Joint venture exit clauses: from gamble to control

At the outset, a joint venture (JV) is accompanied by handshakes, a meeting of minds and a great business strategy. But in addition to the idea of pursuing a new business goal together and pooling resources to share the profits, it is of salient importance to think one step ahead and include an exit strategy in the JV agreement.

When doing business together many unexpected changes can occur and the parties may find that their strategic interests have diverged. When the parties cannot reach a consensus on important issues, they may find themselves in a deadlock. This can disrupt the operations of a JV and hurt the value of the business. Finding an ex-post solution can be a nightmare resulting in a delayed exit and high costs.

Breaking up is hard to do: achieving the best exit strategy for JV parties 

There may be other reasons for a party to seek an exit from a JV, too. An orderly exit may be planned from the outset or simply a desired option, when a good opportunity to sell the share presents itself. Typically, breaches of the JV documentation by a party may also be sanctioned with exit or exclusion rights. To avoid inefficiencies, careful attention should be paid to the drafting of exit clauses in the JV agreement.

Exit clauses are mechanisms that allow the parties to protect their interests when one of the reasons to exit a JV arises. If drafted correctly, they can provide a party with an elegant and equitable solution to exit a JV by disposing its shares or to take full control of it by acquiring the shares of the other party. Many different exit clauses exist and can be combined to achieve an exit strategy best tailored to the party's interests.

"To avoid inefficiencies, careful attention should be paid to the drafting of exit clauses in the JV agreement."

Typical exit clauses

The most frequently used exit clauses are call and put options. They give the beneficiary a right to either sell its shares (put option) or buy the shares of the other party (call option). These clauses may be tailored in a number of ways, especially regarding the calculation of the option price and the time period when the exit may be triggered. They can be used to resolve deadlocks, breaches or planned exits.

Another type of exit clause addresses a potential sale of the JV. In JVs with a majority/minority shareholder structure, the parties typically agree on a tag-along/ drag-along rights regime. A tag-along right entitles a party to participate in the other party's negotiated sale of its share and compels the selling party to include its share in the sale on a pro rata basis. On the other hand, a drag-along right allows the selling party to compel the other party to sell its share to the purchaser on the same terms.

Russian Roulette or Texas Shoutout?

Aimed particularly at deadlock scenarios in 50:50 JVs, clauses like Russian Roulette and Texas Shootout can be agreed. With a Russian Roulette clause, a party can decide to end the JV by setting the price and terms of sale. The other party then has the right to either sell or buy the shares under the set terms. The logic is "I cut, you choose". Alternatively, a Texas Shootout clause resembles a duel between two gunfighters in the Old West. To end a JV, each party can submit a sealed bid with the minimum selling price of its share. The higher bidder wins and acquires the loser's share.

While allowing for a quick solution, exit clauses, especially those aimed at resolving deadlocks, may be too radical. To avoid hampering the operations of the JV, an exit strategy should contain methods for overcoming the impasse. These can be in the form of obligatory talks, elevation of the issue to the higher echelons of corporate structures or a formal mediation process. Only if that fails should the exit begin. Exit clauses should also not give a party the chance to manipulate the JV agreement. They should include sufficiently detailed circumstances under which an exit can commence, clear pre-conditions, realistic deadlines and other procedural requirements for a structured exit.

JVs can be very beneficial to the parties involved, but most of them have a finite life cycle. Planning for an orderly and equitable exit by anticipating the different situations that may occur is essential to secure the economic interests of the parties.

authors: Bojan Brežan and Žana Žabnikar

 

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