Issues to Consider in Structuring an International Joint Venture-Corporate Law

April 1, 1998 Advisory

An increasing number of U.S. companies are viewing the development of foreign markets as a central component of their business strategy. As a result, the number of international joint ventures has expanded dramatically over the past several years. In light of the substantial cultural, linguistic and regulatory hurdles involved in starting an overseas operation from scratch, U.S. companies often conclude that the best way to enter a foreign market is to form a joint venture (JV) with a local partner.

A JV is a traditional method of facilitating entry into a foreign market. U.S. companies have found that JVs are useful for market entry principally because a carefully chosen local partner can readily introduce the U.S. company and its goods to the market while overcoming language and cultural hurdles. The local partner is also better able to deal with local customers and suppliers and, when necessary, the local government. The local partner may have assets that are difficult for a foreigner to obtain, including real estate and zoning for its use, government contracts or permits, or licenses under local patents and technology. Finally, a JV partner provides a local endorsement for the goods being sold.

1. Foreign Legal Issues

  • Legal Form - JVs can be corporations, partnerships, limited liability companies or simply creatures of contract. Typically, if the JV is an entity, it is incorporated or created in the applicable overseas country, while a purely contractual relationship is governed by its choice of law provision. Choice of entity is primarily a local law issue driven by a combination of the foreign investment laws, business considerations concerning the rights and duties of the parties to the JV, and tax implications. Although the choice of legal form is not generally integral to the operating success or failure of the JV, it can have important tax consequences. A careful analysis of U.S. and applicable overseas tax laws (including any tax treaties) is vital so that optimal structuring can be determined before negotiations begin in earnest.

  • Foreign Investment Restrictions - Many countries have restrictions on foreign ownership of certain industries. Typically, industries that are politically sensitive, high profile, or natural resource oriented may be subject to such restrictions. Ownership of real estate by a foreigner or foreign-owned entity may also be subject to restrictions in the absence of a JV. There may also be restrictions on repatriation of profits and foreign exchange controls to consider.

  • Foreign Taxes - Some form of local taxation is inevitable. In most countries, local taxation will take the form of an income tax, often consisting of two components: a withholding tax on gross passive-type payments from the local jurisdiction to foreign entities, and an income tax on the net income of the JV or foreign entity doing business in that country. In addition, there will likely be value-added taxes, customs taxes, taxes on employees, asset taxes, property taxes, and social security taxes. In considering foreign taxes, one should bear in mind that foreign taxes are only one element of the overall tax picture. The terms of applicable tax treaties and the resulting interaction of foreign and U.S. taxes are ultimately the most significant tax consideration.

2. Selected U.S. Legal Issues

All of the following will require attention from your U.S. legal counsel as you structure and operate the foreign JV. In certain circumstances, liability (civil and criminal) can arise to the U.S. joint venturer and its officers and directors for failure to assure compliance with these laws and related regulations.

  • Foreign Corrupt Practices Act (FCPA) - In general terms, the FCPA makes it unlawful for any officer, employee or agent of a company to bribe or offer or to pay directly or indirectly any amount to any foreign government official, political party or candidate for the purpose of obtaining or retaining business.

  • Export Controls - The export of goods or technology from the U.S. requires a license from the Bureau of Export Administration of the Department of Commerce. Although the export of most items to most countries is covered by one or more general existing licenses which do not require any separate application, the possibility of needing specific export licenses must be considered.

  • Hart-Scott-Rodino Antitrust Improvements Act (HSR) - The formation of a foreign JV will generally not require filings pursuant to the HSR Act unless the JV is a corporation that will hold $15 million or more of assets in the U.S., and certain other jurisdictional tests are met.

3. Business Issues

  • Control - Control, in its various forms, is commonly the most sensitive and the most hotly negotiated aspect of a JV. The following is a partial list of operating issues as to which the joint ventures may share control:
    • Budgetary Process
    • Appointment of Management
    • Permitted Scope of Management Activities
    • Contracts, including Related Party Contracts
    • Borrowing Funds Distribution of Profits
    • Issuance of Additional Equity Interests
    • Major Investments
    • Sale or Dissolution

  • Control Mechanisms - A JV usually has two primary control mechanisms: 1) control through voting equity (if permissible under local law) and 2) control through veto power over specified actions. In considering how to operate a JV, experience suggests that full equality in control and management (i.e. 50/50) so as to assure "nothing happens we don't both approve" is often neither necessary nor desirable. The creators of a JV are often tempted to suggest such equality as a symbolic gesture to demonstrate confidence in the other venturer. However, such equality often results (if not immediately, then over time) in gridlock or the lack of a clear strategy. A joint venturer should carefully consider whether it is more desirable to implement a veto power for the non-controlling partner with regard to certain key decisions to prevent management or the majority partner from self-serving actions or actions outside the parties' original intentions.

  • Funding - Issues to be considered with regard to JV funding include the sources of funds and the ability of either partner to make binding calls for additional capital infusions. In addition, the U.S. partner needs to be aware of and manage foreign currency risks.

  • Dispute Resolution - The governing documents typically set forth how the parties wish to deal with the resolution of disputes. Often, there is a provision requiring mediation, arbitration or both before either party can proceed to litigation. Key issues to consider include the identity and location of the mediator or arbitrator, the procedural rules to be applied and extent of the powers granted.

  • Termination - The JV's governing documents should also address the circumstances for the termination of the JV. Issues to address include the amount of notice required, and the effect on any employment agreements, noncompetition agreements, licenses, or technology transfer agreements. In addition, the termination provision should address what happens to the JV's tangible and intangible assets and liabilities.

Practice Pointer

Due to the additional legal, tax and regulatory complexities of starting a joint venture with an overseas partner, it is especially important to obtain legal, accounting and tax advice as early in the process as reasonably possible. By proposing terms of a JV that have been thought through in advance, companies are able to streamline the negotiating process and reduce the possibility that lengthy or acrimonious negotiations will start the venture off badly or even prevent agreement on formation of the venture.