Keeping the peace: how to keep your real estate venture running smoothly

The first insight in this series looked at the structure of and economic aspects of JVs; this article focuses on the day-to-day running of the JV, control mechanisms in favour of each JV partner and what happens where the JV parties find themselves in a dispute.

By its very nature, a JV requires co-operation and a shared purpose and although parties may not envisage falling out at the outset, it's important the JV agreement provides a clear framework for how the decisions of the JV will be made and what happens if the parties do not agree or one is in breach of the JV agreement.

Decision-making

How the JV vehicle will be run on a day-to-day basis and the process for reaching key decisions should be set out in the heads of terms to avoid one party frustrating the running of the JV.

It is common for management of the JV to be delegated to a board of directors or representatives from both JV parties. It is important to ensure these representatives have the requisite knowledge of the underlying JV project and the authority to allow for a smooth running of the JV.

Limits on the authority of the management board are usually set out in the JV agreement with an appropriate set of key decisions requiring the formal approval of the JV parties. The levels of protections may be determined by the relative holdings each party has in the JV with a minority joint venture partner requiring more contractual protection than in a 50/50 split.

Where management is delegated, the JV agreement should set out how often board meetings should be held, which representatives need to be present for a valid meeting and the votes each JV party has through their representatives.

Depending on the nature of the JV and the roles of the parties, management can also be outsourced to one of the parties through asset or development management agreements (DMA) or to third party investment advisers. It is rare for a JV to have employees of its own managing its day to day running.

Conflicts

It is common on real estate JVs for one or both of the parties to provide services or enter into transactions with the JV. While the interests of the JV and party in question may be aligned, there is potential for a conflict to occur between the interests of the JV and of that party.

There are different ways to deal with conflicts and although it is not always necessary to outline the detail at heads of term stage, it is important for the JV agreement to set out the process for dealing with a conflict. The JV agreement should provide for the conflicted party to declare its conflict at the earliest opportunity. Depending on the nature of the conflict, the parties should agree whether the conflicted party is excluded from voting on the conflicted matter at a meeting of the JV. If so, the non-conflicted party is usually required to act in good faith and in the best interests of the JV in reaching a decision.

Deadlock

Disagreements can occur that have the potential to stall the running of the JV. This 'deadlock' can paralyse the decision making of the JV and it's important for the parties to agree a process for what happens in a deadlock event.

Deadlock provisions need to be carefully considered to avoid manipulation by one party.

At the heads of terms stage, the parties should agree:

• what constitutes a deadlock event;
• an escalation process through senior individuals at each of the JV parties to try resolve the deadlock; and
• what happens where the deadlock cannot be resolved.

There are a number of different mechanisms for dealing with unresolved deadlocks, including arbitration or expert determination, the exit by one party from the JV with buy and sell provisions included in the JV agreement or, if the deadlock cannot be agreed, winding up the JV.

Default

It is also important for default events to be appropriate for the nature of the JV given the consequences to the party.

Common default events for real estate JVs are:

• change of control;
• loss of key individuals from one of the JV parties;
• insolvency events; and
• material and persistent breach of the JV agreement (for example for failure to fund).

Cross-default provisions, where default under another agreement (such as a DMA, or management services agreement) leads to a default event under the JV agreement, can sometimes be included. Their inclusion will depend on the nature of the JV and the bargaining position of the JV parties. On a development project, a developer will typically argue against cross-default under a DMA, on the basis that its role as developer is separate to its equity stake in the JV and the DMA will have remedies for breach appropriate – so any action under the JV agreement would be disproportionate.

The parties need to also consider the consequences of default. These may depend on the nature of the default. Possible options are for the defaulting party to lose voting rights or profits whilst the default continues, or the non-defaulting party having the option to elect to wind up the JV, acquire the defaulting party's interest in the JV or have its interest acquired by the defaulting party.

Comment

There are many factors that can lead to bumps in the road on the journey of a joint venture project but being clear in the documentation how such issues are dealt with will assist with a harmonious resolution. A change of focus for one partner, whether because of a policy change, market conditions or personnel turnover, can create issues for the joint venture and we often see a project stall because of such factors. The most successful joint ventures are where parties remain aligned in their vision or work together to navigate fluctuation in the market.