Designing More Durable JV Agreements: Injecting Elasticity into Exclusivity and Non-Competition Clauses

  
Note: A version of this article was previously published in the Harvard Law School Forum on Corporate Governance. See Kira Medish, Tracy Branding Pyle, and James Bamford, “Designing More Durable JV Agreements,” Harvard Law School Forum on Corporate Governance, posted September 8, 2020.

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Designing More Durable JV AgreementsWHEN HONEYWELL restructured its highly-successful joint venture in Japan with Yamatake in 1990, the dealmakers included vaguely-defined scope and exclusivity terms – a decision that ultimately contributed to the end of the 40-year partnership. These terms allowed both Honeywell and the JV to compete in “Other Asia,” a geographic market which included China; the parties felt their history and senior-level ties meant any issues would be quickly resolved. Yet as the business grew and markets globalized, Honeywell and the JV found themselves in repeated head-to-head competition, and personal relationships were no match for potential profits. With customers caught in the crossfire and competitors growing stronger, the partners debated for years over structuring a solution that should have been negotiated at the outset, and the relationship never fully recovered; Yamatake ultimately bought out Honeywell in 2002.1,2


Or consider a media joint venture in India between an international conglomerate and a local partner. In this case, the international partner assigned exclusive use of its brands and the right to market all its products in the country to the JV. When the JV seriously underperformed, the international partner had no choice but to negotiate an expensive buyout of the local partner to regain its ability to compete in a key global market.

Such predicaments may seem like rare errors of strategic thinking and contract drafting. But our recent benchmarking study of 40 JV agreements shows that non-competition and exclusivity terms tend to lack adequate elasticity and contingency provisions in defining the activities the JV and each parent can and cannot do. In our experience, rigid joint venture agreements can lead to otherwise avoidable conflicts between the JV and one or more parents, and thus to suboptimal performance or even failure of the venture. Conversely, smart JV agreements anticipate an array of changed circumstances and other business contingencies and provide a least a degree of elasticity or future-proofing in the exclusivity and non-competes.3

To help companies understand how to structure exclusivity and non-competition provisions in joint venture agreements, we recently reviewed the legal agreements of 40 large joint ventures. The ventures in our dataset were drawn from across industries and geographies and involved three types of ventures: technology commercialization JVs, market entry JVs, and consolidation JVs. All JVs in our analysis were incorporated business entities. Below, we explore the prevalence and contours of exclusivity and non-competition provisions in JV agreements 4 , share examples of how parties have planned such provisions to automatically adjust in the event that JV or parent circumstances change in the future, and offer advice to dealmakers on how to improve JV agreement durability by thinking more fulsomely about future evolution and designing a JV agreement with the flexibility to function in a constantly evolving world.

EXCLUSIVITY AND NON-COMPETE PROVISIONS

Types and General Prevalence. Joint venture exclusivity and non-competition provisions come in many forms, and are often housed in different contractual agreements and provisions. Such contractual terms may impose requirements or limitations on either the venture or a parent with regard to geographic scope, product or service scope, customers, sales channels, use of technology or intellectual property, or services and other supply (Exhibit 1)5. Our analysis shows that product and geographic limitations are by far the most prevalent types of exclusivity in joint ventures, with 70% of agreements including both these types of limitations. Terms limiting freedoms to sell to specific groups of customers were least common in our dataset, present in only 8% of agreements.

Exhibit 1: Exclusivity and Non-Competition Provision Types and Prevalence

Exclusivity and Non-Competition Provision Types and Prevalence

* References to products herein refers to JV products, services, and/or activities (e.g. manufacturing, selling, marketing)
Ankura ©.

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An important note is that certain non-competition arrangements may be prohibited by antitrust laws, which vary by jurisdiction but generally allow some contractual prohibitions on competition in joint venture agreements if the pro-competitive benefits of such an arrangement outweigh anti-competitive effects. JV partners should consult antitrust counsel prior to entering into any exclusive arrangements, and, in particular, should be wary when allocating geographic markets or customers.

Parties mix and match different forms of non-competition and exclusivity to create fit-for-purpose boundaries for a JV and its parents. Because exclusivity provisions are tied to the particular context, certain types of exclusivity are more prevalent in JVs in different industries or venture types. For example, only 36% of downstream oil and gas, chemicals, and agriculture ventures include limitations on both the parents and the JV regarding geography – a prevalence significantly lower than JVs in other industries. One reason for this discrepancy is that such JVs often consist of large facilities located near natural resources and require large capital expenditures (and partner approval) to expand elsewhere and thus geographic limitations are implicit even if not defined by the JV’s scope or limitations on where partners can do business. By contrast, 70% of JVs to develop and commercialize technology included exclusivity or non-competition limitations on one or more parent companies related to intellectual property – a figure which is substantially higher than for consolidation JVs, for instance...

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1 See Case Study “Did Honeywell Create a Competitor?” in Benjamin Gomes-Casseres, The Alliance Revolution: The New Shape of Business Rivalry, Harvard University Press, 1998

2 As part of the buyout, the JV was renamed to Azbil. See Azbil Corporation Group History, accessed August 2020

3 For additional discussion of joint venture non-competes, see Eduardo Gallardo, “Defining a Joint Venture’s Scope of Business: Key Issues,” Harvard Law School Forum on Corporate Governance, accessed August 2020 https://corpgov.law.harvard.edu/2012/09/24/defining-a-joint-ventures-scope-of-business-key-issues/

4 While exclusivity and non-competition arrangements are generally memorialized in the main joint venture legal agreement (e.g., the Shareholders Agreement, Members Agreement, LLC Agreement, Joint Venture Agreement), these provisions may also be included in ancillary agreements, including licenses, services, or supply agreements – which was beyond the scope of this analysis.

5 Partners may impose limitations on each other or on the JV regarding non-solicitation of employees. This analysis does not address non-competition arrangements with respect to individual employees and instead focuses on restrictions on the JV’s or parents’ businesses more generally.