JOINT VENTURE DISPUTES: When To Fight And How To Win

 

Presented at

The Property Litigation Association Annual Conference

 at Keble College, Oxford on Friday, 23 March 2018

by

John McGhee QC

Maitland Chambers

 

John McGhee was called to the Bar in 1984 and took silk in 2003.  He maintains a wide and varied practice in the fields of modern commercial Chancery Work.  He has particular expertise in property related work but his practice equally encompasses company, insolvency and partnership disputes, problems involving trusts and civil fraud, and banking and professional negligence claims.  He also advises in non-litigious matters such as the trusts and property aspects of proposed investment and tax schemes.  He is the general editor of Snell’s Equity. 

 

 

Property law is about relationships – of landlord and tenant, of vendor and purchaser, of lender and borrower and so on.  Some of these relationships involve the parties combining their individual resources for mutual profit.  The classic case is an owner of land and a developer agreeing that the land should be developed and then sold with the proceeds of sale split between them.  Other examples include a commercial and residential developer collaborating to carry out a large scale mixed use development; or a forward funding arrangement in which a major institution acquires a site from a developer and funds part of the building cost with the developer obtaining a share of the profit on sale.  Neither are these relationships necessarily limited to the development of property.  A residential landlord might enter an arrangement with another company to manage the repair and maintenance of its property portfolio on terms that any increase in value will be shared.  The anchor tenant of a department store might enter into an arrangement with the owner of the department store whereby the profits of the store are shared.

What all these arrangements have in common is that the parties perceive that by sharing their own resources (which may include money, property, goodwill or skills) they can make a greater profit than if they did not combine their resources.  All these arrangements can be called “joint ventures”.  But a joint venture is business term.  It has no legal definition.  Nor does it in itself have legal significance save in the context of UK and European competition law.

A joint venture can take many forms.   It may be take the form of a partnership, an limited partnership or a limited liability partnership.  It might be a contractual agreement which does not amount to a partnership at all.  Thus agency agreements, distribution agreements or franchise agreements might be regarded as joint ventures if they involve the sharing of profits.    It might be structured as a lease where the rent is geared to the profit generated by the tenant.

But the most common form of structure for a joint venture is a company in which the participants in the venture are the sole shareholders.  The typical case is where the owner of land and developer each own 50% of the shares in the joint venture company and agree to seek planning permission and finance for the development of the property and, following completion of the development, to sell the property and share the resulting profit.  There will usually be a complex suite of documents.  These are likely to include the grant by the owner to the joint venture company of an option or other interest in the property conditional on planning permission being obtained; an agreement between the developer or its associated company and the joint venture company to perform a project management role; and an agreement by one or other party to provide funding for the project.

It might be thought that the principal terms of the joint venture would be set out in the articles of association of the joint venture company.  But there are doubts as to whether provisions in articles of association which relate to the personal position of a shareholder rather than its position as member of a company are enforceable.[1]  Accordingly the invariable practice is that the principal terms of the agreement between the parties will be governed by a shareholders’ agreement to which they will be parties, possibly with their parent companies joining in as guarantors.  The joint venture company itself may also be a party.

The shareholders’ agreement can be enforced like any other contractual document.  Accordingly a defaulting party may be subject to injunctive relief or an order for specific performance or required to pay damages, and the agreement may be determined for repudiatory breach or pursuant to a contractual termination provision.

A joint venture in respect of property raises interesting issues that lie at the intersection of property law, contract law and company law.  In the remainder of this talk I will address some of the problems that may arise in practice and how they might be resolved.

I know we didn’t sign anything, but I still think I should get a share of the profit

If the parties have been well advised the shareholders’ agreement will of course be in writing.  But sometimes they will have both subscribed for shares in the joint venture company on the basis of an informal oral agreement about the terms of their joint venture.  Provided that informal agreement is intended to be binding and is sufficiently certain then the court will enforce it.  There is no requirement that a shareholders’ agreement be in writing[2] and section 2 of the Law of Property (Miscellaneous Provisions) Act 1989 has no application to an agreement concerning shares in a company even if the company exists to hold property.

However, it does not follow that the absence of writing will simply be ignored.  The court may find as Asplin J did in Charterhouse Capital Ltd, Re Arbuthnott v Bonnyman[3] that “had the (alleged) oral agreement existed, given its importance it would have been documented”.  The court therefore may well find that even if the parties did not use the phrase “subject to contract” they did not intend their agreement to be legally binding until it was reduced to writing and signed by them.

In practice in order to persuade a court to enforce an oral shareholders’ agreement it will be helpful to demonstrate one of both of two things.  The first is that one or other party was commercially unsophisticated.  A court will be much more likely to hold that a legally enforceable oral bargain exists if one or other party is unversed in business affairs than if the agreement was made between seasoned property professionals.  The second is that if the parties have, following the oral agreement, acted in accordance with it for some time the courts will be more likely to view it as enforceable.  This second consideration is of course relevant to the question of whether despite the absence of such an agreement one party is estopped from denying that it or holds assets on constructive trust for the purposes of the joint venture.  But it is also subsequent conduct from which the court may infer that the parties intended their informal agreement to be binding from the outset.

It may be however that it is not possible for the court to hold that an enforceable oral agreement exists because the terms are too uncertain:  the parties may, for example, have failed to agree on an important financial term such as the amount which each would contribute for its share in the joint venture company or precisely how profits would be split.  If A and B agree that A will acquire property through a company which will be owned by A and B jointly through a joint venture company and in reliance on that A obtains an advantage (for example by being able to get the property at a lower price because B has not bid) or B has suffered a disadvantage for example by being deprived of the opportunity of making a profit from the resale of the property) then the court may hold that the shares in the company through which A purchased the property are held on constructive trust for A and B.  Importantly it may reach this conclusion notwithstanding that the parties had not yet reached agreement on some important term of their joint venture and even if the parties have no intention that their agreement would be binding.[4]   But if the parties used the phrase “subject to contract” it is very unlikely that a constructive trust will arise.[5]  It seems that similar principles apply if the property was already owned by A at the date of the arrangement with B although it may be that it will be rather more difficult to enforce a non-contractual arrangement between the parties in those circumstances.[6]

I know that’s what the joint venture agreement seems to say but it’s not what we agreed

More usually there will be a written shareholders’ agreement signed by the parties but the parties will disagree about what it means.  Often one party will rely on a literal construction of a particular provision and the other will contend that that can’t be what the parties meant since it makes no commercial sense.  The courts have wrestled with the tension between the dictionary meaning of words and the commercial purpose of the agreement and continue to do so in a well known series of cases starting from Investor’s Compensation Scheme v West Bromwich Building Society[7] in 1998 and ending, for the moment at least, with Wood v Capita Insurance Services Ltd[8] in 2017.

Although your transactional colleagues and your clients may find this hard to understand, what happened in negotiations preceding the agreement is of course not to be taken into account in construing the shareholders agreement.[9]  But it does not follow that the court is limited to considering the words of the agreement alone.   It can take into account other agreements entered into between the parties at the same time and can take into account other facts known to both parties at the time such as the nature of the property, the prospects of obtaining planning permission and the like.  The choice is not really one between the literal meaning of the words and the commercial purpose of the parties but rather of understanding what the parties meant by the words they used given the commercial context known to the parties when the agreement was entered into.

If there is nothing in the agreement which enables one to construe the words used in a particular way it may be possible to imply a suitable term into the shareholders’ agreement.  It was at one time thought that the principles to be applied in implying terms into contracts were essentially the same as those applied in construing a contract[10] but it now appears that they are more restrictive and that a term will be implied only if it is so obvious as to go without saying or is necessary for business efficacy.[11]

The principles applicable to the construction of contracts and the implication of terms apply also to the company’s articles of association.[12]  This is subject to one qualification.  Given that the articles of association of a company are a public document the only extraneous material which is admissible in construing them is such material as any reader of the articles could reasonable be supposed to know, that is information which is public knowledge.[13]   These are the same principles which were applied by the Court of Appeal in Cherry Tree Investments v Landmain[14] in construing a registered charge over land.

Difficult questions may arise however if the articles and the shareholders’ agreement appear to be inconsistent.  It is not always possible to discern which should take precedence and the court cannot be guaranteed in these circumstances necessarily to construe the shareholders agreement so that it is consistent with the articles.[15]

Sometimes the conclusion that is reached once the words of the agreement are considered is that something has gone wrong with the language and that that those drafting the agreement must have made a mistake.  If (1) it is clear that a mistake has been made and (2) it is clear what is required to remedy that mistake ,then that mistake can be rectified as part of the process of construction.[16]

However, in most cases without regard to what occurred during negotiations leading up to the agreement (all of which is inadmissible on the question of construction of the agreement) it may not be clear that there has been a mistake made or it may not be clear what is required to remedy that mistake.  In those circumstances the mistake cannot be remedied as a matter of construction but the court may rectify the agreement.  There is however an important limitation on the remedy of rectification in this context: although a shareholders’ agreement may be rectified, the remedy of rectification is not available to correct mistakes in the articles of association.[17]

I know we agreed it but it’s unenforceable

There are all sorts of reasons why it might be said that particular provisions of a shareholders’ agreement are unenforceable even if the parties signed a written agreement set out the terms of their agreement.  Even though the agreement as a whole may be sufficiently certain to be enforced it does not follow that all the provisions in the agreement will be enforceable.  For example, it is not uncommon to see shareholders agreements contain aspirational statements about the principles which the parties are to adopt in their dealings with each other and in pursuing the venture.  The court may well find that these provisions are too uncertain to be enforced even though the remainder of the agreement remains enforceable.[18]

In principle a provision requiring one party if it is in default to pay a sum of money or incur some other disadvantage may be regarded as a penalty and so unenforceable.  But the circumstances in which a provision in a shareholders’ agreement will be regarded as a penalty are now narrowly circumscribed.  In Cavendish v El Makdessi[19] the Supreme Court held that a provision would be held to be penalty only if it sought to impose a detriment on the defaulting party which was out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.  So in that case a share purchase agreement requiring the seller to sell its remaining shares in a company at net asset value rather than the higher value reflecting goodwill in the business was held to be enforceable and not a penalty.  In any event the Supreme Court confirmed that the rule on penalties only applied to provisions consequent on the breach of contract of one party.  If the provision in question requires one party to sell its shares to the other at a discount for example simply because there is a deadlock the penalty doctrine has no application.

As I mentioned at the outset it is not uncommon to see the company itself as a party to the shareholders’ agreement thus enabling it to undertake directly to carry out relevant obligations and so avoid those obligations having to be formulated in terms of the shareholders procuring the company to act in a particular way.  But, if not carefully drafted, some of those obligations undertaken by the company may be invalid.  In Russell Northern Bank Development Corpn[20] the House of Lords held that a provision in a shareholders’ agreement purporting to prevent the company from creating new share capital other than with the unanimous written consent of all the shareholders was invalid as an unlawful unfetter on the statutory power of the company to increase its share capital by ordinary resolution.

The implications of the case are not clear.  But it probably only prevents the company fettering its ability to do things which are within the powers of the shareholders (such as altering the share capital, changing the articles of associations, or changing the articles of association) and does not prevent it fettering its ability to do things which are within the authority of the directors.  Even as regards matters which are within the power of the shareholders it does not appear to outlaw a provision for weighting voting rights in favour of one shareholder which has the practical effect that, as regards that particular matter, no resolution can be passed without that shareholder’s approval.[21]  In any event although it prevents the company undertaking directly to do various things it does not prevent the shareholders agreeing to procure that the company will do those things.

Don’t be selfish – act in accordance with the spirit not just the letter of our agreement

Generally, a party to a contract does not need to act otherwise than in its own interests.  It does not need to take into account the interests of the other party at all.  Sometimes there will be an express obligation requiring the parties to act in good faith, to avoid conflicts of interests or not to profit from their position.  In the absence of such provision the question arises whether obligations of good faith or fiduciary obligations can be implied.  The fact that the parties are participating in a joint venture is not enough in itself necessarily to give rise to fiduciary obligations or obligations of good faith.[22]  On the present state of the law it is not easy to predict when the court will imply an obligation of good faith or fiduciary obligations between parties to joint ventures.[23]  But it is more likely in long term contracts where there is a high degree of trust or dependence between the parties.

However, if the shareholders in the joint venture company are to be regarded as in partnership there is no doubt that they will owe fiduciary obligations to each other both by reason of sections 27 to 29 of the Partnership Act 1890 and in equity.  Section 4 of the Partnership Act states that a partnership exists wherever two or more persons are “carrying on business in common with a view to profit”.  The fact that the agreement between the parties may contain a provision declaring that it is not a partnership does not affect the question.  It is a bit like the question of whether a tenancy exists:  it depends on the substance of the relationship and not the label which they have used.  It is an interesting question whether a partnership is formed when shareholders enter into a shareholders’ agreement.    It might be argued that it amounts to a partnership since the shareholders are carrying on business together with a view to earning profit through the joint venture company.    The better view however is probably that it is not a partnership because the shareholders are not carrying on business in common:  it is the company rather than the shareholders which is carrying on the business.

Even if there is no general duty of good faith and no fiduciary obligations, it appears on the basis of very recent authority that where one party to a contract is given a power or discretion to do something that this power may be required to be exercised in good faith and not on arbitrary, capricious or irrational grounds.  The exercise of that power may therefore be set aside if the person exercising it takes into account considerations it should not have taken into account, wrongly fails to take into account relevant considerations or reaches a decision that no reasonable person in that position could have reached.[24]

In any event the directors of the joint venture company will of course owe fiduciary obligations and a duty of care pursuant to sections 170 to 177 of the Companies Act 2006.  It is common for nominee directors to be appointed by each of the parties to the joint venture so that they can control directly the activities of joint venture company.  The question which then may arise is whether a nominee director is in breach of his duties to the company if he acts not in the interests of the company but in the interests of his appointing shareholder.  The answer is that although the director may take into account the wishes of those appointing him he must nevertheless act in the interests of the company.[25]  If he acts simply on the instructions of the person appointing him he is in breach of duty.[26]  The position is different only if there a clear agreement to the contrary in the shareholders’ agreement.[27]

The obligations of directors to the company extend not just to persons appointed as directors but also to de facto directors (that is persons who have assumed the functions of a director without being formally appointed) and shadow directors (that is persons in accordance with those directions the directors are accustomed to act).  A majority shareholder appointing a director might be regarded as itself as shadow director if it controls the board through its nominee directorships but it would not be a shadow director if it was only a 50% shareholder and controlled only half of the votes on the board since it would not have power to direct the board as a whole what to do.

Generally, directors, de facto directors and shadow directors will owe obligations only to the company.  But in exceptional circumstances such obligations may also be owed to the shareholders.[28]  It is unclear what is required for such obligations to be owed to the shareholders but it may arise where for example there are strong relationships of a family character between the directors and shareholders of the company.[29]

Comply with the joint venture agreement or I’ll sue you

A not uncommon situation is where the directors nominated by one party act in a way in which the other party thinks is not in the best interests of the joint venture.  The company could of course bring an action against the directors for breach of duty.  But if there is deadlock on the board and the rival shareholders each hold 50% of the shares in the company no resolution will be passed to bring such an action.  On the face of it there is nothing which the other shareholder can do save in the exceptional situation in which the directors owe duties direct to the shareholders.  There is however a long-established principle whereby the shareholder can bring a so called derivative action on behalf of the company.  This is done by the shareholder in its own name bringing the claim again the director and joining the company as defendant.  The principle was established at common law and lead to the so-called rule in Foss v Harbottle.[30]  But it now has a statutory basis in sections 260 to 265 of the Companies Act 2006.  There are three stages to bringing a claim on this basis.  First the court makes an initial assessment on paper of whether the shareholder has a prima facie case.  If the case is not dismissed at this initial stage the matter proceeds to the second stage of a hearing at which the court will determine on the basis of representations by all parties whether or not the shareholder should be given permission to continue with the claim taking into account amongst other things whether the shareholder is bringing the action in good faith and in the interests of the company.  Thirdly if permission is obtained the case will in due course proceed to a trial of the substantive issues.

Even where the shareholder has a direct action against the other shareholder and so does not need to bring a derivative action it does not follow that it will necessary be able to bring a claim in damages.  In Johnson v Gore Wood[31] the House of Lords held that a shareholder could not recover loss which merely reflects the loss suffered by the company.  The only exceptions to this are where the company has no cause of action itself or where the shareholder has suffered a loss which is distinct from the company’s loss.[32]

I don’t like the expert/arbitrator and I’m not going to accept his decision

Given the potential for dispute, shareholders’ agreements often contain provisions requiring the dispute to be referred to an expert or arbitrator for determination.  Whilst this is likely to lead to a much quicker and cheaper resolution that would result if court proceedings were commenced it not infrequently leaves one party unhappy with the determination that is made and it may attempt to overturn the expert’s or arbitrator’s determination.

The first matter to be considered when seeking to challenge the decision of an expert or arbitrator is what was the scope of the expert’s or arbitrator’s remit.  What were the matters which, on the true construction of the shareholder’s agreement, were to be finally decided by him not the court?  If he has purported to decide questions which fall outside his proper remit then his decision is not binding on the parties at all.  The shareholders’ agreement may well confer an unlimited remit on an arbitrator to determine disputes between the parties but an expert is likely to have a much more limited remit.  It is for the court not the expert, in case of dispute, to determine questions as to his remit.[33]    Difficult questions may arise.  For example, the question of the value to be ascribed to shares on a disposal may be a matter within the remit of an expert.  But it does not follow that a question of the true construction of any assumptions or disregards to be applied by him in carrying out his valuation are within his remit.  Especially if the expert is to be an valuer rather than a lawyer the court may well decide that those matters fall outside his remit.[34]

Even where matters are within the expert’s remit, it is common to provide that his decision is final and binding only in the absence of “manifest error”.  This means an oversight or blunder so obvious and so obviously capable of affecting the determination as to admit to no difference in opinion. [35]  It does not include a case where one would only conclude on a prolonged examination of the matter that he must have gone wrong.

An arbitration award can be challenged on the grounds of serious irregularity[36] or, with the permission of the court on a point of law.[37]  A serious irregularity would result, for example, if the arbitrator failed to give one party a fair opportunity to respond to a new point made by the other party in written submissions.   A question of construction of the shareholders’ agreement might be regarded as a point of law.[38]  However, at least where there is admissible factual evidence relevant to the construction of the relevant provision, the question is one of mixed law and fact and accordingly it has been said that the court should review questions of construction only in the clearest of cases.[39]

You want out – well you need to give me the chance to buy you out first

Where parties enter into a joint venture they need to consider what is to happen when one or other no longer wants to continue with the venture.  What should happen to its interest in those circumstances?  On the one hand it will want to realise its share of the assets of the venture.  But on the other hand, the remaining party might be unhappy finding that he is now in a joint venture with a third party to whom those assets have been sold.  The solution often adopted is to provide that if one party wants to sell its interest it must first offer them to remaining party.

These pre-emption provisions often present a myriad of potential difficulties.  For example, when is the pre-emption provision triggered?  Is it triggered at the point at which one party has decided to sell his interest or only immediately before it enters into a contract for such sale?  The answer will depend on precisely how the provision is formulated.[40]  Questions may arise too as to how the purchase price of the shares is to be determined.  The pre-emption provision may set this as the price at which the other party is intending to receive on a third-party sale.  Alternatively, there may be provision for valuation of the shares either on the basis of a proportionate share of the value of the company as a whole or alternatively on the basis of a value which reflects the extent, if at all, to which the shareholding confers control on the affairs of the company.  If the shares in the company are transferred in breach of the pre-emption provisions and the directors register them the transferee will hold them subject to the pre-emption rights of the other party at least if it had actual or constructive notice of the pre-emption rights at the time of the transfer.

I want out – and I’m entitled to money for my shares

If there are pre-emption provisions in the shareholders’ agreement between A and B and A wishes to sell his shares, B may well not want to purchase them secure in the knowledge that A will not be able to find a willing third-party purchaser.  Is A without any remedy in circumstances when it is no longer willing to participate in the venture?  Not necessarily.  If it can demonstrate that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to it then it may petition the court under section 994 of the Companies Act 2006 and the court, if satisfied that petition is well founded, may make such order as it thinks fit for giving relief in respect of the matters complained of.  This may include requiring the company to do or refrain from doing some particular act, authorising civil proceedings to be brought in the name of the company or regulating the conduct of the company’s affairs in the future.  However, the remedy which it is usually granted is an order requiring the other shareholder to buy out its shares and this will usually be the purpose of the petition.

There is a great deal of case law on what amounts to “unfair prejudice” for these purposes, whether an order should be made if there are buy out provisions contained in the articles of association or the shareholders’ agreement, and how shares are to be valued if a buy-out order is made.

The ultimate remedy of a disgruntled shareholder is to seek an order for the winding up of the company under section 122(1)(g) of the Insolvency Act 1986.  The court can exercise that power whenever it is just and equitable to do so but it is a power rarely exercised, first because an order requiring one shareholder to buy out the other pursuant to s994 is usually more appropriate, and secondly because the sale of the joint venture company by a liquidator will usually achieve far less for the parties.

[1] Hickman v Kent or Romney Marsh Sheep-Breeders Association [1915] 1 Ch 881

[2] See eg, Neville v Wilson [1996] 3 All E R 171;  Beddow v Cayzer [2007] EWCA Civ 644

[3] [2014] EWHC 1410 (Ch)

[4] see Banner Homes v Luff Developments [2000] Ch 372.

[5] Generator Developments v Lidl [2018] EWCA Civ 396

[6] see Cobbe v Yeoman’s Row [2008] UKHL 55

[7] [1998] 1 WLR 896

[8] [2017] UKSC 24

[9] Chartbrook v Persimmon [2009] UKHL 38

[10] Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988

[11] Marks and Spencer plc v BNP Paribas Security Services [2015] UKSC 72

[12] see eg. Attorney General of Belize v Belize Telecom supra as to the implication of terms into articles of association

[13] Cosmetic Warriors v Gerrie [2015] EWHC 3718 (Ch); affd. [2017] EWCA Civ 324 at [23]

[14] [2012] EWCA Civ 736

[15] eg. Dear v Jackson [2013] EWCA Civ 89

[16] Chartbrook v Persimmon supra

[17] Bratton Seymour Servide Co v Oxborough [1992] BCLC 693

[18] see eg. Fujitsu Services Ltd v IBM United Kingdom [2014] EWHC 752 (TCC)

[19] [2015] UKSC 67

[20] [1992 1 WLR 588

[21] Bushell v Faith [1969] 2 Ch 438

[22] Button v Phelps [2006] EWHC 53 (Ch)

[23] see eg. Murad v Al-Saraj [2005] EWCA Civ 959; Globe Motors Inc v TRW Lucas Varity Electric Steering Ltd [2016] EWCA Civ 396.

[24] Braganza v BP Shipping [2015] UKSC 17

[25] Re Neath Rugby Ltd, Hawkes v Cuddy [2007] EWHC 1789 (Ch); [2009] EWCA Civ 291

[26] Central Bank of Ecuador v Conticorp SA [2015] UKPC 11

[27] F&C Alternative Investments (Holdngs) ltd v Barthelemy and Culligan [2011] EWHC 1731 (Ch).

[28] Peskin v Anderson [2000] 2 BCLC 1

[29] Re Chez Nico (Restaurants) Ltd [1992] BCLC 192

[30] (1843) 2 Hare 461

[31] [2002] 2 AC 1

[32] Gardner v Parker [2004] EWCA Civ 781

[33] As to experts see Barclays Bank plc v Nylon Capital LLP [2011] EWCA Civ 826.  As to arbitrators see s67 Arbitration Act 2006

[34] see eg. National Grid v. M25 Group [1999] 1 EGLR 65

[35] Veba Oil Supply & Trading GmbH v. Petrotrade EWCA Civ 1832

[36] s68 Arbitration Act 1996

[37] s69 Arbitration Act 1996

[38] Covington Marine Corp v Xiamen Shipbuilding Industry Co [2005] EWHC 2912 (Comm)

[39] Russell on Arbitration para 8-140

[40] see eg. Hurst v Crampton Bros (Coopers) Ltd [2002] EWHC 1375 (Ch)

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