AN INTRODUCTION TO HONG KONG JOINT VENTURE COMPANY DOCUMENTATION

Tony Hunt and Gavin McQuater Solicitors, Lovell White Durrant

Introduction The purpose of this paper is to give an introduction to some of the general legal principles underlying the structure of documentation for the establishment 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 usual to consider the circumstances of the particular joint venture against general legal principles, to ensure the documentation fits the needs of the particular transaction. This lecture addresses some of the more important 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 joint venture company is established. Those pre-incorporation activities may have unexpected legal consequences. For example, depending on the facts, the joint venturers may have created a partnership, or an agency relationship. Also, if goods or services are commissioned from third parties for the purposes of the joint venture, then it would be necessary to transfer any relevant assets or liabilities into the JVC from the prospective shareholder. This could involve novation of agreements and/or assignment of rights. Therefore, it is desirable to find out what the parties have done in preparation for the joint venture, to identify what needs to be changed for the future.

Introduction to Hong Kong joint venture company documentation 131 Joint venture documentation What documents are normally required to create joint venture arrangements? 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 shareholders 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 can take some time to produce a draft and this is where some form of preliminary agreement can be useful if the parties wish to record in writing the main terms which have been agreed. A preliminary agreement is also often referred to as heads of agreement, heads of terms, a memorandum of understanding, a letter of intent or some similar description, A preliminary agreement can be very useful as a method of clarifying the essential features of the transaction and setting out the basic objectives and understandings of the parties. It can highlight important aspects of the joint venture which have not yet been settled. The agreement 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 when drafting 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 that it is void for uncertainty. Therefore, the usual principles for determining whether 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 main reason is that, because it needs to set out in sufficient detail the important terms of the deal, this could result in the preliminary agreement taking almost as long to settle as the definitive agreement, 1 take the view that, in the absence of special circumstances, it is better for the preliminary agreement to be short and, with the exceptions I have noted, not legally binding, and should set out the essential features of the transaction to enable 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. This concerns exclusive negotiation provisions (which I have said should be expressed to be legally binding). Basically, a positive contract to negotiate is unenforceable this means that the parties can never be 'locked in' to positive negotiations. However, a negative commitment preventing third party discussions may be enforceable in principle. The parties may agree not to negotiate with a third party so long as the agreement provides expressly for the duration of the lock-out' and is supported by consideration, This is the principle in Walfard v Miles [1992] 1 All ER 453. In that case, the defendants owned a photographic business which they decided to sell to a third party offering 1.9M. Then the defendants began negotiations to sell the business to the plaintiffs, subject to contract, at a sale price of 2 million. There was a further oral agreement between the parties under which the plaintiffs agreed to furnish the defendant with a letter of comfort and in return, the defendants agreed to terminate negotiations with any third parties and not to consider alternative satisfactory offers which might be received. The comfort letter was

Introduction to Hong Kong joint venture company documentation 133 provided but subsequently the defendants withdrew from the negotiations and sold the business to the third party with whom they had been negotiating previously. The plaintiffs contended that the defendants were in breach of a collateral 'lock-out' agreement under which the plaintiffs were given an exclusive opportunity to try to reach an agreement with the defendants. The House of Lords made a clear distinction between 'lock-out' and lock-in' agreements. It was held that a negative lock-out' arrangement could be enforceable if it provided expressly for the duration of the lockout' and was supported by consideration, but that the parties could never be locked-in' to positive negotiations by such contract as it would amount to an uncertain and unenforceable contract to negotiate. Articles The Articles of Association are essentially concerned with the company's internal management and administrative structure. They are the primary means of regulation by a company of its affairs. Therefore, it can be useful to entrench some important provisions relating to the proposed joint venture arrangements into the Articles, Contract between the company and its members qua members The general view is that the Articles constitute a contract between a company and its shareholders in that capacity, and with respect to their rights 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 the contract in the Articles, although they can exist and be enforced 'by virtue 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 to comply with the terms of its Articles of Association insofar as they affect the rights and obligations of the members as members. Therefore, a shareholder can sometimes take legal action against the company for breach of the Articles and vice versa. For example, in Wood v Odessa Waterworks Co (1889) 42 Ch 636, a company was restrained by injunction from acting contrary to its Articles pursuant to an ordinary resolu-

134

Law Lectures for Practitioners 1994

tion of its members to distribute debenture bonds instead of a cash dividend. Similarly, each member in his capacity as a member of the company is obliged to the company to comply with its Articles. However, if rights are conferred on a member by the Articles otherwise than in his capacity as a member, normally he cannot sue on the contract constituted by the Articles, but must establish a collateral contract independent of the Articles. In Eley v Positive Government Security Life Assurance (1876) 1 ExD 88, a member of the company sought unsuccessfully to enforce the right which was embodied in its Articles to be employed for life as a solicitor of the company. This general rule has not always been strictly applied. In Salmon v Quin and Axtens [1909] AC 442, the company's Articles vested the general management of the company's business in the directors, although certain resolutions of the directors were to be invalid if either of the two managing directors dissented. On one occasion, such a resolution was passed and Salmon, one of the managing directors, dissented. Salmon sued the company on behalf of himself and all the other shareholders to restrain the company and the directors from acting on the resolution and the House of Lords granted an injunction in the terms sought. Indirectly, therefore, Salmon was allowed to enforce the right given to him as managing director by suing as a shareholder for the enforcement of the relevant Articles. Enforceability between members The extent to which the Articles are enforceable between members themselves is unclear and the courts have never satisfactorily determined this question. Whilst they appear to have acknowledged that the Articles constitute a contract between the members, as well as between the company and its members, there is conflicting judicial authority as to whether one member may enforce the Articles against another member directly or whether he can do so only through the company. On the one hand, there is the authority that the Articles do not constitute a contract between the members themselves and so can only be enforced by one member against another through the medium of the company (Welton v Saffery [1897] AC 299 at 315). However, it seems that some personal obligations between shareholders may be enforced

directly. For example, in Ray field v Hands [1960] Ch 1 it was decided that an Article requiring any member of a company proposing to transfer shares in the company to inform the directors 'who will take the said shares equally between them at a fair value' was an Article regulating the relationship between the plaintiff as a member and the defendants as members rather than as directors, since the directors were in effect specified members of the company. It was concluded that the decision of the court should not necessarily extend to the Articles of every company since the company in question was one of 'that class of companies which bears a close analogy to a partnership.' The decision in Rayfield v Hands should therefore be limited to the specific circumstances. The lack of certainty surrounding enforceability between members is one of various reasons why it can be desirable to have a separate shareholders' agreement between the members, possibly incorporating or repeating provisions of the Articles.

Articles as notice
To an extent the Articles, as a public document, can put third parties on notice of its provisions, but there are limits to this because of the 'indoor management' rule in Royal British Bank v Turquand (1856) 6E&.B 327. Turquand is designed to protect outsiders in their dealings with the seemingly authorised agents of the company. Even where a person dealing with the company has notice of its constitutional documents, he is not affected by matters of 'indoor management.' He is entitled to assume that the internal procedures of a company, both at directors' and shareholders' meetings, have been regularly conducted in the absence of actual notice to the contrary. (Note that the English provision which qualifies the common law rules on directors acting beyond their authority, in the Companies Act 1985 section 35A, does not apply to Hong Kong.)

Alteration of articles
Articles cannot be altered without a special resolution (section 13(1)). There is no contracting out of that section, in that the company cannot deprive itself of the power to change its Articles, and so there is potential for Articles to be changed, provided the alteration is made in good faith for the benefit of the company as a whole. For example, inAllenv Gold

Reefs of West Africa [1900] 1 Ch 656, a limited company by one of its Articles provided that it should have a lien for all debts and liabilities of any member to the company 'upon all shares (not being fully paid) held by such member.' One of the members of the company holding both unpaid and fully paid-up shares died. When he died he was in arrears of calls on the unpaid shares, but his assets were insufficient to pay the arrears. The company then altered the Article by special resolution by omitting the words 'not being fully paid,' thus creating a lien on the fully paid shares. It was held that the extended lien was enforceable, having been made in good faith. Further, there had been no special bargain that the shares should not be affected by any subsequent alteration of the Articles. Apart from fulfilling the requirements of section 13(1), there is no limitation on the capacity of the company to alter its Articles and the company may not deprive itself of or fetter its ability to alter its Articles by any arrangement contained in the Articles in favour of either its members or a third party. This principle was recently re-affirmed by the House of Lords in Russell v Northern Bank Development Corporation Limited and others [1992] 1 WLR 588 (see 'Shareholders' Agreement' below). Thus, any attempt in the company's Articles to elevate any specific Article to the status of being unalterable or requiring a greater majority than that necessary to pass a special resolution will be contrary to section 13(1) and void. Despite this, in practice, there are various techniques to try to secure rights in the company's constitution: Weighted voting Shareholders can be given greater voting power than usual when voting on specified matters. In Bushell v Faith [1969] 2 Ch 438, the Articles provided that on a motion for the dismissal of a director, that director was entitled to exercise three votes for each share which he held. In the circumstances this meant that no director could be voted out against his will, even though section 303 of the Companies Act provides that a company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in the Articles or in any agreement between it and him (cf by special resolution in Hong Kong unders157B). The House of Lords held that the weighted voting rights were legal as the Articles did not attempt to provide for a

Introduction to Hong Kong joint venture company documentation 137 greater majority than that required for the passing of an ordinary resolution. The decision seems to be of general application and there is no 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 classes of shares for different groups of shareholders. Protection will be afforded by a provision that a resolution is valid only if passed by a requisite majority of members holding each class of shares. Often, the Articles provide that those members of a particular class present at a meeting shall on a poll have the same number of votes as could be cast by all members of that class if they were present at the meeting. The purpose of such a provision is to ensure that shareholders are not deprived of their rights through their unavoidable or inadvertent absence from a meeting. Precisely what is a share class is unclear (Cumbrian Papers [1987] Ch 1) so, it is desirable to specify these, but to the extent a share class exists in the Articles and the Articles do not describe the procedure for changing the rights, it cannot be varied without, in effect, 75% majority consent (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 the provisions of the Companies Ordinance and to any conditions in the company's Memorandum of Association. Accordingly, the rights to be protected could be set out in the Memorandum and declared to be unalterable and overriding the Articles. The Memorandum itself is changeable 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 shareholders' agreement to create direct contractual rights between members, so that even if a change in the Articles cannot be prevented, there will be remedies for breach of the direct contract.

138

Law Lectures for Practitioners 1994

Shareholders' agreement Another document which requires closer consideration as regulating the relationship between the shareholders in a joint venture is the shareholders' agreement (the Articles and the shareholders' agreement require careful drafting to avoid conflict between them). There are various advantages 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 (note however that, exceptionally, a shareholders' agreement may constitute a variation of the Articles or another form of shareholder resolution which is registrable under section 117); and it provides an opportunity to devise the rights and remedies for each shareholder which are appropriate to the contribution that that particular shareholder makes to the company.

JVC as party
Sometimes the JVC itself is a party to the shareholders' agreement. The reason would be to bind the company and to give it rights against shareholders in stated circumstances. Care needs to be taken in drafting the restrictions to be imposed on the company to avoid problems such as that encountered in Russell v Northern Bank [1992] 1 WLR 588. The precise implications of Russell have yet to be fully worked out. Briefly, in Russell, a shareholders' agreement was made to which all the present shareholders and the company itself were party. It contained a clause providing that no further share capital in the company should be created or issued without everyone's consent. It was held that a provision, whether in the Articles or elsewhere, is invalid if the company itself is restricted from exercising its statutory powers, such as the power to alter its Articles or to increase its capital. By a curious application of the severance principle, the court went on to decide that the equivalent restrictions on shareholders were enforceable as personal agreements between them which were not binding on the company. There are many odd aspects to the judgment which mean that great care must be taken when seeking to restrict, directly or indirectly, a company's statutory powers. For present purposes, the following should be 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 statutory power (eg a change of name by special resolution) is ineffective; a provision in Articles which is inconsistent with a power which is permitted to be conferred pursuant to a statutory provision is also ineffective (eg the statutory power to reduce capital by special resolution means that a provision allowing a reduction only by unanimous resolution would be ineffective); if a provision of one of the types described above is contained in an agreement to which the company is a party then that provision (or perhaps the whole agreement) is ineffective, at least so far as it affects the company; agreements between shareholders only that they will vote in a certain way 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' duties

Provisions regulating decision-making by the JVC will normally be an essential feature of the shareholders' agreement and the shareholders will wish to ensure that the joint venture is run in accordance with their wishes. Although they may not wish to be involved in the day-to-day operations, they will wish to be kept fully informed and to have some assurance that the directors will not act against their interests. Therefore, it is important to consider the legal implications of whether decision taking is made at shareholder or director level. Some matters will always be of critical importance to the parties. For example, the parties will wish to establish a distribution policy which can be changed only with the consent of all the shareholders. Particularly sensitive will be the issue of new shares and the introduction of new shareholders. Other issues may be important because of their effect on ancillary contracts in which a member is interested, or because they impinge on the business activities of the company itself (for example, the authority to purchase major assets or to borrow money, perhaps above a certain level) or, more importantly, because they affect the value of the participants' shares in the joint venture company. Probably, in legal terms, the most effective method in structuring a decision-making process in a joint venture company is to restrict the

140

Law Lectures for Practitioners 1994

authority of management, reserving the most important matters to the parties themselves. Shareholders are free to exercise their voting power as they think fit (Carruth v ICI [1937] AC 707). So it is possible for a shareholder to commit himself to vote in a particular way, which may be enforceable by injunction (Puddephat v Leith [1914] 1 Ch 200). The objective should be to ensure that those decisions which may affect the value of the parties' stake in the joint venture company are reserved to them, but that such restrictions do not prevent the day-to-day management of the business of the company. The Articles generally contain provisions delegating authority to manage the business of the company to the board of directors. Once this power has been delegated, it is not open to the members to seek to manage the company themselves by resolution (Breckland Group Holdings Limited v London and Suffolk Property Limited [1989] BCLC 100). Therefore, in the case of a joint venture company, these rules will need to be adapted so that there is reserved from the general power of management delegated to the board of directors, those matters which the shareholders feel are particularly important. This is normally done by varying the Articles. However, as the parties may not always wish to set out these matters exhaustively in the Articles, it is not uncommon for the Articles to contain a summary of those matters to be reserved which are capable of affecting third parties, and for a fuller list, including those matters and matters which are relevant as between the shareholders themselves, to be set out in the shareholders' agreement. Dealing with the reservation of the important matters in this way also prevents them being raised at board meetings where the directors may face problems by virtue of their fiduciary duties. Alternative methods of restricting the management include the imposition of quorum requirements or disenfranchising the affected shareholder from voting on the matter in question. A clause operating by restricting quorum may take effect by providing that no vote may be taken upon an issue unless a particular director or member attends the meeting. If unanimity is required, the rule should prevent the board (or company) taking action without the consent of the minority shareholder or its representatives. It will not alter the majority in such a meeting but may prevent a decision being taken. Usually, the appropriate place for such restrictions is in the Articles where they automatically affect new members. However, certain matters

Introduction to Hong Kong joint venture company documentation141

(for example, decisions affecting ancillary agreements between the company and the members or restrictions of a confidential nature) may be of such a nature that the shareholders' agreement will be the more appropriate place. However, the corollary of a restriction on the management of the company or reserving control over important decisions to the shareholders, is the increased risk of deadlock. The ability of one party to cause deadlock should be avoided (unless a true 50:50 venture is desired). In cases where restriction by quorum is stipulated, provisions should be incorporated in either the Articles or the shareholders' agreement to prevent the dissenting shareholder from obstructing the business of the company by non-attendance at meetings. Resolution of deadlock It is not always clear when a deadlock has occurred as the parties may disagree on this issue. Consideration should therefore be given to defining the situations in which the members will be considered to be in deadlock. There are several methods of resolving a deadlock. In selecting the method they consider best in their particular circumstances, the parties will need to consider the nature of the joint venture. Cooling off A number of procedural steps could be taken to give the shareholders an opportunity to reconsider their positions. For example, it could be provided that if the directors or shareholders fail to reach agreement at a meeting, the matter is referred to the next meeting, and if again it is not resolved, a further period of negotiation is stipulated, after which any party may choose to specify the matter as a deadlock. The matter could then be referred to the chairmen (or other senior officials) of the respective joint venturers. The deadlock could of course remain after such discussion and the cooling off arrangement could be coupled with another 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 shareholder wishing to leave the venture must first offer his shares to the other shareholders before offering them to an outsider. The pricing principles

142

Law Lectures for Practitioners 1994

of this procedure will need careful thought. If every shareholder does not want to continue to participate in the venture, this pre-emption procedure may resolve a deadlock. 9 Sale to third party after pre-emption rejected If the pre-emption procedure does not result in the other existing shareholders buying the shares, sometimes it is felt appropriate to allow shares to be sold to a new investor, on no more favourable terms and within a set period. The new investor should be obliged to comply with any shareholders' agreement. Buy-out 'Russian Roulette': In a 50:50 joint venture, on a deadlock either shareholder may have the right to choose to offer his shares to the other at a price stipulated in the offer. If the other party does not agree to buy the 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 to make the first offer, and with the other shareholders having the option to make a higher offer (perhaps by a minimum fixed percentage) and so on. The highest bid would be successful. In suitable cases, this could be refined to apply to the purchase by shareholders from the joint venture company of specific parts or assets of the business, although this would be quite complex. Put and call options Further possibilities are put and/or call options (by which a shareholder can 'put' or require the other to buy his shares, or by which a shareholder can 'call' or require the other to sell his shares to him) at. a pre-determined price or price formula. Sometimes, a suitable formula will be the net asset value of the company, or a P/E multiple. In other cases this will not be suitable and the parties will prefer an open market or fair price fixed by valuation by the auditors or by independent experts. When a price formula is used, the valuation principles will need to be carefully considered. For example, should account be taken of whether the shares represent a controlling or minority interest; or whether a shareholder 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 buyer is connected in some way with the shareholders, or has a special interest in the joint venture?

Introduction to Hong Kong joint venture company documentation

143

Independent referee/arbitrator An independent person may be nominated, for example under an arbitration clause, to settle a deadlock, although this is not really suitable for deciding matters of commercial policy as opposed to a dispute over rights or facts. For example, one shareholder may need a large cash dividend while the other wishes to reinvest, expand and capitalise on an advantageous market position. How is the outsider to weigh these conflicting elements ofself-interest? Casting vote One way of avoiding deadlock would be to give the chairman of the board of directors a casting vote in situations of potential deadlock, but if the prevailing intention is that decisions require consensus, this will not often be appropriate.

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

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

Duties of nominee directors

Directors owe fiduciary duties to the JVC, or rather, must exercise their power in the interests of the shareholders as a whole rather than for the benefit 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 question are nominated by outsiders or by a particular shareholder or a group of shareholders to represent his or their interests. Although there is an Australian case (Re Broadcasting Station 2GB (Proprietary) Limited [1964-5] NSWR 1648) to the effect that directors appointed by a particular shareholder to represent its interests, as a practical matter and

144

Law Lectures for Practitioners 1994

in the absence of contrary reason, can be expected naturally and in good faith to tend to identify the interests of the shareholders as a whole with those of their appointor, that is only a limited qualification and directors cannot act purely as a mouthpiece for the shareholder who appointed them. Slavish adherence to the directions of a shareholder is therefore open to challenge as a breach of the director's fiduciary duties. Also bear in mind the general rules of conflicts of interest according to which directors must not put themselves in a position where there is a conflict (actual or potential) between their personal interest and their duties to the company. The Articles may contain procedures by which directors disclose interests in or connections with businesses with which the 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 future without that commitment constituting an unlawful fetter on the exercise of their discretionary powers, provided that when they make the commitment they view that decision in good faith as being in the best interests 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 be regarded as a director in his own right (the definition of director in the Companies Ordinance includes any person occupying the position of director, by whatever name called). Also, if the JVC becomes insolvent, the shareholder may be exposed to claims under the fraudulent trading and similar rules. Minority protection General law may provide recourse to a disaffected shareholder. Note the unfairly prejudicial conduct rules in section 168A, and the ability to petition for the company to be wound up on the just and equitable ground in section 177(l)(f). A joint venture company can be a type of legal entity which is suitable for exercise of the court's powers under these sections. Ancillary contracts In most joint ventures the parties will be contributing goods, services, know-how and capital.

Introduction to Hong Kong joint venture company documentation 145

Although the contributions of the joint venture parties will be vital to the success of the joint venture itself, the benefit which they will obtain from the joint venture will be the consideration they receive through the goods or services they provide to the joint venture. The party providing such goods or services should have a contract with the joint venture covering such matters. It is betterfor this contract to be separate from the main joint venture agreement although referred to in it. The terms of the ancillary contracts themselves should not usually be incorporated into the joint venture agreement, as it should primarily be restricted to matters relating to the management and operation of the joint venture vehicle. To do so is to risk difficulties in enforcement (particularly where the joint venture vehicle is not a party) and in disentangling the rights and obligations of the parties (especially if coupled by the same termination or deadlock provisions). Although it is better to have ancillary contracts signed (or at any rate agreed) at the same time as the main joint venture agreement, it is vital to do so where the supply of goods and services or other matters is crucial to the success of the joint venture. Where it is necessary to establish the joint venture at high speed, the joint venture agreement can be signed before the ancillary contract, but preferably the basic principles to be incorporated in the ancillary contract should be agreed and incorporated in a clause or schedule to the joint venture agreement itself, as negotiation of the ancillary contract can cause as many difficulties as negotiation of the joint venture itself. Problems may arise as the parties begin to realise the actual cost of their contribution to the joint venture and the amount they expect to receive from it. The joint venture's lawyer's task in relation to ancillary contracts is to ensure that the joint venture will have the legal right to use everything which it will require to achieve the commercial aim of the parties. The most common ancillary contracts found in joint ventures relate to the following areas: 9 Funding agreements Some joint ventures derive their initial finance from a third party provider of venture capital which will itself participate in the joint venture, and whose attention is normally directed less at the management of the joint venture than at the capital growth and the financial return from the joint venture.

146

Law Lectures for Practitioners 1994

There will be a separate funding agreement which will set out the terms on which the funding is to be made available, including the repayment arrangements, the restrictions to be imposed on the management of the joint venture, the financial covenants to be complied with by the business and the parties' participation in the joint venture itself. The covenants and restrictions can be extremely onerous as providers of venture capital often impose stringent demands. Sometimes the funding agreement itself will be preceded by a facility letter setting out the terms upon which the funds are to be provided to the joint venture, including any warranties and further information required. Property rights Suitable arrangements should be made for the license, lease or purchase of the property where the joint venture is to conduct its business, 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 the costs of the enhancement done to the property and who will own such enhancement. Protection of name and trademarks In many cases, the joint venture will derive its service or trademarks from 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 and trademarks and other intellectual property rights, for example, through a registered user agreement for registered trademarks. Such an agreement usually provides that the right to use any of the joint venturers' trademarks will expire if that party ceases to have an interest in the JVC. Otherwise, the parties normally agree between themselves and with the JVC as to which party is entitled to intellectual property rights including 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 shareholders to operate effectively. Where the success of the JVC depends on this, the other party will want some comfort that those services or goods will be supplied. This is one reason why a formal services agreement may be prepared.

Introduction to Hong Kong joint venture company documentation 147

In addition, services agreements can sometimes be a suitable method of extracting funds from the joint venture as an alternative or as a supplement to dividends. Payments by the JVC will normally be made before tax and so will be a tax effective method of extracting funds (the recipient may of course be taxable on the receipt depending upon tax rules applicable to it). The money payable by the JVC for services or goods must bear some relationship to their value as otherwise the excess payment may be open to challenge on both tax avoidance and company law grounds. Among the company law rules which may be relevant are breaches of director's fiduciary duties to the JVC in authorising an excessive payment and the unlawful distribution rules. Secondment agreements If the joint venture is to be successful this will be helped by having skilled and experienced people working on it. One or more of the participating companies are likely to have skilled and experienced personnel whom they would like to work on the joint venture. The parties will need to decide how this should be arranged. The employees may be offered employment directly with the joint venture or alternatively, they may be seconded from the companies participating in the joint venture.