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Dating or marriage: navigating issues in real estate joint ventures

by Editor

August 31, 2017 | 12:20 am
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Human relationships, including dating and marriage, are meant to strengthen each person in the relationship. When two heads bring their personal experience to the table, they synergize to jointly discover things they are much less likely to discover separately and produce far better results than they could individually. This synergy is a process and, more often than not, comes with some hitches. Whether in dating or marriage, conflict/disagreements arise but the relationship is strengthened when they are resolved. Where they are not well handled or resolved, friends part ways and couples divorce.

A real estate joint venture (RE-JV) may combine the real estate expertise of a developer member with the equity of a capital member; or the asset of a land owner with the expertise and capital of the investor in a manner that allows the parties to maximize efficiencies in time, capital deployment, management and expenses.

Major Issues and Navigating the Issues

I have found that key issues in RE-JVs border on project vehicle structuring, capital and funding, governance, deadlock, dispute resolution, and exit and termination. These issues are by no means exhaustive.

Envisaging that issues will arise in an RE-JV helps the parties to agree upfront on how they will be dealt with when they arise. The governing document for an RE-JV is the Joint Venture Agreement (JVA) and the same should anticipate issues identified above amongst other and make provision for navigating the same.

Project Vehicle Structuring

Some people commit to a relationship only because of love and hope that other things will fall in place. They soon realize that a sense of responsibility, compatibility and unity of purpose are also important factors in making such long-term commitment. Then they disagree sharply, have ‘irreconcilable differences,’ separate and divorce. Whilst parties to a RE-JV are clear on their objective of pooling resources for more profitability, many are not clear from the beginning the best structure that helps them achieve their objectives.

  To navigate project vehicle structuring issues, parties must decide the structure that best meets their investment objective; promotes the ease of transfer of title to third party purchasers and ensure tax efficiency. In some instances, an incorporated JV in which the equity contributions of the parties are reflected may be the way to go. In other instances, an unincorporated JV may be the more optimal structure.

  In deciding whether the suitable structure, parties should consider the risks inherent in the investment, the likelihood of liability, the insurability of such liability and the willingness of one or more of the participants to be exposed to that liability.

Capital and Funding

Issues of capital and funding arise in cases of cost overrun or significant change in key assumptions for the project. To navigate capital and funding issues, it is imperative that such potential issues are addressed in the JVA.  The extent of financing flexibility should be agreed – recourse, limited recourse or non-recourse. If it is recourse/limited recourse, it should be agreed whether the project land can be utilized as a security to obtain additional funding in any circumstance.

The modalities for funding of cost overrun should also be agreed i.e. whether each party should have a backstop/contribution obligation to maintain the agreed equity in such circumstance; whether there should be capital calls, limitation on amount(s)/frequency of capital call(s) and required form of capital calls (e.g.  equity vs. debt, cash vs. credit enhancement or third-party debt. The parties should be clear on the modalities for admitting new equity investor seeking to inject funds into the RE-JV project as well as the effect of such equity investment on the existing equity structure.

Above all, the JVA should have robust provisions relating to transparency, disclosures and avoidance of real and perceived conflict of interests whether or not they significantly affect the economics of the RE-JV.

Governance

  Issues also arise when there is no clarity with respect to system of rules and processes by which the RE-JV is directed and controlled particularly as it relates to balancing the interests of the stakeholders of the RE-JV. In my experience, some parties to an RE-JV attempt to import terms of other JVs into their RE-JV where those terms are not contained in the JVA. As in dating or marriage, no two RE-JVs are the same and so what works in one RE-JV may not necessarily work in another.

In order to navigate governance issues, the JVA should clearly set out agreed provisions for the management and control of the JV particularly the appointment of officers to run the venture as well as their powers, functions, approval rights and limits. Should one party be the operator or should there be an operating committee comprising representatives of the parties?

More important, there should be clarity on (i) delegation of authority for day-to-day management; (ii) limitations/threshold for key/fundamental actions or decisions such as incurring debt; sale or lease of property; engaging or terminating the engagement of managers, leasing agents, or other professionals; deviating from budget, etc; (iii) accountability for authority exercised and responsibility for third parties service providers engaged;  (iv) what constitutes key/fundamental decisions and how such decisions are made (simple or super majority); and the process for adoption and amendment of the budget, operating plan and/or business plan including allowable variance as well as modalities for extra-budgetary expenses.

Deadlock

Another area where issues may arise in an RE-JV is in deadlock situations. This occur where votes are split equally, with no majority or unanimity, on a key/fundamental decision issue as required under the JVA. Experience shows that parties to a RE-JV seldom use the ‘’deadlock-breaker” provisions. Parties assume that commercial pressures and negotiation will typically lead RE-JV parties to reach an agreement (albeit reluctantly) on a way forward. This assumption may not always be correct in every circumstance.

In my view, it is better to have a ‘’deadlock-breaker” provisions in place and not operate it, than not having it at all. Thus, the parties should consider the potential for deadlock at the planning stage and agree appropriate resolution or exit mechanisms where deadlocks are unresolved. Parties may agree that a deadlock is resolved by (x) an independent director or chairman’s swing vote; (y) an additional vote reserved in the event of a tie; or (z); reference to chairmen, CEOs or principals of the parties to the RE-JV.  As a proactive measure, the parties can have in place management/governance structures to avoid a deadlock.

Dispute Resolution

Some parties enter a JV and erroneously assume that there would be no dispute and so fail to make robust provision for dispute resolution. Like in dating or marriage, conflicts are sometimes inevitable in RE-JVs. Some parties to an RE-JV get to the point of deadlock and conflict only to realize that robust deadlock or dispute resolution provision have not been made in the JVA.

Disputes typically arise in RE-JVs resulting, in some circumstances, to legal claims with respect to rights and obligations of parties under the JVA. Accordingly, parties should as a matter of importance agree on a robust dispute resolution structure that allows for early detection of potential dispute; create channels for regular communication; prompt resolution of operational disputes (where they arise); escalation of issues to higher levels; or where necessary, having in place a dispute review panel; and  the assistance of an intervening third party – an expert determination or alternative dispute resolution (ADR) processes such as conciliation, mediation, arbitration or a hybrid of any two ADR processes.   

Exit and Termination

JVs are not entered in perpetuity. The JV may become spent at which point the objectives of the JV have been achieved. At other times, disputes may remain unresolved, deadlock unbroken or events of default uncured. In another instance, a party may desire to transfer its interest/shares in the JV even when the JV is still subsisting and no dispute, event of default or deadlock has occurred.

As the RE-JV progresses, parties may have disparate motivations and one may decide to exit the RE-JV at any time. Parties should agree clear exit and termination mechanisms. I have noted also that some parties to an RE-JV seek to keep exit and termination mechanisms simple and commercially realistic. In such circumstances, my approach has been to state the principles as succinctly as possible and expect that they would be useful and important where the need arise.

In agreeing exit and termination mechanism, the parties should have regard to core issues including termination for cause in case of certain trigger events such as material default(s), change of control of a party, insolvency, etc.; termination for convenience requiring notice to the other party in respect to agreed occurrences; significant changes in market conditions; transfer of shares in the JVC and applicable put or call options; and unresolved deadlock situations.

Conclusion

Parties seeking to enter RE-JVs to further their commercial interest should pay attention to the provisions of the JVA. Parties must bear in mind the potential issues associated with JVs and be equally keen to negotiate a JVA that addresses/resolve the issues if or when they arise.


by Editor

August 31, 2017 | 12:20 am
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