This article presents the exit and termination provisions that may assist parties in the event an investor/member in a joint venture is looking to exit or terminate their relations.
Joint ventures are typically flexible business organizations that respond to market conditions and other circumstances. However, as time passes and situations change, parties to a joint venture may no longer have the same goals and share the same strategic interests. For example, one party may have a difficult time performing their responsibilities due to financial difficulties or operational difficulties. In the case that the parties’ motives, goals, and strategies change it is vital to have a well-crafted termination and exit provision within the joint venture agreement.
There are numerous ways joint venture parties can provide for an early exit from, or termination of, a joint venture. An overview of the common themes can provide a good foundation for deal specific, creative solutions. Further, there are two main reasons why joint venture parties need exit and termination provision: deadlock and default or change of control of one of the parties.
Deadlock is usually defined as the inability of the joint venture parties to agree to any one of a particular subset of the supermajority issues. Such supermajority issues are approval of annual budgets and business plans, raising additional equity capital from the existing parties or others; amendments to the joint venture entity’s governing documents; engaging in a public offering; mergers, acquisitions, and dispositions of all or substantially all of the joint venture’s assets; dissolution; and granting liens on material assets. This is not a comprehensive list but an idea of what joint ventures typically have supermajority votes on.
In addition to deadlock situations, if one party materially breaches the joint venture agreement the other party will usually be entitled to trigger exit provisions. The terms of the exit rights in a default or change of control situation usually vary from deadlock situations because one party is at fault. Usually, in the case of default the non-defaulting party can decide whether to buy out the other party or sell its own interest under a buy sell provision. Change of control is treated similarly to defaults.
If a party does not provide for an exit, then that will lead to inefficiency and delay in resolving the situation, resulting in lost value. However, if the parties do not provide mechanisms to deal with a deadlock situation, then they can turn to the applicable law that is used to address those situations.
If a deadlock arises in a joint venture situation. The first step is to try and resolve it with an escalation procedure. An escalation provision applies when the issue has already been discussed by the board of directors. A part that wishes to break the deadlock must provide notice to the one party and then the issue is submitted to specified high level officers of each JV party. Those officers will then be required to attempt to resolve the deadlock for a specified period of time.
Furthermore, a buy sell provision is used in connection with a deadlock. It is also used with certain modifications if the other party materially breaches a joint venture agreement or experience a change in control. A buy sell provision is invoked when one JV party is buying the other party out. Therefore, once the buy sell provision is triggered, it ends the deadlock by removing a party from ownership.
It is vital that joint venture agreements are drafted with the appropriate exit and termination provisions. In ensuring that these provisions are protective and appropriate it is fundamental to hire an attorney to conduct such drafting.
KI Legal’s Transactional attorneys are well versed in these matters and are prepared to help guide you through the process. For more information on joint ventures, or for help with your particular real estate venture at hand, contact us at (212) 404-8644 or email info@kilegal.com to discuss.
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