Construction joint venture generally refers to contractors forming an ad hoc alliance by entering into a legal structure so as to jointly undertake a construction project that may be larger than their individual risk appetite. The strategic reasons for forming a joint venture include pooling resources with partners with complementary skills and diversifying project risks. This is Part 1 of an article series examining tips and traps of such joint venture arrangement by way of commercial analysis. Such review may be of assistance to construction practitioners who are either potentially participating in joint ventures or involved in assessing tender proposals from joint ventures. 

Whilst there are ample of academic literature and journals covering the subject of construction joint ventures with the aim of increasing appreciation of such arrangement, it remains one of the more elusive topics. This is because the commercial considerations in reality can be complex where fact based logical reasoning alone may not be sufficient for decision making. Business acumen and intuition are often necessary. By way of illustration, one of the conventional reasons behind the formation joint venture is finding business partners with complementary skills to handle technically challenging project. However, joint ventures by its very nature often involve sensitive trade off such as splitting of profit, sharing of power, authority and control over the operations of the project. Are these trade off worthwhile from a strategic view point if one could alternatively subcontract the technically challenging portion of works to its designated skilled partner? In this regard, joint venture may be preferred to subcontracting as it denies competitors access to such competitive advantage when the skilled partner enters into joint venture exclusively. Therefore in valuing the initial proportion of equity of such skilled partner, various intangible assets had to be taken into consideration including its opportunity costs for the exclusive arrangement. Very often the legal structure, joint venture agreements, claims and contract administration scheme and other legal imperatives are put in place to give effect to such commercial realities. In other words, the joint venture legal framework should be drafted with a good grasp of the underlying business case.

The formation of the legal structure of joint venture tend to be fluid and somewhat unpredictable given that the negotiations of joint venture agreement between contractors are likely to be held concurrently with the tender negotiation with the Employer and its consultants for the concerned project. The joint venture agreement between contractors could not be finalised until the final terms of the construction project is concluded whilst the Employer may be keen to examine the relevant details of joint venture agreement before deciding on whether to award. This circular interdependence and conflicting conundrum requires finesse by the joint venture members in ensuring the joint venture arrangement evolves from a non binding memorandum of understanding to a binding joint venture agreement. Therefore, the ability of joint venture members to work together in handling ambiguity and challenges is put to test at the very early stage of procurement. Joint venture negotiations often occur within a compressed time frame because the initial conception of such alliance usually takes place upon learning about a prospective large project. In the absence of a ‘standard conditions’ for joint venture agreement, the terms and conditions are typically bespoke by nature and sensitive to the commercial dynamics between parties. Given the absence of industry wide blueprint for construction joint venture formation, an overview of the relevant key considerations and negotiation milestones in this article may be a useful source of reference.

Types Of Joint Ventures

There are generally two types of joint venture namely (i) incorporated joint venture and (ii) unincorporated joint venture. As regards the former, a new legal entity is incorporated, typically in the form of private limited company where the shareholders’ (ie. joint venture members) liability to creditors are limited by its share capital. Incorporated joint venture is a separate and distinct legal entity from its joint venture members. The joint venture members are in fact shareholders of this newly incorporated legal entity. When the project is awarded to an incorporated joint venture, the Employer enters into a construction contract with this new legal entity. Company law or corporate law governs the relationship between joint venture members where the specifics can typically be found in the company’s constitution and/or shareholders agreement.

An unincorporated joint venture does not involve the creation of a new legal entity and the joint venture members remain separate and distinct. Their relationship is governed by a joint venture agreement. When the project is awarded to an unincorporated joint venture and assuming there are two members in such alliance, the construction contract is tripartite i.e. between the Employer, joint venture member no.1 and joint venture member no.2. Given the absence of a newly incorporated entity, company law does not apply in this regard. Instead the specific terms of the joint venture agreement become particularly important in identifying rights and obligations governing their relationship. 

It is not within the scope of this article to provide a comprehensive coverage of the characteristics of a private limited company since most contractors are incorporated in the same manner. Therefore contractors should be aware of the associated governance framework including amongst others the (i) functions of board of directors, (ii) how decisions are made, (iii) fiduciary duties during the discharge of director’s functions and (iv) how shareholders may influence the directions of the company by way of its voting rights and associated shareholding. Although company law and company constitution do not provide a full governance framework for the operations of a private limited company, these at the very least offer a basic structure which then allow shareholders or members to further develop it to suit their needs. On the other hand, an unincorporated joint venture lacks such ‘baseline’ governance framework. Consequently it requires more ‘heavy lifting’ on the part of the joint venture members to start drafting the governance framework from scratch. Therefore any drafting of comprehensive governance framework for unincorporated joint venture is likely to take a longer duration. 

The type of joint venture not only dictates the operations of such alliance but also the manner in which decisions are made when confronted with differences in perspective. No matter how optimistic the joint venture members were in the beginning, their business relationship will be tested from time to time with conflicts and disputes. By way of illustration assuming a joint venture undertakes a design and build project, certain member may be responsible for design whilst the other responsible for construction. The liability of each member is not necessarily confined to its scope of responsibility. The construction member may be responsible for damages arising from design negligence and vice versa. This is because the Employer typically require ‘joint and several liability’ provision to be included in the design and build contract. Therefore fault based indemnity do not necessarily apply. Consequently members should ensure that their governance framework  allow collective decision making on certain critical issues.

As alluded to earlier, under an incorporated joint venture, shareholders could refer to Companies Act of Singapore to understand the formation, operation and regulation of such business entity. They should also refer to company’s constitution which is a legally binding document that sets out rules between the company and its members (or shareholders). Joint venture members should additionally put in place a shareholders agreement that is specific to rights and obligations of each member. The interpretations of Companies Act with the benefit of vast case precedents ensures that the relevant governance framework is established, predictable and consistent. 

On the other hand, the unincorporated joint venture does not have an equivalent established governance framework for its members to rely on. Therefore its governance framework exclusively relies on any mechanism included in the joint venture agreement. Some may view this arrangement as being more flexible for members as they do not necessarily need to subscribe to the legal structure of a corporate entity and shoulder the usual compliance burden. Therefore the Employer is likely to pay close attention to the joint venture agreement of a prospective unincorporated joint venture to understand how the members are organised and whether the arrangements present any risks. However the interpretations of such bespoke joint venture agreement may vary. Such untested and bespoke joint venture agreement could consequently give rise to project execution risk.

Valuation Of Initial Equity Of Joint Venture Members

Given that joint venture members may not always agree on every critical issue and it is almost impossible to predict all likely points of disagreement, the decision making mechanism is crucial. A member’s ability to influence decision making is likely to be correlated to its equity, stake or shareholding under the joint venture. The more one contributes, the higher its decision making influence as well as share of profit. Risk typically commensurates reward. This principle appears sensible. Therefore members to a joint venture should appropriately value their respective initial equity based on certain accepted principles. One should resist the simplistic approach of splitting the equity ‘equally’ amongst members before valuing each party’s contribution. An agreement to a sensible valuation principle is a precursor to a successful joint venture arrangement. 

As alluded to in the earlier scenario regarding design and build project, certain members may be valuable to the joint venture due to expertise in specialised design skills for a technically challenging project. Such member is likely to be operating under an engineering or architectural consultancy business model that is light in tangible asset but primarily contribute skills and expertise which are categorised as intangible assets. Therefore, the valuation approach of initial equity of such skill based member should take these qualitative contribution into consideration. Other forms of qualitative contributions include business connections/ networking credentials, compliance with local law on racial/ citizenship composition, intellectual property right etc. Members with intangible assets are likely to partner with members with the opposite balance sheet profile which are entities with more tangible assets such as cash, plant, equipment, inventory etc. After all the premise to a joint venture is essentially finding business partners with complementary competence. However, tangible assets are relatively easier to value than intangible assets. This creates a dichotomy in valuation of different asset classes. Some may take the practical approach that ‘value’ is defined by what others are willing to pay. However in negotiating a joint venture equity, members are unlikely to be able to get an objective fair market value by way of competitive bidding. Therefore most valuation principles may involve certain accounting assumptions that can be subject to challenge. This underscores the complexity of joint venture formation where members are negotiating amongst themselves whilst simultaneously working together to negotiate against the Employer and its consultants. This evolution of joint venture arrangement from procurement to award will be elaborated further in one of the sections in this article.

Although valuation of initial equity can be challenging, valuation of future contributions to the joint venture can be equally daunting too. In case of prolongation in construction duration (whether due to excusable delay or otherwise), joint venture members may be required to inject more assets into the alliance, that may be in its tangible or intangible form. Therefore having an upfront agreement on the valuation approach is not only crucial at the inception of the joint venture formation but also in ensuring its continuity. These continuous injection of assets should be clearly defined as to whether it may amount to increase or decrease in equity and its corresponding influence in decision making process. Some members with minority interest may prefer future injection of assets to be categorised as debt if it does not necessarily change the decision making weightage. Certain joint venture member may not continuously be involved in the project from inception to completion due to the nature of its upfront responsibility e.g. due diligence, demolition works, foundation works, structural works etc. Therefore, its exposure is limited by its duration of involvement. Under such circumstances, if and when the construction duration is extended and asset injection is expected, such joint venture member may have limited scope to contribute apart from cash/ capital. Therefore such joint venture member may face dilution in its equity when project duration is extended unless it contributes cash. Some may argue that if the project is extended due to excusable delay, the Employer should provide compensation for preventing the joint venture from completing the works. Therefore the financial exposure is limited. However one should take into consideration excusable delays that are caused by neutral event e.g. inclement weather where compensation of loss and expense is not expected. Even if the delaying event was deemed excusable, there may be a need to commence legal action e.g. arbitration of which the recovery of compensation is far from certain and may entail further financing of legal expenses. These considerations should also be included in valuation of initial equity of joint venture members.

Asset Infusion Of Joint Ventures

Once the project is awarded to a joint venture, there are various upfront financial commitments that are due before commencement of actual construction works. These include amongst others procurement of banker’s guarantee, construction insurance, downpayment for ordering of various long lead items, mobilisation costs of plant and equipment, setting up of site office and facilities etc. Managing cash flow of construction project is fairly challenging because the contractor is often required to make payments first before recovering its expenses via interim progress payments retrospectively. Therefore, asset infusion into the joint venture need to happen almost immediately which explains why the joint venture set up or formation has to be concluded upon project award. The process of asset or capital infusion varies depending on the type of joint venture i.e. incorporated or unincorporated. 

Under an incorporated joint venture, the new legal entity’s ability to procure banker’s guarantee or insurance bond in a cost effective manner can be challenging because it is effectively a new company without any track record or existing business relationship of its own. Although the incorporation of a private limited company can be completed very quickly say within a few days, the licensing requirement to carry out construction activities may take a longer time, of which it may need to demonstrate it has sufficient paid up capital to undertake the necessary works. These licensing and permit approvals are also required to engaged workers. Therefore the individual joint venture members may be required to provide some form of parent company guarantee to expedite these transactions and approvals where possible. Under most construction contracts, the submission of a baseline programme for approval and procurement of performance bond had to be fulfilled within weeks upon commencement of time for completion. Whilst the award of project may call for celebration, the reality sets in with pressure of immediate deadlines. The above mentioned multiple critical milestones that are scheduled closely to the project award may not be fulfilled if the joint venture formation is not thoughtfully and methodically planned. This explains why the Employer and its consultants are typically interested in understanding the ‘maturity’ of the bidders’ joint venture agreement and can be subject to intense scrutiny during tender negotiation. The Employer often makes a clear distinction between members of the joint venture (which are usually established organisations) from the incorporated joint venture which is a new and independent entity. 

Under an unincorporated joint venture, the members remain separate and distinct entities where no formation of new legal entity is required. Whilst there is no need to infuse capital or assets to a newly incorporated entity, the Employer may find that the typical deliverables under the construction contract such as performance bond can be tricky. Most construction contracts including its performance bond template are drafted with the presumption that the contractor is a single entity. The involvement of multiple entities may require amendments to the standard wordings. By way of example, the obligor of performance bond is the joint venture that carries out the construction works that is also responsible for procuring the bond from a bank (guarantor). Assuming the unincorporated joint venture consists of two members where each member agrees to contribute half of the amount stipulated in the bond, the Employer should always ensure that it has the right to call upon the full sum notwithstanding that only one member is responsible for the default. Although the construction contract usually include joint and several liability provision, such condition does not necessarily bind the bank since the bank is not a party to the construction contract. Therefore the joint and several liability wordings should clearly be included in the performance bond. Additionally the Employer should refrain from using indemnity bond (where proof of default is required) but to insist on unconditional bond where its right to call upon the full sum is independent of financial contribution of each joint venture member and extent of their respective liabilities in relation to the default. Failure to effect these changes may result in grant of injunction on the calling of bond on ground of unconscionability.  

Joint Venture Arrangement From Tender To Award

As alluded to earlier in this article, joint venture arrangements tend to conclude upon award of project as no contractors are likely to incorporate an entity or to enter into a joint venture agreement without an underlying project. However these contractors are simultaneously required to demonstrate how they intend to organise themselves including the governance framework and capital infusion plans in order to secure the project. It is also fairly common for the Employer to stipulate requirements for the contractors concerned to exhibit certain form of structured alliance for them to participate in tender as a consortium. In view of the delicate balance, contractors can consider entering into a non binding agreement such as memorandum of understanding or letter of intent to the extent that details included therein fulfils the Employer’s tender participation requirements. 

The extent of details that ought to be included in such memorandum of understanding is largely dependent on two factors. Firstly, it depends on the duration available for contractors to negotiate on the governance framework, split of responsibilities as well as liabilities and capital infusion plans to the extent necessary. Secondly, such details ought to address the Employer’s concerns on risks of premature dissolution of alliance that may jeopardise the project. The Employer also ought to be realistic that since the details included in such memorandum of understanding is non binding, there may be a limit to which the Employer may rely on such details communicated during tender. Depending on parties’ bargaining power and negotiation leverage, the Employer may stipulate that tenders submitted should be accompanied by a complete and binding joint venture agreement, with allowances for commercially sensitive information to be redacted. Therefore parties are encouraged to discuss these expectations before officially launching the tender process.

Conclusion

Although an incorporated joint venture could often rely on an established governance framework pursuant to Companies Act, model company constitution etc to expedite the joint venture formation, it comes with a trade off. This is because the newly incorporated entity requires a methodical asset infusion plan as well as a separate statutory licensing approval of its own. Therefore any upfront time savings may be negated by post award pre-construction activities. On the other hand the flexibility that members may enjoy under an unincorporated joint venture arrangement may bring about various uncertainties from the Employer’s perspective for purposes of tender evaluation and award. In short, joint venture formation is a bellwether of contractors’ ability to compromise and forge synergistic alliance. It is always advisable to uncover an ill-conceived alliance sooner rather than later.




Koon Tak Hong Consulting Private Limited