Copyright 2010, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate Joint Ventures, October 2010

The joint venture agreement will usually contain a number of remedies – after the applicable cure period, which should be shorter for monetary defaults than others – if there is a default by a joint venture participant of its obligations thereunder, including the right on the part of the non-defaulting joint venture participant to:

1. invoke a requirement to arbitrate or mediate;

2. commence an action for specific performance, injunction, or other equitable remedy;

3. commence an action at law or in equity in order to recover damages or such other remedies as may be available;

4. deprive the defaulting joint venture participant of the right to take part in the decision-making and voting;

5. terminate the property manager if the property manager is an affiliate of the defaulting joint venture participant;

6. set-off against other monies owed by the nondefaulting joint venture participant;

7. sell the project on behalf of the joint venture participants;

8. enforce any collateral charge; and

9. arrange for the interest of the defaulting joint venture participant to be valued and then, at the option of the non-defaulting joint venture participant, to:

  1. purchase the interest of the defaulting joint venture participant at a purchase price equal to a discount of the market value (which often is agreed to be 90%); or
  2. dilute the interest of the joint venture participant in satisfaction of the monies due and owing to the non-defaulting joint venture participant and secured by any collateral charge.

This article focuses on the remedies or rights of the non-defaulting joint venture participant to purchase the interest of the defaulting joint venture participant at a purchase price equal to a discount of fair market value (say, 90%) and the right to dilute the interest of the defaulting joint venture participant in satisfaction of the monies owed to the non-defaulting joint venture participant and secured by the collateral charge.

Default Buy-Out

There is some doubt as to whether the right of the non-defaulting joint venture participant to purchase the interest of the defaulting joint venture participant at a discount is enforceable in an insolvency situation. As a result, joint venture agreements often provide that the non-defaulting joint venture participant has the right to purchase the interest of the defaulting joint venture participant at the agreed discount of the fair market value, except where the defaulting joint venture participant is insolvent, in which case, the purchase price is 100% of the fair market value thereof.

Some joint venture agreements specify the rights of the non-defaulting joint venture participant to purchase the interest of the defaulting joint venture participant and to dilute the interest of the defaulting joint venture participant in satisfaction of the monies owed to the non-defaulting joint venture participant only in the event of a "major" default and that, in the case of "minor" defaults, the only penalty is the loss by the defaulting joint venture participant of the right to vote on and to make decisions affecting the project.

Most joint venture agreements preclude a defaulting joint venture participant from invoking a buy-sell shotgun or right of first refusal – although such joint venture participant would retain the right to respond to a notice delivered by the non-defaulting joint venture participant. This essentially is a defence mechanism to preclude a defaulting joint venture participant from issuing a buy-sell shotgun notice as a "smoke screen" to prevent the non-defaulting joint venture participant from exercising the default buy-out or other remedies.

If the non-defaulting joint venture participant proceeds to exercise its remedy to purchase the interest of the defaulting joint venture participant, the determination of the purchase price becomes a critical issue. As the buysell shotgun provisions do not apply in such a case, the fair market value of the interest of the defaulting joint venture participant is usually determined by appraisal. Often, the process is that each joint venture participant appoints an appraiser and the two appraisers chosen jointly appoint a third appraiser. If any appraisal is more than an agreed percentage (usually 3% to 5%) lower or higher than the middle appraisal, such appraisal is discarded and the remaining appraisals are averaged. If the two appraisals differ from the middle appraisal by more than the agreed percentage, the middle appraisal is deemed to be the fair market value of the interest.

In determining fair market value in all circumstances, consideration must be given to all relevant factors, including all agreements affecting the interest of the defaulting joint venture participant, all rights attaching to such interest and to which the joint venture participant is entitled, and all obligations relating to the project to which the defaulting joint venture participant is subject.

It would be prudent for the non-defaulting joint venture participant initially to deliver to the defaulting joint venture participant a notice expressing only an interest in acquiring the interest of the defaulting joint venture participant, rather than a firm intention to purchase such interest. Such a notice would initiate the appraisal process but not commit the non-defaulting joint venture participant to purchase the interest of the defaulting joint venture participant if, for example, the price was determined to be too high as a result of the appraisal.

The agreement should provide that, after the fair market value of the interest of the defaulting joint venture participant is determined, the non-defaulting joint venture participant is entitled to deliver a second notice to the non-defaulting joint venture participant, formally advising of the intention of the non-defaulting joint venture participant to proceed with the purchase.

Again, financing is an important consideration, as the purchase of the interest of the defaulting joint venture participant may trigger the "due on sale" provisions of the project financing.

Additional complexities may arise where the interest of the defaulting joint venture participant is subject to a mortgage in favour of a third party.

It may well be that, at the time that it exercises its right to purchase the interest of the defaulting joint venture participant, the non-defaulting joint venture participant is confronted with cash flow issues. In order to assist the non-defaulting joint venture participant in such circumstances, joint venture agreements often provide that the buy-out may be funded over a specified period of time, with a vendor take-back financing on terms favourable to the non-defaulting joint venture participant, thus severing the connection of the defaulting joint venture participant with the project while facilitating the orderly payment of the purchase price over time.

Typically, the management agreement will provide that if the defaulting joint venture participant whose interest is being purchased is an affiliate of the manager, the non-defaulting joint venture participant will have the right to terminate the manager.

Dilution

The dilution of the interest of a joint venture participant usually arises in a situation in which a joint venture participant has failed to contribute its proportionate share of certain expenditures and the non-defaulting joint venture participant has advanced the monies on behalf of the defaulting joint venture participant by way of a "demand loan" to the joint venture. In such event, the joint venture agreement may provide for a determination of the fair market value of the interest of the defaulting joint venture participant – typically by appraisal – and the transfer to the non-defaulting joint venture participant of such of the interest of the defaulting joint venture participant having a value equal to the "demand loan", plus a prescribed rate of interest. Certain joint venture agreements provide that the purchase price for the interest acquired by the nondefaulting joint venturer will be a specified discount from the fair market value for such interest.

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.