3 Ways to Structure Better Dispute Resolution in Your Joint Venture

   

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3 Ways to Structure Better Dispute Resolution in Your Joint VentureGOVERNANCE IN MOST joint ventures is a contact sport and too often lands a knockout blow when deadlock or delayed decision-making drives a JV to termination or early failure. The roots of these disagreements are almost always predictable, which is why we find it surprising that so many JV agreements rely on a combination of unanimous voting and boiler-plate dispute resolution provisions that expose the owners to avoidable risk. Consider:

  • According to our benchmarking, the typical JV contract lists 14 items requiring unanimous agreement (and shareholders often stick to unanimous voting in practice even if not required). The list of decisions often includes annual budgets and plans, capital spending, purchases above a low limit (a median of 1% of operating budget), hiring of the CEO and CEO-reports, and strategy decisions such as changes in the products of the JV. Bottom line, nothing can get done without mutual agreement – even in ventures with a majority shareholder.
  • 88% of JVs have an internal escalation provision, where disagreements are raised to more senior executives in the shareholders. But these executives are usually consulted prior to major decisions anyway, so escalation is not usually helpful.
  • If internal escalation does not lead to resolution, the outcomes are bleak: In 60% of JVs, a deadlock triggers automatic termination (via the unwinding of the JV, buyout by a partner, or sale to third party).

Developing Joint Venture Deal Options by Water Street PartnersDeadlocks that escalate to termination can destroy value and disrupt shareholder strategy, and in many ventures a clear asymmetry between the partners (e.g., one partner lacks the ability to operate the JV; local regulations limit foreign ownership; etc.) is a good reason not to allow for termination. On the other hand, some deadlocks are so fundamental that more value is saved by having a clear path to cut your losses and regroup before missing out on important market opportunities.

Our prescription? Dealmakers should consider the following three ways to tailor voting, dispute resolution, and exit to the specifics of the JV and its predicable flashpoints. This may take a bit more time and effort, but the investment pays dividends later in the JV’s life.

#1: Structure deal terms to reduce the number of issues that can lead to Board deadlock.

We have seen companies successfully embed the following approaches into their JV deals to limit potential causes of deadlock:

  • Pre-agree during deal negotiations on key issues for the first 2 to 3 years, including the budget, capital spending, and staffing
  • Build predictable expansions of the JV’s product, market, or technology scope into the foundational documents so that the JV is authorized to develop add-on products and take natural moves to grow into new markets without extended Board debate
  • Increase delegations of authority to the JV CEO, thereby avoiding opportunities for the Board to get bogged down on operational issues
  • In multi-party JVs, craft supermajority or majority voting for many issues, rather than defaulting to unanimous voting (and thus single minority partner veto) on every issue

#2: Structure deal terms to resolve deadlocks, when they occur.

Not all deadlocks can be avoided, but for those that do arise, our benchmarking shows that most JVs take a boiler-plate approach of starting with internal escalation and then diving headlong into termination or exit. However, creative dealmakers could make good use of a wide variety of dispute resolution paths short of exit (Exhibit 1).

Exhibit 1: Creative Approaches to Deadlock Resolution

First, consider leveraging an impartial voice. Non-binding mediation can be helpful in cases where facilitation and creative problem-solving will overcome differences. Binding arbitration, though rarely used, can make sense for technical issues such as transfer pricing or shared-service agreement disputes that are not central to the JV’s strategy but otherwise only makes sense as a litigation alternative.

Second, think about whether a casting vote makes sense. It may seem at odds with a 50:50 governance model, but it has a potential logic – for example, a partner with asymmetric reputational or financial exposure may well merit a casting vote on the JV’s health and safety policies. Giving different casting votes depending on the issue could even preserve overall governance equality while ensuring there is always a path to take decisions.

Third, there are situations where the JV agreement can prevent deadlock by defining a pre-determined course of action arising when shareholders cannot agree. For example, JV management might be empowered to decide on a service contract if the shareholders are deadlocked. Or, for a major capital expansion, disagreement might allow one shareholder to fully fund and dilute the non-approving shareholder or to proceed under “sole risk” provisions.

Finally, do not shy away from a course of action that simply leaves the issue unresolved. Not all disagreements at the Board are so fundamental that the venture should go to the termination penalty box.

#3: Use exit clauses selectively and creatively to create incentives to resolve deadlocks fairly, when exit is the only way out.

There are certainly deadlock issues and situations in which termination or exit is the right outcome – where the disputes are so fundamental that the shareholders should go their separate ways. But exit terms should be fair, create the right incentives, and not be invoked except where necessary. For example, a termination option should include an option for sale to a third party in any case where both partners are not equally able to bid for and manage the JV post-exit (preventing the advantaged partner from manufacturing a crisis to gain the upper hand).

To create the right incentives, the specifics of the exit mechanism should vary according to the triggering event and should not always be symmetric. Suppose a JV contract allows one of the partners to fund additional investments, diluting the other partner. In that case, an asymmetric dispute/exit approach may be fair – allowing the non-funding partner the right to put their shares to the investing partner or to accept staying in at some level of dilution with fewer governance rights.