an introduction to hk jvc documentation

AN INTRODUCTION TO HONG KONGJOINT VENTURE COMPANY DOCUMENTATION

Tony Hunt and Gavin McQuaterSolicitors, Lovell White Durrant

Introduction

The purpose of this paper is to give an introduction to some of the generallegal principles underlying the structure of documentation for theestablishment of a joint venture company {'JVC') in Hong Kong.Despite the popularity of a joint venture as a common business vehicle,this is a complex legal area where it is even more important than usualto consider the circumstances of the particular joint venture againstgeneral legal principles, to ensure the documentation fits the needs of theparticular transaction. This lecture addresses some of the more impor-tant points.

References to sections are to the Companies Ordinance (Cap 32)unless otherwise stated.

Pre-incorporation relationship

Often, clients will collaborate in some way before the formal jointventure company is established. Those pre-incorporation activities mayhave unexpected legal consequences. For example, depending on thefacts, the joint venturers may have created a partnership, or an agencyrelationship.

Also, if goods or services are commissioned from third parties for thepurposes of the joint venture, then it would be necessary to transfer anyrelevant assets or liabilities into the JVC from the prospective share-holder. This could involve novation of agreements and/or assignment ofrights.

Therefore, it is desirable to find out what the parties have done inpreparation for the joint venture, to identify what needs to be changedfor the future.

Introduction to Hong Kong joint venture company documentation 131

Joint venture documentation

What documents are normally required to create joint venture arrange-ments? Typically, the arrangements for a JVC will be recorded in:• the Memorandum and Articles of the JVC itself;• a shareholders' agreement; and• often, but not invariably, supply agreements by which the sharehold-

ers agree to provide services or goods to the JVC.In addition, there may be some preliminary agreement designed to

summarise the main principles of the joint venture arrangements.

Preliminary agreement

Once an agreement has been reached on the main terms (if not before),the drafting of the shareholders' agreement can begin. Inevitably, it cantake some time to produce a draft and this is where some form ofpreliminary agreement can be useful if the parties wish to record inwriting the main terms which have been agreed. A preliminary agree-ment is also often referred to as heads of agreement, heads of terms, amemorandum of understanding, a letter of intent or some similardescription,

A preliminary agreement can be very useful as a method of clarifyingthe essential features of the transaction and setting out the basicobjectives and understandings of the parties. It can highlight importantaspects of the joint venture which have not yet been settled. Theagreement can also contain an outline timetable for negotiations which,even if not binding, can concentrate the minds of the negotiators.

There are two principal questions which need to be addressed whendrafting a preliminary agreement:« first, the extent, if any, to which the document should constitute a

binding commitment between the parties; and• second, the scope of the document, ie how far it should go in

identifying the main features of the joint venture.Some agreements can be so vague that they are either an 'agreement

to agree' (which is legally ineffective) or the wording is so confused thatit is void for uncertainty. Therefore, the usual principles for determiningwhether a contract exists should be applied. For example, if the agree-

132 Law Lectures for Practitioners 1994

ment is to contain confidentiality or exclusive negotiation provisions,then these should be expressed to be legally binding.

Why not make the agreement as a whole legally binding? The mainreason is that, because it needs to set out in sufficient detail the importantterms of the deal, this could result in the preliminary agreement takingalmost as long to settle as the definitive agreement, 1 take the view that,in the absence of special circumstances, it is better for the preliminaryagreement to be short and, with the exceptions I have noted, not legallybinding, and should set out the essential features of the transaction toenable a full agreement to be prepared.

The precise content of a preliminary agreement can vary enormously,but usually, it will:* identify the scope of the business of the joint venture;• set relevant funding principles;8 describe the decision-making process in outline;• state the basic pre-emption principles;» establish confidentiality provisions;* perhaps, state some exclusive negotiating period; and« identify the governing law,

There is one area which 1 would like to discuss in further detail. Thisconcerns exclusive negotiation provisions (which I have said should beexpressed to be legally binding). Basically, a positive contract to nego-tiate is unenforceable — this means that the parties can never be 'lockedin' to positive negotiations. However, a negative commitment prevent-ing third party discussions may be enforceable in principle. The partiesmay agree not to negotiate with a third party so long as the agreementprovides expressly for the duration of the lock-out' and is supported byconsideration,

This is the principle in Walfard v Miles [1992] 1 All ER 453. In thatcase, the defendants owned a photographic business which they decidedto sell to a third party offering £1.9M. Then the defendants begannegotiations to sell the business to the plaintiffs, subject to contract, ata sale price of £2 million. There was a further oral agreement between theparties under which the plaintiffs agreed to furnish the defendant witha letter of comfort and in return, the defendants agreed to terminatenegotiations with any third parties and not to consider alternativesatisfactory offers which might be received. The comfort letter was


provided but subsequently the defendants withdrew from the negotia-tions and sold the business to the third party with whom they had beennegotiating previously. The plaintiffs contended that the defendantswere in breach of a collateral 'lock-out' agreement under which theplaintiffs were given an exclusive opportunity to try to reach an agree-ment with the defendants.

The House of Lords made a clear distinction between 'lock-out' andlock-in' agreements. It was held that a negative lock-out' arrangementcould be enforceable if it provided expressly for the duration of the lock-out' and was supported by consideration, but that the parties could neverbe locked-in' to positive negotiations by such contract as it wouldamount to an uncertain and unenforceable contract to negotiate.

Articles

The Articles of Association are essentially concerned with the compa-ny's internal management and administrative structure. They are theprimary means of regulation by a company of its affairs. Therefore, it canbe useful to entrench some important provisions relating to the proposedjoint venture arrangements into the Articles,

Contract between the company and its members qua membersThe general view is that the Articles constitute a contract between acompany and its shareholders in that capacity, and with respect to theirrights and obligations, as members. For example, in Hickman v Kent &

Romney Marsh Sheepbreeders' Association [1915] 1 Ch 881, it was held that'outsider rights' given to shareholders cannot be enforced as part of thecontract in the Articles, although they can exist and be enforced 'byvirtue of some contract between such person and the company,' that is,as a result of a separate contract with the company.

Following that principle, a company is obliged to its members tocomply with the terms of its Articles of Association insofar as they affectthe rights and obligations of the members as members. Therefore, ashareholder can sometimes take legal action against the company forbreach of the Articles and vice versa. For example, in Wood v Odessa

Waterworks Co (1889) 42 Ch 636, a company was restrained by injunc-tion from acting contrary to its Articles pursuant to an ordinary resolu-


tion of its members to distribute debenture bonds instead of a cashdividend.

Similarly, each member in his capacity as a member of the companyis obliged to the company to comply with its Articles. However, if rightsare conferred on a member by the Articles otherwise than in his capacityas a member, normally he cannot sue on the contract constituted by theArticles, but must establish a collateral contract independent of theArticles. In Eley v Positive Government Security Life Assurance (1876)1 ExD 88, a member of the company sought unsuccessfully to enforce theright which was embodied in its Articles to be employed for life as asolicitor of the company.

This general rule has not always been strictly applied. In Salmon vQuin and Axtens [1909] AC 442, the company's Articles vested thegeneral management of the company's business in the directors, al-though certain resolutions of the directors were to be invalid if either ofthe two managing directors dissented. On one occasion, such a resolu-tion was passed and Salmon, one of the managing directors, dissented.Salmon sued the company on behalf of himself and all the othershareholders to restrain the company and the directors from acting onthe resolution and the House of Lords granted an injunction in the termssought. Indirectly, therefore, Salmon was allowed to enforce the rightgiven to him as managing director by suing as a shareholder for theenforcement of the relevant Articles.

Enforceability between membersThe extent to which the Articles are enforceable between membersthemselves is unclear and the courts have never satisfactorily determinedthis question. Whilst they appear to have acknowledged that theArticles constitute a contract between the members, as well as betweenthe company and its members, there is conflicting judicial authority asto whether one member may enforce the Articles against anothermember directly or whether he can do so only through the company.

On the one hand, there is the authority that the Articles do notconstitute a contract between the members themselves and so can onlybe enforced by one member against another through the medium of thecompany (Welton v Saffery [1897] AC 299 at 315). However, it seemsthat some personal obligations between shareholders may be enforced

directly. For example, in Ray field v Hands [1960] Ch 1 it was decided thatan Article requiring any member of a company proposing to transfershares in the company to inform the directors 'who will take the saidshares equally between them at a fair value' was an Article regulating therelationship between the plaintiff as a member and the defendants asmembers rather than as directors, since the directors were in effectspecified members of the company. It was concluded that the decision ofthe court should not necessarily extend to the Articles of every companysince the company in question was one of 'that class of companies whichbears a close analogy to a partnership.' The decision in Ray field v Handsshould therefore be limited to the specific circumstances.

The lack of certainty surrounding enforceability between members isone of various reasons why it can be desirable to have a separateshareholders' agreement between the members, possibly incorporatingor repeating provisions of the Articles.

Articles as noticeTo an extent the Articles, as a public document, can put third parties onnotice of its provisions, but there are limits to this because of the 'indoormanagement' rule in Royal British Bank v Turquand (1856) 6E&.B 327.Turquand is designed to protect outsiders in their dealings with theseemingly authorised agents of the company. Even where a persondealing with the company has notice of its constitutional documents, heis not affected by matters of 'indoor management.' He is entitled toassume that the internal procedures of a company, both at directors' andshareholders' meetings, have been regularly conducted in the absence ofactual notice to the contrary.

(Note that the English provision which qualifies the common lawrules on directors acting beyond their authority, in the Companies Act1985 section 35A, does not apply to Hong Kong.)

Alteration of articlesArticles cannot be altered without a special resolution (section 13(1)).There is no contracting out of that section, in that the company cannotdeprive itself of the power to change its Articles, and so there is potentialfor Articles to be changed, provided the alteration is made in good faithfor the benefit of the company as a whole. For example, in Allen v Gold

Reefs of West Africa [1900] 1 Ch 656, a limited company by one of itsArticles provided that it should have a lien for all debts and liabilities ofany member to the company 'upon all shares (not being fully paid) heldby such member.' One of the members of the company holding bothunpaid and fully paid-up shares died. When he died he was in arrears ofcalls on the unpaid shares, but his assets were insufficient to pay thearrears. The company then altered the Article by special resolution byomitting the words 'not being fully paid,' thus creating a lien on the fullypaid shares. It was held that the extended lien was enforceable, havingbeen made in good faith. Further, there had been no special bargain thatthe shares should not be affected by any subsequent alteration of theArticles.

Apart from fulfilling the requirements of section 13(1), there is nolimitation on the capacity of the company to alter its Articles and thecompany may not deprive itself of or fetter its ability to alter its Articlesby any arrangement contained in the Articles in favour of either itsmembers or a third party. This principle was recently re-affirmed by theHouse of Lords in Russell v Northern Bank Development CorporationLimited and others [1992] 1 WLR 588 (see 'Shareholders' Agreement'below). Thus, any attempt in the company's Articles to elevate anyspecific Article to the status of being unalterable or requiring a greatermajority than that necessary to pass a special resolution will be contraryto section 13(1) and void.

Despite this, in practice, there are various techniques to try to securerights in the company's constitution:• Weighted voting

Shareholders can be given greater voting power than usual whenvoting on specified matters. In Bushell v Faith [1969] 2 Ch 438, theArticles provided that on a motion for the dismissal of a director, thatdirector was entitled to exercise three votes for each share which he held.In the circumstances this meant that no director could be voted outagainst his will, even though section 303 of the Companies Act providesthat a company may by ordinary resolution remove a director before theexpiration of his period of office, notwithstanding anything in theArticles or in any agreement between it and him (cf by special resolutionin Hong Kong unders157B). The House of Lords held that the weightedvoting rights were legal as the Articles did not attempt to provide for a


greater majority than that required for the passing of an ordinaryresolution. The decision seems to be of general application and there isno reason in principle why it should not apply to special resolutions,• Creating different share classes

An alternative to weighted voting is the creation of different classesof shares for different groups of shareholders. Protection will be affordedby a provision that a resolution is valid only if passed by a requisitemajority of members holding each class of shares. Often, the Articlesprovide that those members of a particular class present at a meeting shallon a poll have the same number of votes as could be cast by all membersof that class if they were present at the meeting. The purpose of such aprovision is to ensure that shareholders are not deprived of their rightsthrough their unavoidable or inadvertent absence from a meeting.

Precisely what is a share class is unclear (Cumbrian Papers [1987] Ch1) so, it is desirable to specify these, but to the extent a share class existsin the Articles and the Articles do not describe the procedure forchanging the rights, it cannot be varied without, in effect, 75% majorityconsent (section 63 A and section 64 for appeal by 10% dissentients).• Incorporating the provisions in the Memorandum of Association

The general power of alteration of the Articles is subject to theprovisions of the Companies Ordinance and to any conditions in thecompany's Memorandum of Association. Accordingly, the rights to beprotected could be set out in the Memorandum and declared to beunalterable and overriding the Articles. The Memorandum itself ischangeable only as provided by the Companies Ordinance (section 7).

Sample articles

Other examples of provisions which can be found in JVC Articles are:• rights to appoint and remove directors;•• quorum provisions for directors' and shareholders' meetings;• special voting rules for important, specified decisions; and• pre-emption provisions on the issue and transfer of shares.

Alternatively, or in addition, provisions can be included in a share-holders' agreement to create direct contractual rights between members,so that even if a change in the Articles cannot be prevented, there willbe remedies for breach of the direct contract.


Shareholders' agreement

Another document which requires closer consideration as regulating therelationship between the shareholders in a joint venture is the share-holders' agreement (the Articles and the shareholders' agreement re-quire careful drafting to avoid conflict between them). There are variousadvantages in having a shareholders' agreement:• the agreement gives shareholders direct rights between themselves;• unlike the Articles which are a public document, shareholders

agreements have the advantage of being private documents (notehowever that, exceptionally, a shareholders' agreement may consti-tute a variation of the Articles or another form of shareholderresolution which is registrable under section 117); and

• it provides an opportunity to devise the rights and remedies for eachshareholder which are appropriate to the contribution that thatparticular shareholder makes to the company.

JVC as partySometimes the JVC itself is a party to the shareholders' agreement. Thereason would be to bind the company and to give it rights againstshareholders in stated circumstances. Care needs to be taken in draftingthe restrictions to be imposed on the company to avoid problems such asthat encountered in Russell v Northern Bank [1992] 1 WLR 588. Theprecise implications of Russell have yet to be fully worked out. Briefly, inRussell, a shareholders' agreement was made to which all the presentshareholders and the company itself were party. It contained a clauseproviding that no further share capital in the company should be createdor issued without everyone's consent. It was held that a provision,whether in the Articles or elsewhere, is invalid if the company itself isrestricted from exercising its statutory powers, such as the power to alterits Articles or to increase its capital. By a curious application of theseverance principle, the court went on to decide that the equivalentrestrictions on shareholders were enforceable as personal agreementsbetween them which were not binding on the company.

There are many odd aspects to the judgment which mean that greatcare must be taken when seeking to restrict, directly or indirectly, acompany's statutory powers. For present purposes, the following shouldbe adopted as a safe rule of thumb:

Introduction_to_Hong_Kong joint venture company documentation 139

• a provision in Articles which is inconsistent with a direct statutorypower (eg a change of name by special resolution) is ineffective;

» a provision in Articles which is inconsistent with a power which ispermitted to be conferred pursuant to a statutory provision is alsoineffective (eg the statutory power to reduce capital by special resolu-tion means that a provision allowing a reduction only by unanimousresolution would be ineffective);

» if a provision of one of the types described above is contained in anagreement to which the company is a party then that provision (orperhaps the whole agreement) is ineffective, at least so far as it affectsthe company;

• agreements between shareholders only that they will vote in a certainway to ensure that certain things do or do not happen are not affected;

» class rights are not affected; and• weighted voting (a la Bushell v Faith) is not affected.

Decision making and directors' dutiesProvisions regulating decision-making by the JVC will normally be anessential feature of the shareholders' agreement and the shareholders willwish to ensure that the joint venture is run in accordance with theirwishes. Although they may not wish to be involved in the day-to-dayoperations, they will wish to be kept fully informed and to have someassurance that the directors will not act against their interests. There-fore, it is important to consider the legal implications of whether decisiontaking is made at shareholder or director level.

Some matters will always be of critical importance to the parties. Forexample, the parties will wish to establish a distribution policy which canbe changed only with the consent of all the shareholders. Particularlysensitive will be the issue of new shares and the introduction of newshareholders. Other issues may be important because of their effect onancillary contracts in which a member is interested, or because theyimpinge on the business activities of the company itself (for example, theauthority to purchase major assets or to borrow money, perhaps above acertain level) or, more importantly, because they affect the value of theparticipants' shares in the joint venture company.

Probably, in legal terms, the most effective method in structuring adecision-making process in a joint venture company is to restrict the


authority of management, reserving the most important matters to theparties themselves. Shareholders are free to exercise their voting poweras they think fit (Carruth v ICI [1937] AC 707). So it is possible for ashareholder to commit himself to vote in a particular way, which may beenforceable by injunction (Puddephat v Leith [1914] 1 Ch 200).

The objective should be to ensure that those decisions which mayaffect the value of the parties' stake in the joint venture company arereserved to them, but that such restrictions do not prevent the day-to-daymanagement of the business of the company.

The Articles generally contain provisions delegating authority tomanage the business of the company to the board of directors. Once thispower has been delegated, it is not open to the members to seek tomanage the company themselves by resolution (Breckland Group Hold-ings Limited v London and Suffolk Property Limited [1989] BCLC 100).Therefore, in the case of a joint venture company, these rules will needto be adapted so that there is reserved from the general power ofmanagement delegated to the board of directors, those matters which theshareholders feel are particularly important. This is normally done byvarying the Articles. However, as the parties may not always wish to setout these matters exhaustively in the Articles, it is not uncommon for theArticles to contain a summary of those matters to be reserved which arecapable of affecting third parties, and for a fuller list, including thosematters and matters which are relevant as between the shareholdersthemselves, to be set out in the shareholders' agreement.

Dealing with the reservation of the important matters in this way alsoprevents them being raised at board meetings where the directors mayface problems by virtue of their fiduciary duties.

Alternative methods of restricting the management include theimposition of quorum requirements or disenfranchising the affectedshareholder from voting on the matter in question.

A clause operating by restricting quorum may take effect by providingthat no vote may be taken upon an issue unless a particular director ormember attends the meeting. If unanimity is required, the rule shouldprevent the board (or company) taking action without the consent of theminority shareholder or its representatives. It will not alter the majorityin such a meeting but may prevent a decision being taken.

Usually, the appropriate place for such restrictions is in the Articleswhere they automatically affect new members. However, certain matters

Introduction to Hong Kong joint venture company documentation141

(for example, decisions affecting ancillary agreements between thecompany and the members or restrictions of a confidential nature) maybe of such a nature that the shareholders' agreement will be the moreappropriate place.

However, the corollary of a restriction on the management of thecompany or reserving control over important decisions to the sharehold-ers, is the increased risk of deadlock. The ability of one party to causedeadlock should be avoided (unless a true 50:50 venture is desired). Incases where restriction by quorum is stipulated, provisions should beincorporated in either the Articles or the shareholders' agreement toprevent the dissenting shareholder from obstructing the business of thecompany by non-attendance at meetings.

Resolution of deadlockIt is not always clear when a deadlock has occurred as the parties maydisagree on this issue. Consideration should therefore be given todefining the situations in which the members will be considered to be indeadlock.

There are several methods of resolving a deadlock. In selecting themethod they consider best in their particular circumstances, the partieswill need to consider the nature of the joint venture.• Cooling off

A number of procedural steps could be taken to give the shareholdersan opportunity to reconsider their positions. For example, it could beprovided that if the directors or shareholders fail to reach agreement ata meeting, the matter is referred to the next meeting, and if again it is notresolved, a further period of negotiation is stipulated, after which anyparty may choose to specify the matter as a deadlock. The matter couldthen be referred to the chairmen (or other senior officials) of therespective joint venturers. The deadlock could of course remain aftersuch discussion and the cooling off arrangement could be coupled withanother of the provisions outlined below.• Pre-emption

The Articles of the joint venture company (or the shareholders'agreement) may contain pre-emption rights, by which a shareholderwishing to leave the venture must first offer his shares to the othershareholders before offering them to an outsider. The pricing principles


of this procedure will need careful thought. If every shareholder does notwant to continue to participate in the venture, this pre-emption proce-dure may resolve a deadlock.9 Sale to third party after pre-emption rejected

If the pre-emption procedure does not result in the other existingshareholders buying the shares, sometimes it is felt appropriate to allowshares to be sold to a new investor, on no more favourable terms andwithin a set period. The new investor should be obliged to comply withany shareholders' agreement.• Buy-out

'Russian Roulette': In a 50:50 joint venture, on a deadlock eithershareholder may have the right to choose to offer his shares to the otherat a price stipulated in the offer. If the other party does not agree to buythe shares at that price he is obliged to sell his shares at the same price.

Auction: If all shareholders wish to acquire the joint venture com-' pany, the successful purchaser could be decided by sealed or open bids,with the shareholder who claims that a deadlock exists being obliged tomake the first offer, and with the other shareholders having the optionto make a higher offer (perhaps by a minimum fixed percentage) and soon. The highest bid would be successful. In suitable cases, this could berefined to apply to the purchase by shareholders from the joint venturecompany of specific parts or assets of the business, although this would bequite complex.• Put and call options

Further possibilities are put and/or call options (by which a share-holder can 'put' or require the other to buy his shares, or by which ashareholder can 'call' or require the other to sell his shares to him) at. apre-determined price or price formula. Sometimes, a suitable formulawill be the net asset value of the company, or a P/E multiple. In othercases this will not be suitable and the parties will prefer an open marketor fair price fixed by valuation by the auditors or by independent experts.

When a price formula is used, the valuation principles will need to becarefully considered. For example, should account be taken of whetherthe shares represent a controlling or minority interest; or whether ashareholder has received a bona fide offer from an outsider for his shares;and if such an offer has been made, does it matter if the prospective buyeris connected in some way with the shareholders, or has a special interestin the joint venture?


• Independent referee/arbitratorAn independent person may be nominated, for example under an

arbitration clause, to settle a deadlock, although this is not really suitablefor deciding matters of commercial policy as opposed to a dispute overrights or facts. For example, one shareholder may need a large cashdividend while the other wishes to reinvest, expand and capitalise on anadvantageous market position. How is the outsider to weigh theseconflicting elements of self- interest?« Casting vote

One way of avoiding deadlock would be to give the chairman of theboard of directors a casting vote in situations of potential deadlock, butif the prevailing intention is that decisions require consensus, this willnot often be appropriate.• Total sale

Often an outside investor will not wish to acquire part only of a jointventure company. However, the company could be valuable if all theshares in the company were put up for sale. In this case, if the sharehold-ers are all willing to realise their investment, they could jointly nominatea merchant bank or similar organisation to arrange for the sale of all theshares in the company (or its business assets) for the best available price.Each shareholder could be entitled to bid for the shares, and this couldprovide a wider market for the shares than that available under the buy-out options described above, which are exclusive to the shareholders,• Liquidation

An extreme measure would be to wind up the company. This isnormally regarded as a last resort, and it may be unlikely that the fullvalue of the company is realised,

Duties of nominee directorsDirectors owe fiduciary duties to the JVC, or rather, must exercise theirpower in the interests of the shareholders as a whole rather than for thebenefit of or as directed by one section of the shareholders (Howard Smith

v Ampol[1974] 1 All ER1126). This is so even if the directors in questionare nominated by outsiders or by a particular shareholder or a group ofshareholders to represent his or their interests. Although there is anAustralian case (Re Broadcasting Station 2GB (Proprietary) Limited

[1964-5] NSWR 1648) to the effect that directors appointed by aparticular shareholder to represent its interests, as a practical matter and


in the absence of contrary reason, can be expected naturally and in goodfaith to tend to identify the interests of the shareholders as a whole withthose of their appointor, that is only a limited qualification and directorscannot act purely as a mouthpiece for the shareholder who appointedthem. Slavish adherence to the directions of a shareholder is thereforeopen to challenge as a breach of the director's fiduciary duties.

Also bear in mind the general rules of conflicts of interest accordingto which directors must not put themselves in a position where there isa conflict (actual or potential) between their personal interest and theirduties to the company. The Articles may contain procedures by whichdirectors disclose interests in or connections with businesses with whichthe JVC deals (see eg Article 86 of Table A).

On a separate aspect of directors duties, note that, in principle,directors can commit themselves to act in a particular way in the futurewithout that commitment constituting an unlawful fetter on the exerciseof their discretionary powers, provided that when they make the com-mitment they view that decision in good faith as being in the bestinterests of the company (Fulham F C v Cabra Estates Times LR 11/9/92).

A shareholder who interferes actively in the JVC's affairs may also beregarded as a director in his own right (the definition of director in theCompanies Ordinance includes any person occupying the position ofdirector, by whatever name called). Also, if the JVC becomes insolvent,the shareholder may be exposed to claims under the fraudulent tradingand similar rules.

Minority protection

General law may provide recourse to a disaffected shareholder. Note theunfairly prejudicial conduct rules in section 168A, and the ability topetition for the company to be wound up on the just and equitableground in section 177(l)(f). A joint venture company can be a type oflegal entity which is suitable for exercise of the court's powers under thesesections.

Ancillary contracts

In most joint ventures the parties will be contributing goods, services,know-how and capital.


Although the contributions of the joint venture parties will be vitalto the success of the joint venture itself, the benefit which they willobtain from the joint venture will be the consideration they receivethrough the goods or services they provide to the joint venture.

The party providing such goods or services should have a contractwith the joint venture covering such matters. It is betterfor this contractto be separate from the main joint venture agreement although referredto in it.

The terms of the ancillary contracts themselves should not usually beincorporated into the joint venture agreement, as it should primarily berestricted to matters relating to the management and operation of thejoint venture vehicle. To do so is to risk difficulties in enforcement(particularly where the joint venture vehicle is not a party) and indisentangling the rights and obligations of the parties (especially ifcoupled by the same termination or deadlock provisions).

Although it is better to have ancillary contracts signed (or at any rateagreed) at the same time as the main joint venture agreement, it is vitalto do so where the supply of goods and services or other matters is crucialto the success of the joint venture. Where it is necessary to establish thejoint venture at high speed, the joint venture agreement can be signedbefore the ancillary contract, but preferably the basic principles to beincorporated in the ancillary contract should be agreed and incorporatedin a clause or schedule to the joint venture agreement itself, as negotia-tion of the ancillary contract can cause as many difficulties as negotiationof the joint venture itself. Problems may arise as the parties begin torealise the actual cost of their contribution to the joint venture and theamount they expect to receive from it.

The joint venture's lawyer's task in relation to ancillary contracts isto ensure that the joint venture will have the legal right to use everythingwhich it will require to achieve the commercial aim of the parties.

The most common ancillary contracts found in joint ventures relateto the following areas:9 Funding agreements

Some joint ventures derive their initial finance from a third partyprovider of venture capital which will itself participate in the jointventure, and whose attention is normally directed less at the manage-ment of the joint venture than at the capital growth and the financialreturn from the joint venture.


There will be a separate funding agreement which will set out theterms on which the funding is to be made available, including therepayment arrangements, the restrictions to be imposed on the manage-ment of the joint venture, the financial covenants to be complied withby the business and the parties' participation in the joint venture itself.The covenants and restrictions can be extremely onerous as providers ofventure capital often impose stringent demands.

Sometimes the funding agreement itself will be preceded by a facilityletter setting out the terms upon which the funds are to be provided tothe joint venture, including any warranties and further informationrequired.• Property rights

Suitable arrangements should be made for the license, lease orpurchase of the property where the joint venture is to conduct itsbusiness, even if this is to be at the offices of one of the participants.

Thought may have to be given as to who will be responsible for thecosts of the enhancement done to the property and who will own suchenhancement.• Protection of name and trademarks

In many cases, the joint venture will derive its service or trademarksfrom either or both of the joint venturers. As with any new business,thought will have to be given to the protection of the JVC's name andtrademarks and other intellectual property rights, for example, througha registered user agreement for registered trademarks.

Such an agreement usually provides that the right to use any of thejoint venturers' trademarks will expire if that party ceases to have aninterest in the JVC.

Otherwise, the parties normally agree between themselves and withthe JVC as to which party is entitled to intellectual property rightsincluding the right to benefit from any enhancements to such property.• Contracts for the supply of goods and services

Often a JVC will need to obtain goods and services from its sharehold-ers to operate effectively. Where the success of the JVC depends on this,the other party will want some comfort that those services or goods willbe supplied. This is one reason why a formal services agreement may beprepared.


In addition, services agreements can sometimes be a suitable methodof extracting funds from the joint venture as an alternative or as asupplement to dividends. Payments by the JVC will normally be madebefore tax and so will be a tax effective method of extracting funds (therecipient may of course be taxable on the receipt depending upon taxrules applicable to it).

The money payable by the JVC for services or goods must bear somerelationship to their value as otherwise the excess payment may be opento challenge on both tax avoidance and company law grounds. Amongthe company law rules which may be relevant are breaches of director'sfiduciary duties to the JVC in authorising an excessive payment and theunlawful distribution rules.» Secondment agreements

If the joint venture is to be successful this will be helped by havingskilled and experienced people working on it. One or more of theparticipating companies are likely to have skilled and experiencedpersonnel whom they would like to work on the joint venture. Theparties will need to decide how this should be arranged. The employeesmay be offered employment directly with the joint venture or alterna-tively, they may be seconded from the companies participating in thejoint venture.

an introduction to hk jvc documentation

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