- Joint and several liability
- Conventional joint ventures
- Item joint ventures
- Formation and termination of joint ventures
- Agreement on terms of bid
- Participation formula
- General management matters
- Managing partner
- Management fees
- Management committee
- Working capital
- Capital calls
- Failure to meet capital calls
- Return of capital
- Investment of excess funds
- Accounting matters
- Bond and indemnification matters
- Bankruptcy of a partner
- Equipment acquisition provisions
- Item/conventional joint-venture similarities and differences
Two or more construction contractors sometimes compete for a particular project as a joint venture by pooling their resources and sharing the risk and potential profit. Several factors make this practice attractive. Joint venturing may make it possible for a single contractor to participate in a bid on a project that would otherwise be too large a risk. Since each partner in a construction joint venture usually prepares an independent cost estimate for the performance of the project, risk is reduced by basing the joint-venture bid on more than a single cost estimate—that is, two (or more) heads are better than one.
To submit a joint-venture bid, two or more contractors form a new and separate legal entity to submit the bid and, if the joint-venture bid is successful, this entity then executes the ensuing construction contract. The concept is not unlike that of a partnership between individuals, except that entire companies are involved as partners.
When a joint-venture entity submits a successful bid, a series of issues are created that affect both the owner of the project and the joint-venture partner companies. For instance, who is responsible to the owner for contract performance? Who is liable in the event of a default? The partners, in turn, need to decide how liability as well as profits are to be shared between them, where they get their working capital, who will direct the day-by-day activities on the job, who will own the joint venture’s assets, and what will happen if an individual partner cannot or will not meet its obligations to the other partners.
The subject of this chapter—the joint-venture agreement—is the construction industry document that addresses these concerns. This agreement is a contractor’s contract. Although it refers to the owner and the prime construction contract to which the joint-venture entity and the owner are the parties, it is not a flow-down agreement. Usually, the joint-venture agreement will predate the prime contract.
Joint and Several Liability
The fundamental principle behind joint-venture agreements is that the partners agree to be jointly and severally liable with respect to the duties, obligations, and liabilities of the joint venture. Joint and several liability means to each partner company that, if the other partners are unable or unwilling to meet their share of joint-venture obligations, each partner company can be held liable, not only for that partner’s share but also for the other partners’ shares as well-for the joint venture’s total obligation. Without joint and several liability, owners would not award construction contracts to joint ventures.
Conventional v. Item Joint Ventures
Two basic types of joint-venture arrangements are common in the construction industry: conventional joint ventures and item joint ventures. In a conventional joint venture, the partners (two or more in number) agree to share benefits and liabilities according to a participation formula, with each partner accepting its specified share of each according to the formula (subject to the previously explained principle of joint and several liability). Usually, in a conventional joint venture, the actual on-site construction work will be performed by the field forces of just one of the partners. The cost of providing the field forces and other costs of actual construction are charged to the joint venture. In item joint ventures, each partner (usually only two) agrees to be responsible for a separate physical part of the contract work. Each partner constructs that separate part with their own individual field forces according to the contract specifications, incurs separate costs, and retains payment for that part of the work from the owner. One partner may profit while the other suffers a loss. The partners do not mutually share the risks and benefits of the total contract. Rather, each accepts the risks and benefits accruing to each separate part of the contract. The aforesaid arrangements are internal between the partners. There is still only one joint-venture entity responsible to the owner for the total project, and there is still joint and several liability.
A common example where item joint ventures are used is a highway construction contract that contains heavy grading and paving work and bridge work. A grading and paving contractor who does not do bridge work may form an item joint venture with a bridge builder who does not do heavy grading and paving. If the joint-venture bid is successful, the grading and paving contractor will perform the grading and paving work, while the bridge contractor performs the bridge work. This arrangement permits bidding without depending on subcontract bids and can result in certain advantages.
Conventional Joint Ventures
The mode of operation of a conventional joint venture is that of a single independent entity, with its own assets, bank accounts, books of account, and management structure. The joint-venture agreement should contain the following key provisions, which define this mode of operation.
Formation and Termination Matters
The formation section of the agreement normally states that the joint venture is formed for the purpose of submitting a bid for some specific project named in the agreement and, if the bid is successful, to enter into a contract for the project with the owner and construct the project according to the terms of the contract. It should be made clear that the agreement is limited to the single project stated in the agreement and that the agreement expires when the project is completed and all of the terms of the joint-venture agreement have been fulfilled. In other words, the agreement does not create a permanent marriage between the partners, nor is the agreement intended to place any limitation on other business of any of the partners.
The agreement also normally states that each partner in the joint venture is responsible for that partner’s pre-bid expense incurred in investigating the project and preparing an independent cost estimate on which to base the bid.
The agreement provides that no bid shall be submitted until and unless all the partners agree on the terms of the bid. Further, the agreement provides that if a partner disagrees with the terms of the bid, they may withdraw from the joint venture at that point, permitting the remaining partners to continue with the bid.
Once the agreement has been signed and the partners start preparing their bid for the project, a partner who decides to withdraw is precluded by the terms of the agreement from either submitting a separate individual bid for the named project or from becoming a member of another joint venture that submits a separate bid for the same project.
The joint venture created as a result of the agreement constitutes a completely separate legal entity that will exist throughout the entire life of the agreement. That entity must have a legal name-style in order to do business, and the agreement includes this agreed-upon name-style. The agreement states the termination provisions applying to the joint venture. The purpose of these provisions is to establish what happens after the joint venture submits its bid if the bid is not successful and, alternatively, what happens if the bid is successful and a construction contract is awarded to the joint venture. The agreement normally provides that, if no contract is awarded, the agreement expires and has no further force and effect. In the event of a contract award, the agreement remains in effect until each and every provision of that contract has been carried out. Provisions are also included that apply after completion of the construction contract, such as those dealing with disposition of the assets of the joint venture.
The provisions dealing with the assets of the joint venture usually state that no partner will accrue any right to any of the joint-venture assets until the construction contract with the owner has been fully completed according to its terms. The agreement then details the specifics for the division of assets among the partners when the construction contract has been completed. These normally provide that the liquid assets will be distributed to the partners according to the participation formula stated elsewhere in the agreement and that nonliquid assets be sold at auction and the proceeds similarly distributed. Any remaining nonliquid assets are then usually distributed to the partners as the partners may agree at that time.
A conventional joint-venture agreement must establish how partners share the assets and liabilities of the joint venture. A participation formula must be stated defining the proportional share of each partner in percentages, which total 100% for all of the partners.
Since partners are jointly and severally bound to the owner, if one or more partners should refuse or be unable to meet their proportional share of any liability that the joint venture may have, the remaining partners are required to make up the delinquent partner’s share as well as meet their own obligation. Because of this possibility, the agreement provides for cross-indemnification for losses, wherein each partner furnishes indemnification to the other partners for any losses suffered by any of them because that partner failed to meet its full share of any liabilities. This indemnification permits partners who had to pay more than their proportionate shares of a loss, because of another partner’s failure to pay, to get their money back eventually, as long as the delinquent partner has any assets or later comes into any assets.
General Management Matters
Another major section of a conventional joint-venture agreement deals with general management matters, which include at least five separate general management areas:
- The agreement must provide the name of the managing partner. Usually, the managing partner is the partner company that has the largest participation percentage and provides the field organization that performs the actual construction work of the contract.
- The agreement defines the authority of the managing partner. This authority gives the managing partner the ability to legally obligate the joint-venture entity and to designate the individual who will occupy the position of project manager. The project manager usually is a proven member of the managing partner’s permanent organization but can be any person satisfactory to the managing partner.
- The agreement should deal with the often contentious subject of a management fee to be paid to the managing partner (on and above their share of the joint-venture profit) for furnishing the field forces and managing the project. Some agreements provide that the managing partner will not receive a fee. Others may provide that the managing partner receive a fixed fee stated in the agreement, regardless of whether the joint venture makes a profit. This latter arrangement, where the fee is unrelated to profit, is not popular since many contractors feel that it is inequitable for the managing partner to be paid a fee when the joint venture fails to make a profit (or incurs a loss). Consequently, a more common method is for the management fee to be dependent on the profit earned by the joint venture. Under this arrangement, the managing partner is paid a fee equal to a stated percentage of the total joint-venture profit prior to the distribution of the remaining profit to the partners according to the participation formula. For instance, consider the following specific case:
Partner A (managing partner): 60% participation
Partner B: 25% participation
Partner C: 15% participation
The management fee for the managing partner is 10%. The total joint-venture profit = $3,500,000. This would result in the following profit distribution:
A’s share: 0.10 x $3,500,000 + 0.60 x (0.90 x $3,500,000) = $350,000 + $1,890,000 = $2,240,000
B’s share: 0.25 x (0.90 x $3,500,000) = $787,500
C’s share: 0.15 x (0.90 x $3,500,000) = $472,500
Obviously, the greater the joint-venture profit, the greater the management fee taken off the top prior to the distribution of the balance. If no profit or a loss results, there will be no management fee.
- The agreement normally establishes a management committee to set joint-venture policy for the guidance of the project manager. The authority of the committee, the committee’s meeting schedule, and the voting rights of the partners in making committee decisions will generally be set forth.
- Joint-venture agreements sometimes delineate specific tasks or services to be performed by a partner for the benefit of the joint venture for which the partner will be paid directly. Such payments are considered to be normal costs of the joint venture. Common examples include data-processing services performed in the managing partner’s home office or design engineering services for project temporary structures performed in the home office of one of the partners. In these cases, the agreement may also state the dollar value of the compensation to be paid for such services.
Some agreements provide that each partner bill the joint venture each month for an amount equal to their proportionate share of 10% of the revenue received by the joint venture from the owner for that month and that these amounts be paid out to each partner as compensation for that partner’s home office general and administrative effort chargeable to the joint venture. Such a provision in the joint-venture agreement is then advanced as support for a 10% charge on all construction contract change orders to meet the expenses of each partners’ home office general and administrative management effort.
Working Capital Matters
Three main points dealing with working capital should be addressed in a conventional joint-venture agreement. The first, the capital call, is a request made from time to time by the managing partner for each partner to contribute funds to the joint venture for operating capital. The partners are required to respond to capital calls by contributing their proportionate share of the total call. When a call is made, a date is set by which all contributions must be received.
The second point deals with the consequences of a partner’s refusal or failure to meet a capital call. Specific agreements vary but generally provide that from that point onward the delinquent partner loses all voting rights and all rights to a share of the joint-venture profits until the delinquency is made up. Under some agreements, delinquent partners loses all rights permanently. However, delinquent partners are not relieved of their share of the joint-venture’s full liabilities. These potential liabilities flow to the partners as result of each partner signing the joint-venture agreement and, if such joint-venture liabilities eventually occur, they can only be discharged by partners paying their proportionate shares.
The third point deals with the return of capital to the partners. Conventional joint-venture agreements typically provide that the joint venture only retain funds sufficient to guarantee the ability to meet all future liabilities. In other words, the joint-venture management will not retain funds in excess of reasonable needs. A prudent joint-venture management committee will construe this provision very conservatively, particularly in situations where, because of front-end loading, the joint venture’s earnings from contract work are disproportionally high in relation to the cost of the work performed. Unanticipated costs later in the job may require the expenditure of those funds, and an imprudent partner may have committed them elsewhere and be unable to respond to the capital call asking for their return. For this reason, some joint-venture agreements specify that no excess funds be distributed until the project work is completed. This latter provision is viewed by some as overly conservative and is less frequently used than simply providing for distribution of funds in “excess of reasonable needs.” Additional provisions in this section typically deal with such matters as how the joint venture will report income for tax purposes, where options are permitted by the tax laws, conditions under which a partner may borrow from the joint venture against its share of equity, and requirements for the prudent and conservative investment of excess funds in interest-bearing securities, pending eventual distribution to the partners.
A conventional joint-venture agreement must also deal with at least six separate accounting matters:
- The partners must agree on the bank or banks where the joint-venture bank accounts are to be established. The joint-venture agreement should either list the banks or provide a means for their selection.
- The agreement should provide that separate books of account be set up for all necessary joint-venture accounting records and that joint-venture accounts must not intermingle with the accounts of any other business entity, particularly those of any of the partners.
- The agreement should state the required frequency of financial reports to the partners, normally monthly.
- The tax reporting declaration, where there is an option, should be stated in the agreement.
- The agreement should contain a fiscal year declaration fixing the starting and ending dates of the particular fiscal year for the joint venture agreed on by the partners.
- If a home office charge by the managing partner for the provision of data-processing and accounting services is intended, in addition to the management fee, the agreement should so provide.
Bond and Indemnification Matters
A number of provisions in conventional joint-venture agreements deal with bond and indemnification matters. Three main points are of interest:
- Usually only one package of bonds is put up by the joint venture, in which the agreed-upon name-style of the joint venture appears as principal. The sureties of the several partners, through internal indemnification agreements among themselves, arrange for one of the sureties to furnish the necessary guarantees on the bonds and to sign the bonds as surety. For all of this to occur, each partner has to indemnify its individual surety for its proportionate share of the contract. Such indemnifications may involve personal indemnifications by the owners and/or officers of the individual contractor partners.
- When personal indemnifications are required by a partner’s surety, a prudent joint-venture partner will insist that similar personal indemnifications be furnished to all of the other partners as well. Therefore, many joint-venture agreements provide that such “like indemnifications” be given by each partner to each of the others.
- Bond brokerage fees on large contracts can be sizeable. Since the brokers of all of the partners are usually involved to some degree, the total brokerage commission is sometimes split among them in proportion to the partners’ participation percentages, Some joint-venture agreements provide for this.
Conventional joint-venture agreements also contain provisions regarding insurance. Since the joint venture is going to be a separate, independent operating entity, the joint venture name-style appears as the insured on all the normal insurance policies discussed in Chapter 8. The joint-venture agreement insurance provisions deal with five main points:
- All partners in the joint venture should be named as additional named insureds on all joint-venture insurance policies. Otherwise, partners can be sued individually regarding a joint-venture matter and required to defend such suits and pay any judgments that are entered against them without any joint-venture insurance protection.
- Many joint-venture partner companies do not want the insurance company to have subrogation rights. (See discussion of subrogation in Chapter 8.) If this is the case, the joint-venture agreement should require that the insurance company’s subrogation rights be waived.
- The added protection of a completed operations endorsement with third-party liability insurance was discussed in Chapter 8. The joint-venture agreement should require that this endorsement be included with the joint-venture’s third-party liability policy.
- When the prime construction contract requires the joint venture to indemnify the owner and architect/engineer, the joint-venture agreement should provide that the joint-venture’s third-party liability insurance policy be written with the owner and architect/engineer named as additional named insureds for the reason explained in Chapter 8.
- Joint-venture insurance policies should be written to cover the use of partner-furnished construction equipment rented to the joint venture so that the individual partners who actually own the equipment are protected.
Partner Bankruptcy Provisions
The typical conventional joint-venture agreement also contains provisions dealing with the unhappy event of the bankruptcy of one or more of the partners. First, the agreement normally provides that bankrupt partners will immediately lose rights to all further profit and all management committee rights but are not relieved of their share of liability.
The agreement also provides that surviving partners assume the bankrupt partner’s share of any further joint-venture profits, pro rata to the surviving partner’s original shares, and then complete the construction contract according to its terms.
Construction Equipment Acquisition and Disposal
Comprehensive conventional joint-venture agreements deal with the problems of how, and from where, the joint venture will obtain the necessary construction equipment to construct the project through its equipment acquisition provisions. The value of the necessary equipment acquisitions can run to many millions of dollars for large projects.
A comprehensive agreement provides for acquisition of the equipment as determined by the management committee in one of three basic ways:
- The partners may contribute the necessary cash for the joint venture to purchase new or used equipment outright from third parties.
- Some or all of the equipment may be purchased from one or more of the partners at sale prices to be mutually agreed upon. An alternate form of purchase from a partner includes a guaranteed buy-back agreement at the end of the project. With this arrangement, it is often also specified that the original sale price and the buy-back price be determined by an independent equipment appraiser.
- The equipment may be rented, either from one or more of the partners or from third parties at rental rates to be approved by the joint-venture management committee. A related provision is that when equipment rented from one of the partners is damaged when in use by the joint venture, such damage will be repaired at the expense of the joint venture, normal wear and tear excepted.
Item Joint Ventures
The mode of operation for item joint ventures (usually only two partners) is that each partner operates as a separate company. The partners have little in common except a common name-style and common contract bonds furnished to the owner. Each partner has separate assets, bank accounts, books of account, and profits or losses. The item joint-venture agreement provides the specifics of the key arrangements between the partners.
Comparisons with Conventional Joint-Venture Agreements
Item joint ventures are similar to conventional joint ventures in the following ways:
- The partners of item joint ventures are jointly and severally bound to the owner under common contract bonds.
- There will be a single management interface with the owner, and the item joint-venture agreement indicates which joint-venture partner will provide this interface.
- The purpose of the item joint-venture agreement states that the agreement is for the purpose of submitting a bid and performing the resulting construction contract if it is awarded.
- The item joint-venture agreement contains provisions similar to conventional joint-venture agreements in dealing with termination in case no contract is awarded, as well as when a contract is awarded.
- The agreement specifies the agreed-upon name-style for the joint venture.
- The provisions of the item joint-venture agreement in regard to pre-bid expense are the same as for conventional joint-venture agreements. Both agreements call for each partner to bear their own pre-bid expense.
Although item joint-venture agreements have many of the same features as conventional joint venture agreements, many other features are different:
- Item joint-venture agreements contain no requirement for common agreement on terms of the bid. Instead, the agreement provides that each partner controls the portion of the schedule of bid items pertaining to its own work but has no control of portions of the schedule that pertains to the other partner’s work.
- There is no joint-ownership-of-assets provisions in an item joint-venture agreement since each partner maintains full ownership of individual partner assets.
- No common participation in profits or losses is provided for in an item joint-venture agreement. Partners benefit or suffer separately on their own section of the job.
- The item joint-venture agreement provides that the managing partner will control affairs of the other partner only in respect to the necessary interface with the owner and serve only as a necessary administrative conduit. The managing partner is not given the power to bind the other partner legally to anything.
- The item agreement does not provide for a management fee, except for costs of the administrative interface services performed by the managing partner on behalf of the other partner.
- The item joint-venture agreement does not provide for a management committee.
- No common working capital or common books of account, bank accounts, tax returns, or insurance policies are provided for in an item joint-venture agreement. Partners maintain their own.
This chapter concluded the discussion of common construction industry contracts by examining construction joint-venture agreements. It explained why contractors enter into joint-venture agreements and introduced the principle of joint and several liability, without which joint ventures could not exist. The chapter examined typical provisions of both conventional and item joint-venture agreements in detail and concluded with a discussion of the similarities and differences between these two types of joint-venture arrangements.
The following two chapters on the subject of the bidding process in the construction industry shift emphasis from the contract documents themselves to how the customs and practices of the industry and past decisions of courts have influenced contract operation and interpretation.
Questions and Problems
- What reasons for the formation of construction contractor joint ventures were discussed in this chapter? What does “jointly and severally bound” mean? Why is it important with respect to construction joint ventures?
- What are the two major types of construction joint ventures? What are the distinguishing features of each?
- With respect to conventional joint-venture agreements, what are the seven aspects of formation and termination matters that were discussed?
- What is a participation formula for a conventional joint venture? What does cross-indemnification for losses mean? Why is it important?
- What is meant by the term managing partner? What are two important powers normally bestowed on the managing partner by a conventional joint-venture agreement?
- Discuss two alternate arrangements for the payment of a management fee to the managing partner. Which is generally favored by contractors? Why?
- What is a joint-venture management committee? How does it usually work? What is its primary function? Is it intended to control the day-by-day management of the work?
- What are some of the home office services for which a managing partner might reasonably bill the joint venture in addition to any management fee? Why do some joint ventures follow the practice of having each partner bill the joint venture each month for its proportionate share of 10% of the joint-venture revenue for that month?
- What is a capital call? Is notice generally required? What normally happens if a partner fails to meet a capital call?
- What is the reason for a joint venture’s management committee to be very conservative in returning funds in excess of immediate needs? Why is conservatism in this respect particularly important when a job’s payment schedule has been front-end-loaded? What should be done with such excess capital?
- What are six separate issues regarding accounting matters for conventional joint ventures that should be addressed by a comprehensive joint-venture agreement?
- What are the three separate aspects of bond and indemnification matters that were discussed in this chapter with regard to conventional joint-venture agreements?
- What were the five main points made with regard to insurance matters?
- What two consequences will follow the bankruptcy of a conventional joint-venture partner?
- What are three ways for a conventional joint venture to obtain construction equipment?
- What are six similarities between conventional joint-venture agreements and item joint-venture agreements? What are seven differences between the two kinds of agreements?
- Contractor A, contractor B, and contractor C are in a conventional joint venture with shares of 55%, 25%, and 20%, respectively. Contractor A is the sponsor with a management fee equal to 7 1⁄2% of any profits of the joint venture. All capital calls are met by all partners. On completion, the job has made a $2,750,000 profit prior to any distributions.
- What is the total amount that each partner will receive from the job?
- If contractor B failed to respond to any capital calls, what would be the total amount that each partner would receive from the job?
- If contractor B failed to respond to any capital calls and, instead of making a profit of $2,750,000, the job incurred a loss of $200,000, what is each partner’s liability for the loss?