many of the same issues as
“Russian Roulette.”
Continuing Obligations
Even if the Joint Ventures Agreement is
terminated, there may be continuing
obligations, including:
– Continued production
– Supply of replacement parts
– Warranty
– Product liability
– Use of intellectual property
INTERNATIONAL
JOINT VENTURES:
NATURAL
RESOURCES
Generally, the Joint Venture Parties to a natural
resources Joint Venture are making very
different contributions. One, usually the
government of the country in which a mineral
reserve is located (or an agency thereof) is
contributing access to such reserve for a period
of time and the other usually a private entity is
contributing technical, business and marketing
expertise and capital. Because the contributions
are so different and the fact that frequently the
minerals are located in developing countries,
unique questions arise for both the host
government and the contracting private Party.
Concession
– Must be defined as to area and also which particular
minerals are the subject of the Concession
Work Program
– Must define the work that the Concessionaire will
carry out as to development of the mine and building
or repair of existing infrastructure. This can be a
combination of specific tasks (e.g., extract a specific
minimum amount of iron ore) and an agreement to
make capital expenditures in a minimum amount.
– Preparation of a feasibility study demonstrating that
there is a sound basis for a particular project.
Licenses
– Exploratory License
– Mining License
Social and Environment Issues
While these may be to some extent covered by
local law, the Concession Agreement needs to
deal with the following to the extent not covered
by local law:
–
–
–
–
Wages
Health care for employees and dependents
Safety
Education for workers and families when the mine is
located away from existing educational facilities.
Social and Environment Issues (cont’d.)
– Training and employment of local workers;
limits on employment of expatriates.
– Protection of existing residents within the area
where a Concession is located
– Private security forces
– Right to use existing infrastructure (e.g., ports,
roads and water)
– Environmental issues
• responsibility for past pollution?
• obligation to observe adequate environmental
standards
Example of a Corporate Structure
Government or
Governmental Agency
Concessionaire
(ownership
interest)
(ownership
interest)
Joint Venture Company
Sales Company
(Marketing Product)
Operating Company
(providing management services)
This structure suggests many of the issues that arise with Natural Resources Joint
Ventures
Capital Structure
Concessionaire generally has a majority of
the stock of the Joint Venture Company
– What does Government pay for its interest?
– Is the Government’s interest subject to dilution
upon the issuance of additional shares upon
the increase of the Joint Venture’s capital?
– Assuming that both the Government and the
Concessionaire have an ownership interest as
stockholders of the Joint Venture Company,
what right does the minority stockholder,
which is usually the Government, have?
Under most corporation laws, ownership of
less than 50% of a Joint Venture Company
gives few rights except for major actions
such as mergers, sale of substantially all
the assets and dissolution.
– As in the example cited above under
manufacturing Joint Ventures, stockholders
may be given specific rights to approve or
disapprove particular matters, e.g., capital
expenditures in excess of a stated amount or
to name a certain number of the directors of
the Joint Venture Company.
Right to name a certain number of directors or
certain officers (e.g., a vice president) are only
substantive if such persons can institute or block
certain actions by the Joint Venture Company.
This relates to:
– Social/Environmental Issues, and
– Economic Issues
Insofar as the Joint Venture Company names an
Operating Company to carry out day-to-day
operations and a Sales Company to market the
mineral produced, the Government is further
removed from influence as to both
Social/Environmental Issues and Economic
Issues.
Economic Issues
Amounts paid by the Concessionaire to
the Government include the following:
– Upfront payments, royalties (insofar as
royalties are based on verifiable production
figures and arm’s length prices) and real
estate taxes based on the area covered by
the Concession are effective ways to provide
revenue to the Government.
Economic Issues (cont’d.)
– Dividends and similar amounts paid by the
Joint Venture Company to the Government
and the Concessionaire as stockholders
• Are based on earnings and thus influenced by:
– charges by the Operating Company, prices paid by the
Sales Company
– declared by the Board of Directors of the Joint Venture
Company, usually at the discretion of the Board
– require agreement on applicable accounting principles,
sophisticated accounting systems and financial controls
and the personnel to perform these tasks
Transparency and Confidentiality
– Need to protect true business secrets but lack
of transparency raises major issues
• limits civil society participation,
• encourages lack of accountability and
• provide an opportunity for corrupt behavior
– Extractive Industries Transparency Initiative
(EITI) to disclose payments by
Concessionaires and receipts by
governments of all payments by one to the
other
Term and Termination
– Natural Resource Joint Ventures have longer terms
because of time required for development and will
usually permit the Concessionaire to develop the
particular reserve which may take an extended period
(e.g., 25 or more years). Extension by mutual
agreement, or unilaterally by Concessionaire or
based on new feasibility study.
– Termination
• for default or non-performance
• rights to concession and infrastructure
• payment obligations upon termination
– immovable assets become property of the Government
– movable assets
» Concessionaire may have right to remove
» Government may have an option to purchase
Stabilization Clauses and Tax Holidays
– Establishes that certain clauses of the
contract override applicable law
• protect long-term investments
• would not be accepted by countries in developed
world
– Tax holidays are common but can very
substantially limit the payments made to the
Government.
Other Issues
– Reports
– Benchmarks which permit the government to
terminate if certain benchmarks are not realized so as
to avoid a concessionaire from signing concessions
with the intention of holding them for resale or holding
them as a reserve against future contingencies
– Access to geological and other information developed
by the Concessionaire and the Joint Venture
Company
– Arbitration
• important for Concessionaire
• Tajikistan aluminum plant litigation in London
– Force Majeure
• exclude governmental action
Case Study
• The following Case Study is based on
provisions actually included in agreements
relating to one or more Natural Resources
Joint Ventures and illustrates some of the
risks to which an agency of the
government of the country where the
Project is located (“Governmental
Agency”) may be exposed.
I. CONTRACTING PARTY, CONTRIBUTIONS OF THE
PARTIES
Is the Concessionaire a substantial entity which could carry out
its obligations and be able to pay damages for a failure to
perform?
Joint Venture
The project will be carried out by a company (the “Joint Venture
Company”) formed under the laws of the government (the “Host
Government”) of the country (“Host Country”) in which the Project
is located to be owned 68% by the Concessionaire and 32% by the
Governmental Agency. The primary agreement among the
Concessionaire, the Governmental Agency and the Host Country
will be referred to as the “Joint Venture Agreement.”
• What problems?
• What are the powers of the holder of a 32% minority interest?
Contribution of the Parties
The Concessionaire’s obligations are:
• Payment to the Host Government of a lump sum of US$200 million.
However, this is subject to fulfillment of certain conditions, such as
the approval of the Prefeasibility Study by the Concessionaire at the
time of the approval of the agreement constituting the Joint Venture
Company, an audit of the validity of certain mining rights to be
transferred to the Joint Venture Company and the actual transfer of
such mining rights to the Joint Venture Company.
• Arranging financing for the Governmental Agency for the
rehabilitation of certain existing mining facilities.
• Carrying out a Prefeasibility Study.
• Helping the Joint Venture Company achieve commercial production
of a defined level within a certain period.
• Arranging financing for the mining and infrastructure projects.
The infrastructure projects contemplated are listed in an annex to the
Joint Venture Agreement and include the rehabilitation of railway lines,
the construction of roads and the building of hospitals.
•
•
•
•
There is no guarantee as to which infrastructure projects will be
undertaken and when.
Some of the projects are subject to the availability of revenues
resulting from the mining operations.
No guarantee of the total amount of the investments to be made.
Lending the Governmental Agency the funds necessary to pay for
its shares and its proportionate share of any capital increase.
– Where will the Governmental Agency find the funds to repay such
loans?
•
•
Does the Governmental Agency risk seeing its interest diluted?
How much equity will the Concessionaire provide?
•
Anti-dilution will be important to the extent that the equity ownership of the
Governmental Agency gives it veto rights or the right to receive dividends in
so far as there is some assurance that profits will actually be paid out as
dividends. In some agreements, the share of the Governmental Agency’s is
non dilutable and the Governmental Agency is not obligated to pay for any
additional shares to maintain its proportionate interest.
The obligations of the Governmental Agency are:
• To transfer to the Joint Venture Company mining rights to reserves of more
than a specified number of tons of ore with an obligation to transfer
additional reserves if the Feasibility Study does not support these reserve
figures,
• Help the Joint Venture Company achieve commercial production of a
defined level within the time specified in the Feasibility Study
• Transfer to the Concessionaire other mining concessions or other resources
in case the revenues generated by the Joint Venture Company prove to be
insufficient to reimburse the investments in the mining and infrastructure
areas,
• The Convention requires that the Prefeasibility and Feasibility Studies show
an Internal Rule of Return (“IRR”) of a specified amount. There is no
indication of how or by whom the IRR will be calculated. It is unclear what
happens if, notwithstanding the Feasibility Study, the Project turns out to be
less profitable when actually executed.
II. COMPENSATION AND PAYMENTS
Reimbursement by the Joint Venture Company of Mining and Infrastructure
Investments
Three-stage Mechanism
The Joint Venture Agreement sets out a three-stage mechanism for the
reimbursement of mining and infrastructure project costs by the Joint
Venture Company:
•
•
Mining Cost Recovery: During Stage I, all profits of the Joint Venture
Company will be applied to the repayment of these mining costs.
Infrastructure Cost Recovery: During Stage II, which is the period after the
recovery of the investment in mining operations, 66% of the Joint Venture
Company's profits will be applied to reimbursing the costs of certain
infrastructure projects and 34% distributed to the joint venture partners.
- What percentage of the profits will be distributed to the Governmental
Agency?
•
Commercial Exploitation (Stage III): once the amount of the investments
and costs have been repaid, all profits will be allocated among the joint
venture partners according to the 68%/32% equity split.
Dividends
No provisions are made as to the payment of dividends. The Joint
Venture Agreement provides only that the Joint Venture Company will be
formed in accordance with the rules and customs current in the Host
Country. Since the Concessionaire is entitled to 68% of the equity, any
payment of dividends will be subject to the accounting standards adopted
and, to the extent that there are profits, the approval by the Board of
Directors of the Joint Venture Company which is controlled by the
Concessionaire.
Transfer Pricing
There are no provisions as to transfer pricing in the Joint Venture
Agreement, and thus no guarantee that there will be contractual limits on
either (i) the amounts charged by the Concessionaire and its affiliates to
the Joint Venture Company for the mining work and the infrastructure
projects, or (ii) for the price to be paid to the Joint Venture Company by
whatever company that will be marketing the ore produced.
Windfall Profits
The Joint Venture lacks a provision to deal with the eventuality that the
resources are far more profitable than anticipated.
IV. OPERATION AND OVERSIGHT
Minority Joint Venture Partner
The Governmental Agency will be the 32% owner of the Joint Venture
Company with no provision as to rights to name directors or officers or
to veto certain major decisions by the Joint Venture Company and/or
decisions which may adversely affect the Host Country or the local
inhabitants or the environment.
Moreover, the Joint Venture Agreement provides for the naming of a
prime contractor for the infrastructure projects and says that the Joint
Venture Company will not intervene in the operations or the supervision
of the infrastructure projects. The Joint Venture Agreement refers to the
Concessionaire presenting financial and technical proposals for the
infrastructure projects chosen by the Host Government, but no review
of the Concessionaire’s determination of costs is provided for.
An article of the Joint Venture Agreement provides for annual meetings to
discuss the Project and any differences. Such very general language has
been used to reassure certain parties to joint ventures that any future
difficulties can be worked out.
Financial Controls
There are no provisions in the Joint Venture Agreement for financial
statements or information which would permit the Host Government or
the Government Agency to be informed as to the operation of the Project,
or for auditing and no requirement for:
• quarterly unaudited financial statements.
• annual audited financial statements
• independent auditors of internationally recognized standing
• making financial information public
Loans
Loans will be arranged by the Concessionaire and the interest rates
charged will almost certainly be lower than the Governmental Agency
could obtain on its own.
• There are no limits to the interest charged to the Joint Venture
Company
Procurement, Employment, Training
The Joint Venture Agreement provides that businesses located in the Host
Country will be used to the extent that they are able to carry out the
particular assignment, and the infrastructure projects will provide major
benefits when and to the extent realized. The Joint Venture Agreement
provides for a preference for subcontractors located in the Host Country in
the rehabilitation of certain facilities.
• There are, however, no express provisions relating to the training or
employment of nationals of the Host Country. The Joint Venture
Agreement contemplates employment of, or contracting with the Host
Country enterprises only if they are “capable”, but no provision is made
for training or technical assistance where local capacity does not
currently exist.
Local Population and Environment
There are no provisions relating to social or environmental matters.
As the mining operations are subject to the laws of the Host Country,
they would be subject to the social and environmental provisions in
existing law. However, the stabilization clause referred to below means
that any improvements in the laws of the Host Country will not apply.
V. MISCELLANEOUS OTHER PROVISIONS
Confidentiality and Transparency
Usually there are confidentiality provisions in the agreement relating to
such Projects.
Choice of Law, Stabilization and Most Favored Nation Clause
The Joint Venture Agreement refers to the law of the “place of the act”
• Does this refer to (i) the signing of the Joint Venture Agreement, which
took place in the Concessionaire’s home country, (ii) the performance
of the Joint Venture Agreement, which will take place in the Host
Country, or (iii) something else?
• If the governing law cannot be determined using this provision, the
Joint Venture Agreement will refer to the criteria usually used in
international commerce to decide the question.
–
Does this provide any additional guidance?
The Joint Venture Agreement provides the Joint Venture Company with
the benefits of any new laws and most favored nation treatment with
respect to any other investment contracts.
The Joint Venture Agreement also contains a stabilization clause with
respect to existing laws. This means that any improvements in the
laws of the Host Country which are burdensome to the Concessionaire
– in the environmental and social areas, or as part of the Extractive
Industries Transparency Initiative (“EITI”) – will not apply.
Termination
The Concessionaire has the right to terminate the Joint Venture
Agreement if the National Parliament of the Host Country does not
adopt a law legislating the fiscal, customs and exchange provisions of
the Joint Venture Agreement.
In the event that there are defects in the mining rights which cannot be
corrected, the Joint Venture Agreement will be cancelled. It will also be
cancelled in the event of failure to approve the Feasibility Study that
cannot be remedied by the transfer of additional mining rights to the
Concessionaire.
The Host Government and the Governmental Agency have no
termination rights if, for example, the Concessionaire fails to arrange
the financing referred to in the Joint Venture Agreement. Moreover,
there are no restrictions on the Concessionaire terminating the Joint
Venture Company and distributing its assets to its shareholders.
Transferability
No limitations are placed on the Concessionaire from transferring all or
part of its interest.
Conclusion
I thank you for your attention and
participation and hope that you have found
these lectures to be interesting. As I stated
at the beginning of this course, the purpose
of the lecture was not to explain what legal
provisions would apply to particular
agreements in particular countries but to
consider certain questions which may arise
in a variety of cross border transactions.