Oil and Gas Investor Cross-border Partnerships: International JVs

Presented by:

[Editor's note: A version of this story appears in the March 2021 issue of Oil and Gas Investor magazine. Subscribe to the magazine here.]

The oil and gas industry has been global for most of its history. Many U.S. companies in the sector already do business around the world. As new discoveries continue to be made, new technologies continue to be invented and market conditions continue to change, there will always be opportunities not only for U.S. production companies, but also for energy sector supply and services companies to pursue new international business or to restructure their existing operations.

Joint ventures (JVs) are one of the most common ways of doing business abroad. Doing business abroad can be a great way to grow your business and deepen your customer relationships, but there are traps for the unwary. Thoughtful planning can help you reduce the risk of getting burned.

Following are some high level, key practical considerations relevant to international JVs, and in particular for energy sector supply and services companies that wish to set up a presence in a foreign country to sell their products and services to the production companies in that country.

What is a JV?

The term “joint venture” is used to describe many things. In the popular sense, it can encompass virtually any endeavor in which two or more parties—companies, individuals, or even governments, charities and educational institutions—work together on something. In the business context, however, the term typically refers to a situation where two partners jointly own a company (the “JV company”) and do business through that company.

Many variations are possible. For example, there could be more than two partners. Or the partners could choose to work together pursuant to a contractual arrangement rather than through a company in which they share ownership.

For simplicity’s sake, this article focuses on the classic model for an international JV: a JV company that is incorporated in the target country and is owned jointly by a U.S. partner and a local partner.

Is a JV company right for you?

Once you have decided that you want to do business in the target country, you need to decide what type of structure you wish to use. A JV company is among the most common structures, and the following are some of the reasons why you might choose to form one:

Local ownership/local content requirements. Local law in the target country may require you to do business through a JV company owned jointly with a local partner, or your customers may require or encourage you to do so. Government-owned customers in particular, such as national oil companies, may have policies that mandate or allow preferential treatment toward vendors that have local ownership.

General business considerations. You may believe that having a JV company owned with a local partner will help make your business in the target country more successful, for example, through your local partner’s ability to contribute business leads, customer service support, assistance with collections or logistical support on anything from customs clearance for shipments to work visas for expatriate employees. For these reasons, U.S. companies sometimes choose to form a JV company even when there is no local law or customer requirement for them to do so.

Keep in mind, however, that a JV company is often not your only option for doing business in the target country. Before you commit to forming a JV, check with local legal counsel as to what other structures are available to you. Other structures may include:

• A company or branch in the target country, wholly owned by you.
• Direct sales from your facilities in the U.S. to your customers in the target country.
• Engaging a local agent to sell your products in the target country, with the agent typically being paid on a commission basis.

Assuming that you decide a JV company is the way to go, the following are some practical tips for getting it set up properly.

Finding a local partner

Some U.S. companies select their local partners based on long-standing relationships or introductions from trusted third parties. Other companies meet their local partners through customer recommendations, through their own research, at industry conferences and trade shows, or purely by chance.

It is important to get your choice of local partner right. Whether you expect your partner to play an active role or a relatively passive role in the business, you want someone you can get along with. If the relationship goes sour, local partners may find ways to gum up the JV company’s works and make your life difficult.

Choose a deal structure that will incentivize your local partner to work hard, stay engaged and cooperative over the long term.

Assembling your deal team

Internal team. Step one is to figure out who at your company will be responsible for bringing the JV company to life. At very large U.S. companies that do a lot of international JVs, there are often people on the business side (e.g., corporate development) and people in the in-house legal department whose fulltime job is to set up the company’s international JVs and manage ongoing work related to them.

At a smaller company, the C-level executives might roll up their sleeves and work on the JV themselves. Make an honest assessment of your internal capabilities. That will help you hire the right team of external advisers.

Outside advisers. In most JV deals, your main external advisers will be your lawyers. There are certain issues on which companies typically consult with their tax advisers (e.g., transfer pricing requirements).

And there are some JV deals, particularly very large ones, in which investment bankers or other financial advisers play a role. But on most JV deals, your internal team and your external lawyers will do the heavy lifting.

Local counsel. When it comes to choosing your legal team, you will almost always want to include local counsel in the target country. While your prospective local partner may volunteer to handle the entire JV company setup, think twice before taking them up on that offer.

It’s prudent to have your own legal counsel in the target country to advise you on the relevant legal requirements, to help you evaluate what you are being told by your local partner and others, and to make sure the JV company gets set up correctly per the agreed deal structure.

U.S. counsel. Consider whether it makes sense to have U.S. outside counsel involved in the deal as well. If your internal team has a lot of experience doing international JVs, has the subject matter knowledge that the JV work requires and has the time to be fully engaged, you might decide to work directly with local counsel.

“Choose a deal structure that will incentivize your local partner to work hard, stay engaged and cooperative over the long term.”

But in many cases, having the right U.S. counsel involved in the deal can add significant value, both in taking the laboring oar on the work and also in helping to steer things in the right direction. Look for U.S. counsel that is experienced in doing international deals and working directly with local counsel.

Structuring the JV company

JVs are challenging to structure because you are creating a framework that you intend to govern a long-term business relationship, in which any number of unforeseen contingencies may arise over time. The following are some of the most important issues to get right:

Governing documents. The JV company typically will have articles of association or other constitutional documents of the type used in the target country. Ask local counsel about how much room you have to customize these documents, but in many cases, you will not be able to fit all your desired deal terms into the constitutional documents, so you will also have a shareholder agreement in which you can set them out in full.

Ask local counsel about the enforceability in the target country of shareholders agreements generally and of the particular terms you wish to include in yours. Some of the key terms normally addressed in the shareholders agreement are discussed below.

Financial terms. Make sure you and your local partner are in agreement on how much startup capital the JV company will need, where that capital will come from, and when it will be injected. Ask local counsel whether there are any local legal requirements for capitalization.

If you will be loaning your local partner its share of the JV company’s startup capital, make sure to document that. If you are relying on outside financing and you have not yet secured a firm commitment, make sure to include an exit provision in the shareholders agreement that gives you the right to unwind the JV if the financing falls through. Specify how and when the JV company’s profits will be distributed to you and your local partner.

Business of the company and noncompetition. Make sure you and your local partner have a clear understanding of what the JV company’s domain will be. Which business lines will it have? Which geographic markets will it cover? Who will have the authority to determine any additions to (or subtractions from) the business lines, markets and customers that the JV company will serve? Consider whether you and your local partner want to agree to any nocompete restrictions. If so, ask your local counsel whether those would be enforceable in the target country.

Corporate governance. Ask local counsel about the legal requirements and customary practices in the target country. Should the JV company have a board, or should all corporate governance decisions be made at the shareholder level? How often should meetings occur? Can meetings occur remotely, and can decisions be made by unanimous written consent in lieu of a meeting? What are the voting thresholds for key types of decisions?

What types of decisions will be “key” varies greatly from one JV company to another, but some of the most typical hot-button issues are decisions relating to capital increases, taking on debt, reorganizing and dissolving the JV company. Another thing to keep in mind is that having the right to appoint the JV company’s general manager, or whoever else will be in charge of the JV company’s day-to-day operations, is crucial.

Share transfers. Consider whether you want to impose any restrictions on share transfers, and if so, ask local counsel whether they would be enforceable. Common share transfer restrictions may include lock-up periods, rights of first refusal (which may be required by local law in the target country anyway), tag-along rights and drag-along rights.

Ask local counsel about the mechanics of share transfers in the target country. For example, could a share transfer that is allowed or required by the shareholders agreement be thwarted if a party refuses to sign documents?

Exit provisions. Include a clear framework for how to achieve separation if the JV company’s business doesn’t work out, if your relationship with your local partner sours, or if there is any other kind of deadlock that cannot be resolved. The most common forms of separation are for one shareholder to buy out the other or for the JV company to be dissolved.

There are many ways this can be structured. Also remember to have a framework for termination of related party business between you, your local partner and the JV company (e.g., supply agreements, service agreements, intellectual property licenses) in the event of a breakup.

Dispute resolution. Ask local counsel how to structure dispute resolution and how it would work in practice. The tougher it would be to enforce your rights in the target country, the more reason to structure your JV company from the outset in a manner that will optimize your chances for long-term success.

Robert G. Kenedy is a special counsel in the Houston office of Jones Walker LLP, where he advises clients on a broad range of corporate and commercial transactions. Prior to joining Jones Walker, he was a counsel in the Dubai office of an international law firm, where he advised on cross-border M&A and joint ventures.