A Legal Study On Deadlock In International Joint Ventures

From an organization law perspective, international joint ventures can take a form ofeither partnership, corporation or by contractual arrangement. Equity joint venturesare commercial vehicles combining the natures of partnership and corporation, andtherefore are called as “incorporated partnership”. While EJVs have characters of“capital connection” and limited liability, they also have a high degree of “personconnection”. The trust and synergy of JV partners are foundations to the success of aJV but it is not possible that the interests of JV partners are always aligned. Conflictof interest between JV partners will ultimately be seen at the board level orshareholder level. The close nature of a JV limits the transfer of shares in the JV andthe exit of a shareholder, which causes the conflict of interest between JV partiesbeing easily going to a deadlock. Something there is no way out for a JV shareholder.Balancing the interest of JV partners is a key consideration before using the JVvehicle.This research starts with the commonly encountered phenomenon JV deadlock,combing the corporate governance of international joint ventures, and discusses fromdifferent perspective the legal measures to deal with deadlock including prevention,self-resolution and judicial intervention. This is to have a deeper understanding of theJV vehicle so that we can better use it both domestically and internationally. This research is of a character of “trans-border” and “internal perspective”.Trans-border means the conflict of application of law, and the competition ofcompany law regime in different counties. Internal perspective means a focus on riskidentification and prevention. The author hopes that the above mentioned perspectivecan reflect the trends of company law development under the globalizationcircumstances, including the independent legislation for close companies (no longerattaching to the public companies), the flexibility of company organizations (e.g., notcompulsory to set up the supervisory board), freedom of shareholder’s governance toa company (except those compulsory requirements shareholders are permitted tofreely set up all governance issues for the company), etc.The article has6chapters. Chapter1is about the international investment and jointventures. The essence of JV is cooperation among independent enterprises but theform can be varied from partnership, incorporation or contractual arrangement.International JVs are joint ventures established among investors from differentcountries. You can tell the reasons for a JV from various perspectives. If you deemmarket and company as two basic ways to allocate resources, JV is the vehiclebetween market and company who exists due to a lower transaction cost. Acompetitive advance or mutual supplementary benefit may be achieved through a JV.JV can also be used as a tool of “organization study”. These can improve thecompetition capacity of the JV participants and JVs are therefore deemed as animportant choice of investment vehicle for international investment. Under a“de-regulation” environment, traditional JVs that are subject to the legal restriction ofhost country are going less, while new JVs which are responding to the severe globalcompetition and market risks will become mainstream. In the new JVs, shareholder’sself governance will exert a fundamental role but timely judicial intervention is stillneeded where the self governance fails.Chapter2is about JV corporate governance and JV deadlock. Difference companies have different interest structure and therefore should choose different approaches ofgovernance. JV is combination of partnership and corporation with a nature of“capital connection” and “person connection”. The common issues in JVs arecorporate oppression and deadlock. Deadlock arises from conflict of interest betweenthe shareholders and the function of governance rules in a close company.Shareholders of a JV may have its own interest and target and the conflict is thereforeunavoidable. Existing shareholders are not allowed to exit and new shareholders arenot allowed to join in easily, and deadlock occurs with a high occurrence rate in JVs.Both shareholders and other stakeholders to a JV are suffered from JV deadlocks.International investors should be fully aware of the advantages and disadvantages ofJVs, and prepared for the deadlock prevention and relief. Under the deregulationenvironment, good corporate governance and deadlock prevention will be mainlybased on shareholder self governance, with the supplement of state intervention.Chapter3is about prevention of JV deadlock. Prevention is the primary step formultinational companies to control risks in practice. Prevention is to identify the riskand design appropriate mechanism to balance the interests that may conflict with eachother. This chapter discusses various steps to promote the JV success, includingchoice of JV vehicle, selection of JV partner, the reasonable allocation of control ofJV among shareholders, the breaking mechanism in a voting process. All thesepreventive measures should be reflected on the JV legal documents. A clear agreementwill prevent the occurrence of future disputes and a foundation to resolve the disputeswhen they occur. A selection of JV means compromise and cooperation. JV partner isas important to a partner in a marriage. Only balance allocation of control will causethe sustainable success. Oppression will cause loss of trust, deadlock and failure ofthe JV. Decision making in a JV is balance between efficiency and fairness. It is artrather than science in a sense.Chapter4is about JV directors’ due duty and the deadlock. JV directors’ positioncould be embarrassed because the interest of shareholder and JV could be conflicting. It is common that JV directors facing a conflict of interest situation. And this is one ofthe reasons for JV board deadlock which will definitely cause damages to the JVperformance more or less. Theoretically, JV can sue the director if the directorchooses the interest of shareholder rather than of the JV, which can be deemed asbreach of fiduciary duty. In practice, legal actions against JV directors are used toresolve the dispute between the shareholders, but individual liabilities of a JV directoris seldom seen. It is advisable to isolate the conflict of interest of JV directors fromcorporate governance perspective, i.e. the shareholder representative is responsible forshareholder matters, and the JV directors should be focused on the success of the JV.The responsibilities and duties of a JV director should be clearly described in the JVcontract.Chapter5is about the break of deadlock by shareholder exit. When a deadlock occurs,with the incorporation continuing existence, some shareholders can select to exit fromthe JV to break the deadlock. It is common for JV articles or shareholder agreement toput restraints on the share transfer given the close nature of a JV. The most commonlyseen mechanisms are “consent clause” and “preemptive right clause”. No matter howthe restraint may look like, shareholder’s right to exit from a JV is a right that cannotbe deprived. So the balance should be drawn between the interests of exitingshareholder and other shareholder of the JV. In order to make sure the JV sharetransfer is conducted in a way desired and predictable to shareholders, and to avoidundesired shareholder to joint in, the JV shareholders can align on the call option,draw option and buyout arrangements. These mechanisms may not as effective as theshareholder think, and the enforcement could be also a problem. The arrangementshowever will still provide a basis for shareholders in the future share transfer. Undercertain conditions, minor shareholder can be entitled to use its right to exit. And incase the self governance fails, judicial intervention can enforce the share transfer inaccordance with the law.Chapter6is about breaking JV deadlock by dissolve the company. Company dissolution is the final option for breaking a JV deadlock. It is a nuclear weapon.Dissolution of company usually does not good the whole social benefit. It can even beabused by an opportunist shareholder and therefore should be used very cautiously.There are voluntary and compulsory dissolutions and judicial dissolution is a relief tothe corporate deadlock and shareholder oppression existing in a close company. Stateintervention is a choice when the shareholders self governance fail. Strict conditionsand processes should be followed when using. This chapter discussed the applicationconditions, status of shareholders, application principles, etc. To prevent abuse ofdissolution litigation, systems like litigation guarantee or compensation when failedcan be used. Alternative measure should be considered before a court decides todissolve a JV. The courts in US and Germany explored some alternatives for thedissolution, for example, provisional director or custodian in US, and right to sellshares and dismissal right in Germany. The JV should be liquidated after dissolutionso that its legal person status can be terminated.