How to embark on a successful joint venture in the UAE

When entering into a joint venture, partners need to be on the same page in relation to the establishment, management and operation of the joint venture company. The key to ensuring a successful joint venture from the outset is agreeing a detailed heads of terms (HOTs).

What are heads of terms?

HOTs, often referred to as a memorandum of understanding (MOU), capture the objectives and intentions of each joint venture partner. They will set out the commercial understanding between the parties and the headline agreement for how the joint venture will be operated, governed and funded.

Although non-binding, executing a detailed HOTs document will ensure the parties are on the same page and will make the process of drafting and negotiating the more comprehensive contractual documents – such as the joint venture agreement or shareholders agreement – more efficient. This saves time and costs.

In the context of joint ventures in the UAE, HOTs can contain lots of detail. However, five key elements that tend to require the most thought are: structure; funding; deadlock; events of default; timing and exit plans.

Structuring your joint venture

Prior to the incorporation of the joint venture company, partners will need to consider and agree an appropriate corporate structure for the group, including the jurisdiction of incorporation of the joint venture company, the type of entity and the equity ownership split between the joint venture partners. This would require a structuring analysis to be undertaken and the approved structure should be captured in the HOTs.

The UAE is made up of ‘mainland’ and ‘free zone’ areas, with over 50 separate jurisdictions across the seven Emirates. Joint venture partners will need to decide to incorporate in one of these areas based on the activities that the joint venture company will be conducting. If the joint venture company is to be a ‘mainland’ entity, foreign ownership restrictions will also need to be taken into consideration in relation to certain restricted activities.

It is often advisable that the joint venture company is established as a holding company, often in one of the financial free zones such as the Abu Dhabi Global Market (ADGM) or Dubai International Financial Centre (DIFC). The ADGM and DIFC are both common law jurisdictions meaning that sophisticated concepts in joint venture agreements are generally more enforceable. The holding company may, in turn, set up operating subsidiaries to carry out the activities of the joint venture company in other jurisdictions.

Funding your joint venture

From a funding perspective, the HOTs will need to capture how the joint venture company will be funded. Companies are often initially funded by way of the joint venture partners paying the initial share capital into the joint venture company’s bank account following joint venture company’s incorporation. However, this is usually insufficient to cover the full working capital requirements of joint venture company.

Therefore, the budget and business plan should go into some detail about how the joint venture company will cover its further working capital requirements. The HOTs will also typically state how the joint venture company will raise further financing, such as from shareholder loans, further capital contributions in exchange for equity or traditional bank lending.

Dealing with deadlock

Joint venture partners will also need to consider how the joint venture company will operate and make day-to-day decisions, including situations where the company is not able to operate due to a deadlock. Deadlock occurs when the company is unable to make decisions that are material to the continued operation of the business, often as a result of disagreements among the shareholders or directors of a company. A deadlock may arise if there is no quorum at meetings of directors or shareholders or if there is a 50:50 split with no right for any individual to take a casting vote.

The key to the operation of a successful joint venture company is to avoid the risk of a deadlock. the joint venture partners should agree on methods to resolve a deadlock situation in the HOTs, to avoid the risk of the company not being able to operate if a deadlock occurs. Depending on the jurisdiction of the joint venture company, there are certain statutory quorum and notice requirements for shareholders’ meetings, which would need to be factored into deadlock provisions.

Events of default

Although the aim is always for joint venture relationships to operate smoothly, it is prudent to consider what would happen if one party defaulted on their obligations. An event of default is a predefined circumstance that allows a party to seek recourse from the other party. The joint venture partners will need to consider what would constitute an event of default, as well as what recourse the non-defaulting shareholder might have, and outline this in the HOTs.

For example, parties might agree on a “put option” – a right of the non-defaulting shareholder to sell the shares at a premium – or a “call option” – a right of the non-defaulting shareholder to require the defaulting shareholder to sell their shares at a discount. Rights of this type will require careful analysis and drafting when considering the jurisdiction of incorporation of the joint venture company. If a joint venture company is a ‘mainland’ company rather than a free zone company, sophisticated concepts such as put options and call options, or draft rights and tag rights, can be more difficult to enforce.

Timing

Timing is important when setting up a joint venture company. Documents such as the business plan, budget and joint venture agreement are fundamental to the set-up and day-to-day operations of the company. As such, it is important for these to be agreed prior to incorporation in order to avoid risks associated with the failure of the joint venture partners to agree these documents. Such risk could include having to wind up a newly incorporated joint venture company, which can be lengthy and costly process in the UAE.

To avoid delays in incorporation, joint venture partners can agree to collate all documents that would be required for the incorporation in parallel with negotiations surrounding the budget and joint venture agreement. The joint venture agreement can even be agreed between the joint venture partners prior to incorporation and the joint venture company can become a party after incorporation by signing a deed of adherence. The HOTs should explicitly state the completion steps and timing expectations.

Exit plans

Joint venture parties often forget to consider the long-term direction of the joint venture company. It is prudent for joint venture partners to consider their ultimate goals and timeframes, including in relation to the duration of the business relationship, the purpose of the joint venture company and any continuing business goals.

On an exit from the joint venture, certain procedures would need to be followed which may require cooperation between shareholders. For this reason, the HOTs should ensure all parties are on the same page in relation to any lock-in period and any plans to IPO, sell or liquidate the joint venture company in the future.

Other considerations

A comprehensive set of HOTs would include many other key points including governance obligations, anticipated acquisitions of any operating companies, employment and sponsorship of employees, merger clearance, and dispute resolution mechanisms.