Corporations and Cross Border Transactions by vivi07

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									Corporations and Cross Border Transactions

Visiting Prof. John W. Reboul
September 2009

Course Overview
• Introductions • American Corporations • Cross Border Transactions
– International Mergers and Acquisitions – International Component Supply Agreements – International Distribution Agreements – International Joint Ventures
• Manufacturing • Natural Resources

• Who is Visiting Professor Reboul? • Class Introductions • Questions

Who is Professor Reboul?
• 1964, Doctorat de l’Université, Faculté de Droit et des Sciences Économiques • 1963, LL.B., Harvard Law School • 1959, A.B., Harvard College

He co-founded Reboul MacMurray with John MacMurray in 1973 and is a corporate lawyer with extensive experience in international corporate, finance and securities, joint ventures/strategic alliances, and private equity law. He joined Ropes & Gray in 2003 when Reboul MacMurray Hewitt & Maynard combined with Ropes & Gray.

Who is Professor Reboul? (cont’d.)
Professional Experience
He has advised clients on multinational transactions centered in Europe (France, Germany and The Netherlands) and Asia (Japan, Korea, Malaysia and Thailand). He represented Mitsubishi Motors Corporation for many years, including in its alliance with Volvo Car Corporation to develop and produce a car to be assembled at the Netherlands Car B.V. (NedCar) plant. He has worked on cross-border joint ventures, acquisitions, distribution arrangements and other agreements involving many countries in Europe and in Japan.

Who is Professor Reboul? (cont’d.)
Professional Experience (cont’d)
• He represented a South African private equity fund borrowing from Overseas Private Investment Corporation. • He represented the Democratic Republic of the Congo in the renegotiation of certain mining contracts entered into with international mining companies.

Class Introductions
• To give me an idea of your backgrounds and interests, I would appreciate it if several of you would stand up and inform me of your:
– Name – Program in which you are enrolled and year in program – Home city – Why are you taking this class?

• This is an open class, as such questions and comments are both encouraged and welcome. • I will ask questions about some of the situations described. There are frequently no “right” or “wrong” answers and the purpose of the questions is to encourage discussion of the issues raised. • You may ask questions in any way related to the subject matters being presented but suggest that questions about current events and politics be raised after the class. • Raise your hand if you do not understand anything discussed or if you cannot hear me or if I speak too fast.

Characteristics of a Corporation
– General
• Created by law • Can exist indefinitely

– Legal
• Can sue or be sued • Can own property • Shareholders not personally liable for actions of corporation, except to prevent abuses

How does a Corporation compare to other legal business relationships?
Individual Proprietorship Persons Required Formation One No formalities Partnerships At least two people No paper work required. This may be a default business structure. Corporations Only need one adult to form Formal filing required


Full liability

Each partner responsible Shareholders not for all actions of the personally liable, except partnership to prevent abuse.
Each partner equally unless specified otherwise Flows through to partners Board of Directors and Officers Separate taxpayer


Individual Control


Included in Individual's tax responsibility


There are also limited partnerships (where the general partners run the business and are responsible for the partnership’s debts and the limited partners are primarily investors) and limited liability companies combining some or all of the characteristics of a limited partnership.

Taxation Concepts
Partnership Partners Partners pay income tax, proportionately, on 100% of the profits


100% Profits


Pass Through Taxation (money only taxed once)




Corporation pays Expenses and taxes

Net Profits

Net profits distributed to Shareholders as Individuals, who pay income tax

Corporate Taxation (money taxed twice)


Where to Form the Corporation
• Multi-state corporations
– Most are formed in Delaware
• • • • Over 50% of U.S. publicly traded corporations Over 60% of Fortune 500 companies Certainty of results if litigation Management-friendly

• Offices/operations in only one state
– Delaware or state where corporation will be physically located – Formation extremely simple by signing a Certificate of Incorporation and causing it to be filed with the Secretary of State or other official in the state in which the corporation will be incorporated.

General Characteristics of Delaware Corporation
• Share capital. Delaware does not impose minimum or maximum limits on share capital. • Non-cash consideration. A corporation's shares can be issued for non-cash consideration. • Rights attaching to shares. The rights, powers and preferences of shares must be set out in a corporation's certificate of incorporation. • Foreign shareholders. Delaware does not impose restrictions on foreign shareholders. • Management structure. Unless the certificate of incorporation provides otherwise, a Delaware corporation is managed by, or under the direction of, its board of directors. There are no co-determination rules or citizenship requirements for management.

Certificate of Incorporation
NAME AND ADDRESSES • Name must not be the same as another corporation incorporated in the same state • Must include word “corporation”, “corp”, incorporated” or similar • Must include address of each incorporator CAPITAL STRUCTURE (STOCK) MUST INCLUDE : • Number of authorized shares • Number of classes of stock • Information on par value, rights, preferences or limitations of each class • Information on any series (structures) of preferred stock.

CORPORATE PURPOSE: • Must include corporate purpose, but purpose can be very general • For example: “The purpose of this corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware”

Governance – State Law
• Certificate of Incorporation • By-Laws
– – – – Not filed with the state Outsiders to corporation not bound by By-Laws Incorporator adopts initial By-Laws Shareholders and Board of Directors (if so provided) can adopt By-Laws

Management Structure
• Management Structure
– A Board of Directors elected by the shareholders manages the corporation. Officers appointed by the Board take care of day-to-day operations

• Board of Directors
– – – – Acts by Board of Directors Meeting; or No meeting with unanimous written consent Meeting may be held outside state of incorporation

– Conference call acceptable, if directors can hear all participating directors simultaneously

Management Structure (cont’d.)
• Notice
– Regular meetings are specified in the By-Laws, no notice – Special meetings require notice with method set in By-Laws – If Director not given notice, any action taken at meeting is void, unless director waved notice by:
• Attending the meeting without objection; or • Writing and signing a waiver of notice at anytime

• Quorum Requirements
– Must have quorum at meeting (generally majority of all director seats) – Can lose quorum if director leaves meeting before voting – At meeting, only need majority present to pass resolutions

Duties of Board
• Directors of corporations owe a fiduciary to the corporation and can be held liable for breach of this fiduciary duty. Directors can also be liable for the unlawful payment of dividends or unlawful share purchase or redemption. – Liability can arise for breaches of the duty of loyalty (this deals, for example, with conflicts of interest). – Breach of duty of care:
• Failure to discharge duties in good faith and with that degree of diligence, care and skill that an ordinarily prudent person would exercise under similar circumstances.

Officers are generally named by the Board of Directors and are the persons who run a Corporation. Generally, officers include:
– President – Secretary – Treasurer

but, may include:
– Chairman – Vice Presidents, and many other titles

Mergers & Consolidations



• The Board of Directors of each corporation must generally adopt plan of merger or consolidation • Each corporation must generally have shareholder approval • No shareholder approval in “short form” merger: B owns 90% of each class of stock of A • Deliver certificate of merger of consolidation to Dept. of State for filing • Right of Appraisal for shareholder of Corporation that disappears
• includes dissenting shareholder in short form merger


• Surviving corporation succeeds to all rights and liabilities of the constituents “successor liability”

Transfer of Substantially All Assets/Share Exchange
• Fundamental change for selling corporation only
– – – – Each corporation's Board of Directors must authorize deal and Approval by selling corporation’s shareholders Buying corporation generally does not vote Department of State for filing
• • Only if share exchange Does not apply to asset transfer

– Selling corporation shareholders may have right of appraisal

• Only successor liability if:
1. Deal provides otherwise; 2. Purchasing company is mere continuation of the seller; or 3. Deal was entered fraudulently to escape such obligations

• Voluntary: By vote of board and shareholders or by all shareholders without board vote. • Involuntary: Judicial
– Board Resolution or resolution of majority of shareholder entitled to vote
• Insufficient assets to discharge liabilities or • Dissolution beneficial to shareholder

– Under Delaware law, in the case of a corporation having only 2 stockholders owning 50% of the stock engaged in a joint venture and such stockholders are unable to agree on discontinuing the joint venture either one may petition the Court of Chancery to dissolve the corporation.

Dissolution (cont’d.)
• Dissolution does not end corporation’s existence. Requires winding up:
– – – – Gather all assets Convert to cash Pay creditors Distribute remainder to shareholders

• Shareholders are never paid before creditors.

Cross Border Transactions
• This is a very broad topic and can involve almost any business arrangement involving parties in different countries. My lectures will address the following categories of transactions: Cross Border Mergers and Acquisitions
- Includes situations in which a company (Company A) in one country buys a company (Company B) in another country or combines with Company B - Also includes Company A buying an interest in Company B of less than 100% - The acquisition of an interest of less than 50% is frequently part of a larger relationship, for example, a joint venture

Cross Border Transactions (continued)
Cross Border Supply Agreements
A product made in one country is a component in a final product made in another country
- For example, an engine made in Japan may be incorporated in an automobile finally assembled in the United States

Cross Border Distribution Agreements
A product manufactured in one country by Company A is distributed in another country by Company B
- For example, many automobiles are distributed by unrelated distributors in countries other than the country in which they were made

Cross Border Transactions (continued)
Joint Ventures
- A very broad term which may include one or more of the following: the acquisition of an interest by Company A in Company B, a component made by Company A being included in a final product made by Company B or a product made by Company A being distributed by Company B in another country - A characteristic of Joint Ventures is that Company A and Company B are carrying out some business together over a period of time - We will examine two types of joint ventures
- Manufacturing joint ventures, and - Natural resource join ventures

These lectures will focus on the issues arising in connection with the

categories of transactions listed above but note that, in the case of any joint venture, the laws of each country touched by a cross border transaction must be considered
- A manufacturing joint venture located in say The Netherlands between a Japanese and a German company will involve the laws of The Netherlands, Japan, Germany, the European Union and maybe other countries, for example England if English law is chosen to govern the interpretation of the joint venture agreement and Singapore law if arbitration is to take place in Singapore.


International Mergers and Acquisitions
In the first part of this course, we looked on some of the provisions of U.S. Corporate Law which apply to mergers and acquisitions. In the following discussion, we will consider some of the agreements that are typically involved and some of the issues that need to be addressed. One point to be noted is that a merger or acquisition is a transaction which results in one company acquiring another company or a combination of two or more companies and that distinguishes such transaction from the International Component Supply Agreement, International Distribution Agreement and International Joint Venture in which companies maintain their separate existence and agree to work together for specific purposes.

TYPICAL AGREEMENTS • Typical Agreements at Signing:
– Stock Purchase Agreement or Merger Agreement – Debt Commitment Letter(s)

•Types Additional Agreements by Closing
– – – – Stockholders Agreement Employment Agreements Stock Incentive Plan and Awards Management Agreement

Business Issues
• Identify assets and liabilities to be transferred • Set payment terms • Allocate risks (known and unknown) between the buyer and seller(s) • Obligate parties to take specific steps to get the deal closed • Establish degree to which parties are bound (e.g., closing conditions) • Establish rights in the event that assumptions are not correct (e.g., right to terminate; breakup fee; indemnification) • Establish terms of any continuing relationships (e.g., component supply, IP licensing, transition services)

Basic Perspectives of Sellers and Buyers
• Sellers want:
– – – – Best price Quick closing Minimal risk of non-consummation Minimal continuing obligations

• Buyers want:
– Exclusive opportunity to analyze the business – Substantive and procedural opportunities to reset the price or exit the deal if Buyer’s assumptions are wrong – Time and process to obtain financing – Minimal exposure if Buyer doesn’t close – Where feasible, indemnification if Buyer’s assumptions are wrong

Transaction Structure
• Types of transfers:
– – – – Stock sale Asset sale Merger Recapitalization

• Types of consideration:
– – – – Cash Stock Debt Contingent payments and earnouts

• Tax consequences differ depending on:
– Type of transfer – Type of consideration – Jurisdictions in which Buyer, Seller and Target are located

• Local law issues:
– – – – – Limitations on financing Diligence risks Limitations on allocation of risks and responsibilities by contract Procedural issues Sometimes counterintuitive

• Examples of legal issues:
– US
• State corporate law limits breakup fees that may be paid – generally 2 ½ to 3 % in Delaware • Shareholder merger approval thresholds vary by state
– Majority of outstanding shares in Delaware – 2/3 in Texas

– Germany
• Criminal penalties for financial assistance and failure to timely declare insolvency • German statue ensures good title--title warranties unnecessary • German state limits purchaser recovery if purchaser knew of the breach of warranty – explicit language needed to remove limit • Difficult to enforce employee non-competes • Real estate taxes due on stock transfers

– UK
• • • • Financial assistance limitations on financing Limits on warranty claims and proof of damages vs. indemnity Post-closing pension liabilities Limitation on break-up fees (e.g. 1%)

Purchase Price Adjustments
• Picking the right measure
– Net assets – Net working capital – Other

• Picking the right target
– Historical – Projected – Average

• Mechanics
– Closing vs. most recent month-end – International Financial Reporting Standards (“IFRS”) vs. “Company Accounting” – Consistency with IFRS vs. consistency with baseline – Locking certain variables (such as how to calculate reserves and whether to permit reversal of reserves) – Treatment of cash, foreign cash, debt and debt-like liabilities – Preparing calculation vs. objecting to calculation – Preventing manipulation through the operation of the business

Representations and Warranties
• Overview
– These are the Seller’s promises to the Buyer as to what the Buyer will receive when the transaction is completed. – Provide basis for closing condition (bring down) – Provide basis for indemnification (allocation of risks) – Materiality and knowledge – Essential although not always included

• Key Representations Often Negotiated
– – – – – – – – – – Accuracy of securities law filings Financials (IFRS) Undisclosed liabilities (going beyond IFRS) No material adverse change (“MAC”) Intellectual property Noncontravention; material contracts Compliance with law Customers and suppliers Transactions with affiliates Sufficiency of assets

Material Adverse Change
• Possible Inclusions
– Forward looking element
• Prospects

– Language that aggregates problems – Adverse effect on timely performance of agreement


Possible Exclusions
– – – – – – – – – – – – – – – Changes in the economy Changes in political conditions Changes in industry Changes in IFRS or interpretations thereof Changes in law or regulation Acts of war or terrorism Natural disasters Suspension of trading in securities Changes in market price or trading volume of target securities Failure to meet projections Fluctuations in sales or earnings consistent with past practice Changes in analyst recommendations Changes in ratings of target securities announcement or performance of deal Identity of buyer Litigation related to the deal

• Promises as to the pre-closing conduct of business
– – – – Preserving business Restricting new long-term commitments Restricting equity issuances Avoiding manipulation of purchase price adjustments


No shop/Go shop
– Limit seller's ability to solicit or facilitate alternatives – Procedural protections to preserve first mover advantage


Approvals and Consents
– Allocation of responsibility for obtaining approvals and consents
• Shareholder approval • Antitrust and regulatory approval • Third party consents

– Providing for failure to obtain consents

• •

Confidentiality and non-competition (pre-and post-closing) Post-closing matters
– Transition services – Cooperation re tax returns and tax audits – Employee matters

Closing Conditions
• • • • Updating representations Absence of material adverse change (MAC”) Absence of injunction Approvals and Consents
– Stockholder approvals – Regulatory approvals

• Key agreements
– Transition services – Leases, licenses, etc.

Termination Arrangements
• By material consent • By buyer or target if not closed by a “drop dead date” • By buyer or target if target shareholders reject deal

Post-Closing Remedies
• Anyone to sue?
– Public company – Private company or subsidiary

• Types of remedies
– Fraud – Claims under securities laws – Contractual indemnification

• General indemnity for breaches of representations, warranties and covenants
– Thresholds, baskets, caps – Length of survival by category – Exceptions to limitations

• Special indemnities
– Taxes, environment, employee benefits – Known or partially known problems

• Making the indemnity work
– – – – Solvent seller Holdback, escrow and set-off mechanics Providing for seller representative Suing estates

• Effects of listing items on disclosure schedules
– E.g., representation will say no litigation, no employment agreements, no tax claims, etc. except as listed in a particular schedule. – Disclosure – Allocation of risk

• Updates to schedules between signing and closing
– Buyer’s remedies – Pre-signing occurrences – Post-signing occurrences


Manufacturers of products from computers to automobiles are dependent on components made in countries other than their own and the component supply agreements governing such sales are essential for both the manufacturer of the component (the “Component Manufacturer”) and the manufacturer of the finished product (the “Product Manufacturer”). What will be addressed in this part of the course is the relationship between independent contractants.

The vast majority of sales are transactions between independent parties and are covered under simple purchase orders. - The U.N. Convention on Contracts for the International Sale of Goods (CISG) provides that, in the absence of an express provision specifying that it is not to apply, the CISG is deemed to be incorporated into (and supplant) any otherwise applicable domestic law(s) with respect to a transaction in goods between different contracting states.
As of July 1, 2008 ratified by 71 countries including Hungary Brazil, India and UK only major trading countries that have not ratified

- Battle of the forms
- A purchaser may send a purchase order with detailed terms printed on the reverse specifying the purchaser’s responsibility and electing the law of the purchaser’s country - The seller may return a form also with printed conditions which may specify a different law and may specify arbitration in the seller’s country.
- Different results under CISG and the Uniform Commercial Code (UCC) in effect in 49 states of the United States - CISG a rejection and counter offer - UCC tries to avoid battle by saying that any acceptance conditioned on offeror consenting to additional terms

- We will look especially at two of the relationships indicated on The Supply Chain diagram below, which are the contractual arrangements between the Component Manufacturer and the Product Manufacturer and between the Product Manufacturer and the Distributors:
Sales Reps/Agents Raw Materials PRODUCT MANUFACTURER

Component Manufacturer

Retailers and Dealers

including Wholesalers

Technology And IP

Definition of the component – Does is currently exist? – Is it being developed? • What will be the specification of the components to be sold? – output, e.g., horsepower for an engine – fuel efficiency – performance • Evaluation testing to determine
– whether technical objectives are attained – whether new regulations are complied with

• Is the price fixed or is there a procedure for price adjustments? Purchase Obligations • Maximum and Minimum quantities • Protections for Component Manufacturer against obligation to furnish quantities which it cannot produce or which would require unplanned investment to increase capacity

• Protections for Component Manufacturer for Product Manufacturer’s failure to purchase an agreed minimum – Need to agree on amount of investment relating to a particular program
• How much capacity already exists • Calculation may be subject to difficult negotiations

– Reimbursement for unamortized investment – Liquidated damages • can protect the Component Manufacturer’s Profit • fixed amount or a percentage of the price; may be reimbursable based on future excess purchases • Limitations of liability
– Direct vs consequential – Liability caps (e.g., US $x)

Prices • Most favored nation clause • Adjustments for: – Changes in components
• Voluntary changes • Changes to update components or to meet regulatory requirements • Calculation of price adjustments

– Currency
• What currency does Component Manufacturer usually want? • What currency does Product Manufacturer usually want?

– Currency fluctuations and whether risk is to be shared
• E.g., no adjustment if the exchange rate is between 85 yen = US$1 and 105 yen = US $1 and 50/50 sharing outside that band

– Inflation formulas may be crafted for particular components, e.g., respective weighting for steel prices and wage rates

– An example of a formula:
P1 = PO (S1 x .18 + C1 x .09 + L1 x .17 + (SO CO LO M1 x .16 + W1 x .20 + .20) MO WO ) P1 = Adjusted Engine Price PO = Engine Price Prior to Adjustment The other letters refer to indexes related to steel (S1 & SO), cast iron products (C1 & CO), light metal ingots (L1 & LO), wholesale prices (M1 & MO) and a wage index (W1 & WO). – Would a 10% increase in the cast iron index result in a greater increase in the Engine Price than a 10% increase in the wage index? – Why is the last item in the index “.20” without being multiplied by a fraction comparing two indices?

Payment • Advance cash payment • Letter of credit • Payment after a period of time
– Exposure could be large, e.g., a Component Manufacturer could be one of the largest creditors in the event of the bankruptcy of the Product Manufacturer

• Currency of payment
– Distinguish from adjustments for fluctuations in exchange rates

Shipping Terms • What is included? – Handling – Packaging – Freight – Insurance – Export taxes – Import duties

Standardized terms may answer many of these questions and some of the most common are the following as defined in Incoterms:
EXW: “Ex works” means that the seller delivers when he places the goods at the disposal of the buyer at the seller’s premises or another named place (i.e., works, factory, warehouse, etc.) not cleared for export and not loaded on any collecting vehicle.

FOB: “Free on Board” means that the seller delivers when the goods pass the ship’s rail at the named port of shipment. This means that the buyer has to bear all costs and risks of loss of or damage to the goods from that point.

Incoterms (cont’d):
CIF: “Cost, Insurance and Freight” means that the seller delivers when the goods pass the ship’s rail in the port of shipment. The seller must pay the costs and freight necessary to bring the goods to the named port of destination BUT the risk of loss of or damage to the goods, as well as any additional costs due to events occurring after the time of delivery, are transferred from the seller to the buyer. However, in CIF the seller also has to procure marine insurance against the buyer’s risk of loss of or damage to the goods during the carriage. DES: “Delivered Ex Ship” means that the seller delivers when the goods are placed at the disposal of the buyer on board the ship not cleared for import at the named port of destination. The seller has to bear all of the costs and risks involved in bringing the goods to the named port of destination before discharging.

Chart of Responsibility The following chart summarizes the responsibilities of both the buyer and seller for each of four INCOTERMS described above.

SERVICES Warehouse Storage Warehouse Labor Export Packing Loading Charges Inland Freight Terminal Charges Forwarder’s Fees Loading On Vessel Ocean/Air Freight Charges On Arrival At Destination Duty, Taxes & Customs Clearance Delivery to Destination Seller Seller Seller Buyer Buyer Buyer Buyer Buyer Buyer Buyer Buyer Buyer

Ex Works

Free Onboard Vessel Seller Seller Seller Seller Seller Seller Buyer Seller Buyer Buyer Buyer Buyer

Cost Insurance & Freight Seller Seller Seller Seller Seller Seller Seller Seller Seller Buyer Buyer Buyer

Delivered Ex Ship Seller Seller Seller Seller Seller Seller Seller Seller Seller Buyer Buyer Buyer

Why Do We Care?
• Seemingly small amounts can have a significant impact on the profitability of an agreement. A US $0.50 handling fee on a US $ 1.000.00 component seems insignificant but not if the profit on the component is $10. • Who bears the risk if the components are destroyed or damaged? • Who bears the risk if the seller or buyer becomes insolvent?

Schedules of production and shipment
• Forecasts • Firm orders and modifications permitted • Obligations of Component Manufacturer to expedite shipments and allocation of the related costs

Quality Control
• Inspections • Cost of repair of defects not included in warranty allowance
– When should there be a recall, voluntary or governmentally required?

Further Development and Changes to Components
• To meet legal requirements • To reflect normal product improvements • Allocation of costs of legally required and other changes

Technical Assistance and Information
• Warranty
– Obligations of Component Manufacturer and how is this obligation paid for
• Warranty allowance or reimbursement of actual expenses

• Patent Rights
– Responsibility for infringement – Confidentiality

• Product Liability
– indemnity

• Other Provisions
– Do not overlook provisions at the end of an agreement – Force Majeure – Term and termination
• post termination obligations e.g., continued supply of parts

– Governing law – Arbitration


• Reasons for a Distributor
– Use local knowledge about market – Reduce initial investment

• Distinguish distributor from sales agent which
– Does not take title – May or may not be able to take orders – Usually paid a commission

• Define Product
– Does it include successor products and replacement parts?

• Non-Exclusive or Exclusive
– Non-Exclusive
• Is the distributor one of many in the country? • Benetton has more than 6000 stores in 120 countries. • More costly products will have fewer distributors or even only one in a particular country.

– Exclusive distributor’s rights and obligations in designated country

Non-Exclusive or Exclusive (cont’d.)
• Exclusive Distributor may work harder but will want to be protected in market it develops. • Is there a minimum purchase obligation? • Does the product manufacturer have a right to terminate if designated volume not purchased? • Distributor “will actively promote and develop the sale of products distributed by distributor under this Agreement”
– How much protection does this give the manufacturer?

• Risks of saying nothing

– When a distributor is also a manufacturer of similar products
• Why? A distributor in a particular country may want to complete its line of products and prefers to buy, for example, a small car rather than build it. • Particular problems if the manufacturer is also selling directly or through a subsidiary in the same country.


Independent Distributor

Affiliated Distributor

Independent Distributor’s Retail Dealers

Affiliated Distributor’s Retail Dealers

Retail Customers

• Allocation of volume. Independent Distributor will want a guaranteed minimum but will resist minimum commitments. • Manufacture will want minimum commitments from the Independent Distributor. • Choice of products will all products be made available to both distributors? • Pricing
– If Manufacturer can determine price unilaterally, it can squeeze the margins of Independent Distributor. – Agreement among Manufacturer, Independent Distributor and Affiliated Distributor fixing the price to dealers or to the public would be illegal. – If Distributors in a particular industry establish a single price at which they sell products to their dealers, does this suggest a solution for the case of the same product being sold to the Independent Distributor and the Affiliated Distributor? Assume that a reasonable margin for a distributor is 15%.
• Adjustments for physical differences between similar products • Adjustments for differences in terms of sale, rebates, allowances etc.

• Manufacturer’s obligations
– Minimum supply obligation – Meet legal requirements of country into which product is shipped including indemnity for failure to meet such obligations and for product liability claims – Warranty – General and Repetitive Defects
• When is a defect normal wear and tear, when is it to be covered by a warranty, when is it a general and repetitive defect
– Windshield wipers need replacing? – Door handle falls off in 1% of cars, in 20% of cars? – Engine fires?

– Transfer of intellectual property rights (both patent and trademark rights) and allocation of responsibility in the case of infringement
• Who is responsible Component Manufacturer, Product Manufacturer or Distributor?

– Delivery delays
• How does this differ from situations of a component supply agreement?


– Planning volumes – Lead times – Assurance of payment
• Advance payment or letter of credit

– Passage of title
• FOB port of shipment • DES delivered ex ship • Why does it make a difference?

– Freight and insurance

• Confidentiality • Governing Law
– Obligations imposed on all entities operating in the applicable jurisdiction – Interpretation of joint venture agreement and rules for operation of joint venture entity – UN Convention for International Sale of Goods

• Force Majeure • Choice of forum or arbitration • Termination
– Fixed term – Termination for a default or failure to achieve certain minimum volumes

• Effect of termination
– Obligations arising before the termination continue, for example, paying for products already shipped, indemnity for product liability claims for vehicles already sold

• Effect of termination (cont’d.):
Assume that the Independent Distributor has a network of dealers which sold the products and will want these dealers to make repairs under the warranty granted by the manufacturer both during the term of the warranty and thereafter. What does the following clause do? Which important issue does it fail to address? “The parties recognize that Independent Distributor has assumed a warranty obligation under this Agreement and that this obligation to third parties will continue for some time after the termination of this Agreement. Notwithstanding termination of this Agreement, Manufacturer agrees to supply Independent Distributor with a sufficient supply of replacement parts for Products and any required technical information for Independent Distributor to meet its warranty obligation to third parties and to comply with all applicable laws and regulations until arrangements for assumption of Independent Distributor’s warranty obligation have been made between Manufacturer and a new distributor. The prices for such parts will be the same as if this Agreement were still in effect. Delivery, passage title and the terms of payment will be as specified pursuant to clauses __ and __ of this Agreement.”

• What types of product could this apply to?
– Motor vehicles? – Computers? – Appliances? – Food products?


Joint Ventures frequently start with a great deal of enthusiasm without a careful analysis what each Party hopes to achieve and what conflicts are likely to arise. – Why a Joint Venture? Is a Joint Venture the best way for a company to achieve its objectives? Could a simple component supply or distribution arrangement or a merger achieve the same commercial objectives? – Basic Questions
• What is the business? • What is the likely turnover and market share?

Basic Questions (cont’d.)
• • • Where will the business be based? What are the Parties’ objectives? Will it work, feasibility study?
– – – – – due diligence identity of Joint Venture Parties long term aims and corporate culture expected financial regulatory or business problems likelihood of change in control

Studies indicate that where there is little overlap between the businesses of potential Joint Venture Parties, a Joint Venture will be more likely to succeed than a merger but conversely where there is a reasonable degree of overlap between the Parties’ businesses, a merger is significantly more likely to succeed than a Joint Venture.

Will a Joint Venture succeed?

Minimal overlap
14% 24%

Moderate/high overlap
25% 38%




Mixed results


Alliances are more likely to be successful where each Party brings something different. Source: “The way to win in cross-border alliances” Bleeke and Ernst. November/December 1991 issue of Harvard Business Review and the McKinsey quarterly 1992. The report studied 49 strategic alliances established by top companies in the US, Europe and Japan.


– There is no common template and the structure must be designed to fit the particular situation. – Can be in the form a joint company, partnership or contract

Varying interests may be accommodated in a Joint Venture. • N. Car
– Government looking to sell its interest in the automotive industry – Auto Manufacturer V looking for the design of a new model – Auto Manufacturer M looking for sufficiently large potential sales volume to make production of cars in Europe economically feasible.


Natural Resources Joint Venture
– Government looking to develop its mineral resources – Mining companies looking for a source of a particular mineral

• What will the Parties contribute to the Joint Venture?
– Cash: purchase of stock of Joint Venture or loans to Joint Venture or guarantee of loans to the Joint Venture. Is there a continuing obligation to provide financing? – Non-cash:
• Technology, e.g., the design of a new product, manufacturing processes for a new production facility • Components, e.g., an automotive engine essential for the production of a new car • Existing manufacturing plant or the site for a new plant • Market for the products made by the Joint Venture
– Protect ability of Party to receive a minimum quantity – Protect the Joint Venture against short falls in orders

• Source for minerals • Verify contributions

• What will the Parties take out?
– Royalties for Party contributing technology or resources – Dividends (What earnings will be paid out and what amounts will be retained?) interest on loans, management fees – Ability to sell products to Joint Venture – Products produced by the Joint Venture – Can initial losses be used by either Joint Venture Party to achieve tax savings


Many of the issues are the same for Manufacturing Joint Ventures and Natural Resources Joint Ventures, but I will address in this section those questions arising frequently between two manufacturers and in the next section those particular issues which arise between mining companies and the governments of the countries in which they are operating.

• Management
– The McKinsey Study referred to above indicates that Joint Ventures are most successful if they have a strong independent management in place
– Not just a representative of one of Joint Venture Parties but mindful of interests of Joint Venture itself – If all questions are referred back to the head offices of the joint venture participants, operations will become impractical.

– Procedures to keep Joint Venture Parties informed
– Business plan and annual budgets


Management Issues
– If the manager is a director of the Joint Venture Company, then he or she may face conflicting legal duties. – He or she may also be subject to obligations of confidentiality in relation to the information he or she learns as manager. – The manager that a Party appoints may eventually identify more strongly with the Joint Venture than the appointing Party and face conflicting loyalties.


The reporting of information and confidentiality issues should be addressed in the documents. Employees A number of employment issues will arise, particularly if employees are to be transferred to the Joint Venture by the Joint Venture Parties.

Key questions will include:
– Is employee consultation/consent required prior to the establishment of the Venture?

– Will redundancies be necessary? If so, what procedures should be followed? How much will it cost and who should bear the ultimate cost? – Will it be necessary or commercially desirable to harmonize terms and conditions of employees in the Joint Venture? Local laws may restrict the ability of the Parties to do this.

Key questions (cont’d.):
– If managers are to be transferred or seconded to the Joint Venture: • what is their tax position? • how difficult might it be to obtain work permits for them? • what is their potential liability as managers or directors of the Venture? If an existing business located in the European Union is transferred, the Acquired Rights Directive (as implemented by member states) will apply. Broadly this provides for the automatic transfer to the Joint Venture entity of the conditions of employment of employees engaged in the business.

Even split of Ownership. A study carried out in 1993 found that success is more likely where there is an even split of ownership

10 8 60 31

Even split of ownership (sample of 20)

Uneven split of ownership (sample of 13)

Mixed results Success An even split of ownership is more likely to result in a successful Joint Venture. Source: “Collaborating to Compete”. Bleeke and Ernst, 1993

Unequal Ownership Percentages, Minority Protection
Identify areas where the interests of the Joint Venture Parties may diverge. For example:
– – – – – – – – Business plan Access to profits Expansion of business Future investment requirements Future finance (share issues/loans) Acquisitions/disposals Change of business Access to intellectual property and research and development

Unequal Ownership Percentages, Minority Protection
• Divide the areas into three categories
– Matters over which the minority would require a veto – Matters over which the minority should have a positive right of action (for example, to appoint and remove a quota of directors) – Matters on which a majority vote will be acceptable

Unequal Ownership Percentages, Minority Protection
• Divide board and shareholder powers
Who should have control over each matter: the board or the shareholders? (Most countries recognize a division between board and shareholder powers but this is not universal.)
The documents can detail the division of power between the management and shareholders of the Joint Venture Company or alternatively, in a 50:50 Venture, the structure may be such that the deadlock provisions will require that appropriate decisions are made at the Joint Venture Party level. It is best practice even in a 50:50 Venture to define the extent of each Party’s control because of the independence (at least as a matter of law) of the company’s management.

– Appointment and removal. What power does each Party have to appoint and remove directors? What proportion of the board is appointed by the respective Parties? – Veto. What powers of veto do those directors have and when? What happens when any veto is used? – Quorum. Is there a requirement for directors appointed by all Parties to be present for a quorum? Care is needed with the quorum provisions. For example, if one of the directors that a Party wants to appoint to the board of the Joint Venture Company is often abroad, it is important to ensure that notice must be given to directors abroad on a timely basis. – Chairman. Who appoints the chairman? Is he/she to have a casting vote?

What rights will the Parties have as shareholders? In a 50:50 Joint Venture the rights of the shareholders will be based on the division of control between the Joint Venture Company board and the Joint Venture Parties. The extent of shareholder rights will be more of an issue where there is a minority shareholder.

Documenting Minority Protection
Methods of Minority Protection
• The method of protection will depend on the law of the Joint Venture Company. Few jurisdictions allow a company to establish the rights and obligations of the shareholders without regard to the corporate law applicable to the entity through which the Joint Venture is operating. For example, in Brazil and The Netherlands. But there may be other forms of business organizations which could accomplish the Parties’ obligations. • It may also be possible to give an effective veto right in some other way. For example, the shares of a company can be divided into different classes. It is possible to provide that certain matters (such as amendments to the by-laws) are deemed to be a variation of class rights and therefore require the approval of that class of shareholder. • Set forth below is an example of a provision giving minority shareholders rights in a Joint Venture among three Parties owning the same number of shares two of which were manufacturing companies owning Class A Shares and the third of which was the government of the country in which the plant was located owning Class B Shares.

Veto Rights
For each of the actions set forth below in items (i) through (vii) (other than any action expressly required to be taken by the Joint Venture Company pursuant to the Shareholders Agreement or any of the Business Agreements) approval of a majority of the issued and outstanding Class A Shares [held equally by the two Manufacturing Companies] and a majority of the issued and outstanding Class B Shares [held by the Government] shall be required:
i. ii. amend the Articles of Association and adopt or amend the Management Board Regulation; change the outstanding share capital;

Veto Rights (cont’d.)
iii. enter into a merger; iv. appoint auditors to examine the annual accounts, adopt the annual accounts and distribute profits; v. approve the filing of a petition for bankruptcy or moratorium, a voluntary agreement with creditors, or a dissolution or liquidation of the Joint Venture Company; vi. substantially change the business of the Joint Venture Company, bring about major changes in the organization of its business enterprise or amend or terminate any of the Business Agreements; and vii. enter into or amend any agreement between the Joint Venture Company and either of the Manufacturing Companies. [Question: How many of these veto rights limit the day-to-day
operations of the Joint Venture Company?]

Veto Rights (cont’d.)
For each of the actions set forth below in items (viii) through (x) (other than any actions expressly required to be taken by the Joint Venture Company pursuant to the Shareholders Agreement, or any of the Business Agreements) approval of a majority of the issued and outstanding Class A Shares shall be required but not a majority of the Class B Shares:
approve the Long-Term Plan, the Annual Budget and any amendments thereto; [Questions: What type of things should be included in the longTerm Plan and/or the Annual Budget? Why not include these in the agreement creating the Joint Venture?]


Veto Rights (cont’d.)
ix. make any departure from an Annual Budget, including any loan or guarantee to, or borrowing from, a third party, and any asset acquisition or disposition, and any commitment or expenditure, in each case not included in an Annual Budget; and make any grant of license for any patent, knowhow or other intellectual property of the Joint Venture Company.


For each of the actions set forth above, with the exception of the actions set forth in item (iv), the approval of the Supervisory Board, acting by a simple majority vote, will also be required.

Shareholders Agreement
It is also possible to list the matters over which the Parties are to have a right of veto in a shareholders agreement providing that the company cannot do any of the things listed without the consent of all Parties. Again this may be limited by the laws of the country where a Joint Venture is established.

Conflicts of Interest and Assuring that Parties do not Avoid their Obligations
– Arrangements for the audit of transactions between the Joint Venture and any of the Parties. – Non-compete clauses seeking to prohibit the Parties to the Joint Venture from competing with the Joint Venture Company during the life of the Joint Venture. – Confidentiality agreements requiring each Party to keep information about the Joint Venture and each other confidential.

If it is intended that the Parties should have access to confidential information in the Joint Venture Company, this should be expressly stated. Parent companies do not automatically have this right. • This can be an extremely difficult issue. Each Joint Venture Party will have certain unique things to contribute to the Joint Venture. Consider issues raised by the following:
– Intellectual Property: scope of intellectual property being contributed and royalty payment. – Components
• Which components, e.g., everything to be contained in the final product other than listed items? • Prices/and price adjustments. Does a replacement component call for a price increase? • Services provided
– premises, management, workforce

• Sales to and Purchases from Joint Ventures
– A Joint Venture Party selling to a Joint Venture keeps 100% of any increase in selling price but only its pro rata shares (e.g., 50%) of any increased profits earned by the Joint Venture. – If one Party is looking for products made by a Joint Venture and other is looking for a share of a Joint Venture’s profits -- a conflict. – If one Joint Venture Party is reselling products manufactured by the Joint Venture, such Party has every reason to buy cheap and resell at the highest possible price.
• How can other Joint Venture Party protect itself?
– cost plus? – market price less a discount? – competitive price?

Duration Exit and Termination
Duration: Most Joint Ventures do not have a long life span, other than natural resource Joint Ventures where many years may be required for the development and exploration of a mine or other natural resource.
– Joint Venture Parties are joining for a specific reason, e.g., to make a new product and after a period of time one Party or the other may want to make such a product under its sole responsibility and control. – Other than natural resource Joint Ventures, most last less than 10 years.

Duration Exit and Termination (cont’d.)
Exit and Termination:
– The fact that a Joint Venture will have a limited life should be recognized from the outset and the bargaining position of the Parties may change, e.g., one Party may become dependent on the production of a Joint Venture company and the other may want to walk away.

• Alternatives
– Make no provision: “If we make no arrangements for termination, that will encourage us to work together.”
• that particular Joint Venture was terminated in less than 5 years

Duration Exit and Termination (cont’d.)
Situation to Deal With: • Consensual Termination
– Both Parties agree in advance that the Venture should end. For example:
• The Joint Venture is for a fixed term and the Parties agree in advance that the Venture will terminate at the end of the term. • The Joint Venture is established for a specific purpose and the Parties agree in advance that the Venture will end once the purpose has been satisfied.

In each case the agreement will need to deal with the transfer of shares (if it is a corporate Joint Venture) or the distribution of the Venture’s assets on termination/winding-up.

Disposal of an Interest
• The Parties may have picked each other for particular reasons and want a veto over any transfer of the interest of the other Joint Venture partner. Joint Venture Party #1 may have picked Joint Venture Party #2 and neither would want a transfer to Company #3 which is a competitor . The Parties may be willing for one of their number to leave the Joint Venture, but for the Venture to continue either with the introduction of a new Party or under the control of the remaining Party or Parties alone. In such case, the documents may provide each Party with pre-emption rights in respect of a proposed transfer of shares by the other Party, either at the price that the third party purchaser (if identified) is willing to pay or at an independent valuation. There is often an exception for intra-group transfers so that preemption rights will not be triggered if one of the Parties transfers its shares in the Joint Venture to another company in its same group. Most agreements prevent each Party from selling only a part of its shareholding. This prevents the shareholdings splitting up into many parts. The discussion so far on disposal of an interest pre-supposes the existence of a third party buyer. What happens if the Party having the right to buy the interest of the other Party is not able to finance such a purchase? •

Disposal of an Interest (cont’d.)

The Parties may agree that on the happening of a defined event of default (or certain other trigger events) the Party in default will be required to sell its shares in the Venture. Common trigger events are:
– Insolvency of either Party to the Venture. – Change in control of either Party. – Material breach of the shareholders agreement or by-laws (possibly limited to specific provisions). – Material breach of any other agreement between the Parties.

On the happening of an event of default, the Party that is not in default is commonly given a right exercisable by notice to buy the shares of the other or, sometimes, to require the other to buy its shares. This normally follows a cooling off period. This may be a long period. For example, one Party only exercised its buy out rights two days before the end of a twelve-month option period. The value of the shares will usually be determined according to a formula specified in the agreement or by an expert on the basis of specified guidelines.

Disputes and Deadlock
Whether the Joint Venture is a 50:50 Venture or one with a minority Party with veto rights, the Parties need to address the possibility of dispute or management deadlock. The documents should define the matters that are serious enough to start a dispute resolution process and set out the process itself. Normally, any formal resolution process will not be initiated unless and until informal negotiations between the Joint Ventures’ directors/managers fail to settle the dispute.

Disputes and Deadlock (cont’d.)
Common dispute resolution procedures which have been suggested:
– Chairman’s Casting Vote. In a corporate Joint Venture, the board chairman can be given a casting vote. – Outsider’s Swing Vote. This refers to the decision of an identified outsider. – Arbitration or Expert Resolution. This is really only suitable for a limited range of disputed matters, which are more factual in nature (for example, a dispute over the valuation of intangible contributions to the Venture by either Party). – Escalation. This is where disputes are referred to the chairmen or chief executives of the Joint Venture Parties. The threat of enforcing this provision is often enough to encourage managers to agree before the process is instituted.

None of these are likely to work except in limited circumstances. If the Joint Venture Parties think that they may be deadlocked over an issue essential to the Joint Venture (e.g., a decision to double the production of the Joint Venture), they are unlikely to be willing to turn that decision over to any third party. In practice, the only resolution is for one Joint Venture Party to buy out the other through negotiation or various procedures, including “Russian Roulette” and “Texas Shoot-out”, described below. Although I have participated in discussions of such arrangements when negotiating Joint Venture Agreements, I have never seen them actually included in a final contract.

Russian Roulette:
• Either Party can serve notice on the other requiring the other Party to buy its shares at a set price or to sell its own shares to the Party giving notice at the same price. The other Party then has a period in which to accept the offer to buy or sell its shares at that price. This seems a fair solution and likely to establish a fair price since the Party setting the price does not know whether it will be a buyer or seller. But it only works if both Parties are confident that they will be of similar financial strength when the deadlock occurs and will be able to replace whatever product the Joint Venture is making from another source.

An example of how such a mechanism may be drafted is set forth below:
“(d) Final Impasse. Within forty five (45) days after notice of a Final Impasse, the notifying Shareholder (the “First Shareholder”) may offer to the other Shareholder (the “Other Shareholder”) a cash price per share (the “Offer Price”), fully payable sixty (60) days after such notice, for the Other Shareholder’s shares in the Company. Within (30) days after such notice, the Other Shareholder may notify the First Shareholder in writing that it will purchase the First Shareholder’s shares in the Company for an amount equal to the Offer Price, multiplied by the number of shares then held by the First Shareholder, on said sixtieth (60th) day. If the Other Shareholder fails to so notify the First Shareholder of its intent to purchase the First Shareholder’s shares, the Other Shareholder shall be compelled to sell its shares to the First Shareholder for the Offer Price, multiplied by the number of shares then held by the Other Shareholder on said sixtieth (60th) day. If no offer is made by any Shareholder on or before the forty-fifth (45th) day after notice of Final Impasse, the status quo shall prevail and no further action may be taken with respect thereto. If either Shareholder notifies the other Shareholder of its intent to purchase the shares but fails to tender the required cash on the required date, the process shall continue as if such notification had not been provided, and the defaulting party shall be liable for damages under Applicable Law.”

However, the Parties may not be willing to run the risk of a “Russian Roulette” and such a version is set forth below: “Deadlock Situation (a) Presidents’ Meeting. If the Parties cannot come to an agreement as to a question as to which Parties are required to agree to pursuant to this Agreement and in either case the failure to reach any such agreement seriously prejudices the operations of the Joint Venture Company and the production of the [product] as provided in this Agreement, then one of the Parties may give a notice of a deadlock, specifying the nature of such deadlock in reasonable detail. If such a notice of deadlock is given, the Presidents of the Parties will meet within sixty (60) days after the date on which such notice of deadlock has been given. The Presidents of the Parties will endeavor to resolve in good faith the matters which are the subject of such notice of deadlock. Offer Rights. If the Presidents of the Parties do not both resolve the deadlock and enter into a memorandum confirming that the deadlock has been resolved, within one hundred and twenty (120) days after such notice of deadlock is given, then either Party (hereinafter referred to as the “Offeror Party”) may deliver, no later than ninety days after the expiration of such one hundred twenty (120) day period, a notice (hereinafter referred to as a “Notice of Offer”) to the other Party (hereinafter called the “Offeree Party”) making an irrevocable offer to sell for cash all the Shares held by the Offeror Party at the price per Share set forth in the Notice of Offer. Such Notice of Offer may be accepted by the Offeree Party during a period of sixty (60) days after the Notice of Offer has been given by giving written notice to the Offeror Party and will thereafter expire.”


Texas Shoot-out:
• A variation on Russian Roulette, if the Parties both wish to buy, is for both Parties to submit sealed bids, the highest winning. Alternatively, there can be provision for bidding by auction. This raises many of the same issues as “Russian Roulette.”

Continuing Obligations
Even if the Joint Ventures Agreement is terminated, there may be continuing obligations, including:
– Continued production – Supply of replacement parts – Warranty – Product liability – Use of intellectual property


Generally, the Joint Venture Parties to a natural resources Joint Venture are making very different contributions. One, usually the government of the country in which a mineral reserve is located (or an agency thereof) is contributing access to such reserve for a period of time and the other usually a private entity is contributing technical, business and marketing expertise and capital. Because the contributions are so different and the fact that frequently the minerals are located in developing countries, unique questions arise for both the host government and the contracting private Party.

– Must be defined as to area and also which particular minerals are the subject of the Concession

Work Program
– Must define the work that the Concessionaire will carry out as to development of the mine and building or repair of existing infrastructure. This can be a combination of specific tasks (e.g., extract a specific minimum amount of iron ore) and an agreement to make capital expenditures in a minimum amount. – Preparation of a feasibility study demonstrating that there is a sound basis for a particular project.

– Exploratory License – Mining License

Social and Environment Issues While these may be to some extent covered by local law, the Concession Agreement needs to deal with the following to the extent not covered by local law:
– – – – Wages Health care for employees and dependents Safety Education for workers and families when the mine is located away from existing educational facilities.

Social and Environment Issues (cont’d.)
– Training and employment of local workers; limits on employment of expatriates. – Protection of existing residents within the area where a Concession is located – Private security forces – Right to use existing infrastructure (e.g., ports, roads and water) – Environmental issues
• responsibility for past pollution? • obligation to observe adequate environmental standards

Example of a Corporate Structure
Government or Governmental Agency Concessionaire (ownership interest)

(ownership interest)

Joint Venture Company

Sales Company (Marketing Product)

Operating Company (providing management services)

This structure suggests many of the issues that arise with Natural Resources Joint Ventures

Capital Structure
Concessionaire generally has a majority of the stock of the Joint Venture Company – What does Government pay for its interest? – Is the Government’s interest subject to dilution upon the issuance of additional shares upon the increase of the Joint Venture’s capital? – Assuming that both the Government and the Concessionaire have an ownership interest as stockholders of the Joint Venture Company, what right does the minority stockholder, which is usually the Government, have?

Under most corporation laws, ownership of less than 50% of a Joint Venture Company gives few rights except for major actions such as mergers, sale of substantially all the assets and dissolution.
– As in the example cited above under manufacturing Joint Ventures, stockholders may be given specific rights to approve or disapprove particular matters, e.g., capital expenditures in excess of a stated amount or to name a certain number of the directors of the Joint Venture Company.

Right to name a certain number of directors or certain officers (e.g., a vice president) are only substantive if such persons can institute or block certain actions by the Joint Venture Company. This relates to:
– Social/Environmental Issues, and – Economic Issues

Insofar as the Joint Venture Company names an Operating Company to carry out day-to-day operations and a Sales Company to market the mineral produced, the Government is further removed from influence as to both Social/Environmental Issues and Economic Issues.

Economic Issues Amounts paid by the Concessionaire to the Government include the following:
– Upfront payments, royalties (insofar as royalties are based on verifiable production figures and arm’s length prices) and real estate taxes based on the area covered by the Concession are effective ways to provide revenue to the Government.

Economic Issues (cont’d.)
– Dividends and similar amounts paid by the Joint Venture Company to the Government and the Concessionaire as stockholders
• Are based on earnings and thus influenced by:
– charges by the Operating Company, prices paid by the Sales Company – declared by the Board of Directors of the Joint Venture Company, usually at the discretion of the Board – require agreement on applicable accounting principles, sophisticated accounting systems and financial controls and the personnel to perform these tasks

Transparency and Confidentiality
– Need to protect true business secrets but lack of transparency raises major issues
• limits civil society participation, • encourages lack of accountability and • provide an opportunity for corrupt behavior

– Extractive Industries Transparency Initiative (EITI) to disclose payments by Concessionaires and receipts by governments of all payments by one to the other

Term and Termination
– Natural Resource Joint Ventures have longer terms because of time required for development and will usually permit the Concessionaire to develop the particular reserve which may take an extended period (e.g., 25 or more years). Extension by mutual agreement, or unilaterally by Concessionaire or based on new feasibility study. – Termination
• for default or non-performance • rights to concession and infrastructure • payment obligations upon termination
– immovable assets become property of the Government – movable assets » Concessionaire may have right to remove » Government may have an option to purchase

Stabilization Clauses and Tax Holidays
– Establishes that certain clauses of the contract override applicable law
• protect long-term investments • would not be accepted by countries in developed world

– Tax holidays are common but can very substantially limit the payments made to the Government.

Other Issues
– Reports – Benchmarks which permit the government to terminate if certain benchmarks are not realized so as to avoid a concessionaire from signing concessions with the intention of holding them for resale or holding them as a reserve against future contingencies – Access to geological and other information developed by the Concessionaire and the Joint Venture Company – Arbitration
• important for Concessionaire • Tajikistan aluminum plant litigation in London

– Force Majeure
• exclude governmental action

Case Study
• The following Case Study is based on provisions actually included in agreements relating to one or more Natural Resources Joint Ventures and illustrates some of the risks to which an agency of the government of the country where the Project is located (“Governmental Agency”) may be exposed.

Is the Concessionaire a substantial entity which could carry out its obligations and be able to pay damages for a failure to perform? Joint Venture The project will be carried out by a company (the “Joint Venture Company”) formed under the laws of the government (the “Host Government”) of the country (“Host Country”) in which the Project is located to be owned 68% by the Concessionaire and 32% by the Governmental Agency. The primary agreement among the Concessionaire, the Governmental Agency and the Host Country will be referred to as the “Joint Venture Agreement.”

• What problems? • What are the powers of the holder of a 32% minority interest?

Contribution of the Parties The Concessionaire’s obligations are: • Payment to the Host Government of a lump sum of US$200 million. However, this is subject to fulfillment of certain conditions, such as the approval of the Prefeasibility Study by the Concessionaire at the time of the approval of the agreement constituting the Joint Venture Company, an audit of the validity of certain mining rights to be transferred to the Joint Venture Company and the actual transfer of such mining rights to the Joint Venture Company. • Arranging financing for the Governmental Agency for the rehabilitation of certain existing mining facilities. • Carrying out a Prefeasibility Study. • Helping the Joint Venture Company achieve commercial production of a defined level within a certain period. • Arranging financing for the mining and infrastructure projects.

The infrastructure projects contemplated are listed in an annex to the Joint Venture Agreement and include the rehabilitation of railway lines, the construction of roads and the building of hospitals.
• • • • There is no guarantee as to which infrastructure projects will be undertaken and when. Some of the projects are subject to the availability of revenues resulting from the mining operations. No guarantee of the total amount of the investments to be made. Lending the Governmental Agency the funds necessary to pay for its shares and its proportionate share of any capital increase.
– Where will the Governmental Agency find the funds to repay such loans?

• •

Does the Governmental Agency risk seeing its interest diluted? How much equity will the Concessionaire provide?


Anti-dilution will be important to the extent that the equity ownership of the Governmental Agency gives it veto rights or the right to receive dividends in so far as there is some assurance that profits will actually be paid out as dividends. In some agreements, the share of the Governmental Agency’s is non dilutable and the Governmental Agency is not obligated to pay for any additional shares to maintain its proportionate interest.

The obligations of the Governmental Agency are: • To transfer to the Joint Venture Company mining rights to reserves of more than a specified number of tons of ore with an obligation to transfer additional reserves if the Feasibility Study does not support these reserve figures, • Help the Joint Venture Company achieve commercial production of a defined level within the time specified in the Feasibility Study • Transfer to the Concessionaire other mining concessions or other resources in case the revenues generated by the Joint Venture Company prove to be insufficient to reimburse the investments in the mining and infrastructure areas, • The Convention requires that the Prefeasibility and Feasibility Studies show an Internal Rule of Return (“IRR”) of a specified amount. There is no indication of how or by whom the IRR will be calculated. It is unclear what happens if, notwithstanding the Feasibility Study, the Project turns out to be less profitable when actually executed.

Reimbursement by the Joint Venture Company of Mining and Infrastructure Investments
Three-stage Mechanism The Joint Venture Agreement sets out a three-stage mechanism for the reimbursement of mining and infrastructure project costs by the Joint Venture Company:


Mining Cost Recovery: During Stage I, all profits of the Joint Venture Company will be applied to the repayment of these mining costs. Infrastructure Cost Recovery: During Stage II, which is the period after the recovery of the investment in mining operations, 66% of the Joint Venture Company's profits will be applied to reimbursing the costs of certain infrastructure projects and 34% distributed to the joint venture partners. - What percentage of the profits will be distributed to the Governmental


Commercial Exploitation (Stage III): once the amount of the investments and costs have been repaid, all profits will be allocated among the joint venture partners according to the 68%/32% equity split.

Dividends No provisions are made as to the payment of dividends. The Joint Venture Agreement provides only that the Joint Venture Company will be formed in accordance with the rules and customs current in the Host Country. Since the Concessionaire is entitled to 68% of the equity, any payment of dividends will be subject to the accounting standards adopted and, to the extent that there are profits, the approval by the Board of Directors of the Joint Venture Company which is controlled by the Concessionaire. Transfer Pricing There are no provisions as to transfer pricing in the Joint Venture Agreement, and thus no guarantee that there will be contractual limits on either (i) the amounts charged by the Concessionaire and its affiliates to the Joint Venture Company for the mining work and the infrastructure projects, or (ii) for the price to be paid to the Joint Venture Company by whatever company that will be marketing the ore produced. Windfall Profits The Joint Venture lacks a provision to deal with the eventuality that the resources are far more profitable than anticipated.

Minority Joint Venture Partner The Governmental Agency will be the 32% owner of the Joint Venture Company with no provision as to rights to name directors or officers or to veto certain major decisions by the Joint Venture Company and/or decisions which may adversely affect the Host Country or the local inhabitants or the environment. Moreover, the Joint Venture Agreement provides for the naming of a prime contractor for the infrastructure projects and says that the Joint Venture Company will not intervene in the operations or the supervision of the infrastructure projects. The Joint Venture Agreement refers to the Concessionaire presenting financial and technical proposals for the infrastructure projects chosen by the Host Government, but no review of the Concessionaire’s determination of costs is provided for.

An article of the Joint Venture Agreement provides for annual meetings to discuss the Project and any differences. Such very general language has been used to reassure certain parties to joint ventures that any future difficulties can be worked out. Financial Controls There are no provisions in the Joint Venture Agreement for financial statements or information which would permit the Host Government or the Government Agency to be informed as to the operation of the Project, or for auditing and no requirement for: • quarterly unaudited financial statements. • annual audited financial statements • independent auditors of internationally recognized standing • making financial information public

Loans Loans will be arranged by the Concessionaire and the interest rates charged will almost certainly be lower than the Governmental Agency could obtain on its own. • There are no limits to the interest charged to the Joint Venture Company Procurement, Employment, Training The Joint Venture Agreement provides that businesses located in the Host Country will be used to the extent that they are able to carry out the particular assignment, and the infrastructure projects will provide major benefits when and to the extent realized. The Joint Venture Agreement provides for a preference for subcontractors located in the Host Country in the rehabilitation of certain facilities. • There are, however, no express provisions relating to the training or employment of nationals of the Host Country. The Joint Venture Agreement contemplates employment of, or contracting with the Host Country enterprises only if they are “capable”, but no provision is made for training or technical assistance where local capacity does not currently exist.

Local Population and Environment There are no provisions relating to social or environmental matters.
As the mining operations are subject to the laws of the Host Country, they would be subject to the social and environmental provisions in existing law. However, the stabilization clause referred to below means that any improvements in the laws of the Host Country will not apply.

Confidentiality and Transparency Usually there are confidentiality provisions in the agreement relating to such Projects.

Choice of Law, Stabilization and Most Favored Nation Clause The Joint Venture Agreement refers to the law of the “place of the act” • Does this refer to (i) the signing of the Joint Venture Agreement, which took place in the Concessionaire’s home country, (ii) the performance of the Joint Venture Agreement, which will take place in the Host Country, or (iii) something else? • If the governing law cannot be determined using this provision, the Joint Venture Agreement will refer to the criteria usually used in international commerce to decide the question.
– Does this provide any additional guidance?

The Joint Venture Agreement provides the Joint Venture Company with the benefits of any new laws and most favored nation treatment with respect to any other investment contracts. The Joint Venture Agreement also contains a stabilization clause with respect to existing laws. This means that any improvements in the laws of the Host Country which are burdensome to the Concessionaire – in the environmental and social areas, or as part of the Extractive Industries Transparency Initiative (“EITI”) – will not apply.

Termination The Concessionaire has the right to terminate the Joint Venture Agreement if the National Parliament of the Host Country does not adopt a law legislating the fiscal, customs and exchange provisions of the Joint Venture Agreement.

In the event that there are defects in the mining rights which cannot be corrected, the Joint Venture Agreement will be cancelled. It will also be cancelled in the event of failure to approve the Feasibility Study that cannot be remedied by the transfer of additional mining rights to the Concessionaire.

The Host Government and the Governmental Agency have no termination rights if, for example, the Concessionaire fails to arrange the financing referred to in the Joint Venture Agreement. Moreover, there are no restrictions on the Concessionaire terminating the Joint Venture Company and distributing its assets to its shareholders.
Transferability No limitations are placed on the Concessionaire from transferring all or part of its interest.

I thank you for your attention and participation and hope that you have found these lectures to be interesting. As I stated at the beginning of this course, the purpose of the lecture was not to explain what legal provisions would apply to particular agreements in particular countries but to consider certain questions which may arise in a variety of cross border transactions.

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