Corporations and Cross Border Transactions by sofiaie

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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
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
Who is Professor Reboul? (cont’d.)
Professional Experience (cont’d)
• He represented a South African private equity fund
  borrowing from Overseas Private Investment

• 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
  – 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      Partnerships                 Corporations

Persons Required           One                            At least two people          Only need one adult to
Formation                  No formalities                 No paper work required.      Formal filing required
                                                          This may be a default
                                                          business structure.

Liability                  Full liability                 Each partner responsible Shareholders not
                                                          for all actions of the   personally liable, except
                                                          partnership              to prevent abuse.
Control                    Individual Control             Each partner equally         Board of Directors and
                                                          unless specified             Officers
Tax                        Included in Individual's       Flows through to              Separate taxpayer
                           tax responsibility             partners

Note:       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

                                                                         Partners pay
$$$   Partnership   100% Profits      Partners            $          tax, proportionate
                                                                     ly, on 100% of the

                    Pass Through Taxation (money only taxed once)

                                                                         Net profits
                                   Corporation pays                     distributed to
$$$   Corporation       $$$         Expenses and       Net Profits    Shareholders as
                                        taxes                         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
  – 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
• 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 must not be the same as another                 • Number of authorized shares
  corporation incorporated in the same state           • Number of classes of stock
• Must include word                                    • Information on par value, rights, preferences or
  “corporation”, “corp”, incorporated” or similar        limitations of each class
• Must include address of each incorporator            • Information on any series (structures) of preferred

                  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
  – 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
   – 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
+                   C     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             consolidation to Dept. of State for filing
                        • Right of Appraisal for shareholder of
                          Corporation that disappears
                B           • includes dissenting shareholder in
                              short form merger
                A       • 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
               - 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 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
• 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;
• 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
   • 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
    – 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
   – 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:

Raw Materials

                         PRODUCT                                          Retailers
                         MANUFACTURER                                    and Dealers
                         (PLANT, INVENTORY,
Manufacturer             SHIPPING)
                                                 including Wholesalers
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
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
       • 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)

• 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?
• 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
• 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
    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.

                                       EXW                FOB                     CIF                   DES

         SERVICES                     Ex Works     Free Onboard Vessel      Cost Insurance &      Delivered Ex Ship

   Warehouse Storage         Seller              Seller                  Seller                Seller
   Warehouse Labor           Seller              Seller                  Seller                Seller
   Export Packing            Seller              Seller                  Seller                Seller
   Loading Charges           Buyer               Seller                  Seller                Seller
   Inland Freight            Buyer               Seller                  Seller                Seller
   Terminal Charges          Buyer               Seller                  Seller                Seller
   Forwarder’s Fees          Buyer               Buyer                   Seller                Seller
   Loading On Vessel         Buyer               Seller                  Seller                Seller
   Ocean/Air Freight         Buyer               Buyer                   Seller                Seller
   Charges On Arrival At     Buyer               Buyer                   Buyer                 Buyer

   Duty, Taxes & Customs     Buyer               Buyer                   Buyer                 Buyer

   Delivery to Destination   Buyer               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
      • 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                 Affiliated
 Distributor               Distributor

Independent             Affiliated
 Distributor’s         Distributor’s
Retail Dealers        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
•   Orders
    – 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
   – 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
• 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                                Moderate/high overlap

                 14%      24%                               25%

                  62%                                             37%

             Success                       Mixed results                    Failure

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.
•   Structure
    – 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
    – 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
   – 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
   – 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
  – 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
       • 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



              Even split of ownership       Uneven split of ownership
                 (sample of 20)                (sample of 13)
                                        Mixed results
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
       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
  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
  – 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

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’
       • 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.    amend the Articles of Association and adopt or
        amend the Management Board Regulation;
  ii.   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
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:
viii.approve the Long-Term Plan, the Annual Budget
     and any amendments thereto;
[Questions: What type of things should be included in the long-
        Term 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
x.    make any grant of license for any patent, know-
      how 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
  – 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
Duration Exit and Termination (cont’d.)
Situation to Deal With:
• Consensual Termination
   – Both Parties agree in advance that the Venture should end. For
      • 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 pre-
    emption 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.)
                            DEFAULT/TRIGGER EVENT

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
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
   – 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

“(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
      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.

(b)   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
  – 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
   Example of a Corporate Structure
              Government or                             Concessionaire
           Governmental Agency

     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
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
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
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

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

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
•   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
• 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
• 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

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.
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

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 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

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.

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

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

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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