Australia: Dangerous Alliances: Is Peter Druker right about Joint Ventures?

Statistics tell us that more than 25% of project/construction Joint Ventures (JVs) end in internecine dispute. So, was Peter Druker right when he said they are growing in use, dangerous in nature and fundamentally misunderstood?

Joint ventures (JVs), are almost as old as the law itself. The mechanism of sharing profit and risk has been deployed in a range of industries and circumstances throughout history. There is no doubt, however, that its prevalence and sophistication is on the rise.

Peter Druker, one of the founders of modern management, is quoted as saying:

"Businesses once grew by one of two ways; grass roots up, or by acquisition... Today businesses grow through alliances - all kinds of dangerous alliances. Joint ventures and customer partnering which, by the way, very few people understand."1

In our experience, Druker's primary observation on JV's is accurate. We see the JV structure deployed in all manner of projects, as parties seek to defray their risk, bring scale to a project, or access skills and capabilities that reside in another organisation.

Ordinarily, as the usage of a business structuring model increases and becomes mainstream, we would expect less friction and fewer disputes and issues to arise, as parties become more familiar and better at deploying the model.

However, contrary to expectations, this theory doesn't always run true. According to Mike Allen (Global Leader – Contract Solutions – Arcadis), in his 2016 report "Global Construction Disputes Report"2:

  • 25.5% of joint ventures ended in some form of dispute; and
  • 41.4% of all disputes in Asia are JV related.

These numbers appear to support Druker's second observation. There appears to be an inherent danger in these alliances.

So, it is to Druker's third observation we turn – that very few people understand the structures: but is it a lack of understanding regarding the legal implications of JVs that is driving the increasing wave of internecine fights between JV parties or is something else at play?

Irrespective of the cause, with the apparent risk of dispute between JV parties being demonstrably high, parties need to carefully consider whether the JV structure is in fact the most appropriate, and if so:

  • which mitigation strategies should be deployed?
  • how can these minimise the possibility of disputes derailing the relationship?

JVS: LEGAL AND OTHER ISSUES

The JV structure is both simple and complicated at the same time.

From the simple perspective, as Mason J said in United Dominion Corporation Ltd v Brian3:

"it connotes an association of persons for the purposes of particular trading, commercial, mining or financial undertaking or endeavour with a view to mutual profit, with each participant usually (but not necessarily) contributing money, property or skill."

However, there is complexity as well. In this respect, in the same case as is referred to above, Mason J further said:

"it is generally considered that the borderline between what can properly be described as a Joint Venture and what can properly be seen as no more than a simple contractual relationship can on occasion be blurred"4.

The term "joint venture" does not have a simple settled meaning in Australian common law. The JV can be incorporated, unincorporated or managed via a trust structure. The JV agreement itself can delimit the rights and obligations of the parties and the manner in which day-to-day tasks will be decided. It is this foundation that is the essential element of the JV. Properly established and managed, the JV is a powerful collaborative structure.

But beware, the JV has a number of legal idiosyncrasies that impact it and are peculiar to it:

  • Fiduciary obligations: for a JV the scope and existence of fiduciary obligations (unlike a partnership) is a question of examining all of the circumstances of the relationship and considering whether a person has undertaken to act in the interests of another and not in his or her own interests. However, that said, the Court of Appeal has seen fit to imply a fiduciary obligation into a JV arrangement.5 The Victorian Court of Appeal has also agreed that a party can contract out of being in a fiduciary relationship in a JV6.
  • Record keeping: parties to a JV must maintain books and accounts that would permit the affairs of the JV to be assessed with reasonable facility and within a reasonable time7.
  • Tax and related obligations: the tax treatment of the parties will always need to be considered, in relation to the setup, operation and eventual termination of the JV.
  • Competition issues: JVs are subject to certain limited exemptions in respect of cartel conduct, anti-competitive agreements and exclusionary provisions. However, they remain subject to a range of other prohibitions recognised under Australian Competition law.
  • Overseas recognition / treatment: Not all jurisdictions recognise or treat JVs (legally) the same way. So care must be taken if a JV is to operate across state boundaries.

The above legal features of the JV structure are reasonably well known to legal practitioners. Whilst some are notoriously imprecise in their application (such as the issue of fiduciary duties), the law around JVs is relatively fixed. Having regard to this position, we don't think it was the legal realm that Druker was referring to when he said very few people understand... JVs.

Instead, we think Druker was referring to something more amorphous: the bringing together of two different operating structures and cultures to work towards a common goal, when both have potentially different skills, expectations and reasons for entering the JV structure in the first place. We look to examine this through two high level case studies below.

JVS – DIFFERENT PERSPECTIVES: HIGH LEVEL CASE STUDIES

The reasons parties will enter into a JV arrangement are varied. For example, in the energy & natural resources sector, parties will often seek to spread risk due to the inherent uncertainties with large, expensive and complex projects.

JVs are popular because parties can set and manage the parameters of their relationship. JVs can address matters such as the purpose of the joint venture, the rights and obligations of each party, the duration of the agreement and dispute resolution procedures.

However, it seems from the high proportion of JVs that eventually end in dispute that JV parties and JV agreements are failing to properly think about what happens if there is a difference in view between the parties – either on a commercial or legal issue.

Example 1: Difference in commercial objectives

Two experienced parties entered into a JV to operate and maintain a network of facilities. One party was the owner of warehouses and the other was responsible for maintenance and related services. While both parties had a common interest in ensuring the proper management and maintenance of the warehouses, their commercial objectives (as to how that should occur) were vastly different:

  • Party 1 considered that an increase to the operations and maintenance budget was paramount to ensure the successful long-term viability of the warehouse. In contrast,
  • Party 2 did not see the need to increase the operations and maintenance budget and refused to do so.

The difference in commercial objectives has the potential to result in a dispute between the parties, which in turn may adversely affect the long term relationship of the parties.

As the JV agreement between the parties did not have a mechanism for the determination of commercial disputes, the question of how the divergence in opinions was to be determined become challenging. With a long term contract and relationship at stake it is imperative that the JV parties are able to effectively manage and determine these types of matters.

Example 2: Lack of requisite expertise

Party A and Party B entered into a JV agreement as contractor for the construction of a major gas supply pipeline. The parties had agreed to become JV partners on the basis of their respective expertise in different areas of pipeline construction – trenching and welding. A dispute arose with the principal regarding the construction of the pipeline, with one of the matters in dispute being about the condition of the welding performed.

Party B was directly responsible for the welding of the pipeline. The failure of Party B to hold up its end of the bargain – i.e. the skills required to weld – had resulted in the JV parties entering into dispute with the principal. While the JV parties were in dispute, they were still required to manage their dispute with the principal.

This raises other issues between the JV parties such as the possibility of breach of fiduciary duties owed to one another, waiver of privilege over internal documents of each parties' relevant legal documents and the parties' shares for the payment for legal fees.

MITIGATION: SO WHAT CAN YOU DO?

Is the JV the right contracting structure?

When determining how the relationship between parties will be governed in any project, one of the foremost considerations should be about structure. That is, what legal structure is best suited to the parties, the project, their goals and, significantly, the associated risk – both commercial and legal.

While JVs continue to be popular (and their popularity seems to be on the rise), they are not the only contracting option available. A partnership, alliance or specific form contract (e.g. operations and maintenance or design and construct) may better suited to the objectives of the parties and the risks associated with the project.

Importantly, JV parties may be in a fiduciary relationship, meaning that the standard of care that they owe each can be high and higher than that of parties under other contracting structures. The fiduciary relationship will necessarily impact how disputes arise, are managed and resolved. Using a different contracting model may change the legal relationship between the parties and result in no fiduciary relationship, and, therefore, a lower standard of care when determining disputes.

Ongoing dispute resolution procedures

Of all of the mitigation strategies, establishing an appropriate dispute resolution strategy, structure and procedure (within the JV) from the onset will make a real difference in actually avoiding disputes.

Parties should consider how issues that arise may be dealt with. For example, how will the parties determine differences in commercial views? Will a CEO to CEO formal discussion be mandated or can these issues be managed through a prescribed step-by-step process at project management level? The dispute mechanisms established from the start will set the tenor for the relationship between the parties during the life of the project.

In respect of technical or expertise issues, the parties should consider including provision for a rapid expert determination. This will assist in resolving technical disputes quickly and cost effectively – helping the parties to get on with the project – before they fall into dispute with the principal.

For projects of significant cost and duration, the inclusion of a dispute resolution board (DRB) consisting of technical and legal expertise may be valuable. The purpose of the DRB has been described as being to "prevent disputes arising in the first place and if this is not successful, to assist and facilitate the parties in the equitable resolution of disputes".8 The DRB can be used as a tool for dispute avoidance by JV parties as the preventative nature of the DRB is undoubtedly its major strength.

The DRB employs its dispute avoidance role by being instituted from the commencement of a project and maintaining an informed position during the construction process. That is, the DRB will "check in" during the duration of the project. By being actively involved from the beginning of the project, the DRB members are able to identify potential issues that may arise and proactively manage those issues before they crystallise into a dispute between the JV parties.

If a dispute does arises, the DRB has familiarity with the matters and can efficiently manage the dispute for the parties and rapidly make a determination. One of the key features available from a DRB is that the recommendations it makes to the JV parties may be non-binding.9

It is interesting to note that even when the DRB recommendations are not binding, parties tend to accept the recommendations made due to the familiarity of the DRB members with the project, the fact the members are well versed with the issues, the expertise of the members and the confidence and trust the parties have in the members. In fact, in the US, for projects between 1975 to 2007, in 97% of disputes where a DRB gave a recommendation the parties did not continue with more formal dispute resolution.10 This high success rate also applies to DRB decisions outside of the US.11 Indeed, "industry experts consider that similar levels of effectiveness are unattainable with arbitration or litigation".12

CONCLUSION

Druker was correct in his observations that the use of JV structures is increasing. He was similarly correct that there is an inherent danger in the structure. However, while the law surrounding JVs is somewhat imprecise, it is largely well settled. We think Druker's reference to people not understanding JVs was not directed at the law, but rather to the nature of the enterprise and the risk of bringing together two organisational cultures, systems and structures to work together – we think Druker was right again on this point, that is certainly an area that few people understand.

For those contemplating or engaging in this powerful and flexible legal structure, we recommend:

  • Careful consideration of whether the JV model is in fact the best suited for the parties and the project, given the high proportion of disputes.
  • A well thought through and proactive, efficient and ongoing dispute resolution process (such as the DRB process) built into the JV agreement to assist with management and effective resolution of disputes.
  • Planning for a wide range of "what if's".
  • Considering issues of culture, systems and people integration is fundamental.
  • Constant monitoring (and regular health checks) that these flexible structures are working as intended is also of paramount importance.
  • Not letting internecine disputes between JV partners fester – there is often a view that the parties should sort their internal issues out once the job is done. In our experience this often only magnifies and entrenches the issues – driving more significant disputes.

Footnotes

1 Peter Drucker, quoted in Rajesh Kumar and Anoop Nathwani, "Business Alliances: Why managerial Thinking and Biases Determine Success". Journal of Business Strategy 33 No 5 (2012) 44-50

2 ARCADIS: Construction disputes hit record length of over 15 months - Global Construction Disputes Report 2016: Don't Get Left Behind

3 (1985) 157 CLR 1 at 10

4 Ibid.

5 Ross River Limited and anor v Waverley Commercial Ltd and others [2013] EWCA Civ 910.

6 ASIC v Citigroup Global Markets Australia Pty Ltd (No 4) [2007] FCA 963.

7 Koompahtoo Local Aboriginal Land Council v Sanpine Pty Ltd (2007).

8 G Golvan QC, Chairman of the Dispute Resolution Board of the Sydney Desalination Plant as quoted in Douglas Jones, 'Dispute Boards: the Australian experience Part 1' (2012) 7(2) Construction Law International 9, p 3.

9 Ibid., p 4

10 Ibid., p 4.

11 Ibid., p 4.

12 Ibid., p 4.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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