Joint venture by contractors is often described as an ad hoc alliance that brings about synergy in that the combined effect of such cooperation is greater than the sum of individual contractor’s competence. A successful joint venture makes strategic sense given that it allows contractors to jointly undertake project larger than their typical risk appetite by cooperating with allies with complementary competence. However such alliance is not without risk if approached with blind optimism. This article is Part 2 of an article series examining tips and traps of joint venture arrangement so as to enable contractors to make an informed decision on how to approach such alliance. In previous Part 1 article of this series, several key subjects of joint venture were examined including the types of joint venture and how such choice may affect the ways in which assets and capital are set up at the inception of the alliance. It was also pointed out that valuation of each joint venture member’s contribution whether in the form of tangible or intangible assets could have significant downstream implications such as splitting of profit, distribution of liabilities and internal decision making mechanism. 

In Part 2 of this article series, there will be further focus and analysis on how contractors participating in joint ventures should ensure that the joint venture agreement which regulates their rights and obligations should be drafted in congruence with the construction contract with the Employer. To this end, the manner in which joint venture members split their roles and responsibilities as it relates to executing the underlying project may have consequential effects on key issues such as claims, payment entitlements and liabilities. As pointed out in article of Part 1, certain joint venture members may contribute intangible assets to the alliance e.g. access to critical business relationship, design and engineering skills etc where it may be challenging to value its initial percentage equity to the joint venture. Additionally, members that exclusively contribute intangible assets may have either low or limited actual physical involvement in the carrying out of the project works. If and when the construction duration is extended and the joint venture requires additional capital infusion, the fabric of partnership between contractors may be tested. Those who contribute mainly intangible assets may have light balance sheet and therefore could either be unwilling or unable to provide continuous financial support to the joint venture. Consequently there could be dilution of equity for members who are unable to participate in fund raising, which could result in acrimonious disputes if the joint venture agreement does not include a thoughtful mechanism to deal with such possibilities. By the very same token, fault based indemnity may not be applicable to joint venture members as they may be required to either directly or indirectly responsible for certain default caused by other joint venture members. This is quite common given the inclusion of ‘joint and several liability’ provision under construction contract typically stipulated by the Employer. 

The next section of this article examines certain key issues that may arise in case of conflicts between joint venture agreement and construction contract of the underlying project. Joint venture agreement should not be drafted in isolation of the construction contract. Where possible it should be premised on a ‘back to back’ arrangement with the construction contract. This underscores the reason why it is not advisable to conclude the joint venture agreement without having a good grasp of the final terms of construction contract.

Alignment Between Joint Venture Agreement And Construction Contract

The requirement for consistency between joint venture agreement and construction contract can be best illustrated as analogous to the relationship between main contract and subcontract. There may be occasions where the main contractor may be responsible for defaults caused by its subcontractors even if the main contractor is not culpable. Therefore, most main contract and subcontract are drafted on a ‘back to back’ basis such that the contract administration of subcontract are effectively in sync with the main contract. By way of illustration, any extension of time granted under the main contract typically is allowed to trickle down to the relevant subcontract and likewise the main contractor is able to recover liquidated damages that it is liable to the Employer from the culpable subcontractor based on subcontract terms. By the same token in negotiating joint venture agreements, contractors should decide how various key provisions under construction contract e.g. liquidated damages, extensions of time, variations, interim progress payments, dispute resolutions etc impact the rights and obligations of various joint venture members. Unlike most standard conditions of contract which have a suite of template agreements that cater to both main contract and subcontract with default back to back arrangement, there are no industry wide ‘standard conditions’ available for joint venture agreements. This is because joint venture agreements tend to be highly bespoke with a wide variety of permutations of types of joint venture legal structure, number of venture partners with differing equity proportions as well as split in roles and responsibilities etc. Notwithstanding the difficulties in ensuring that construction contract and joint venture agreement are in sync, it continues to be a worthwhile effort. The challenge however is that unlike main contractor and subcontractor that are separate and distinct legal entities that are in an arm’s length transaction with each acting in their own self interest, the same may not always be the case for joint venture members. Contractors may participate in an incorporated joint venture where they become shareholders of the very same legal entity whereby their commercial interests are relatively more aligned than unrelated parties’ transactions. Therefore in the interest of clarity, the rights and obligations of all joint venture members ought to be expressly provided for out of abundance of caution. 

By way of illustration and assuming there is proper delineation of responsibilities between joint venture members, any delay to programme caused by upfront construction activities may only be felt towards the end of the construction schedule. This is particularly common where baseline programmes are likely to have more float and flexibility to reposition its critical path. Such flexibility diminishes with the passage of construction period. It is therefore entirely possible that the culpability of an upstream joint venture member can disproportionately affect another downstream joint venture member. If and when liquidated damages are imposed by the Employer, how should the damages be apportioned? Should it be based on the identity of the prevailing member carrying out the works during the period of schedule overrun? Or based on determination made by the certifier appointed under the construction contract? Or be split equally amongst all joint venture members regardless of culpability and percentage of equity? As there are no universally acceptable solutions to these difficult issues, some may suggest that the dispute resolution outcome under the construction contract to be final and binding as it relates to the joint venture agreement. This option can be helpful as it avoids confrontation of awkward issues by leaving it in the hands of a neutral third party. However, not all construction claim may end up in a legal proceeding e.g. arbitration and neither should arbitration be the default dispute resolution option for every construction dispute. The balancing act of finding an equitable approach that is also commercially sensible can be tricky to say the least. However having an aligned joint venture agreement and construction contract can be helpful in avoiding nasty surprises in the midst of the project. 

Whilst the illustration above on the issue of liquidated damages demonstrate how joint venture agreement should include mechanism on ‘burden sharing’, it may be equally problematic in the case of additional payments from the Employer. In this regard, the same line of enquiry applies i.e. how should additional payments e.g. loss and expense compensation, advance payment, variation works payment, incentive payments under pain and gain share commercial mechanism be distributed amongst joint venture members? These issues will be further elaborated in the subsequent sections of this article. In any case, it is fair to say that having a joint venture agreement that is drafted in line with the commercial principles of construction contract is an essential starting point. It is a critical early indication of whether joint venture members are able to both collaborate and compromise. 

Delineation Of Responsibilities Within Joint Venture

As joint venture partners are typically a coalition of contractors with complementary skills and strengths, it is common for the construction project to be carried out in accordance with their unique set of attributes. Where the joint venture consists of members with interdisciplinary skills e.g. architectural and builder works, civil and structural works, mechanical and electrical works, the project may be divided based on their respective expertise. As a matter of sequence of construction trades, one may find that joint venture member responsible for civil and structural works may commence and complete its works earlier than the rest. By contrast, architectural and builders works particularly those involved in internal furnishings are likely to be completed later, typically coinciding with the practical completion of the project. As construction risk fluctuates in tandem with its lifecycle, the risks are therefore not evenly distributed amongst the joint venture members. As alluded to earlier, risks tend to concentrate towards the end of the project schedule with less flexibility in critical path and increase in time pressure to meet statutory inspection. In view of this phenomena, joint venture faces challenges in balancing risks and rewards with contractor carrying out tail end trades may understandably demand for more equity to commensurate with the risks it shoulders. Ironically most architectural and builders works are typically subject to nominated subcontract, which meant that these very risks are actually outsourced to third parties down the contract chain. In view of the unique risk profile relating to interdisciplinary joint venture between contractors, there ought to be an express agreement on how to objectively measure risk and its subsequent effect on equity split. 

There may also be cases where joint venture is formed primarily to share risk of a large project amongst two or more contractors with similar background and expertise. In this regard the project could be divided either geographically based on pre-defined phases of works, or be undertaken concurrently by the joint venture members. Under this scenario there is more even allocation of execution risk as well as an increase in redundancy or resilience. Joint venture of such nature should ensure that the redundancy is not reduced to being duplicative with multiple parties tripping over one another due to confusion in roles and responsibilities. Whilst joint venture members are part of an alliance, it is ultimately an ad hoc cooperation where they could be competitors before and after the joint venture. Joint ventures are not permanent mergers. Naturally, there may commercial sensitivities in working together under one roof as well as conflicts in different business practices, workflow and governance structure. An incorporated joint venture is perhaps a better form of cooperation where a new legal entity is formed with autonomy to implement bespoke contract administration system that is specific to the project in hand. A board of directors comprising representatives from each joint venture member can be instituted to provide strategic oversight to the joint venture without necessarily getting involved in the day to day operational issues. 

It is important to note that the delineation of responsibilities between contractors should not be an afterthought that is informally arranged after project is awarded. It should be clearly documented in the joint venture agreement since this is the basis of construing rights and obligations between various parties. By way of illustration, the extent of entitlements to progress payments between each joint venture member and any cross party indemnification obligations are premised on allocation of responsibilities, amongst others. How construction contract is administered can be heavily influenced by the nature of such delineation of responsibilities which will be examined in the next section of this article. 

Contract Administration – Payment To Joint Venture

Joint venture in general receives its payment and revenue through work done. Occasionally there may be additional revenue from variation works as well as acceleration of works. There may also be payments to compensate for loss and expense in cases where entitlements are established. Whether the joint venture is in the form of a newly incorporated entity or otherwise, there is typically an agreement to set up a designated bank account with upfront working capital contributed by all members based on a pre-agreed percentage split. This is also the account that is communicated to the Employer for purposes of receipt of payments, so as to establish transparency and accountability in cashflow. Under most construction contracts, the contractor is required to temporarily finance the project in that it recovers its expenses through progress payment some one or two months later. Payment is generally derived based on actual work done on site. Under joint venture arrangement, the financing of project involves an additional layer of complexity because joint venture member that carries out certain works using its own plant, machineries, equipment, labourers and construction materials based on delineation of responsibilities may not be compensated directly by the Employer for its work done. This is because payments are typically directed to the joint venture account rather than the specific joint venture member. Much like the relationship between main contractor and subcontractor, the latter does not get paid directly by the Employer for its subcontract works. Therefore joint venture members carrying out significant portion of the works may find itself stretched financially due to the expected time lag between the moment expenses are incurred to its recovery of progress payments. The cashflow problem could be compounded if the progress payments are retained in the joint venture account for working capital purposes and only be split upon finalisation of account. Such approach is often justified on the basis that large projects can be financially burdensome where the joint venture is expected to finance disputed variation works and shoulder prolongation costs without clarity of whether extensions of time will eventually be granted. There are usually provisions for the contractor to comply with the instructions issued by the Employer’s agent notwithstanding the existence of dispute on whether the event is compensable. 

In order to assist with the cashflow burden imposed on the joint venture members, the joint venture agreement could incorporate various types of payment mechanism to disburse funds based on specified grounds. Firstly, the joint venture could reimburse the joint venture member for its costs incurred based on receipts and daywork sheets of resources expended. The joint venture member concerned is likely to charge its goods, services and reasonable overheads to the joint venture at rates and prices below market level due to the exclusion of profit. The joint venture member therefore is able to recover its costs and only be in the position to have access to its share of profit, if any much later. Whilst such arrangement may sound sensible in theory, the devil is in the detail. What constitute profit and cost are often debatable at least from an accounting perspective. For clarity, the joint venture agreement should include specific definitions e.g. gross profit, operating profit, net profit, direct cost of goods sold, operating costs etc.

Alternatively instead of fully retaining progress payments in joint venture account, the progress payments could be split immediately upon receipt based on the respective scope of works carried out by various members. In order to ensure sufficient working capital, an agreed fraction of payments could be retained in the joint venture account. These retained earnings could then be used to finance disputed variations and other prolongation costs where necessary without the need for fresh fund raising.

What is evident from the above is that it underscores the importance not just to appropriately delineate responsibilities in terms of scope of works but also an agreement of the corresponding baseline schedule. These information in turn can be used to construct a projected cashflow or commonly known as the “S-curve” that provides an accurate estimation of capital outlay expected from each joint venture member depending on their allocated scope of works. This helps facilitate an agreement on the magnitude of working capital required in the joint venture account depending on the fund disbursement method adopted by the joint venture.

Contract Administration – Liabilities Of Joint Venture

As regards the issue of liability of joint venture, there are two important elements to consider namely joint venture’s ‘external liability’ as well as ‘internal liability’. As regards external liability, it pertains to joint venture’s outside exposure such as to the Employer, third parties (e.g. members of the public) that could arise out of accidents, acts of negligence etc which result in damages to properties, bodily injuries or even death. It could also include breach of construction contract that may attract liquidated damages, remedial costs for defective works etc which the joint venture will need to be responsible for. On the other hand, ‘internal liability’ refers to acts or omissions by certain member(s) of joint venture that inflict damages to other members within the consortium. As alluded to earlier, most construction contracts include stipulation for joint and several liability where all joint venture members may be held liable for the full compensation even if only one of them that is culpable. Therefore joint venture member’s liability is not limited by the extent to which it had ‘contributed’ to the loss or damages. As the stipulation on the contractors for external liabilities are fairly standard market practices, most contractors are usually aware of its exposure and would manage such risks by procuring the appropriate insurance policies e.g. contractor’s all risks policies which may be inclusive of third party liabilities, workmen compensation policy etc. As regards potential default by the joint venture in respect of its construction contract obligations, the Employer typically require performance bond as well as retention monies to cushion any financial risks. 

On the other hand, how internal liability within the joint venture is managed lacks standard industry practice and should be carefully negotiated for the purposes of incorporating into the joint venture agreement. Certain joint venture agreement may include cross indemnification stipulation where culpable joint venture member may be required indemnify other members for any of their liability in the absence of default. This cross indemnification stipulation can be tricky if the risks in hand are not insurable. In other words, the ability of the concerned joint venture member to shoulder any such indemnification burden is limited by its balance sheet. By way of illustration, contractor is usually required to comply with various advance notification requirements or condition precedents under the construction contract prior to its entitlement to either payment or compensation. The joint venture could lose its right to claim if in breach of such condition precedent. Depending on the way in which responsibilities are delineated, it is possible for the acts or omission of one member to implicate the joint venture as a whole. Even if the joint venture is established as a newly incorporated entity, the Employer occasionally require parent company guarantee to underwrite such risk. This can be problematic for joint venture members that are primarily contributing intangible assets which may not have the financial heft to meet such requirement. In negotiating these issues, contractors may be compelled to reconsider the original rationale behind joint venture formation and whether the risk and reward commensurates. Whilst certain party could have valuable contribution to the alliance, it may not always need to be included into the joint venture particularly when there is a significant disparity in relative financial wherewithal. An alternative ordinary counter party transaction may be an option to consider. 

Conclusion

As pointed out in Part 1 of this article series, joint venture remains an elusive subject of construction law because logical reasoning alone may not always be sufficient in structuring a successful alliance. The decision making process often involves intuition and business acumen. Unfortunately the benefits of forming a joint venture is often more enticing at the outset before parties go through arduous negotiation journey to forming a joint venture agreement. Additionally, there is no blue print on what constitute a comprehensive joint venture agreement. Parties often ignore these critical details at their own peril without a sufficient dosage of paranoia.



Koon Tak Hong Consulting Private Limited