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10 April, 2018
Financing A Joint Venture Company – Importance Of Dispute Resolution Mechanisms Between Joint Venture Parties (Learning Points From “perennial (Capitol) Pte Ltd And Another V Capitol Investment Holdings Pte Ltd And Other Appeals”).
A financing bank should ensure that there are agreed and effective mechanisms for fair resolution of deadlock situations between joint venture parties before financing a joint venture company. The lack of such a mechanism can lead to protracted disputes between joint venture parties which may ultimately affect or even lead to the winding up of the joint venture company. This was highlighted in the case of Perennial (Capitol) Pte Ltd and another v Capitol Investment Holdings Pte Ltd and other appeals [2018] SGCA 11 (“Perennial”), in which the Court of Appeal (the “Court”) held that if a party had an option of exiting a 'quasi-partnership' relationship that had irretrievably broken down and was able to do so on fair terms, this option should be adopted instead of the winding up of the joint venture company, unless certain exceptions apply.
The Case
Perennial concerned an unsuccessful joint venture, in which the appellant shareholders sought to liquidate three separate companies under the ‘just and equitable ground’ pursuant to s 254(1)(i) of the Companies Act. The application for winding up emerged in the context of a deadlock between equal shareholders of the three companies whereby neither party desired to sell its shares to the other. The Court dismissed the appeals, affirming that where there is a ready and available means of allowing a joint venture party to extricate itself from an untenable relationship on fair terms – for instance a pre-emptive buy-out clause which allows one party to give reasonable offer to the other for fair value of the shares – there is no jurisdiction for a court to order a winding up under the ‘just and equitable' ground. Further, the present facts in Perennial did not fall under any of extenuating circumstances as established by the same Court in Ting Shwu Ping (administrator of the estate of Chng Koon Seng, deceased) v Scanone Pte Ltd and another appeal [2017] 1 SLR 95 (“Ting Shwu Ping”), namely, that the articles in the companies' constitution were arbitrary, artificial or did not capture the legitimate expectations of parties when it came to share valuation.
Analysis and Learning Points
(1) Agreed and clear mechanism for dispute resolution
A financing bank should ensure that there is an agreed mechanism for dispute resolution between joint venture parties. It is salient that the shareholders in Perennial were unable to agree on the terms of the joint venture and though numerous drafts of the proposed joint venture agreement governing the shareholders' relationships, interests and rights were circulated, they were never duly executed. The lack of contractual agreement dealing with protracted disputes and 'lock-in' situations ultimately resulted in the eventual application to wind up the company.
Financing banks should therefore take heed to ensure that such dispute resolution mechanisms are established by valid and binding agreements in the constitutional documents of the joint venture company and/or joint venture agreements. The mechanism should also be clearly drafted to avoid any ambiguity and dispute.
(2) Effective and Fair mechanism for dispute resolution
The mechanism for dispute resolution must also be effective and acceptable to a financing bank. In Perennial, the Court relied on Article 22 of each respondent company's articles of association which gave a right to a shareholder to give notice and transfer its shares in the company at an agreed price and if the price could not be determined, the company's auditor would certify a fair value for the shares. Although this pre-emption article did not expressly contemplate a situation of deadlock between shareholders, it was still accepted and regarded as a mechanism which applicants could invoke before commencing an application for winding up. Article 22 thus readied a means which allowed a party's exit on fair terms and the Court held that there was no situation in which a finding of unfairness could be made to give the Court a 'just and equitable' basis to order the liquidation of the companies.
In general, dispute resolutions mechanisms broadly fall into two distinct categories: the first category would assist in breaking deadlock and equipping parties with workable solutions for the continuity of the joint venture, for instance, an independent directors’ swing vote or a general dispute resolution procedure such as references to mediation or expert arbitration; the second category would consist of ‘divorce’ methods which concede that a deadlock is irreconcilable and accommodates objective means of terminating the joint venture, such as the exercise of put or call options, pre-emptive rights (rights of first refusal or first offer), the sale of the joint venture company as a whole or ‘shoot out’ procedures.1
Where pre-emptive rights or transfer of share clauses are provided for, they should be further bolstered with fair price determination of shares, such as market valuation on a pro rata basis or determination by fair value, assessed by an independent auditor or investment bank.2 This would alleviate any enforcement issues of having the buy-out offer or transfer of shares being deemed unfair, arbitrary or unreasonable.
Conclusion
A financing bank should be cognizant of the risks of breakdown in relationships in a joint venture and the eventuality of an impasse between joint venture parties. This may ultimately affect the recovery of the loan to the joint venture company. Perennial underlines the importance of agreed, clearly drafted and effective provisions on establishing legal transferability of interests in a joint venture and a mechanism on dispute resolution to evade protracted disputes and even liquidation.
1 I. Hewitt, Joint Ventures, 4th edn., Sweet & Maxwell Limited, 2008, pp. 236 – 247
2 I. Hewitt, Joint Ventures, 4th edn., Sweet & Maxwell Limited, 2008, p. 283
