Joint venture (JV) arrangements are now routinely being utilised in large scale residential property developments.
They are generally seen as a way to combine the expertise of the developer with the capital needed to carry out a project. The last decade has also seen a significant increase in the interest shown by registered providers (commonly referred to as housing associations) in entering into JVs with developers. Registered providers normally act as the investor but also take up the social housing component of a development. For a developer, the identity of an investor can have implications beyond the initial investment – for instance, it can influence the JV’s ability to raise future debt finance. Having a JV partner with a high credit rating, such as a registered provider, on board means that the JV is likely to be offered lower rates of interest on its borrowing.
The two commonly used corporate entities in residential real estate JVs are the limited company and the limited liability partnership (LLP). Both share the characteristic of providing a separate legal identity, which means that internally (e.g. in terms of management and staff) and externally (e.g. the ability to contract with third parties, own assets, grant security to funders, sue or be sued) they have a unique corporate personality. This also means that they can ring fence any liabilities or losses within the structure. Beyond these, contractual arrangements (including traditional partnerships) and unit trusts are also used in JVs, however, these are outside the scope of this note.
The company is the more familiar of the two corporate entities. The liability of a JV party is limited to the amount it contributes by way of share capital, and share rights can be tailored to reflect the nuances of a particular arrangement. Importantly, a disposal of shares will not impact the underlying business and, similarly, this flexibility extends to introducing fresh capital. Using a company is likely, however, to give rise to a double charge to taxation – a company will pay corporation tax on any profits it makes and the JV parties will be taxed when they take profits out of the company or realise their investment.
An LLP has members whose liabilities are also limited to their capital contribution. However, the LLP is treated as a partnership for tax purposes, meaning that it is transparent. The LLP is not taxed on the income and capital profits it makes, each JV party is directly taxed on its share of realised profits.
In the case of both corporate structures, the parties enter into a JV agreement (although in the case of companies, a corresponding bespoke set of Articles of Association is also usually required, while in the case of LLPs, the terms of the JV are written into the LLP Agreement). The JV agreement sets out the parties’ rights in relation to matters such as distributions of profits, management, rights relating to transfers and exit rights.
The JV agreement specifies the initial capital contributions of the parties, which is normally a negotiated amount (e.g. to establish a 50:50 ratio). In residential property development JVs, the parties’ business plan is also routinely annexed to the JV agreement and provisions are put in place in the agreement to deal with budgets, cost overruns and unforeseen costs.
A number of other provisions are also fundamental to the smooth operation of the JV. These include, first, ‘waterfall’ mechanisms – these determine the priority of distributions, the order in which parties receive operating or capital proceeds and the nature of such proceeds. Secondly, fees – it is usual for the developer to provide a number of services for which it will charge fees (common examples are asset management, construction management and property management) and the JV agreement sets out what these are, the level at which they are set and the frequency of payment. Thirdly, the mechanisms by which major decisions are taken and what approvals are required. There are also often complex provisions on the resolution of deadlock between the parties, including triggering a process to buy or sell a stake, rights of first refusal, drag along and tag along rights. Finally, a JV agreement will deal with the default of a party and its remedy. These are all areas where provisions are tailored to the commercial drivers of a particular transaction.
A corporate JV, therefore, provides both developers and investors the vehicle through which to implement, in common, their respective business aims.
John Parpounas-Matossian is a partner in our corporate and commercial department.
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