TWO’S company, three’s a crowd – but any number is a joint venture.
Farm sales may have cooled in the past few months but there is no doubt that buying a farm is still beyond the reach of most people.
This is one reason why many more farm purchases are being completed by groups of people in various structures. This article broadly discusses factors that need to be considered when buying property as a group.
There is no strict legal definition of a joint venture enterprise, but essentially it consists of two or more parties who are involved in a relationship with a common commercial objective.
By leveraging off each other the parties are together able to enter into transactions which would otherwise be beyond their means or ability, such as the purchase of an expensive farming block.
The downsides are that any rewards which are obtained need to be shared between those parties, and that there is a potential loss of control in how the operation is managed.
One of the key factors in making a joint venture enterprise work is to ensure that there is certainty at the very beginning as to how the enterprise will operate, as well as documenting the mechanisms for making decisions and dealing with any disputes that may arise. First there needs to be a decision made on the type of joint venture which is to be used.
Partnership
Common to many farming
operations is the partnership, which is simply a relationship between two or more people carrying on business in common with a view to profit. All the partners have unlimited joint and several liability for the partnership debts.
They share in the profits (or losses) based on an agreement reached between them, or their share of the partnership. The partnership can be used as a vehicle to split income equally between the partners, and therefore redistribute tax to lower rates, as for example in a ‘husband and wife’ partnership.
The partnership is treated as a separate entity from the partners, in which each partner owns a share. The income is determined at the partnership level and then allocated to the partners. In some cases it is possible to structure a partnership agreement in order to allocate items of income in a more tax-effective way.
Tax losses incurred by a partnership are, in effect, treated as having been incurred by the partners themselves and can be offset without special restrictions against other income, just as if the partner had operated the business directly. The partners do not need to be
individual people but can be other entities, eg: companies.
Limited liability partnership
These partnerships share some of the benefits of both partnerships and corporate structures. The limited partnership is like a company in that it has a separate legal personality from its partners. However, while the liability is limited for those who are known as limited partners there is still a requirement to have at least one general partner who is responsible for the management and business of the partnership, and is also jointly and severally liable for all the liabilities of the partnership.
There is no income tax payable by the partnership itself. Instead, there is a flow through to the individual partners as is the case in a normal partnership.
Unincorporated joint venture
Unincorporated joint ventures are frequently treated as partnerships for legal purposes, if the business is carried on with a common view to a profit.
In situations where the same parties agree to share a joint product, rather than the joint profit, or they are simply only co-owners of property, then a partnership does not exist. Such an unincorporated joint venture would not be required to file a joint return of income, and that would allow flexibility for the parties to have different tax positions.
An example of this type of venture would be where parties together bought a farm in proportionate shares and agreed that at some stage there would be a subdivision reflecting that proportionate shareholding in the land.
The parties would then enter into a deed of partition reflecting these arrangements, and would confirm that at no time are they in fact to be treated as a partnership.
Incorporated joint venture
A common form of enterprise is an incorporated joint venture which is, effectively, a company where the shares are held by the parties to the joint venture.
The benefits of a company are its limited liability which gives protection from creditors, the ability to transfer a proportion of ownership, and an in-built regulated management structure via mandatory compliance with provisions of the Companies Act.
The disadvantages are that losses could potentially be locked in the company and not be able to be released, depending on the nature of the company and its shareholders.
Additionally, a company is not able to carry forward losses and imputation credits unless there has been some continuity in ownership.
When forming a company there must be a significant amount of thought given to how decisions are to be made, and the consequences when a dispute arises. Quite often, these matters will be incorporated in a shareholders’ agreement, rather than simply relying on the company constitution.
A shareholders’ agreement is not filed at the Companies Office, unlike a constitution, and is therefore not publicly disclosed which is important when it deals with issues requiring confidentiality such as restraint of trade on shareholders, dividend policy and funding matters.
The shareholders’ agreement will also outline which matters require shareholder approval, (unanimous, a certain percentage of support or a mere majority) and will also outline similar requirements for those matters to be decided by the board.
The process for the sale of shares can also be entrenched in the shareholders’ agreement. For example, the agreement could provide that minority shareholders may tag along in a situation where the majority shareholder is selling its shares, or have those majority shareholders impose a ‘drag along’ provision on these minority shareholders.
Another important matter is to document the method of resolving shareholder disputes in deadlock situations; this is routinely incorporated into the shareholders’ agreement.
The flexibility provided by the incorporated joint venture model has seen parties combine resources to enable the purchase of some vast tracts of land.
We have also seen the development of an industry which co-ordinates the purchase of very large farms funded by public investment in exchange for a share in the farm owning company.
The company structure has even allowed for the purchase of property for grazing by shareholders dependent on the number of shares purchased. For example, a dairy farmer could secure quality grazing at a fixed price with the investment giving the right to discounted grazing. There would also be cash flow benefits to other investors and the ability to benefit from any growth in the value of the farm.
Summary
In conclusion, joint ventures provide investors with an opportunity to access enterprises which would otherwise be unavailable to them.
This results in the sharing of risks and rewards, but also raises issues relating to control.
As is always the case, detailed advice should be obtained from your lawyer and other professional advisers on the appropriate structure (including tax purposes), which should then be backed up by exhaustive agreements setting out a clear mechanism for regulating the operations of the joint venture.
• Simon Brdanovic, partner in law firm Edmonds Judd, Te Awamutu. First published in their client newsletter, Fineprint, Autumn 2009
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