Joint ventures: How to Avoid Corporate Conflict

Mainstream

A joint venture is not just a pooling of resources. It is a structure that must be designed from day one to meet inevitable disagreements.

Corporate conflict in the joint venture does not start suddenly. It is being laid at the stage of negotiations, when the parties fix framework agreements, but ignore scenarios in which their interests no longer coincide.

The main question is not whether it is possible to agree on the creation of a joint venture. The main question is how the decision-making mechanism will work when the partners are on opposite sides of the barricades.

Therefore, effective protection against corporate conflict is based on three axes:

• Clear management structure with pre-distributed control.
• Pre-agreed procedures to break the impasse.
• Legally verified corporate contract that operates in a real jurisdiction.

If these three elements are not fixed before signing, the conflict turns from a hypothetical risk into a near-guaranteed scenario.

When there is a risk of a corporate conflict

A potential conflict is created if:

• The partners have different visions of the strategic goals of the joint venture;
• One side wants quick profits, the other wants long-term growth.
• the procedure for appointing and dismissing the Director General is not defined;
• Additional funding issues have not been resolved;
• There is no mechanism for resolving deadlock situations.
• the partner transfers his share without the consent of the other party;
• Control of one of the JV participants is changing;
• One of the parties is competing with the joint venture.
• a dispute over profit distribution or dividend policy;
• the partner does not fulfill the obligations to finance, transfer technology or provide contracts;
• The transaction is structured without taking into account sanctions, tax or currency restrictions;
• The JV operates in a jurisdiction with weak judicial protection of participants’ rights.

The mistake most of the participants make

Most participants begin with the question:

How to divide the shares: 50/50 or 51/49?

That's the wrong first question.

The right question is:

What kind of rules ensure that businesses continue to work even when partners no longer trust each other?

Sometimes, the optimal distribution of shares really helps. Sometimes, the key is not the size of the share, but the scope of the veto. Sometimes, the best protection is built through a layered deadlock resolution mechanism. Sometimes, through the right to buy out the partner’s share under predetermined conditions.

Preventing corporate conflict requires not a compromise at the launch stage, but a legal architecture that withstands a crisis of trust.

Step 1. Select a partner and conduct due diligence

A corporate contract will not correct a mistake in choosing a partner. Before you design a structure, you need to understand who you are entering the business with.

What to check:

• ownership structure of the partner and ultimate beneficiaries;
• reputation and history of litigation;
• financial condition;
• the presence of sanctions risks;
• Experience in similar projects;
• Corporate decision-making culture;
• Real reasons for entering the JV;
• the presence of a parallel business competing with the future joint venture;
• the possibility of fulfilling non-monetary obligations (technology, personnel, contracts).

Surface testing creates the illusion of reliability. Full due diligence provides a risk map on which to build protection.

Step 2. Harmonize management structure and control

Conflict often arises from uncertainty: Who actually manages the joint venture?

At this stage, it is important to record:

• composition and powers of the board of directors or other management body;
• the procedure for the appointment and release of the Director General;
• List of issues requiring unanimous decision (reserved matters);
• a list of issues adopted by a qualified majority;
• the mechanism for appointing key managers;
• Rules for the adoption of the budget, business plan and investment program;
• powers to conclude major transactions, attract loans, issue guarantees;
• The procedure for blocking decisions that can cause damage to the JV.

Protection is not built through a share, but through a list of issues that the partner cannot solve without your consent.

Step 3. Establish mechanisms for resolving deadlock situations (deadlock resolution)

Deadlock is not exotic. This is the point when the governing bodies cannot make a decision because of equality of votes or blocking the rights of the parties.

A strong corporate contract contains an escalatory ladder:

• transfer of the issue to the top management of the parties (management escalation);
• Mediation or negotiation involving a neutral intermediary;
• Involve an independent expert to make recommendations;
• the option to sell (put option) or buy (call option) shares while saving deadlock;
• The mechanism of Russian roulette (one party calls the price, the other chooses to buy or sell at this price);
• Texas Shootout (both sides file sealed price offers, the bidder wins);
• sale of the joint venture to a third party or division of assets;
• The elimination of the JV as a last resort.

If the mechanism is not pre-defined, the deadlock becomes a corporate war. If written, the conflict gets a controlled legal scenario.

Step 4. Settlement of funding and additional contributions

One of the typical causes of conflict: One party demands additional funding, the other refuses to provide it.

The corporate contract should include:

• the procedure and schedule of initial financing;
• conditions under which participants are required to make additional contributions;
• consequences of non-fulfillment of obligations on financing (dilution, penalty, forced exit);
• the procedure for financing through loans of participants or bank leverage;
• Rules of subordination of loans of participants;
• the right to refund the financing;
• Restrictions on withdrawals until certain indicators are reached.

Tight funding rules reduce the risk of blackmail from a partner who stops funding at a critical time.

Step 5. Restrictions on the transfer of shares (shares)

Free transfer of the share can lead to a third party in the joint venture with whom the initial partner is not ready to work.

Minimum set of protective mechanisms:

• The right of first refusal (right of first refusal)
• Prohibition of transfer without consent of the second party (consent right);
• Tag-along right – protection of minority shareholders when the majority shareholder leaves;
• The right of extortion (drag-along right) is a mechanism for majority shareholders.
• restrictions on the transfer of a stake in a competing business;
• restrictions on the pledge of a share or the issue of options;
• ban on transfer to offshore structures without transparency;
• Change of control clause (change of control clause)

These mechanisms protect not only against unfriendly third-party entry, but also against erosion of participation.

Step 6. Definition of exit conditions (exit provisions)

The exit from the joint venture should be settled in advance, not in the midst of a conflict.

The corporate contract should contain:

• list of grounds for voluntary withdrawal;
• list of grounds for forced withdrawal (violation, bankruptcy, default on financing);
• the procedure for determining the fair value of the share;
• payment mechanism (on a single-time basis, in installments, with a discount for certain violations);
• Put and call options with pre-agreed triggers
• rules of withdrawal in case of death or incapacity of the participant;
• mechanisms for dealing with the consequences of withdrawal on intellectual property, personnel and contracts.

The absence of an exit mechanism at the start means that when the parties break, they will trade in a state of maximum uncertainty – and usually with maximum losses.

Step 7. Consider applicable law and jurisdiction

The corporate contract and the charter of the joint venture may be regulated by different legal systems. It is important to synchronize:

• applicable law to the corporate contract;
• the law of the country of registration of the JV;
• mandatory rules of jurisdiction that restrict freedom of contract;
• the possibility of execution of an arbitration decision against the JV and its participants;
• The ratio of the provisions of the corporate contract and the articles of association (in which jurisdictions the charter takes precedence).

A mistake at this stage leads to the fact that even a perfectly written corporate contract is unenforceable at a critical moment.

Step 8. Arrange dispute resolution

Arbitration or trial is not the only option. It is important to build a system:

• mandatory negotiations at the level of appointed representatives;
• escalation to the level of CEO or owner
• Mediation or expert determination on financial and technical matters;
• arbitration (institutional or ad hoc) with a pre-agreed place, rules and language;
• The possibility of emergency relief through a court or emergency arbitrator.

The built-in dispute resolution process reduces the likelihood of disagreements escalating into open corporate war.

Step 9. To formalize the corporate agreement and charter as a single system

The corporate contract and the charter of the joint venture should work as complementary tools.

Key points:

• provisions duplicated in the articles of association to provide protection at the company and third party level;
• mechanisms for bringing the charter into compliance when changing the contract;
• procedure for actions in case of contradiction between the corporate contract and the charter;
• the obligation to vote in a certain way in the governing bodies;
• sanctions for violation of the corporate contract (fine, option, reduction of the share).

The contradictions between these documents are a direct path to paralysis of governance.

Step 10. Build a corporate governance and communication system

Even the best contract is no substitute for regular expectations management.

Practical measures:

• regular meetings of the Board of Directors with logging;
• joint strategic sessions;
• a reporting and audit system that both parties trust
• transparent document management on key decisions;
• procedure for disclosure of conflict of interest;
• Compliance mechanisms that meet the requirements of both parties.

Conflict often arises in an information vacuum. Transparency and predictability of procedures reduce the risk of escalation.

Methods of resolving deadlock situations: comparison

The choice of mechanism depends on the specific balance of forces, financial capabilities of the parties and the strategic value of the joint venture.

How to strengthen your position before setting up a joint venture

The best defense is not built after a dispute has arisen, but during the negotiation phase.

The corporate contract is recommended to include:

• List of issues requiring unanimous approval;
• deadlock resolution mechanisms with escalation staircase;
• clear grounds and procedure for forced withdrawal;
• financing rules and consequences of default on contributions;
• Protective mechanisms of share transfer (ROFR, tag-along, drag-along, change of control);
• arbitration clause with a realistic place of arbitration;
• applicable law tested for enforcement in the jurisdiction of the JV;
• the procedure for determining the fair value of the share at the exit;
• the sanctions clause and the procedure for the introduction of restrictions;
• Refusal of competition and obligation of confidentiality;
• distribution of intellectual property rights created in the JV;
• the division of assets upon termination of the JV.

The contract is not written for the first three months of cooperation, but for the day when the partners will no longer trust each other.

Common mistakes in the creation and management of a joint venture

1. The basic provisions of the charter are almost never sufficient to protect the interests of participants.
2. The parties hope that “we will always agree”. Practice shows otherwise.
3. No sanctions for violation of a corporate contract The contract without consequences for violation is a set of wishes.
4. A 50% ownership does not protect if all key decisions are made by a simple majority.
5. Weak development of the financing mechanism Blurring shares, loans of participants, capitalization - without rules, this is a time bomb.
6. Ignorance of mandatory rules of jurisdiction of the SPC Corporation contract, subject to foreign law, may not work in the country of registration of the company.
7. The exit without a predetermined price and procedure leads to protracted wars and the destruction of value.
8. Unrealistic arbitration clause Too expensive or inconvenient arbitration can make the protection of rights economically meaningless.
9. The withdrawal of one partner from under sanctions can paralyze the entire business.
10. A conflict of interest, not settled in a document, almost always leads to corporate war.

Checklist of the joint venture participant

Before signing and during the activities of the joint venture, 15 questions must be answered:

1. Is the due diligence of the partner carried out?
2. Are the strategic goals and business plan of the joint venture fixed?
3. Are there any issues that require a unanimous decision?
4. Is there a deadlock resolution mechanism in at least three steps?
5. Are there clear rules for additional funding?
6. Are there restrictions on the transfer of shares?
7. Is the procedure for determining the share price at withdrawal agreed?
8. Are there any working put/call options with specific triggers?
9. Is the applicable law and place of arbitration defined?
10. Is the enforcement of the award verified in the jurisdiction of the JV?
11. Are intellectual property issues resolved?
12. Are there any changes in control of the partner?
13. Is there an effective auditing and reporting system?
14. Are sanctions, tax and currency risks taken into account?
15. Does the charter comply with the provisions of the corporate contract?

What a strong strategy to prevent corporate conflict looks like

A strong strategy usually includes five levels of protection:

1. Partner Integrity Verification of the partner, his motives, structure and beneficiaries.

2. Contractual Architecture A corporate contract with reserved matters, deadlock, exit, financing and sanctions.

3. Governance Design Charter and internal policies synchronized with corporate contract and real management practices.

4. Exit Engineering: A pre-calculated output with share value protection and predictable scenarios.

5. Dispute Resolution Readiness is a ready-to-use system of negotiation, mediation and arbitration that eliminates business paralysis.

Skipping any level increases the likelihood that a corporate conflict will cost the business.

FAQ

Can a joint venture be created without a corporate contract?

Legally, yes. Commercially, this is a high-risk move. The charter almost never offers a level of protection comparable to a detailed corporate contract.

Which fraction is safer: 50/50 or 51/49?

Security is not determined by percentage, but by the list of issues on which the parties have veto power and the mechanisms of deadlock resolution. Conflict is possible with any distribution of shares.

What is a deadlock and how to resolve it without trial?

Deadlock is a situation where the authorities cannot make a decision due to the blocking of votes. Without a court, negotiations, mediation, experts, options and mechanisms of “Russian roulette” are applied, provided that they are prescribed in the contract.

Can I force my partner to be removed from the joint?

Yes, if the corporate contract or applicable law provides grounds for the forced redemption of the share (violation, default on financing, loss of license, bankruptcy, etc.).

What if a partner withdraws assets or creates a competing business?

Violations must be recorded immediately, interim measures must be applied, assurances must be relied upon, non-competition obligations must be relied upon and corporate contract mechanisms must be established, including forced withdrawal and recovery of damages through arbitration.

How to protect yourself from the erosion of the share when you refuse additional funding?

The corporate contract should contain anti-diluction mechanisms, the right to proportional participation and sanctions for the partner’s refusal to finance, up to the forced redemption of his share with a decreasing coefficient.

Can a corporate contract be subject to English law if the joint venture is registered in another country?

In many cases, yes, but it is necessary to check compatibility with the mandatory rules of the country of registration and to reflect the key protective provisions in the articles of association to ensure their application at the company and third party level.

What if the conflict has already arisen, and the deadlock mechanism is not prescribed?

The parties then enter the mode of “unstructured conflict”: negotiation, pressure, threat of lawsuits, loss of value. In this situation, the best way out is to try to conclude a settlement agreement with clear terms of exit of one of the parties.

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Conclusion

Corporate conflict in a joint venture is not prevented by negotiations at the moment of crisis, but by the legal architecture laid down before its creation.

A strong position is based on the choice of a partner, a detailed corporate contract, clear management rules, a calculated mechanism for exiting the deadlock and readiness for compulsory protection of rights.

In joint ventures, it is not the one who controls the higher percentage that wins. The winner is the one who knows how decisions will be made, how to resolve deadlocks and how the value of his investment is protected in any scenario.