GE Image Gallery 133

Joint Ventures

11 February 2020

Are you working on a business idea with a friend or thinking of developing a business idea with someone as a joint venture?

A "joint venture" is not in itself a legal structure, and there is no “law” of joint ventures as such. It describes a joint undertaking carried out in a structure other than a partnership. It can involve a mix of contract and company law and can incorporate concepts from equity and agency law. Due to the absence of a set of defined legal framework around "joint ventures", it is particularly important that you document the arrangements reached between the parties, and you carry out the venture under an appropriate structure. A recent Court of Appeal case illustrates the costly consequences for a couple of friends for failing to take such steps.

In Detection Services Pty Limited v Pickering [2019] NZCA 575 [21 November 2019], the Court of Appeal overturned a High Court decision involving two former friends who developed a leak detection system for use in high pressure water mains. During the course of their undertaking, the parties had a falling out due to a dispute about ownership of the leak detection system. It was placed in storage and remains there today.

The terms of the joint venture as established by the courts were that Mr Pickering would develop the leak detection system for the exclusive use of Detection Services group. Mr Pickering would be reimbursed for all third-party costs in developing the system as well as be compensated for his time and efforts. Mr Pickering would retain intellectual property in the system and Detection Services group would exploit commercial opportunities in Australia and New Zealand for leak detection in high pressure water mains. There were many examples of technical and financial information being shared between the parties. But, the terms of the joint venture were not formally recorded.

Upon completion of the prototype, Detection Services group requested delivery of the system to Australia for commercial use as had always been the parties' intention. However, Mr Pickering claimed ownership of the entire system and refused to deliver it until agreement was reached on the price and other terms governing its use. Lawyers became involved. Detection Services group subsequently developed a new system and then sued Mr Pickering for the costs of developing the new system and lost profits suffered. Mr Pickering counterclaimed in contract for the costs he incurred in developing the original system. Both claims failed in the High Court; however, the Court of Appeal overturned this decision and found for Detection Services.

What is interesting to note is that the High Court and the Court of Appeal adopted a very different legal analysis over the nature of the joint venture.

The High Court held that parties owed obligations of a fiduciary nature, such as a duty of loyalty, towards each other. Although Mr Pickering breached his obligation to deliver the system to Detection Services group, Detection Services group could not be granted relief as it also failed to negotiate in good faith and did not come to equity with clean hands. The High Court applied laws of equity.

The Court of Appeal, however, disagreed that the laws of equity (clean hands principle) applied. The Court of Appeal considered that the obligations of the parties under the terms of the joint venture were of a contractual nature and not fiduciary. The Court of Appeal decided that Mr Pickering failed in his contractual obligation to deliver the completed system, which resulted in Detection Services group not being able to exploit the system commercially and the consequent failure of the joint venture.

The two courts traversed difficult and complex legal issues resulting in costly and lengthy litigation. This could have been avoided, or at least the risk minimised, if parties had agreed on the terms that were reached and documented them.

I make some general comments about the risks of entering into a joint venture without legal advice. If a joint venture is not documented properly, the arrangement could be deemed to be a partnership and be subject to partnership law. This would result in unintended consequences affecting the share of profits, and losses and liabilities between the parties.

A partnership is an arrangement whereby partners carry on business in common with a view to making and sharing a profit. The partners have unlimited joint liability for the partnership's debts and obligations (unless they have contracted otherwise), they owe fiduciary duties to each other, and a partner's actions binds the other partners. A key aspect of a fiduciary relationship is that it creates obligations of a different character from those deriving from the contract itself.[1] Fiduciary duties include a duty of loyalty, a duty of good faith, and a duty not to profit for oneself.

This form of legal structure requires parties to be heavily involved with each other with a high degree of trust. Such a structure is not suitable for many joint ventures, and it is common for agreements that document a joint venture to expressly provide that no partnership is to be implied into the relationship.

A joint venture that is not a partnership is a different beast. In a typical joint venture (that is well documented), parties would put in assets but continue to have separate interests in these assets. Parties would carry on separate businesses, which would not merge. One party's action would not bind the other, and parties are severally liable (not jointly) only in their proportionate interests for debts of the joint venture. Parties would hold the assets of the joint venture as tenants in common in undivided or specified shares (that is, the separate property of each party) based on each party's individual contribution to the joint venture. Profits would be shared in proportion to a party's interest in the joint venture.

While a joint venture can successfully be operated as an unincorporated entity with a good agreement in place, a simple structure that many people understand (including financiers, which would assist in funding applications) is an incorporated limited liability company. The benefit of the company is that parties are free to agree on their respective arrangements in a shareholders’ agreement. But, they can also fall back on the default provisions under the Companies Act where parties have not reached specific agreement. The company owns the assets and the profits are shared by the shareholders in proportion to their shares. In a shareholders’ agreement where there are two shareholders with equal shares, there is often a deadlock provision, which is a mechanism for one party to buy the other out. This could be useful in a joint venture with two parties when differences become irreconcilable.

Should you wish to discuss agreements and possible structures for your joint venture, please do not hesitate to contact Ah Song Sunwoo.

[1]Re Goldcorp Exchange Ltd (in rec) [1995] 1 AC 74 (PC) at 98 quoted in Detection Services Pty Limited v Pickering [2019] NZCA 575 [21 November 2019] at [32].