October 28, 2018
By Matthew T. Collins
Matt is a shareholder in the Construction Litigation Department at the Fabyanske, Westra, Hart & Thomson law firm. He can be reached at 612.359.7610 or firstname.lastname@example.org
Participants in the construction industry have long used joint venture arrangements to further their business objectives. Joint ventures allow participants to spread risk, expand skills and bonding capacity, and take on projects they otherwise might not get. Because of the unique risks presented by the joint venture relationship, it is important to make sure that the joint venture agreement clearly defines the rights and responsibilities of the parties. This Briefing Paper identifies the key issues that should be addressed by your joint venture agreement.
Form of the Joint Venture Relationship
In general, a joint venture is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. The parties to a joint venture agree to shared ownership, shared returns and risks, and shared governance. In the construction industry, a joint venture is typically used to bid on and complete a specific construction project.
In the end, the most important part of forming a joint venture relationship is the selection of the participants. Depending on how the joint venture is structured, the parties can have separate or shared risks and rewards from the joint venture’s performance. However, if one entity is not able to cover or pay for its share of the venture’s liability, the other joint venture party will have joint and several liability for the acts of the defaulting joint venture party. In other words, joint and several liability can result in one participant being 100% responsible for the acts of the joint venture and the outcome of the project.
Some people confuse a joint venture with a limited liability company (LLC), but the two are distinct types of entities. Just like a corporation, an LLC’s liability is limited to the assets of the LLC. As previously explained, however, a joint venture’s liability extends to the assets of each individual joint venture party. Of course, each member of a joint venture can also be a corporation or an LLC, but the assets of all members of the joint venture are subject to joint and several liability. Because an LLC may have limited assets available to respond to any potential liability, many public entities in best value procurements want assurance that the LLC has substantial assets before accepting the LLC as a responsible bidder or proposer. Public entities are usually more comfortable in finding a joint venture of established companies to be a responsible bidder or proposer because each joint venture partner is ultimately jointly and severally liable for any liability of the venture.
As a result of these and other considerations, construction industry participants typically choose to enter into a contractual joint venture agreement for specific projects. The contractual joint venture agreement will identify the rights and responsibilities of the participants for all of the anticipated management issues that will arise on the construction project. Because an internal dispute among the joint venturers could have a substantial impact on the project, bonding capacity, and profitability, the agreement must be carefully negotiated to address all anticipated risks.
Management and Control
Management and control of the joint venture is typically determined by the percentage of the cash contributions made by the participants. The percentage of the contribution also usually reflects the percentage of loss the party accepts. The party making the largest contribution with the equivalent risk of loss will want the most control over management of the joint venture. On the other hand, a properly drafted agreement should also protect the other members of the joint venture from an abuse of authority by the largest contributor.
The joint venture agreement should designate a management board consisting of senior level executives of the participants. The management board should have sole authority for making certain critical decisions for the joint venture. Examples include commencing litigation, borrowing money, capital expenditures, and allocation of self-performed work by the members of the joint venture, among others. In case of a deadlock on any decision, the largest contributor will typically have final decision-making authority.
To protect against perceived unfair treatment of minority percentage participants, the joint venture agreement may include a provision for chief executive officer review, project neutral review, expedited alternative dispute resolution review, or a combination of these mechanisms.
The joint venture agreement must also establish a project executive team with authority to operate the venture’s day-to-day functions. Usually, the project executive team will consist of representatives of the members of the joint venture. All decisions of the project executive team should be reviewable by the management board.
The agreement should authorize the opening of a banking account with a minimum opening balance for day-to-day expenses. Payment applications, invoicing, and accounting should be managed by one participant for a uniform reporting system. The parties should agree that no profit distributions will occur pending final completion of the project.
The agreement should address acts of default by participants. Defaults can include the filing of bankruptcy, loss of bonding capacity, or failure to make required capital calls. The agreement must address the consequences of each of these events.
Insurance and Bonding
The joint venture will need insurance and potentially bonding for public projects. Careful planning for insurance coverage is required when forming the joint venture. Insurance may be procured for the joint venture or the joint venture may be named as an additional insured on each of the participants’ policies. Each venturer should obtain a joint venture endorsement on its CGL policy. In addition, each participant should ensure that other participants have obtained completed operations coverage for their participation in past joint ventures.
When obtaining bonding for the joint venture, the participants should anticipate exchanging underwriting information with each surety involved. To increase bonding capacity, the joint venture may need to consider adding “silent” participants that may not be responsible for the completion of the project, but who will provide additional financial support for bonding purposes.
Because the participants will be using historical pricing, estimating, and pricing techniques, and other proprietary information when establishing and submitting the bid, the agreement must address how confidential information is treated. The agreement should also address the potential remedies available to the participants if confidential information is misused.
By entering into the joint venture, the participants are agreeing to undertake duties of honesty, good faith, fairness, and loyalty. The agreement should define these duties to include an agreement that the parties will not solicit the employees of the participants for employment. The parties should also agree not to compete with the joint venture for the targeted project or work.
Because it is typical to use one participant’s accounting system for management of the joint venture and the project, the other participants must be provided audit rights. In addition, the joint venture should be subject to an outside audit by an independent accountant on a periodic basis. Full financial disclosure must be provided at all times and should include wage rates, burden, equipment and rental rates, general conditions, and all other costs incurred in performance of the work.
Disputes and Indemnification
The parties to the agreement should provide for an expedited dispute resolution procedure so that disputes between and among them can be resolved quickly and the work for the joint venture can resume. The parties to the joint venture should recognize that protracted disputes will adversely impact the construction project and increase costs. A simplified and expedited dispute resolution process is the best way to avoid the adverse impacts disputes cause. The parties should also mutually waive liability for consequential damages against each other.
Similarly, a well-drafted indemnification provision is essential to the joint venture agreement. A non-breaching participant should not be responsible for the acts of the breaching participant of the joint venture. Responsibilities of the joint venture that cannot be allocated by fault should be appropriately based on the percentage of the contributions made.
Each participant in the joint venture has the right to demand and expect from every other participant full, fair, open, and honest disclosure of everything affecting the relationship. A clearly written joint venture agreement should establish these rights and provide a mechanism for their enforcement. Before your next venture, consider having a careful review of the agreement performed.
This article is a general discussion only and does not constitute legal advice or representation.
Congratulations to Tom Vollbrecht for being elected as a new Fellow of the American College of Construction Lawyers.
On October 18th, Tom was announced as an elected Fellow by the ACCL board.
“Fellowship is extended by invitation to those who are found to have mastered the practice or the teaching of construction law and dispute resolution in the complex technical and legal fields pertaining to the built environment, whose professional careers have been marked by the highest standards of ethical conduct, scholarship, professionalism, and collegiality, and who have demonstrated a commitment to “give back” to the construction industry.”
Gary Eidson will be presenting a Minnesota CLE Webcast Commercial Drafting: Insurance, Indemnity and Waiver Clauses on Wednesday, December 12th, streaming live from 2:00 – 3:00 p.m. For additional information please visit www.minncle.org.
This discussion is generalized in nature and should not be considered a substitute for professional advice. © 2018 FWH&T