PSST. WANNA KNOW a seemingly innocuous joint venture deal term that packs a mighty punch? Consider this clause:
Unless otherwise and expressly agreed in a provision of this Agreement, or as otherwise required by applicable law, all decisions and actions shall require Majority Approval of the Shareholders.Sounds harmless enough – especially when tucked at the end of the voting section of a joint venture agreement, following a list of several dozen matters explicitly labelled as unanimous, supermajority, or simple majority decisions. But that simple provision – in effect, a “default setting” for shareholder voting rights – can carry profound implications, both positive and negative, both today and in the future.
TOO MUCH UNDEFINED
When negotiating a joint venture agreement, too many dealmakers and lawyers fail to ask a simple question: “How will decisions not explicitly listed in the voting section or delegations table of the joint venture agreement be decided?” A typical joint venture agreement spells out 20-30 or more decisions – such as liquidation of the company, changes to the venture’s authorized scope, incurrence of indebtedness, capital calls, payment of dividends, adoption of the annual operating plan and budget, etc. – and defines whether each will be determined by unanimous, supermajority, or majority shareholder or board approval.
But how will matters not otherwise explicitly defined be decided?
After negotiating the voting thresholds of 20-30 plus decisions, it is perhaps understandable that fatigue drives dealmakers to remain silent on this question. But in legal contract jurisdictions that do not establish as a matter of law how voting works when an agreement is silent, such silence can bring future pain – for the company, the counterparty, or venture management – as authority over undefined matters is open to competing interpretations. This is especially the case for more operational decisions, which tend to be undefined in the legal agreements and may be considered the purview of either venture management or a majority shareholder, if one exists. Silence on such matters can breed shareholder misalignment and dispute. And it can foster management frustration, especially for JV CEOs who took the job expecting freedom to operate commensurate with their title.
But silence may have a larger cost. It may mean that your company has missed a critical source of influence, leverage, and control. Our analysis shows that less than 1% of agreements contain a broad provision describing how all undefined decisions are taken – but that many companies would actually benefit from it if in place.
Consider the ways a firm may be advantaged by stating that all matters not otherwise defined shall be determined by a specific voting threshold. For minority partners looking for maximum protection, a default setting of unanimous or supermajority ensures their voice is always heard. For a large company in a multi-partner venture with no majority shareholder and high risk of deadlock among competing views, the optimal answer might be to propose setting the dial at simple majority, which would promote decision efficiency. In a multi-partner consortium, it could also create knock-on benefits if the company stepped up as a buyer in the event that a minority partner chose to exit.
The purpose of this note is to illustrate important decisions that are generally undefined within venture agreements, to show how a “default setting” for voting can be a powerful lever for companies in certain situations, and to introduce other remedies to deal with undefined decisions in venture agreements.
CASES IN POINT
To understand what this looks like in practice, consider a notional example drawn from numerous real-world examples. Let’s say that five partners entered into an agribusiness JV to develop and commercialize new technologies, and to construct and operate world-scale food processing facilities using that technology. Assume that each partner owned an equity interest of 10% to 35%. And assume that the JV Agreement contained standard voting provisions, including defining certain unanimous shareholder matters (e.g., amendment of the bylaws or shareholders’ agreement, sale or liquidation of the Company, settlement of legal disputes), and a limited set of of simple majority decisions (e.g., approving the annual operating plan and budget).
Like most JV Agreements, the legal contracts in this example would be silent on what authority is required to approve more than 20 critical business decisions (Exhibit 1) – decisions that relate to strategy, finance, operations, commercial, and organizational matters. In other words, the legal agreements would not establish which of these key decisions require unanimous or supermajority shareholder approval – versus can be approved by simple majority vote, or would be delegated to management.
Exhibit 1: Matter Not Defined
Notional Examples - Agribusiness JV
Sample of decisions not explicitly included within the voting provisions of the Joint Venture Agreement
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This sets the venture on a collision course with misunderstanding, misalignment, or disputes.
Or consider an industrial high-tech JV on which we advised. An initial draft of the LLC agreement made no mention of how matters such as the five-year strategic plan, customer pricing, the product and technology roadmap, regulatory strategy and communications, and vendor contracts would be determined. Left unaddressed, this was bound to create misalignment, especially since one partner was to hold a 51% ownership interest, and, as the controlling shareholder, might assume that these matters were within its purview.
DEFAULT SETTING FOR VOTING
To understand the implications of including a “default setting” within the voting sections of the venture agreements, first consider the 51:49 industrial high-tech JV mentioned above. Rather than extending the standard list of decisions and corresponding voting thresholds, the minority partner might include a provision that simply states that “unless otherwise stated and agreed, all other decisions shall require super-majority approval.” This simple statement, if accepted, could provide extraordinary protection, and leverage to the minority partner.
The same concept might be applied, for different reasons and in a different way, in the five-partner agribusiness venture. In this case, the default might be set at simple majority. In other words, the agreement would contain a provision that establishes that “unless otherwise stated and agreed, all other decisions shall be decided by a majority vote of the Board.” The purpose of this would be to prevent decision gridlock, which is a common affliction of multi-partner ventures, especially when basic operating decisions require all or most owners to agree. In this case, decisions could be passed with either the two largest owners agreeing, or one large owner and two small owners.
NOT THE ONLY REMEDY
Of course this is not the only – or necessarily always the optimal – way to handle undefined decisions. Our experience points to a range of other remedies (Exhibit 2).
Exhibit 2: Potential Remedies for Poorly - Defined Voting
Six approaches to handle important undefined decisions in joint ventures agreements
Source: Water Street Partners. © All rights reserved
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One alternate approach is to simply live with the uncertainty, and allow any dispute resolution mechanism to handle future disagreements. (This, of course, requires the agreement to have an effective dispute mechanism – which merits a separate discussion). A second approach is to add to the list in the voting section of the joint venture agreement, while a third is to create a schedule of decision rights in significant detail appended to the joint venture agreement. One such schedule we created for a 50:50 financial services JV defined the decision rights associated with over 70 different matters. While we generally advocate for more detail within venture agreements, we also recognize that there are limits as to how many decisions companies have the capacity to negotiate, given all the other issues that need to get resolved.
A fourth approach is to include more expansive language under the definition of key terms – and, in so doing, capture important decisions within other terms. For example, in a 51:49 JV where we were advising the minority partner, the parties agreed that the annual operating plan and budget would require supermajority approval. Within the definitions section, we then defined annual operating plan and budget to mean: “The agreed annual planning and budgeting document that shall include annual financial, operational and strategic targets, product roadmap and development priorities, pricing strategy and framework, sales and marketing plans, regulatory strategy and engagement plans, and other items.” Therefore, rather than adding each of these as separate line items in the voting section (which would have likely been rejected by the counterparty, which was already feeling like the supermajority list was too long), these items were tucked in elsewhere.
A fifth approach, which tends to focus on more operational decisions and to clarify the role of management relative to the board, is to develop a Table of Delegated Authorities. Typically, a delegations table will be included in a Governance Framework or equivalent policy document – and not in the legal agreement. In most cases, it will list 30-100 plus decisions that have a more operational focus than matters found in a voting schedule of the venture agreements. Example decisions found in a delegations table include the right to open bank accounts, make public announcements, and approve sole source vendor contracts. For each of those matters, the table will spell out approval and other rights for different stakeholders, including the Board, Committees, the CEO, and other members of Management (e.g., CFO or COO). Ideally, the delegations table will be developed prior to deal close, and formally agreed agreed as a Day 1 Board Resolution. To connect the delegations table to the legal agreements, the voting section of the legal agreement should state that changes to the agreed delegations shall require unanimous approval.
Silence can be deadly in joint ventures. When drafting or reviewing the voting and delegation provisions of a potential joint venture agreement, dealmakers, attorneys, and executive sponsors need to ask: What important decisions are not yet defined within the current terms, and am I better off – today and in different future scenarios – having these matters defined in some way? The answer is often yes.
To read our analysis of JV CEO delegations, please click here >>