Joint Venture Exit Strategies: Navigating Sale Restrictions

Considering selling your joint venture stake? Discover crucial due diligence steps to identify potential sale restrictions. Learn how to evaluate transfer limitations, rights of first refusal, and other key factors that may impact your exit strategy. Essential reading for joint venture participants and potential buyers.

Background

The following applies to “unincorporated joint ventures” (or “UJV”) which can be described as a business arrangement where two or more parties come together to work on a specific project or business venture. Unlike a corporation, an UJV is not a separate legal entity. Instead, it is a contractual relationship between the parties involved, each referred to as a “Joint Venture Participant” or “JVP”. The parties typically define the terms of the venture through a Joint Venture Agreement (or “JVA”) (also known as a Joint Operating Agreement or “JOA”).

Compare this to an incorporated joint venture whereby a separate company is formed (outside the scope of this blog post).

Restrictions on selling an interest in the joint venture

If a Joint Venture Participant wishes to sell its interest in the joint venture to a third party, as part of your due diligence, you must consider whether there are any restrictions on the participant doing so. Usually (but not always), if the interest is being sold to another participant, as opposed to a third party, then the restrictions won’t apply. As such, the following analysis applies to selling the interest to a third party (not already party to the JVA).

Before diving into the restrictions that might apply, it is helpful to understand why JVA’s contain such restrictions on a JVP transferring (or selling) their interest to another party. The identity of the joint venture participants and what each contributes to the joint venture are critical to its success. For example, their contributions might be their technical expertise and/or their contributions to funding the joint venture’s operations. Existing JVP’s want to ensure that a new entrant will make similar contributions. If the JVP exiting has consent or veto rights over management decisions, then it is even more important for the existing JVPs to evaluate the incoming JVP.

Lock-out period

The JVA will sometimes contain a 'lock-out' period during which transfers of joint venture interests is prohibited. This might be for a period of time within which it is considered desirable to have the original JVPs involved, and unable to exit.

Pre-emption rights

A common type of restriction on selling an interest in a joint venture is called a “pre-emption right”. One type of pre-emption right that may apply is called a “right of first refusal” or “ROFR”.

A ROFR gives the other parties to the joint venture the opportunity to match any bona fide offer that the selling party has received for the sale of its participating interest in the joint venture by a third party bidder. If the other parties choose to exercise their ROFR, they must match the terms and conditions of the third party’s offer, including the bona fide consideration, in order to purchase the sale interest. If the other parties do not exercise their right of first refusal or are unable to match the offer, the selling party is free to sell the sale interest to the original bidder.

How is the transaction structure relevant to your analysis of restrictions on exiting a joint venture?

When you are reviewing the pre-emption right, you will need to review it in light of the proposed transaction structure and whether this structure will trigger the pre-emption right. Namely, is the participant selling an interest in the joint venture only (asset sale) or are shares of the company that owns the participating interest in the joint venture being sold (share sale)?

If you are unsure about the differences between an asset and share sale, we have written about this in another blog post.

Asset sale (participant selling an interest in the joint venture only)

Share sale (shares of the company that owns the participating interest in the joint venture being sold)

Do pre-emption rights apply if the buyer purchases the shares of the company that owns the participating interest in the joint venture?

It depends on the specific terms of the joint venture agreement. Pre-emptive rights typically apply to the sale of a participating interest in the joint venture, rather than the sale of shares in the company that owns the participating interest (Participant A in the above example). However, it is possible that the joint venture agreement includes a provision that gives the other parties a right of pre-emption in the event of a sale of shares in the company that owns the participating interest.

A buyer (and/or its advisors) should carefully review the joint venture agreement to determine whether there are any pre-emptive rights that apply in the event of a sale of shares in the company that owns the participating interest.