Joint ventures in the energy sector

Choosing a partner

There are a host of reasons that support parties collaborating in some shape or form in connection with energy projects, most notably: 

27th February 2009

Choosing a partner

There are a host of reasons that support parties collaborating in some shape or form in connection with energy projects, most notably: 

  • ability to share costs and risk, which in turn enables parties to undertake larger scale projects (for example, given the costs associated with constructing an offshore windfarm, Round 3 of the UK Offshore Wind Farm Programme will likely see bids submitted by a number of consortia as opposed to individual developers); 
  • access to new markets/local knowledge in the context of foreign or cross-border projects; and
  • pooling of experience, skills, technology and resources.

Notwithstanding the potential benefits, participants often overlook some of the 'softer' issues that are central to the success of any commercial collaborative relationship. They must ensure that their objectives are suitably aligned by mapping out clear strategic objectives, that any cultural differences or variations in management styles will not hinder effective co-operation and communication on a day-to-day basis, and that they fully understand and are committed to fulfilling their responsibilities in connection with the project.

Choosing a structure

Once the participants are comfortable with the possibility of working together, they must consider the most effective and efficient structure within which to undertake the project. This can range from establishing a purely contractual relationship on the one hand, to setting up a stand-alone joint venture company on the other.

Although there may be tax and accounting issues driving a particular structure, there are other factors to consider:

(a) Corporate Joint Venture

If the participants choose to undertake a project by forming a separate corporate entity (be it a limited company or a limited liability partnership), that entity will be in a position to undertake the project in its own name. Consequently, the joint venture entity can own its own assets, contract with third parties, grant security to funders over its assets and employ its own staff. Significantly, in the absence of any guarantees by the participants, broadly speaking, all of the joint venture entity's rights and obligations are ring-fenced.

(b) Contractual Joint Venture

A basic contractual relationship between the participants is, on the face of it, a simpler means of proceeding, and helps avoid the administration and publicity requirements (in the form of submission of accounts/annual returns to the Registrar of Companies) that go with corporate joint ventures. However, governing the relationship between the joint venture participants becomes increasingly problematic if there is project-specific funding, assets, employees and/or third party contracts, with the apportionment of costs and liabilities between the participants often fraught with difficulty. Although this can be addressed by putting in place mutual indemnities, these can prove difficult to negotiate (and, if not carefully drafted, can leave the participant granting the indemnity exposed to an unquantifiable and uncapped future liability).

An illustration of the successful use of contractual joint ventures (albeit more akin to a hybrid between corporate and commercial joint ventures) is the joint operating agreement structure used in the oil and gas industry. To a significant extent, these have been standardised over the years to reflect industry practice and experience, in turn helping to ensure that transaction negotiations are streamlined and deal costs minimised. It remains to be seen whether standardisation will be adopted in other areas of the energy sector.

Being alive to the issues

Regardless of the structure chosen, there are a number of issues that the participants should consider at an early stage of the negotiation process. For example:

Funding requirements and Participant Contributions 

  • How will the joint venture be funded (e.g. will bank funding be required)? 
  • Will the participants provide loans and/or guarantees?
  • Are the participants obliged to plug any funding gaps - if so, what are the consequences if one participants refuses? 
  • Will the participants provide/make available services, assets, land and/or employees to the joint venture (if so, on what terms)?

Management/Control 

  • How will the joint venture be controlled and managed, both strategically and on a day-to day basis?
  • Should there be a list of matters requiring the unanimous decision of the participants (e.g. variations to the agreed budget/business plan)?
  • Is it appropriate to have 'minority shareholder' protections where one participant has a minority interest?

Deadlock 

  • What happens if the parties cannot agree on a particular course of action – should the documentation stay silent or provide a procedure for resolving a dispute (e.g. mediation; internal escalation procedure)?
  • If the procedure does not result in a resolution of the deadlock, should there be any consequences (e.g. winding-up; appoint a third party to seek a purchaser for the entire project; submit to the binding decision of an independent expert; inclusion of buy-out mechanisms such as 'Russian Roulette' or 'Texas Shoot Out')?

Exit 

  • Can the participants freely transfer their interest in the project? 
  • Should the other participant have a 'pre-emption' or 'first right of refusal' right?
  • If a participant breaches its obligations and an event of default is triggered, should this give rise to a right for the innocent party to compulsorily acquire that party's interest in the project on a discounted basis (or alternatively require the party in breach to acquire the innocent party's interest in the project at a premium)? 
  • If a participant has provided assets, land, services, employees or land to the project, how will those arrangements be addressed in the event of a shareholder exit? 
  • Does responsibility for contingent/future costs (e.g. decommissioning) need to be addressed?

Although joint ventures can provide an effective means of adding value to, in particular, larger and more complicated, energy projects, it is critical that the parties understand what that relationship entails, in good times and in bad.