Contractors often pursue projects using a JV approach. The term, “joint venture,” (or JV) can mean different things. This column examines different JV approaches and their advantages and disadvantages.A contractual JV is an unincorporated association among firms created by a contract, usually referred to as a JV agreement, to perform a specific contract or opportunity. The JV agreement will typically spell out the duties and responsibilities among each of the venturers. Important elements include sharing of profit/loss, contributions to the project, control, participation and allocation of resources. The law generally treats contractual JVs as general partnerships, with each co-venturer jointly and severally liable to its customer and third-parties for the JV’s debts, obligations and conduct. Any agreement among the co-venturers to limit such liability to third parties and customers is generally of no legal effect.
JVs are often referred to as either populated or unpopulated. A populated JV has its own employees; an unpopulated JV does not. The unpopulated JV relies on each partner to perform work on behalf of the JV using its own resources. Contractors often prefer unpopulated JVs due to simplicity. These allow each venturer to perform tasks with its own resources on behalf of the JV, without transferring employees or resources to a different entity. Costs are simply charged to the JV.
JVs can also be implemented through the use of limited liability entities such as limited liability companies and limited liability partnerships. Under this approach, companies form a new legal entity established under a particular state’s laws that limit certain liabilities the new entity could have to third-parties. States such as Texas have specific formalities that must be followed in order to rely upon the limitation of liability protections available from limited liability entities. The formalities generally involve establishing a separate legal entity that operates independently of its owners, partners or members. It is important that the co-venturers properly establish the new entity and allow it to be managed in accordance with a well-defined operating agreement.
I have seen clients use a basic contractual JV agreement based on an unpopulated JV as the “operating agreement” for a limited liability entity. One of my colleagues refers to this as trying to place a square peg in a round hole. This approach can result in the limited liability entity losing its protections against certain third-party claims because the co-venturers do not observe the limited liability entity’s independence.
Another “red-flag” results when co-venturers try to manage the limited liability entity JV using sponsor or managing-member concepts. This approach, commonly used in unpopulated contractual JVs, is counter to the concept of a manager-managed limited liability company in which members have no governance powers other than electing managers and perhaps approving specified “major decisions.”
To rely on the liability protections of a properly formed limited liability entity, the entity should perform the contract itself and be populated with its own employees, management and resources. Even under this approach, it is possible for the entity’s owners to reserve approval authority.
Customers may be hesitant about contracting with a thinly capitalized limited liability entity because its members may not be jointly or severally liable. Co-venturers can address this with appropriate bonds, insurance and, if necessary, parent guaranties.
Federal construction programs present special opportunities and challenges for JVs, particularly involving small business set-aside contracts. Generally, small business can pursue opportunities under the SBA’s mentor-protégé program. JVs formed between small business and large contractors, outside of this program, usually cannot qualify as a small business.
As with most business arrangements, it’s always a good idea to spend time at the front-end, when the partners are happy, addressing the important issues of profit sharing, risk, participation, control, taxes, liability and similar matters.