Joint ventures: To incorporate or not?
Joint ventures: To incorporate or not?
Once business partners have agreed on a joint venture (JV) as a suitable business structure, one of the initial considerations is often whether or not the JV should be incorporated. Making this decision will depend on myriad factors ranging from formation, financing, ownership of assets, regulatory, taxes, commercial considerations to dissolution.
At a glance
- The decision whether or not to incorporate a joint venture will depend on myriad factors ranging from formation, financing, ownership of assets, regulatory, taxes, commercial considerations to dissolution.
- Although an unincorporated joint venture may be appealing from an administrative perspective in that there will be no completion and lodging of forms and documents with the Companies and Intellectual Property Commission, the main disadvantage is that it has no separate legal personality, unlike a joint venture company.
- The advantages and disadvantages of either option will largely be influenced by the regulatory framework governing the respective participants to the joint venture and whether any regulatory approvals will be required for the formation of the unincorporated joint venture or joint venture company.
This article sets out some of the key legal considerations in deciding whether or not to incorporate the JV. In making this decision, it is important to understand the pros and cons of an unincorporated joint venture (UJV) where the participants hold contractual “participatory interests” versus an incorporated joint venture (JV Company) where the participants hold shares in a company, vice versa.
Formation and administration
A UJV is established through an agreement between the participants. Therefore, the incorporation or registration with the Companies and Intellectual Property Commission (CIPC) is not required as it is for a JV Company. Although this may be appealing from an administrative perspective in that there will be no completion and lodging of forms and documents or filing annual returns with the CIPC, the main disadvantage is that the UJV has no separate legal personality unlike a JV Company. Therefore, the participants will become liable to third parties jointly and severally, which does not ordinarily happen in a JV Company with the exception of piercing the corporate veil. Amongst the participants inter se, the participants are liable for the debts of the UJV in accordance with their participation interest.
Furthermore, in a UJV the participants will not enjoy the statutory rights and protections entrenched in the Companies Act 71 of 2008 (Companies Act) and its regulations. Therefore it is crucial for the joint venture agreement to clearly set out the parties’ rights and obligations and provide for any protections a party may require. While risks identified for a UJV can be mitigated through appropriate contractual provisions in the joint venture agreement, a contractual claim may be insufficient.
While a JV Company (depending on its public interest score) may be obliged to appoint a social and ethics committee and audit its financial statements in accordance with the Companies Act, a UJV does not have this obligation unless it voluntarily chooses to do so. This provides greater flexibility between the participants to determine in the joint venture agreement how the UJV should be managed and administrated.
In relation to assets contributed to the UJV, such assets are jointly controlled and often jointly owned by the participants. However, in the case of the JV Company, assets are not owned by shareholders but the JV Company. Therefore, assets would need to be vended by the partners to the JV Company through one or other mechanisms (as subscription consideration or through a sale or donation).
The participants are not faced with statutory requirements in “withdrawing” assets contributed to the UJV – they can regulate these matters by agreement. On the other hand, a JV Company has to comply with the provisions of section 46 of the Companies Act to make a distribution.
The advantages and disadvantages will largely be influenced by the regulatory framework governing the respective participants to the joint venture and whether any regulatory approvals will be required in relation to establishing the UJV or JV Company.
Further, it must be determined whether licences and/or permits of the participants can be contributed to the UJV or transferred to the JV Company. If the licences and/or permits will continue to be held by the participant and not the JV, the parties should consider who would be responsible for complying with the terms and obligations thereunder and the apportionment of liabilities for non-compliance. It is advisable to request indemnification by the holder against any claims for historical liabilities.
Like any other corporate structuring, it is important for parties to take into account tax considerations including, but not limited to, (i) the treatment of the JV as a partnership vs a separate taxpayer; (ii) the tax implications upon the entry and exit of a participant; and (iii) the transfer of assets from the participants to the JV Company.
Although a UJV structure may appear more flexible than a JV Company, the major commercial downside of a UJV is that each participant’s balance sheet is exposed to the risk of the UJV business as a whole (due to each participant being jointly and severally liable to third parties for the debts of the UJV). Therefore, the decision whether or not to incorporate should be considered on a case-by-case basis as no cases are equal.
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