Joint Ventures - The Good and The Ugly

Attorneys: Schoumacher, Bruce H.

Related Practices: Corporate/Commercial

Related Industries: Construction

Spring 2014
 
Joint ventures can be good for all the partners in the venture.  However, they can have a downside.
 
Companies use joint ventures for several reasons. First, one company may have need for expertise for a project which it does not have internally.  For instance, an architect firm may want to submit a proposal for design of school, but does not have any one on its staff who has experience designing schools.  So, the firm may look for another design firm which has experience designing schools to see if both firms can submit a proposal as a joint venture.
 
Or, a contractor may want to bid a major construction project, but does not have sufficient resources for the project. Accordingly, it may look for another contractor to join forces with it as a joint venture.
 
Also, a design firm may want to submit a proposal for a project in a community where it does not have a presence.  It may look for a local firm to join forces with it as a partner.  Joining with a local firm will give the other firm a partner who is knowledgeable of the local building code and how building and zoning agencies work.  Further, the local firm may be well known in the community and have a good reputation there, which will enhance the credibility of its out-of-town partner.
 
Notice, however, the use of the term “partner.”  Under the law, joint ventures are partnerships.  In partnerships, each partner is equally liable for the debts and actions of the partnership.  For example, if one partner commits negligence in design of a building leading to a claim of defective design, each partner is equally liable for any resulting damage, even if some of them were not negligent.
 
When deciding to join with another business to make a proposal for a project, each venture must take steps to limit its potential liability for the negligence or actions of the other venturers.  There are many steps which can be taken to protect against the actions of the other venturers.
 
First, in the joint venture agreement, they can agree to share the percentage of any loss according to the ownership interest of each partner in the venture.  However, that does not protect a solvent partner from the inability of one of the partners to pay its share of the loss.  Obviously, cross-indemnification, where each partner agrees to hold the other partners from expense of paying more than their share of a loss may not work, since the venture who has not paid its share of the loss may be insolvent.
 
Second, the joint venture can require each partner to have sufficient insurance to cover losses.  However, this may not be feasible because not all losses are covered by insurance.  For contractors, many business risks are not covered by insurance; such as, warranty or defective construction claims.  Further, most business insurance policies provide the partner in a joint venture will only be insured for its own negligence or action and not for any liability assumed arising from the negligence or action of another partner.
 
Third, the joint venture can look to establishing a separate insurance program, which will cover the joint venture and each of the partners from loss.  Unfortunately, many potential losses cannot be covered by insurance, so each partner has unlimited liability for uninsurable losses.
 
Fourth, the venturers can look at doing business as a corporation or a limited liability company.  The advantage of a corporate or LLC is that the owners’ liability is ordinarily limited to the amount of their investment.  Thus, if the venture has a significant loss, the owners would not have to cover the loss from their personal assets.
 
Establishing a joint venture should not be a haphazard endeavor. The venturers must explore the potential liability of each in order to determine how to organize their business.  Further, the terms of the joint venture are critical. The joint venture agreement determines the procedure of decision making, control, daily operation and sharing losses.
 
When the venturers start to consider whether they join together to do a project, each of them should do so with advice of their attorneys, CPAs or tax advisors and risk manager or insurance broker. They have to avoid the ugly side of joint ventures, which is deciding how the partners will pay for any loss of the joint venture, while minimizing their personal liability.
 
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Reprinted with permission from  Business Development: Helping AEC Firms Win New Business, Volume 2, Issue 3, April 2014.
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