International joint ventures and collaborations

The first initiative for free-trade was taken soon after World War-II. During the war, the countries protected economies by imposing too many restrictions on imports. After the war, reconstruction activities were to be started in war-torn countries with a view to achieve rapid rehabilitation and increasing employment. These objectives could not be realised until free-trade was promoted in the world community.
Accordingly, in the International Conference on Trade and Employment (ICT&E) in 1946 at Geneva a draft charter was advanced and mooted for creation of International Trade Organisation.
The US did not go with this proposal. As such, the same was dropped and with continuous efforts and persuasion, another body, namely General Agreement on Tariff and Trade (GATT) was created in 1947. The purpose was to promote free-trade amongst member countries, so that they may share fruits arising from economic growth and development in their countries.
GATT started functioning with effect from 1st January, 1948 at Geneva with a view to conducting world trade on non-discriminatory basis, protecting domestic industry by means of customs tariffs and not through other commercial measures, eliminating non-tariff barriers like import licensing, quotas and other forms of restrictions and reducing tariff and other barriers to trade through negotiations.
WTO's predecessor GATT was established in the wake of multilateral institutions, notably the Bretton Woods institutions known as the World Bank and the International Monetary Fund - dedicated to international economic co-operation, coming into being.
The result of the Uruguay Round negotiations was the Agreement on Trade Related Investment Measures (TRIMs) which prohibits WTO member countries having any TRIM inconsistent with GATT. There is general agreement that trade liberalisation is one of the most effective methods of stimulating competition, and that competition in turn stimulates efficient allocation of resources, protects quality and innovations, and as such promotes industrial and technological development and restructuring.
Article 5 of the Agreement requires members to notify the Council for Trade in Goods all the existing TRIMs not in conformity with the agreement and to do away with such TRIMs within a period of time depending on the country's level of development. Disputes over members' use of TRIMs are required to be settled under the dispute settlement mechanism of the WTO.
The agreement on TRIMs, a separate agreement that is part of the agreement on trade in goods, only confirms the legal situation under the GATT regarding inconsistency of certain TRIMs.
It resents those measures, which are prohibited by GATT Article III (on national treatment, prohibiting local content and trade balancing requirements) and XI (on prohibition of quantitative restrictions). Though the agreement provides for certain flexibilities, in essence it does not add any new restrictions and obligations.
The movement of some US Companies to Europe in pursuit of new pastures appears to have really kicked the phenomenon of internationalisation soon after the World War II. By their so moving to Europe these companies became multinational or transnationals.
The global free trade regime has changed the philosophy of production. Exporting their products to other markets, in the beginning, multinationals companies had their manufacturing structures clustered in the countries of their domicile. Their later modus operandi has been that they set-up their plants in other countries and started producing locally.
This had to lead to internationalisation of trade, commerce and services. And it did. As a sequel to globalisation, international joint ventures had to emerge and they have.
Products of the multinationals are standardised. The products they sell with relatively less importance given to difference and diversity of consumers over places they market the products. They, however, recognise the consumers preferences. They attempt and in fact change such preferences. Reaching distant markets they attract consumers who previously held different habits and tastes. Follows the flow of capital across borders.
'Joint venture' or 'collaboration' refers to an agreement between parties to do business in a particular form in a jurisdiction by means of a stable legal entity for a term, usually indefinite, with economic independence and a lawful commercial purpose.
An international joint venture arises when it is doing business in a jurisdiction that is not the country of origin of at least one of the parties. When all the parties are citizens of the same country, we have a domestic joint venture. Not initially found in a theoretical framework, the international joint venture has been adapted to confront an immense diversity of factual situations. Displacement of one commercial entity to a foreign jurisdiction has the roots of so many problems associated with international joint ventures.
There is a variety of forms of international joint ventures and collaborations like distribution contracts, agency relationships, franchises, various licences, patents, copyrights, trade secrets, know how agreements and of course direct equity investments. Equity investments can also be made by purchasing share(s) in an existing company.
Cautious investors make sure that they are aware of the laws affecting foreign investment in the host country. A foreigner most successful is the one who knows various sources of law affecting foreign investment.
Every country has its operational code. It has a system imbibing both written and unwritten laws.
The operational code occupies a pivotal position in a host nation's governance of foreign direct investment because it allows the governments to unequally treat foreign enterprises. More important than permitting unequal treatment is that a potentially unpopular, flexible, operational code is hidden from the public eye.
Responsible disposition is of the one who may simply have "read" the operational code more effectively than others. Nationalistic pressures may have caused the enactment of a restrictive public code for foreign investment. A nation's public code governing foreign direct investment may be extensive. Consequently, the public is permitted to think nationalistically while the government is able to function pragmatically.
Foreign investors' advisors do not rely on the written code as constituting the total framework of investment regulations. To understand the operational code is important, more so because a large part of it is unwritten. Often this is part of the public code. Orders issued by the government may, however, be in such a large number and are difficult to locate. They must be considered a part of the unwritten operational code. Ignorant of these a foreign investor is not in a secure position.
Not following the public code can lead to increased criticism from the public, particularly the press and academia which may identify practices of foreigners that, in their perception, appear to be at variance with the public code. Although they may not have necessarily violated the law. They may have followed the written public code completely.
Lawyers are diligent in finding all the written laws affecting foreign investment in the host country. Still the investor finds that he has unanticipated roadblocks in the host country. The 'unwritten laws' part of the operational code has an array of regulations which blurs the certainty of written laws. Its magnitude is often enough to push business negotiations to a sense of futility. As a result some investors have a detour - a costly one. Such a detour converts a potentially profitable proposition into a loss situation.
JOINT VENTURE AGREEMENTS:
Variety and innovation accompany the creation of an international joint venture. This flexibility has one limiting factor. The possible form of a joint venture or collaboration can only be a legal form viz. limited liability companies, business trusts, general and limited partnerships. Even this enumeration is just a reasonable part of the legal possibilities. The form is more dependent on the underlying purpose of the participants. Variety and innovation accompany an international joint venture.
The words 'international joint venture' encompasses a wide variety of concepts such as:
-- co-partnering arrangement.
-- cross-border co-operation.
-- cross-border merger.
-- international acquisition.
-- international co-operation.
-- international merger.
-- joint adventure.
-- joint partnership.
-- mergers and acquisition.
-- strategic alliance.
These terms are useful in calling attention to the various methods of operating a business abroad. The terms strategic alliance and international co-operation as also such other nomenclatures are fruitful in revealing the broad scope of legal alliances, the myriad techniques entrepreneurs have developed through experience.
The final joint venture agreements should state the purpose of the venture. It should protect confidentiality of information. The agreement can be an exhaustive document. There may also be a number of documents for the purpose and thus an integrated approach pursued. At times, segregating components of a joint venture agreement may be advantageous.
Accounting and other financial procedures for a joint venture have to be set forth in detailed documents. Concepts or terms may need to be defined on a basic level to provide a margin of safety in interpretation of the agreement. Definitions laying down in the agreement is a helpful method for understanding the substantive provisions. These provide an extra level of guidance to future readers who may have had no involvement with the original joint venture negotiations.
The joint venture parties have to agree on the law that should govern the joint venture. Normally, the joint venture should be governed by the local laws. The parties may, however, desire to have their contract governed by the laws of another country.
The parties may be able to specify that different laws will apply to different sections of the contract. Many countries have strict laws protecting native employees. They do not permit the parties to avoid local laws by invoking foreign laws to govern their employees.
Normally, all joint ventures are subject to laws and regulations relating to local export controls and sanctions, local anti boycott rules, antitrust, labour, environment and securities, importation, agency or distribution contracts, franchises, technology transfers. In consultation with local counsels, parties may be able to lessen local laws impact.
A joint venture agreement may be detailed and a multi page document. It may also be a one page document. A detailed agreement may cover:
-- contributions by the parties.
-- 4technology transfer risk.
-- responsibilities.
-- laws governing the enterprise.
-- governance.
-- disputes resolutions.
-- language, covering interpretation.
-- formalisation.
-- force majeure.
To avoid going to a court where, in their perception, the local partner may have a 'home field' advantage, parent companies prefer to have their disputes settled by arbitration or alternative disputes resolution method.
The problem of local counsel may be simplified if there is already an established relationship. Such a convenience is not available to a party looking to use a joint venture arrangement to enter a market for the first time.
ESSENTIAL FEATURES OF A JOINT VENTURE:
A joint venture is an arrangement between parties to get into a combination and to commit resources with the objective to manufacture, produce or sell certain products or to render a service, share profits and the relevant risks, in an agreed manner. These are often the means to put in place production facilities, technology or know how.
The risks of operating in an unfamiliar jurisdiction can be daunting. The risks can be catered by a joint venture with a compatible local partner familiar with local business practices, processes, procedures, laws and customs.
Manufacturing companies can license their products for production and sale to foreign firms. Service firms may franchise their type of operations to overseas companies. Through collaboration relationship, a company may enter into a variety of joint ventures and strategic alliances. Collaboration may take place by ways of:
-- Licensing manufacture and sale of the products, services or technology transfer to a company in another country in return for royalty.
-- Franchising.
Licensing is also used to kno more about a foreign market. The knowledge so acquired may be used by the principal to determine feasibility of a direct investment.
Franchising has become enormously grown. Growth of franchising method of doing business is attributed to increased demand for contemporary style services in developing countries. A franchise is given only after the prospective buyers are able to show that they have the requisite capital and managerial ability. Franchising method of operations is most prominent in eatables industries, particularly in fast food. McDonalds, KFC and Dunkin's Donuts are popular in other countries.
An understanding between parties for setting-up and operation of a joint venture company involves various issues. It may require devotion of sizeable time by the parties concerned. Drafting various provisions of the agreement has to be preceded by careful negotiations. The issues may be:
-- purpose of the joint venture.
-- contributions by the parties.
-- capital structures, mode of raising the initial capital and further issue of capital.
-- management.
-- control and administration.
-- duration, continuity and termination of joint venture.
-- other operational issues.
To come to a decision whether a joint venture should be equity based or otherwise, factors entering consideration are:
-- goals and expectations; rewards, cost of funds and opportunity costs.
-- effect of domestic and foreign taxes.
-- needs regarding control and management.
-- business considerations of the local jurisdiction.
Specific methods employed by companies operating in international environment are:
-- operating facilities in other countries.
-- entering into strategic alliances.
-- establishing contracted relationships with foreign companies.
-- marketing abroad directly.
Selection or rejection of one or more methods of joint ventures is based on a variety of reasons. A joint venture may be set-up as a counter to barriers to the parent company existing in a country.
The essential features of a joint venture agreement are:
1. Agreement between the parties on common objectives.
2. Pooling of facilities by the constituents e.g. finances, know how, intellectual property rights and characterisation of the pooled assets.
3. Pursuance of the agreed objectives through the joint venture's own management.
4. The method of sharing profits of the joint ventures, with liabilities of the parties limited to their capital contributions.
There is not much of a problem of documentation in case the investment is made through purchase of shares of a company quoted at the stock exchange and regulations of the relevant country allow sale of shares to aliens ie to persons who are not citizen of the country.
Aside purchase of shares from the market or through personal negotiations, investment can be made by forming a company, a legal person, or without forming a company e.g. through establishing a relationship by contract. When the decision is to form a company, the question is: what will be the form? A private limited company, a public limited company - not listed, a company listed on the stock exchange or a statutory body formed through governmental legislation! There are countries which allow 100% foreign equity. Pakistan is one of them. There are others which insist on a minimum local equity percentage. The next question to be attended would be whether the total resources required should be ploughed through equity or partly through equity and partially through debt. What ratio should debt have to equity? Answers have to be found. Understanding will have to be developed of the relationship between capital and corporate control, accounting implications, minimum percentage of shareholding required to grip veto power, alternations to capital contributions and aspects regarding debt.
OWNERSHIP AND CONTROL:
Apparently the measure of control over the enterprise should be determined by the proportion of equity contributions of the respective parties. But this is not the case in real life. Divorce of the degree of control, exercise of management is decided by a variety of factors. In many cases, the local shareholders are essentially recipients of dividends or entitled to representation on the management boards. Effective management is left to be catered by the foreign partner without reference to his equity contribution towards the enterprise.
Foreign investors have a feeling of their technical superiority. They hold that this is a sufficient cause to prevent the local majority party from abusing its voting control. After getting into a minority participation sort of situation, the foreign partner often tries to get compensated for the voting control given away.
This he does by concluding special agreements with the local majority partner and/or by exercising a de facto control on the enterprise. After he has sought or accepted a minority participation, it has a variety of protective devices. Some of there are provided by the local corporate laws. Others have to be stipulated in the joint venture company's statutes/articles of association. The right of veto and representation in management bodies are the two common devices in this respect.
The articles of association of the joint venture may, in addition, provide that other specified matters may be decided only by a special resolution. While drafting the articles of association the two major parties ensure that important matters relating to their interest in the company may not be decided without their consent.
The joint venture agreement should hold the structure. To this end, the agreement provides for governance of the company and appointment of key personnel to oversee and manage the joint venture operations. The joint venture parties should spell out what matters they can vote upon. The requirements for a successful vote on particular matters may also be laid. The number of directors and appointment procedure may be prescribed. So provided can be the procedure by which decisions are to be made at the board of directors level. Through the World Trade Organisation's promotion of 'natural treatment', loosing control on foreign ownership should be the trend. But in some countries there are substantial limitations which have a start from prohibition to do business in certain sectors.
It is common to limit foreign participation to a minority share where limitations on foreign equity in a joint venture exist. Where foreign participation has to be restricted to a minority share, protective measures or even control over the venture may be structured also through:
-- joint venture agreement.
-- intellectual property rights agreement.
-- articles of incorporation.
-- partnership agreement.
Devising an appropriate governance structure for a joint venture company is of critical importance to the growth and success of that venture. The parties have to consider various issues e.g.:
-- complexion of the board of directors.
-- appointment of officers and key managers.
-- what should constitute material issues.
-- rights of each party on material issues.
-- officers and committees to manage functions of the venture and the mode of their working.
-- outsourcing.
-- method of resolution of disputes.
Decision making power vests in a joint venture. Normally it is with the party that brings essential skills, technology or other resources to the project even if equity-wise it is a minority party.
MANAGEMENT OF JOINT VENTURES:
To compensate for the absence of voting control a foreign investor accepting a minority participation tries to put in place special agreements with the local majority partner. The objective is to have overall control. Alternatively, put in place is a system in terms of which the foreign investor he has a de facto control on the enterprise.
This is despite the fact that technical superiority represents a sufficient lever to be effective in a situation in which real effectiveness of a party having majority of voting powers is consigned to its real place.
Parties hands are somewhat tied by local laws. To be a success, the joint venture should be compliant with the particular laws and local business climate. Agreement for management of the joint venture must be crafted in a way that they so do.
Presence of a local businessman may be considered necessary to get essential tasks completed despite the fact that the law allows 100 percent foreign equity. Some regulations or postures in the investee countries require that specified positions should be filled by locals. The joint venture agreement should provide for the relevant positions and mode of their filling.
The joint venture has to cater bringing together the approach of people who, drawn from different cultures, are part of a team. Association or hiring of outsiders may sometime be called for to bridge the gap. Such a substitution may be unfeasible when particular knowledge or expertise is existing only among the contributories of a joint venture. It may be appropriate to assign day to day management to one of the parties to a joint venture.
Key managers of a venture may or may not remain part of the parent company's organisation. They may be kept on a joint venture parent's payroll. Complications difficult to do away with may arise if the management's loyalties are not with the venture. Therefore, career issues of the management personnel viz. current advancement, future opportunities and compensation packages should be carefully sorted out at the time of joint venture taking shape.
THIRD PARTIES IN A JOINT VENTURE:
There may be substantial disparity between resources of parties to a transnational joint venture. Because of insufficiency of resources of one of the parties additional capital, when needed, may not be easy to get. Disturbing the subsisting capital ratio between the parties may not be feasible.
What should be done if one party is not in a position to contribute additional capital? To keep the capital contribution ratio in tact the convenient mechanism would be to look to a third party to foot the additional funds requirement bill. The joint venture agreement has to provide for such a situation.
The agreement may provide that, in a predetermined manner, the other party can make the contribution in some way, directly or by lending to that party or to the joint venture. Even when the joint venture obtains loan finances from one of the existing shareholders, there may be concerns of the other party regarding effects of the borrowing on the business relationship between the venture and the loan provider.
JOINT VENTURE PARTIES/SHAREHOLDERS AGREEMENT:
Selection of goods partner(s) is key to success in any joint venture. Negotiations require an understanding of legal and cultural background of the parties. Personal interviews with a prospective partner need to be supplemented. There has to be due diligence.
After the decision for going into the partnership the parties sign a memorandum of understanding (MOU) or a letter of intent. The terms should be thoroughly debated and digested to ensure that the same duly take care of interests of the parties. Such a clear understanding is necessary to avoid a possible misunderstanding later on.
It is very common that joint venture agreements, more particularly involving transactions, seek to confer upon parties special rights, often referred to as veto rights, qua board meetings and general meetings. These rights may form part of articles of association of joint venture companies. These may be provided by way of agreements.
The shareholders' agreements are not binding on the company (joint venture). A shareholders' agreement and a joint venture agreement vis. a vis. statutory rights of directors are not valid. A shareholders' agreement, not in keeping with the articles of association, is not in order. There may be a policy agreement in between two or more shareholders, which provides for exercise of votes in a given manner whenever voting is held.
In a pooling agreement the shareholders retain ownership of their shares but bind themselves to vote in a specific manner. It is a contract binding the parties that the shares held by them shall be voted as a single unit. Generally, pooling agreements are for purposes of control of companies in a joint venture. However, the law does not permit superseding the statutory rights and responsibilities of the board of directors.
The directors are fiduciaries of the company and the shareholders. It is their duty, in their individual capacity also, to do what they consider best in the interest of the company. They can not abdicate their judgement by entering pooling agreements. What is prohibited by law can not be achieved by a pooling.
No stipulation is lawful in terms of which one agrees to carry out his duties in accordance with the instructions of another person rather than on his conscientious judgement or to perform in accordance with dictates in a document.
It is in disregard of the fact according to which he had agreed to sub-ordinate the interests of those whom he is duty bound to protect. Discretion of the directors to act in administration of affairs of a company can not be fettered by agreement. Therefore, an agreement in this behalf is invalid.
An agreement between the shareholders can not be a contract binding on the company even if the company has acted thereon. Some law pundits are of the view that even if the articles provide that the directors shall give effect to a pooling agreement between the shareholders, such an agreement shall not be construed a part of the articles.
RIGHTS OF DIRECTORS AND SHAREHOLDERS:
Conclusions in relation with joint venture agreements viz. a viz. rights of the parties are:
1. The joint venture documents and agreements are critical to the success of a venture. These form basis of relationship between the parties. These are relied upon to affirm that everybody understand his role, responsibilities and rights in the game. Joint ventures are entered with good faith but their terms need to be closely scrutinised.
2. The joint venture agreement may be one (single) document or an integrated approach may be adopted. An integrated or composite approach would mean that a host of documents put together bring fore the position of a joint venture. It is not necessary that all these documents are drawn under the same country laws.
3. As a sequel to these agreements, the party(ies) named have effective control over the joint enterprises. The Board of Directors and managers of companies remain where they are. But they are affected rather they are subservient to the agreement(s). Therefore, the parties must strike a balance between their rights and privileges as also responsibilities and powers of the relevant board of directors. As stated herein, the authority in effect flows with the agreements between the parties. However, as the companies are legally driven by the boards of directors, advisable is to include key issues relating to operation of the joint venture agreement enterprises eg:
-- legal compliances.
-- insurance.
-- disclosure of information.
-- accounting and financial reporting.
-- allocation and distribution of income and dividend policy.
-- purchase of interest of the party walking out of the joint venture.
-- additional capital issues.
-- borrowing of money.
-- investment of funds.
With reference to a combination of these, the joint venture agreements or the articles of association may provide that the same will be decided by a unanimous vote of the board of directors of the venture concerned. Nominees of the parties on the board of directors normally seek advice of their nominators before they vote in relation to the specified matters.
4. The restrictive clauses of a joint venture agreement can not bind individual directors at meetings of board of directors of the company.
5. The restrictive clauses of a joint venture is a contractual matter. It is not an exacting law. Being unconstitutional, restrictive clauses against the public interest are void contracts.
6. A company and its shareholders are distinct and separate legal entities. Restrictive clauses in a joint venture may be binding on the shareholders but not on the company. The restrictive clauses do not bind the shareholders unless they have consciously given-up their rights as shareholders. Whether a set of shareholders can divest with the rights available to them under a statute will depend on the circumstances.
7. It would not be in order to give powers to a director to obstruct a company's decision making by not attending the board meetings or doing or abstaining from doing any or more of such acts. Unless upheld by over riding considerations such as public interest, the power of veto is oppressive, obnoxious and arbitrary. As an instrument of obstruction or retardation of progress of the company, veto power can never be justified.
8. If not violative of law, a joint venture agreement may retain restrictive clauses. The company, its directors and shareholders may restrain from doing their business in the normal way in the wake of such clauses. But veto rights relating to quorum and voting on resolutions etc are not enforceable under the Companies Law. The law would be with violators of the unlawful conditions instead of being with the ones who seek their enforcement. As such violators of unlawful conditions can not be put to task.
DRAFTING A JOINT VENTURE AGREEMENT:
It would be naïve to believe that one can conveniently draw a set of or frame the terms and conditions of joint venture agreements. The conditions vary according to the requirements. Drafting a joint venture agreement should take place bearing in mind the following factors:
DRAFTING AN AGREEMENT FOR MANUFACTURE, DISTRIBUTION ETC:
1. Definitions of technical terms should be provided.
2. Nature, terms and condition of technical know-how, disclosure of drawings, specifications and other documents, furnishing of technical information in respect of processes with flow charts etc, plant layout, list of equipment and machinery.
3. Capability of the parties and requirements of the parties should be clearly indicated.
4. Whether the products shall be manufactured/sold on exclusive or non-exclusive basis.
5. Details regarding specifications and quality of the products to be manufactured should be provided.
6. Mode of making available engineers and / or skilled workers by the party(ies) and provisions regarding payment of expenses to them including payments relating to their stay per diem to be specified.
7. Quality control to be spelled out.
8. Trademarks to be used to be stated.
9. Responsibility of the collaborators in establishing or maintaining the Assembly, plants etc.
10. If sub-contracting of the work is involved, detailing restrictions, if any.
11. The rate of royalty, mode of its calculation and payment etc and who will bear taxes related with such payments.
12. Provision regarding the collaborating institution providing training personnel to the joint venture enterprise and its time frame. Also clearly provided should be the terms and conditions of such assistance, place of training, period of training and fees payable.
13. Use of information and industrial / intellectual property rights.
14. Force majeure.
15. Specific provisions regarding penalties/liquidated damages
16. A comprehensive clause on arbitration or disputes resolution and place for the purpose.
DRAFTING AN AGREEMENT FOR TECHNICAL KNOW-HOW TRANSFER:
In case of an agreement for technical know-how transfer, should be provided:
1. Definition and characteristics of the subject-matter of know-how.
2. Mode of transfer of technical know-how ie the time and place of transfer and whether the transfer is absolute or for a specified period.
3. Arrangement for safeguarding secrecy of the technology.
4. Details of training to be given to the technical personnel of the joint venture by the foreign collaborator.
5. Performance guarantee in regard to achievement of the required quality/standard of the product, quantities to be produced and minimum performance level.
6. Indemnity clauses.
7. Details of conferring license or patent right for technical know-how and the product to be manufactured, if any.
8. Mode and method of payment by way of royalty or technical fees - lump sum or ad valorem.
9. Ownership issues of (future) improvements in the technology of the transferor made by the transferee of the technology.
AGREEMENT FOR A JOINT VENTURE OTHERWISE SHOULD ALSO PROVIDE:
1. details regarding form of joint venture.
2. constitution of the Board of Directors with election, number of directors and the powers of the Board:
-- who will run the management of the company, and
-- pre-emption rights on the shares of the company.
3. mode of declaration and distribution of the dividends.
4. area of marketing of the products.
5. restrictions on a change in ownership ratio.
(The writer is a former Chairman of the ICAP and ICMAP Joint Committee, Qaisar Mufti is a Sales Tax and WTO Consultant).