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Inhoudsopgave Prof. mr. E.P.M. Vermeulen

Alliance Governance: ‘Balancing Control and Trust in Dealing with Risk, Long Range Planning, vol 42 2009, p. 75-95

p. 4

Joseph A. McCahery and Erik P.M. Vermeulen, ‘Joint Ventures and the Shareholders Agreement

p. 25

E. Lee Reichert & Robert M. Fogler, ‘Legal issues in creating and documenting Joint Ventures and Strategic Alliances’

p. 73

Mr. H. Uittien en mr. S.A. Alleman, ‘Drag along and tag along’, Tijdschrift voor Ondernemingsrechtpraktijk, nummer 3, mei 2009

p. 99

A guide to Venture Capital Term Sheets

p. 104

Equity Joint Venture Contract – BMW Brilliance

p. 159

Joint Venture Agreement – Template

p. 215

Long Range Planning 42 (2009) 75e95

http://www.elsevier.com/locate/lrp

Alliance Governance: Balancing Control and Trust in Dealing with Risk Ard-Pieter de Man and Nadine Roijakkers When designing an alliance governance structure, managers have to choose between approaches based on control or on trust. This article proposes a framework to help managers decide which of the two is appropriate in a particular situation. The debate in the literature on control and trust centres on two issues: first, on the question of whether control and trust are substitutes or complements, and second on the links between control, trust and risk. This article connects these two debates. Our framework proposes that whether control and trust are substitutes or complements depends on the level and type of risk an alliance faces. We argue that in high risk situations companies use complex combinations of control and trust in a complementary way, rather than loose relationships as suggested by current thinking. In low risk situations we expect control and trust to be substitutes. In line with current contributions, we find that intermediate levels of risk require alliance governance to be based either exclusively on trust or exclusively on control, depending on the type of risk the alliance faces. These principles are illustrated by a detailed analysis of the governance structure of alliances in the financial, consumer goods, retail, construction and agriculture sectors. Ó 2008 Elsevier Ltd. All rights reserved.

Introduction When Philips Domestic Appliances and Douwe Egberts (a subsidiary of the Sara Lee Coffee and Tea Co.) decided to introduce an innovative way of making coffee, they faced the question of how best to design their alliance. They were completely different firms intending, with no pre-history of cooperation, on collaborating to launch a new concept into a traditional arena. How could they ensure the stability and adaptability of their alliance? Should they rely on contracts to define their relationship e or on trust? What level of control would they require? Which topics needed to be covered in the initial contract, and which things were better decided later? And how would those decisions be taken? In short: what was the right governance structure for their alliance?

Alliance governance refers to the combinations of legal and social control mechanisms which coordinate and safeguard the alliance partners’ resource contributions, and define their administrative responsibilities and the division of rewards from their joint activities.1 While the literature has paid 0024-6301/$ - see front matter Ó 2008 Elsevier Ltd. All rights reserved. doi:10.1016/j.lrp.2008.10.006

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only occasional attention to alliance governance in recent years,2 and LRP has devoted previous attention to an earlier phase in the alliance lifecycle - partner selection - and to the later phases of management and change of alliances,3 this article discusses the phase of designing the alliance governance structure.

Two general views on governance are found in the literature - the control view and the trust view e which can be summarized by the debate conducted between Williamson and Ghoshal and Moran in their sequential papers.4 The ideal balance of trust and control has been the subject of much research: some authors argue these approaches are complementary, others that they are substitutes. In parallel to this debate, other authors (of whom Das and Teng are typical) have developed theories about the optimal balance between control and trust in alliances depending on the level of risk these relationships face.5 How are managers to draw lessons from these different points of view?

this article integrates the debate between the complement and substitute views about control and trust with current understanding of risk in alliances.

This article aims to help resolve the debate between the ‘complement’ and ‘substitute’ views by integrating it with current understanding of control, trust and risk in alliances. Our detailed case analysis of alliance governance confirms that levels of control and trust in an alliance depend on the levels of the risks it faces. Das and Teng note that two elements of risk are particularly important: relational risk (that partners will deceive each other) and performance risk (that the alliance will not deliver the expected business results). We propose that a high relational risk and a low performance risk require strict alliance control, and that in the reverse situation the alliance will fare better under trust based governance. When both elements of risk are high, control and trust are complementary: when both are low, they are substitutes.

For practitioners our article highlights key governance elements that need to be addressed when designing an alliance, and points to which circumstances indicate the use of either a control- or a trust-based approach: the five distinct governance models illustrated in our case descriptions serve as frames of reference. Academics will be interested in the article’s contribution to the debate between the complementary or substitional nature of control and trust. Our argument e that they are complementary in high risk situations e diverges from current thinking (which indicates loose relationships in such circumstances): this finding may open some new avenues for research.

In the following section control and trust are discussed and applied to alliance governance. The complement/substitute debate is then briefly summarized, and on the basis of current understanding of control, trust and risk, we present a theoretical framework to resolve this debate. Five case studies illustrate the framework, and theoretical and managerial implications are defined in the final section.

Control, trust, and risk The theoretical foundation for the control view on alliance governance derives from transaction cost economics, and a key element concerns controlling partner opportunism.6 In the transaction cost tradition, relationships between companies are understood in a context where opportunism and bounded rationality characterise firms’ participation in transactions. When it comes to alliances, researchers subscribing to the control view consider the relational risk in alliances to be high because self-interested alliance partners are expected to behave opportunistically in an effort to maximize results for their firm, rather than outcomes for the alliance. Although this risk may differ depending on circumstances, self-interested and opportunistic behaviour of alliance partners are likely to be found in all alliance relationships. Therefore it has to be balanced by a formal 76

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governance model that will prevent partners from abusing the alliance by taking advantage of opportunist possibilities. Such control based governance models are based on adequate legal and ownership safeguards, such as detailed contracts, equity investments, and strict rules agreed between the partners.

The trust view sees trust between alliance partners as an important element in understanding the nature of inter-firm alliances,7 and therefore sees creating and building trust as the core challenge in alliances,8 emphasizing the role of informal elements in alliance governance. Recent work by Bierly and Gallagher in LRP has gone into detail about the antecedents to trust, and it is not our intention here to research this area further. Behind the trust approach lies the idea that when partners are intrinsically motivated to make an alliance successful there will be less need for formal controls to prevent opportunistic behaviour, as partners will automatically act in the interest of the alliance.

In contrast to the control approach, partners’ shared vision and mutual trust are the ‘glue’ that keeps alliances together. Their shared goals for the alliance stimulate information sharing between partners, enabling them to adapt to each other in self-organized alliances.9 The trust view expects governance to be informal and at arm’s length, and some commentators (such as Ghoshal and Moran) even hold that emphasizing control elements may lead to distrust. For example, asking for contractual guarantees may undermine the relationship by sending a signal that a company distrusts a partner: there is some empirical evidence to corroborate this view.10 A debate has emerged about the question as to whether control and trust are substitutes or complements. Some argue that they are complements, and that using both mechanisms allows companies to be able to manage complex alliance relationships better. In this view control based mechanisms - contracts, penalties and mutual hostage taking - enhance trust within the alliance by providing a level of certainty about the partner’s behaviour and hence acting as a basis for closer collaboration: evidence for this view has been found in dynamic markets.11 In contrast to this view, others have argued that control and trust can be seen as substitutes, and that trust often supplants formal controls. In that case, both control and trust are equally valuable governance mechanisms, and there is no ‘a priori’ preference for one or the other.12 A related debate looks at the relationship between risk and control and trust. Authors in this tradition, such as Das and Teng, distinguish between relational risk and performance risk. Relational risk is the perceived threat that a firm will behave opportunistically and consciously harm its partner’s interests. Performance risk is the perceived chance that factors such as market uncertainty, competition and governmental regulation may have negative effects on alliance results. These contributions predict that when both forms of risk are high companies will avoid bilateral contract based alliances, and enter into unilateral contract based alliances such as client-supplier relationships instead. When both risks are low, companies can opt for joint ventures, an alliance structure which has many advantages, but which does not cope well with high forms of risk. Low performance risk and high relational risk require minority equity alliances, while bilateral contract-based alliances are indicated when these forms of risk are reversed.

Unfortunately our current understanding of control, trust and risk fails to take into account the substitute/complement debate. To integrate the two debates we must pay attention to two specific elements of the current view on control, trust and risk. First the typical operationalisation of alliance governance in terms of four contractual forms (unilateral contract based alliances; joint ventures; minority equity alliances and bilateral contract based alliances) is far removed from the broader concepts of control and trust put forward by Williamson and Ghoshal and Moran. Although control and trust have often been conceptualised in terms of the mode of contract employed, this appears to be inadequate to capture the essence of their operation in an alliance governance structure, and more fine-grained analysis has led to better balanced insights into the conditions under which they play a role, including looking at different ways in which control and trust may exist (or co-exist) in practice.13 Second, this problem becomes particularly acute where both relational and performance risks are high. Current contributions predict the use of simple subcontracting relationships in these circumstances, but (apart from the question of whether these can really be classified as alliances) Long Range Planning, vol 42

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partnerships that may seem to be unilateral contract based alliances may, in reality, exhibit governance based on a complex mix of trust and control. For example, the Bayer-Millennium alliance appears contractually to be a sourcing relationship in which Millennium performs certain research for Bayer. However, the governance structure for the relationship is very elaborate, and shows a mix of the two elements.14 Practice shows other examples where the contractual form of high risk alliances is bilateral rather than unilateral: despite facing high risks in both categories, the KLMNorthwest relationship is a marriage of equals.

in practice, bilateral alliances occur regularly in high risk situations .spreading high performance risks across partners more than offsets [high] relational risks.

RELATIONAL RISK

Many authors assume that in high risk situations bilateral alliances should be avoided, but in practice they occur regularly. It could even be argued that, in those situations, the need for such alliances is greatest, because spreading the performance risk across partners will be more than enough to offset any increase in relational risk. This agrees with other findings that long term alliances actually work better in turbulent environments.15 Of course the governance of such alliances is complex: it is in this situation that trust and control may act as complements. Elements of control need to be built into the alliance to cope with relational risk, but trust building elements are also needed to deal with performance risk. Unexpected things may happen, and a company needs to trust that its partner will not behave opportunistically if conditions change. Control elements are not very useful in volatile business environments, because it is impossible to adequately define all possible future events. The more volatile the environment, the more difficult it will be to use a control approach and the more trust-based mechanisms will need to be part of a governance structure,16 giving confidence that alliance partners will respond to environmental changes in similar ways. We can therefore expect control to be a more valid option in a stable environment with low performance risk, whereas trust is required in a turbulent environment with high performance risk.

The framework in Figure 1 integrates this reasoning with current thinking about control, trust and risk. In the high/high risk quadrant we find that trust and control mechanisms must be combined in a complex governance structure. When performance risk is low and relational risk is high, control is necessary to meet the relational risk. Control is more likely to be achievable too, because with low performance risk, agreeing on how to deal with possible future events is more feasible. In the opposite situation (low relational risk and high business risk) a trust model is made possible by the former, and made necessary because the latter makes control less effective.

(Our predictions for these two quadrants echo those of others). In the low/low quadrant we expect Case: Keerpunt Control

Case: Senso

High needed to cope with uncertainty about partner’s intentions (but also makes sense in a stable environment).

Low

Cases: Talentgroup Plantform Trust or Control as Substitutes.

Either or both can be applied in an undemanding business environment.

Trust and Control as Complements Both need to be applied simultaneously to deal with a demanding environment and uncertainty regarding partner.

Case: Futurestore Trust needed to cope with an unpredictable environment (and is also possible when partner’s behaviour is predictable).

Low

High PERFORMANCE RISK

Figure 1. Control and Trust in alliances facing different risks 78

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to find that control and trust can be substitutes. Low relational risk makes it possible to use trust, while low performance risk makes it possible to use control. Investing in both seems unnecessary and costly, and companies have the choice to opt for trust and forego control - counting on the fact that performance risk is limited - or opting for control, expecting that they will be able to solve relational issues as and when they occur.

While this framework helps shed light on the complement/substitute debate, it also points to the fact that this debate is too narrow: pure control and pure trust are also governance options that are both feasible, and may well preferable in some cases. The framework builds on existing work, but predicts a different governance structure in the high/high quadrant where, rather than simple relationships, we expect complex relationships to cope with high risk situations. The framework will be illustrated with a number of case studies, for which the concepts of control and trust need to be operationalised.

the complement/substitute debate . is too narrow: pure control and pure trust may well be preferable options in some cases Operationalisation of control and trust Companies use a variety of mechanisms to develop a governance structure. Among the mechanisms listed in the literature to create tighter control over alliances, equity and extensive contractual safeguards are the most often mentioned. Equity gives an organization a formal say in a partner- or in a joint-venture. It may also create a ‘hostage’ situation, where opportunistic behaviour by one partner against another also damages the first partner. Extensive contractual safeguards may include confidentiality or exclusivity agreements, as well as the right to examine the partner’s books. Hence, the control approach to alliance governance tends to involve lengthy contracts. In a trust approach, on the other hand, there is no equity relationship and contracts are short: instead, the alliance is governed by shared vision, shared values, and trust. Another control mechanism is the use of incentive systems to motivate managers and personnel to contribute to the alliance. This type of motivation is extrinsic: people are motivated not by themselves or by an inspiring alliance goal, but by financial rewards or punishments. The opposite is intrinsic motivation (or volition), where people are motivated to contribute to the alliance because it enables them to learn and to be involved in something they perceive to be inherently valuable. Boards of management play a role in alliance governance as well: in a control situation, boards will be involved in supervising the alliance more frequently, whereas when trust mechanisms are employed, boards will intervene less often, but act as coaches for alliance managers. Formal operating procedures describing planning, budget cycles, and the division of revenues are used in the control approach to ensure alignment of interests and allow the partners to maintain their grip on the alliance, helping partners have confidence in each others’ behaviour. In the trust approach no such formal procedures are defined, but discretion about decision-making is left to the managers in the alliance, with self-organization as the method of daily coordination. This point is reflected in the way partners in an alliance manage changes. The control approach uses formal changes to the contract or the alliance board, which may occur regularly. Under trust systems, contractual and board changes will be less frequent, and the emphasis is instead on informal change through mutual adaptation: partners negotiate jointly on the way forward, adapting to each other’s needs.

Finally the focus of optimisation differs in the two approaches. Under the control approach, firms will seek to optimise the results from the alliance for their own organization, and appropriation concerns lead to a focus on ensuring that revenues flow from the alliance to the individual partners. A trust based approach will focus primarily on optimising the alliance, in the expectation that what is good for the alliance will be good for the partners.17 Long Range Planning, vol 42

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By studying these elements (equity, contract length, incentives, board involvement, formalization, change management, and optimisation) in a specific alliance, it is possible to judge whether that alliance has a governance model based on trust, control or on a mix of both. Including an assessment of the relational and performance risks faced in the alliance will make it possible to study the relationship between control, trust and risk.

Method Five cases are analysed below with the aim of illustrating our proposed framework and generalizing towards theory. We define a new relationship between variables to explain a certain effect, in this case a specific alliance governance form.18 This small sample of cases cannot test whether our framework applies to other (or all) settings: that would require large scale empirical research. However, the literature suggests that our finding in our high risk quadrant case - that in such circumstances control and trust can be complementary - is not an exception, but may be indicative of a range of alliances.19 Our minimum claim, therefore, is that existing theory should be applied very cautiously, as it certainly does not account for all alliance governance structures adopted in high risk situations.

existing theory does not account for all the alliance governance structures adopted in high risk situations.

The cases also illustrate that our contribution to the complement/substitute debate e that the choice as to whether control and trust are complements or substitutes will depend on the type of risk the alliance faces - is corroborated by practice, although large-scale research is also needed to confirm whether this holds in other empirical settings. The cases were selected by theoretical sampling based on the levels of risk they face, as in our framework risk predicts the governance form. All cases were successful in achieving their goals, the main differences between them relating to their industry and the number of partners involved. The industry difference was to some extent unavoidable to ensure differences in performance risk between the cases, although further research should test whether industry differences affect governance forms independently of the level of risk they face. The difference in the number of partners per case may lead to some caution in interpreting our findings. Most of the literature has focused on bilateral alliances - multipartner alliances have not been researched in depth. Intriguingly, however, our conclusions on the multipartner cases fit with the existing literature for bilateral alliances. On the other hand the most important instance where our argument departs from existing literature is a bilateral alliance case: in the Senseo case, high risk situations are managed by complementary trust and control mechanisms, suggesting the difference in partner numbers may not be a cause of primary concern. (Further details about our method are found in the Appendix).

The Keerpunt case The intention behind the formation in 2001 of the Keerpunt joint venture between two large Dutch insurance competitors, Nationale-Nederlanden (NN) and Fortis Verzekeringen Nederland, was to offer a more complete service package to their clients by providing reintegration services for sick employees. Employees who fall ill involve considerable costs to employers, who, under Dutch law, must continue to pay full salaries for a substantial period. Thus companies’ costs can be minimized if employees can be rapidly reintegrating. For the most part, Keerpunt’s clients are small and medium sized companies who have insured against employee illness with NN or Fortis, and who ask them to provide reintegration services. (Dutch law also obliges companies to do everything in their power to reintegrate their sick employees). The joint venture thus addresses a clear need of its partners’ clients, as well as contributing to reducing their operating costs. Keerpunt’s reintegration services lead to lower insurance claims: the sooner the company 80

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can get somebody back at work, the lower the indemnity payments NN or Fortis have to make.

Keerpunt is small, but growing rapidly e by 2006 it had 85 staff.

The Keerpunt venture is not intended to make great profits; its most important goal is to reduce costs for the partner firms involved.

Risk assessment The Keerpunt alliance ranks high on relational risk and low on performance risk. NN and Fortis had not previously cooperated with each other in offering joint services, and in fact had little experience with cooperation in general. The partners are also direct competitors in their particular financial sector, and thus the risk of them behaving in an opportunistic manner is comparatively high. By contrast, the performance risk involved for this alliance is relatively low. Specifically, it was clear from the beginning that Keerpunt’s reintegration services fulfilled an existing market need e in effect, government regulations facilitate the venture in achieving its goal. The fact that Keerpunt faces little competition in offering its reintegration services to small and medium sized enterprises also contributes to lower the performance risk, as does the fact that NN and Fortis act as Keerpunt’s sales channels, ensuring sales by offering its services to their clients.

Governance The cooperation between NN and Fortis is based on a formal joint venture structure where both partners hold a 50% equity stake in the newly created Keerpunt firm (see Figure 2). Control over the venture’s operations is ensured through the shareholder’s agreement, an extensive document that stipulates formal issues such as the composition of the Keerpunt Supervisory Board, exit procedures, daily management etc. The Supervisory Board, which consists of three members, one from each of the partners and one independent chairman, controls Keerpunt in a formal manner, meeting three times a year to discuss issues such as strategy, clients and services. The exit clause of the equity agreement dictates that one partner can only sell its shares to an external party with consent of the other. The daily management of the venture is handled by two independent directors.

The directors’ managerial performance is evaluated on the basis of formal planning and control systems setting targets with respect to four key performance areas: finance, personnel, client base, and sales to external parties. In addition to the Supervisory Board’s formal meetings, the partners have regular informal meetings with Keerpunt to discuss operational control issues. The level of formality in this case is high, with formal planning and control systems, clear targets and

NationaleNederlanden

50%

Shareholder agreement

Supervisory Board

Fortis

50%

Keerpunt

Figure 2. Keerpunt Governance structure Long Range Planning, vol 42

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Table 1. Governance Elements in Keerpunt case

Governance elements

Example from the case

Equity/contractual Length of contract

Equity: 50/50 joint venture Extensive, stipulates formal procedures such as composition of the Supervisory Board, exit clauses, daily management.

Extrinsic, based on formal, measurable performance indicators Supervisory Board directs and controls the JV in a formal manner.

High, with formal planning and control systems, clear targets.

Informal negotiation on strategy, clients, and services takes place as well.

Formal: changes agreed by the Supervisory Board lead to changes in the contractual agreement.

Most important goal is to reduce costs for the individual partner firms involved.

Motivation Role of board Formalization Change management Optimisation

decision-making. Strategic change has to be agreed in the Supervisory Board, and any changes agreed there e the level of revenue generated from other insurers is an important issue that is discussed - lead to changes in the contractual agreement. NN and Fortis not only have a controlling interest in Keerpunt, they are also its most important customers, generating over 90% of its sales.

The venture is not intended to make great profits; its most important goal is to reduce costs for the partner firms involved. The governance structure of Keerpunt is summarized in Table 1.

The Senseo case Before the Senseo coffeemaker was introduced in the Netherlands in 2001, its inventors, Philips Domestic Appliances (DAP) and Sara Lee/DE, had met informally on several occasions. Both parties needed to come up with new products to target their mature coffee and coffee-machine markets.

Serious negotiations between the companies started in 1998. In a joint effort the partners developed an innovative concept of making coffee. The introduction of a brand new coffeemaker in combination with coffee ‘pods’ containing fixed quantities of various flavours of coffee, sealed to ensure high and consistent quality, was targeted at making coffee-drinking part of consumers’ daily routines. The Senseo coffeemaker was launched at a relatively low price to ensure first-mover advantages: by 2005 worldwide sales had reached ten million.

the Senseo alliance ranked high on both types of risks. The partners had no experience of how [each other] was likely to behave ..the alliance targeted joint innovation in an increasingly dynamic. market Risk assessment At the start of this cooperative relationship, the Senseo alliance ranked high on both types of risks.

The partners had not previously cooperated with each other, so could not draw from built-up experience of how their partner was likely to behave. They also had entirely different industrial backgrounds, which added to the level of relational risk, as neither company understood much about the common modes of behaviour in the other’s industry. The performance risk was high as well, as the alliance was targeted at joint innovation and new market creation, so there was a high chance of failure. Various other coffee machines were being introduced in the market, and with coffee chains like Starbuck’s rejuvenated the industry, the coffee market was becoming increasingly dynamic.

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Governance The cooperation between Philips and Sara Lee is based on a formal contract. The lengthy, detailed contract stipulates the roles played by each partner as well as the division of revenues from the alliance. Philips receives a percentage of the sale of coffee pods by Sara Lee to compensate for the low price of the coffee machine. The contract is specifically drawn up for the portioned coffee market, the alliance’s particular business arena. The motivation of those involved in the alliance was mainly intrinsic, rooted in the excitement of being involved in something new. The governance model underlying the Senseo alliance’s daily operations is the ‘multiple points of contact’ model, with formal alliance contacts appointed at all hierarchical layers in both organizations (Figure 3 depicts the governance structure).

At the top of this formal decision structure is the International Steering Committee (ISC), consisting of three managers from each partner, which is responsible for approving the Senseo business plan and the product roadmap. As well as being in charge of Senseo’s long-term development, this committee also has a controlling function, providing leadership to committees at lower hierarchical layers. Despite its important role with respect to formally approving budgets and business plans, the ISC’s general involvement is arm’s length, with most decision-making taking place at lower levels of the hierarchy. Below this layer, the National Steering Committees, consisting of employees from the Philips’ National Sales Organizations (NSOs) and Sara Lee’s national Operating Companies (OPCOs), are responsible for country-level sales. A third hierarchical layer is the joint sales teams consisting of sales representatives of both partners who visit retailers jointly. In addition, the Marketing and Equity Meeting is in charge of all issues related to the marketing of Senseo coffee makers and pods, including the creation and development of brand equity. Although Philips decides which models of the Senseo coffee maker it brings to market and Sara Lee determines which blend of coffee it introduces to the market, both partners coordinate their product development efforts at the Product Innovation Meeting (PIMM). This decision and communication structure also provides for conflict resolution through formal escalation procedures, which state when and how an issue should be moved to the next hierarchical level.

The hierarchy of communication and decision-making structures in this ‘multiple points of contact’ model results in a relatively high level of formalization, but, despite this, much is negotiated on a case-by-case basis. Although no formal adaptations to the original contract were made during the study period, both partners have had to informally adjust their working procedures to accommodate each other’s needs. In particular, several cultural background and business procedure differences had to be bridged. For instance, Philips and Sara Lee’s planning and control cycles do not run parallel, with Philips’ fiscal year ending on 31 December and Sara Lee’s on 30 June, which has resulted in a number of informal adaptations to budgeting and business plan reviews. As Philips Philips DAP Corporate Level

Sara Lee/DE Corporate Level

International Steering Committee

Marketing & Equity meeting

PIMM

DAP

Core Line

OPCO

OPCO

OPCO

Senseo

National Steering Committees

NSO's

Joint sales teams

Figure 3. Senseo alliance Governance structure Long Range Planning, vol 42

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Table 2. Governance Elements in Senseo case

Governance elements

Example from the case

Equity/contractual Length of contract

Contract Long. Detailed contract stipulating the role played by each partner and the exact value appropriation Mainly intrinsic Arm’s length, but International Steering Committee formally approves budgets and business plans. Most decision-making is at lower levels.

Medium to high. Hierarchy of communication and decision-making structures, but much is negotiated on a case-by-case basis.

Informal. No contractual changes, mutual adaptation by verbal agreement.

Alliance is optimised. Profit sharing arrangement provides incentive to optimise alliance.

Motivation Role of board Formalization Change management Optimisation

is a major player in the market for consumer durables, it has developed long-term views on product development, and its planning cycles are thus based on long time frames. In contrast, Sara Lee operates in a market where consumer tastes can vary very quickly, and its product development cycles are focused on fulfilling short-term customer needs. This difference in focus has required a high level of mutual understanding and adaptation within the alliance. Such company differences were addressed in a cultural session between groups of Philips and Sara Lee employees, which led to higher levels of understanding of behavioural differences. The partners’ formal profit sharing agreement provides incentives to both sides to optimise the alliance as a whole, automatically benefiting the individual partners. Senseo’s governance structure is summarized in Table 2.

The future store initiative case METRO, the third largest supermarket chain in the world, aims to distinguish itself from competitors by being at the forefront of technology. One of the most eye-catching ways it chose to implement that strategy was to build a ‘store of the future’, full of the latest technologies, including RFID (Radio Frequency Identification Tags), automatic weighing scales, automatic check out, information pillars, automated personal shopping assistants, etc.. Realizing it lacked the technological knowledge and experience to be able to create the future store by itself, METRO set up an alliance - the Future Store Initiative (FSI) e and invited technology firms such as Intel, Cisco and SAP to contribute to developing this ambitious project. Over fifty partners joined, and each was asked to make a financial contribution to the alliance and contribute staff and resources as they though necessary, remaining responsible for their own expenses and investments. The benefits for the partners would be in learning about the effect of new technologies in a real life situation (as METRO intended to implement the technologies in an existing supermarket) and in setting retail standards that would open up new markets. Metro promised the initiative would be given extensive publicity, a field in which their reputation is outstanding.

[given the very tight deadline] inviting supermodel Claudia Schiffer to open the METRO store ran the risk of an enormous publicity failure Risk assessment METRO invited partners it already knew to participate in this initiative, many of them existing METRO suppliers with whom they had developed numerous interpersonal relationships. For technologies in areas where they had no prior relationships, METRO asked existing partners whether they had partners who would be interesting in the Future Store, thus bringing ‘friends of friends’ 84

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on board. This tactic limited relational risk e but performance risk was still high. First, as with all innovations, the risk of failure loomed large, while the level of complexity was quite high, as FSI aimed at introducing a whole variety of innovations into the retail business. Second, METRO ensured enormous publicity by inviting supermodel Claudia Schiffer to open the store: combined with a very tight deadline, the risk of an enormous publicity failure was not imaginary.

Governance The Memorandum of Understanding between the partners that underlies the FSI is only a handful of pages long and covers few specific issues. No end date is set. The Memorandum sets out the vision of the collaboration and the resource commitments that need to be made. It includes a non disclosure agreement stipulating that the collaboration is nonexclusive, and that all proprietary knowledge companies bring into the alliance remains their property: all knowledge developed in the alliance, however is free for all partners to use.

METRO counted on a number of aspects to ensure that the FSI would progress. The first was the fun aspect: the vision of creating ‘the store of the future’ created enthusiasm among people working on the project, which ensured coordination - so all noses were in the same direction.20 Second, the time pressure and the risk of high profile failure made partners mutually dependent on each other, as failure of the store to open on time would harm the reputations of them all. These two elements created a ‘macroculture’ or ‘network identity’: working for the Future Store alliance felt like belonging to a club.21 The FSI was governed by simple rules, and a structure depicted in Figure 4. METRO Group and its three top ‘Platinum’ partners meet regularly in the Executive Committee, which has powers to admit new partners and end relationships. The Executive Committee verbally agrees changes to the FSI, and the making of specific investments, on the basis of consensus with all the partners, and approves cash outlays from the Initiative’s fund made up of partners’ cash contributions. All partners are invited to the Marketing Committee’s two or three annual meetings, where progress is reviewed and the METRO Group shares its future plans with partners.

There are also four project teams, each dedicated to one of the four innovation areas of the Future Store - comfort shopping, smart check-out, in-store information and supply chain - and each headed by a METRO Group project manager.

The role of METRO in organizing the alliance was pivotal. It did not enforce decisions on the partners, but acted as a ‘first among equals’, understanding that benefits would need to accrue to all participants if the alliance was to succeed. The level of formalization in the FSI is relatively low, and there are few working procedures in place: most work within the alliance is organized by the individual project teams themselves. The project happened very quickly: the first preliminary ideas were discussed in September 2001, by July 2002 the outline of the idea was clear so that the partner base could be recruited, and the store (at Rheinberg, Germany, a village close to METRO’S corporate head office in Düsseldorf) was opened in April 2003. There was also little up-front planning, but this lack was compensated for by thorough attention to detail in implementation. The

Marketing Committee

PT Comfort Shopping

- For all partners - Meets 2/3 times

Executive Committee

- Platinum Partners - Regular Meetings - Marketing & Communication

PT Smart Check out

PT ‘in-store’ Information

PT Supply Chain

- Project Teams - Open to all partners - Led by METRO Project Manager - Partners have Project Innovation Projects headed by Project Managers Manager per PT

a year - Review, Evaluate, Future plans

Figure 4. Future Store Initiative Governance structure Long Range Planning, vol 42

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Table 3. Governance Elements in Future Store case

Governance elements

Example from the case

Equity/contractual Length of contract

Memorandum of Understanding Short. Only Memorandum of Understanding in place covering basics Intrinsic. Vision of creating a store of the future created enthusiasm METRO acts as first among equals Low. Few working procedures in place. Most work organized by project teams themselves.

Informal, mutual by verbal agreement. No further written agreements.

Consensus created in Executive Committee. Changes made as implementation took place.

Alliance is optimised. Focus was on creating the Future Store.

Implicitly this benefited the individual firms.

Motivation Role of board Formalization Change management

Optimisation

focus of the FSI is on optimising the alliance e its primary objective was creating the Store, which automatically benefits all the individual partners. The governance structure of the Future Store is summarized in Table 3.

The Talentgroep Montaigne case The construction industry has undergone major changes over the past years, and the Dutch Talentgroep, a collaborative alliance between the construction company Strukton, the installation firm Imtech and the facility manager ISS, has taken a proactive approach to these changes. Specifically, the Talentgroep combines the construction, installation and servicing (i.e. catering, cleaning, and maintenance) of school buildings into single projects that are jointly carried out by the core partners, who can realize substantial synergy effects by combining their complementary skills and assets.

While it is common practice in the construction industry for partners to cooperate on a temporary basis for the duration of individual projects, the Talentgroep was set up in 2001 as a long-term cooperative agreement based on commitment and mutual adjustment. Partners jointly engage in the tendering process and, once a deal is struck, create a separate alliance for each project. The first such alliance was for the construction and servicing of Montaigne College, following a successful tender to the city of The Hague. Long-term cooperation in the construction of school buildings produces important learning effects with respect to construction and building management that lead to lower overall costs, and thus higher profit levels. An example of such cost savings is the use of easy-tomaintain materials in each building project: while such materials entail high initial investments by the builder (Strukton), cheaper maintenance (by ISS) results in substantial cost savings for the alliance over time.

using easy-to-maintain materials entail high initial investments for the builder [but] cheaper maintenance results in substantial cost savings for the Talentgroep alliance over time Risk assessment The Talentgroep ranks low on both relational and performance risk. The partners know each other from previous projects, are not competitors, have complementary goals and a similar vision about the school construction market. Performance risk is relatively low because the collaborative projects 86

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Shareholder agreement

Strukton

Imtech

ISS

Montaigne joint venture

Figure 5. Montaigne alliance Governance structure

are based on experience, the core variables that determine revenue and cost are known, and, while price swings in these variables have to be managed, they can be largely charged to the client. This sharing of costs, revenues and risks has led to an extensive contract that specifies all the known variables and the way the alliance will deal with changes in them.

Governance A legal entity for the Montaigne College construction contract was set up on the basis of equity participation by all partners, and the joint venture was based on a lengthy and detailed agreement.

The equity positions of partners were supplemented by further rules for profit sharing which ensured that each would obtain a reasonable profit margin. The rationale behind this procedure is that the commitment of all partners is needed to ensure the success of this joint venture, and so it is underpinned with strict rules and procedures with regards to planning, quality and budgeting which include the definition of a number of key servicing performance indicators. Besides ensuring reasonable profits for all partners, the control approach in this alliance was also necessary because of penalty clauses for late delivery in the contract with the client. Talentgroep appointed a tender manager for the Montaigne College project, and formed two working groups - a Commercial Working Group and a Technical Working Group - staffed with employees from all three partners. The tender manager and the chairmen of these groups make up the Tender Management Team responsible for preparing the tender, a phase where the partners’ boards were intensively involved. Once the deal was struck and the Talentgroep contracted to construct the school building, the formation of the separate legal entity for this project (see Figure 5) allowed the partners’ main boards to remain distanced from the actual operational execution of the alliance.

Table 4. Governance Elements in Talentgroep case

Governance elements

Example from the case

Equity/contractual Length of contract Motivation

Equity. Legal entity set up Detailed agreements and strict control on planning, budgets, quality Complementary goals underpinned by detailed agreements which stipulate strict performance targets Elaborate contracts allow boards to remain at a distance from the actual operational execution of the alliance.

Board is involved before the alliance set up.

Formal decision-making is based on equity positions of partners, but reaching unanimity and consensus is also viewed as highly important.

Most possible changes are listed in the initial contract Agreement is targeted at optimisation of profits.

Role of board

Formalization Change management Optimisation

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The partners’ equity positions can determine their influence on decision-making, but, while formal procedures exist, decisions are typically reached in an atmosphere of unanimity and consensus.

The extensive initial contract provides for most possible contingencies, and is targeted at optimising profits from the alliance. The governance structure of Talentgroep is summarized in Table 4.

The Plantform case Plantform is a cooperative of twenty-five growers of potted plants aimed at developing Enterprise Resource Planning (ERP) systems dedicated to horticulture. The growers feel an increased need to get a better grip on their production processes, as most do not know the cost price of their plants, and their production planning tends to be only intuitive. Some have reached the limits of increasing production by traditional means, and now need to delve much deeper into data to see how they can further improve their yields. Most ERP systems are too complex for SME’s, and many existing systems do not take into account a number of issues specific to horticulture, such as the fact that plants change over time. But a number of growers felt it was clear they needed better software support to run their businesses. At the same time, this concept was not seen as a non-competitive issue: the growers did not perceive ownership of an ERP system as giving them a competitive advantage over other growers, and so the joint development of a system was a feasible option.

Four members of the cooperative were selected whose business processes were described in flow charts defined to such a level of detail that a specific ERP system could be built from them.

With a blueprint in place, the association selected two software companies to build ERP systems for two of the association’s members, to spread the risk and ensure competition between suppliers.

Members of the cooperative receive a discount when they buy ERP software from either of the software suppliers, who pay a licence fee to the cooperative. These fees are designed to allow the association to recoup its initial investments, beyond which it does not aim to be profitable - hence there is explicit agreement on how value is distributed. To prevent ‘free-riding’ by growers not making the initial investments, but trying to join Plantform later to buy software cheaply, the cooperative stopped admitting new members in early 2006.

the Plantform growers know each other, come from a small region where collaboration has traditionally been strong, and are often members of other cooperative ventures

Elected Board

PLANTFORM COOPERATIVE – 25 Growers

Technical Working Group

Figure 6. Plantform Governance structure 88

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Table 5. Governance Elements in Plantform case

Governance elements

Example from the case

Equity/contractual Length of contract Motivation Role of board

Contractual Membership in cooperative has simple rules Intrinsic; need to solve own IT problem Core partners are heavily involved; majority of partners are at arm’s length Low. Basic agreement with simple cost and revenue sharing rules Largely informal, requiring consensus Alliance. Optimal alliance performance automatically leads to optimal performance for the partners

Formalization Change management Optimisation

Risk assessment The relational risk was limited in this case because most of the growers know each other. They are all located in a small region where collaboration has traditionally been strong, and many run into each other as members of other cooperative ventures. The most important performance risk was that no working software would be developed, but this was limited by hiring IT specialists and building on existing software. The objective of the cooperative is narrowly defined: to create software that each grower could use individually. Thus the main risk was that the partners would lose their original investment (a membership fee to the cooperative), but this is set low enough not to cause them significant financial exposure.

Governance The Plantform alliance is underpinned by a simple contract agreement setting up the cooperative.

Membership involves agreeing the contract and paying the membership fee, which created the fund to hire IT specialists to develop the ERP blueprint. The motivation to set up the alliance was intrinsic: the growers believe they will be able to improve performance with dedicated software. There is an elected cooperative board and a technical working group of some core members who do most of the work (see Figure 6). Not all the association’s members are actively involved, but the numbers involved helps create a sizeable scale for the group, allowing it raise sufficient funds to pay for the research. The less active members follow developments from a distance, leaving much of the management responsibility to the board which sends out newsletters to update growers on the association’s progress.

The level of formalization in Plantform is low. The basic agreement underlying the alliance is simple, with few cost and revenue sharing rules. Major changes in the collaboration need to be agreed by a general meeting of members, which might involve voting, although the preferred mechanism for decision-making is to achieve consensus. Exit barriers are low and consensus is a more effective decision-making mechanism for keeping everyone on board. Looking at optimisation, it is in the growers’ interest to optimise the alliance so that it can succeed in providing them with the new software they want: after that, it is up to them to turn the software into a profitable tool for their business. The governance structure of Plantform is summarized in Table 5.

Discussion Table 6 summarizes the results from the cases. Although no alliance fits perfectly with the archetypes of trust and control, the results largely fit with the framework proposed in Figure 1. In the Senseo case trust and control are used complementarily to manage the high levels of performance and relational risk. The Future Store has trust-based governance, fitting with its low relational but Long Range Planning, vol 42

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Table 6. Contingent views of Alliance Governance

Risk

Case 1 Keerpunt

Case 2 Senseo

Case 3 Future Store

Case 4 Talent Group

Case 5 Plantform

Relational risk Performance risk Governance elements Equity/contractual Length of contract Motivation

High Low

High High

Low High

Low Low

Low Low

Equity Long Extrinsic

Contractual Short Intrinsic

Equity Long Mixed

Contractual Short Intrinsic

Role of board

Formal

Contractual Long Mainly intrinsic Arm’s length

First among equals

High involvement in early phase; arm’s length later

Formalization

High

Low

High

Mostly arm’s length; more formal for core partners Low

Change management

Contractual changes Partners

Verbal agreement Alliance

Formal decisionmaking Alliance

Alliance

Trust

Largely control

Largely trust

Optimisation Overall governance structure

Control

Medium to high Verbal agreement Alliance

Complementary

Largely informal

high business risk, while Keerpunt’s governance is control based, which fits with its high relational and low performance risk profile. Where both elements of risk are low, we find that governance in one case (Montaigne) is largely control oriented, while in the other (Plantform) it is mainly trust oriented.

The cases confirm some elements of existing thinking. First, it makes sense to relate governance forms to risk. Second, in situations of low/high and high/low risk our cases deliver the same results as previous research. However, our findings partly diverge from existing literature in the low/low risk quadrant. Even though control is possible here (as existing thinking predicts) trust may also be a feasible option. But neither of our ‘low-risk’ cases exhibits the use of ‘pure’ trust or control models. It may be that companies in this quadrant apply control and trust in ‘light’ modes to fine tune their governance to the specific requirements of their operating contexts. However, whether control and trust are really substitutes is not conclusively shown: that would require an experiment in which Plantform were managed via control and Montaigne via trust. Neither case shows any a priori reason why the other approach should not have been chosen, but, equally, neither group seem to have ever seriously considered doing so.

Where our findings do diverge from the existing literature is in the high/high risk quadrant: here the Senseo alliance employs both control and trust as complements. If this finding holds in other similar cases - or in large-scale research - current thinking on alliance governance in such situations may need to be adapted.

A limit of this study lies in contingencies suggested by the literature, which especially mentions culture and the management style of the organization,22 and suggests that low trust cultures will perceive partner risks as being higher, and high trust cultures will generally estimate partner risks to be lower.23 To avoid such cultural issues, all cases were Dutch, except METRO, which was German. The prediction for a German case might be that alliances would emphasize control because of the higher power distance in German culture.24 In fact, we found a trust based alliance: if culture plays a role, in this case 90

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it was certainly overridden by other elements. As to management style, control oriented managers may opt for more elaborate controls even when trust is indicated, but the framework developed here predicts that such behaviour will be less effective when performance risk is high and relational risk is low.

Implications Theoretical implications In terms of the debate as to whether control and trust are complements or substitutes, the first implication is that this is contingent on the type of risk. In addition there are circumstances where control and trust are neither complements nor substitutes, but are applied in their pure forms.

The debate should therefore refocus on the contingencies and broaden to include the ‘pure’ governance forms. The contingency of the complement/substitute debate raises further issues as to how companies can complement control and trust. What tactics do companies have to combine these two? The notion of control and trust as substitutes also raises a number of issues. Can partners just choose either type of governance by flipping a coin? Or do companies in this quadrant use other factors in deciding governance forms for their alliances?

Second, the operationalisations of trust and control that are typically used lead to some difficulties. Most authors have used a relatively crude operationalisation of alliance governance by measuring it in terms of contractual forms only, with the result that important information is lost. An operationalisation that is closer to practice gives more information about alliance governance.

For example, the question of how companies trade off control and trust in certain circumstances cannot be answered just by looking at the legal structure of an alliance: it is either an equity alliance or not. Such over-simplicity masks important differences in terms of board involvement, goals, levels of formalization, etc. In particular, contractual structures, which might seem to lay the grounding for trust-based relationships, may still involve high levels of control. Further research may incorporate a more detailed operationalisation of alliance governance, which would be helpful in developing an organization design approach to alliances. Despite the vast quantity of alliance literature, the study of the organizational design approach to alliances is still in its infancy.

contractual structures, which might seem to lay the grounding for trust-based relationships, may still involve high levels of control Third, our framework and the Senseo case make one prediction about the nature of governance in high risk situations that is completely opposite to current understanding. Current theorizing states that high risk situations will not produce intense or long-term alliance between equals, but rather unilateral alliances such as client-supplier relationships. As noted earlier, our findings suggest that this verdict may be inadequate, since our case in this quadrant shows that in these situations intense bilateral alliances are a viable organizational form, provided trust and control are used as complements. In fact, we would go further, to suggest that the combination of high performance and high relational risks may perhaps only be dealt with effectively by using all available governance mechanisms. Further research will need to clarify the extent to which our Senseo case is representative of other alliances.

Managerial implications What guidelines can we give to assist the manager responsible for designing an alliance governance system? Our cases show that managers have to make many choices when setting up an alliance. The legal form (contract or equity) is only one of them, and not the most decisive. Contracts and equity stakes are only one part of a broader alliance governance structure, which also includes intangible Long Range Planning, vol 42

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trust-based elements, although management attention is often most focused on formal aspects. At first sight, companies may also seem to face a trade-off between extensive contracts which may lead to decreased flexibility, and short legal agreements which may increase the possibility of opportunistic behaviour. However, good use of relational factors can enable a company to have the best of both worlds. The Senseo case shows that extensive contracts combined with attention to relational issues can keep an alliance flexible. The METRO case shows that, even without an extensive legal agreement, substantial alliance projects can be successfully realized when companies consciously build on trust and reputation. Hence it pays to think beyond contracts and equity stakes.

[using] standardized alliance programmes [is] sub-optimal: each alliance faces a unique set of risks, so each requires a custom made governance structure Next, over 70% of companies have set up standardized alliance programmes which they then use to determine the governance structure for the partnerships they undertake.25 While that it is suboptimal: in fact, as each widespread practice may appear to be cost efficient, our analysis suggests that it is, in fact: sub-optimal: each alliance faces a unique set of risks, so each requires a custom made governance structure. Companies need to determine the level of relational and business risk first, and then build in the elements of governance as defined in this article, based on the amount of trust and control required.

Finally, what skills might an effective alliance manager need? The control and trust mode may require completely different personalities, and whether the same person will be equally well equipped to lead different types of alliances is doubtful. So matching the right person with the right alliance may well be critical for alliance success. Alliance management may be demanding for top management too, and they are often vitally involved. As alliances continue to grow in importance, the ability to switch between control and trust modes may be one of the core skills for the CEO of the future.

matching the right person to the right alliance may well be critical for success.

Acknowledgement The authors are grateful to the Journal’s Editor in Chief and his anonymous reviewers for their useful and encouraging comments on earlier versions. They would also like to thank Stichting Management Studies for their support for this study.

Appendix Method A multiple holistic case study design is used in the expectation of finding different governance structures in different circumstances. Theoretical sampling was used to replicate the emerging framework.26 Cases were selected on the basis of expected differences in relational and performance risk in each alliance. This particular case study design and selection of cases enables replication of the theoretical predictions: different results (governance structures) are expected for predictable 92

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reasons (different relational and performance risks). Theoretical sampling aims to verify the theoretical framework and generalize theoretically, as opposed to statistically from the sample to a general population.27 Five cases were selected: one for each quadrant of the framework, and two for the low/low quadrant, to show how both trust and control based alliances occur there.

A choice was made to study successful cases only, to ensure consistency in cases and make it possible to show how the governance structure fitted the needs of the different levels of risk. The focus of the cases was on the initial set up of the alliance, even though governance structures may change over time.28 Key subsequent changes in the relationships have been briefly summarized.

Information was gathered from various sources. First, 33 semi-structured interviews were conducted with alliance partners - which involved a subset of all partners for the Plantform and Future Store Initiative cases - between mid-2006 and mid-2007. Those interviewed were those managers accountable for the alliance in their company, and the levels above and below them. In the Plantform, Future Store and Senseo cases we were also able to interview independent third parties who had acted as consultants to the alliance. Second, internal documents - company presentations, press releases and internal reports etc. - were gathered to support the analysis. Third, external documentation was also gathered, including published interviews with alliance members and press articles.

This procedure helped us to check for respondent bias in three ways: the view from one partner was compared with that of another partner; the views of insiders were contrasted with those of outsiders; and oral testimony was contrasted with written sources. A detailed case description was assembled based on the sources and sent to the respondents for comments, with their feedback leading to minor factual changes in four instances. The cases in this article are based on these detailed case descriptions.

Figure 7 depicts our operationalisations and way of working. A semi-standardized questionnaire was used as a guideline for each interview. Trust and control were identified based on the governance elements as set out in the main body of our text. Relational risk was measured by studying whether previous collaborations had taken place between partners, whether their industry background was similar and whether the partners were competitors or not (elements identified previously by Bierly and Gallagher). Business risk was checked by asking respondents for their perception of the speed of change in their market, the level of competition the alliance faced, and how the alliance project compared to other projects in terms of risk and the possible damage it might do to the partners should it fail. Alliance success was checked by asking whether it had met its original goals (and checking that with these matched the goals as described in company documents) and whether managers were satisfied overall with the alliance. The types of risk and governance were classified as in Table 6 and then compared to our framework.

Relational risk Previous collaboration: Competitors or not: Industry background

Performance risk Changes in the Market; Competition for Alliance, Inherent Project Risk, Possible damage to partners

Classify risk High/high: low/low; High/low, low/high

Compare to Framework Classify governance Trust, control, Complement, substitute

Governance Equity; Contract length; Motivation; Role of Board; Formalization; Change Management, Optimisation

Figure 7. Operationalizations and Concepts Long Range Planning, vol 42

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22. J. H. Davis, F. D. Schoorman and L. Donaldson, Toward a stewardship theory of management, Academy of Management Review 22(1), 20e47 (1997); P. E. Bierly and S. Gallagher (2007) op. cit. at Ref. 3.

23. F. Fukuyama, Trust, Hamish Hamilton, London (1995).

24. G. Hofstede, Culture’s Consequences, SAGE, London (1984).

25. Association of Strategic Alliance Professionals, The Second State of Alliance Management Study 2007, ASAP White Paper, (2007) Available from: www.strategic-alliances.org (2007).

26. K. M. Eisenhardt, Building theories from case study research, Academy of Management Review 14(4), 532e550 (1989).

27. See R. K. Yin (1989) and A. S. Lee and R. L. Baskerville (2003) both op. cit. at Ref. 18.

28. I. Hipkin and P. Naudé, Developing effective alliance partnerships, Long Range Planning 39, 51e69 (2006); J. Reuer and R. Zollo, Managing governance adaptations in strategic alliances, European Management Journal, 18(2), 164e172.

Biographies Ard-Pieter de Man is Professor of Management Studies at VU University Amsterdam and principal consultant at Atos Consulting, the Netherlands. His research concerns alliances, networks and innovation. He is the (co-)author of about thirty articles and nine books, mainly on alliances. His interest in alliances and networks is not only academic, as he has worked as a consultant for a variety of companies and governmental institutions in Europe and the USA. VU University and Atos Consulting, De Boelelaan 1105, 3A-28, 1081 HV Amsterdam, The Netherlands. aman@feweb.vu.nl Nadine Roijakkers is Senior Consultant in strategy and innovation with Atos Consulting. Her research and consulting interests include innovation, networks, and alliances. She published several articles and book chapters on these topics. Outlets for her research include Research Policy, British Journal of Management, and Harvard Business History Review. She previously worked at UNU-MERIT and Eindhoven University of Technology. Atos Consulting, Papendorpseweg 93, 3528 BJ Utrecht, The Netherlands. Tel: +31 (0)882658361. nadine.roijakkers@atosorigin.com Long Range Planning, vol 42

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2009

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Strategic Alliance and Joint Ventures

Joseph A. McCahery and Erik P.M. Vermeulen

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Joint Ventures and The Shareholders’ Agreement: The Practitioner’s Viewpoint (forthcoming in: J.A. McCahery and Erik P.M. Vermeulen, Strategic Alliances and Joint Ventures).

Ronald Charles Wolf

I. Introduction My experience as an American born, educated, and trained lawyer has been counselling companies and guiding them for over the past forty years in establishing international joint ventures in Portugal. The journey from New York to Portugal has admittedly been circuitous but a great deal of functional professional experience has been garnered in this voyage, and with it practical information which I am pleased to pass onto my colleagues.

When I began to specialise in international joint ventures in Portugal on behalf of American corporations in the early 1980s, I soon discovered, whether the client was a multinational or a family corporation going global, that when the client stated joint venture there was no common understanding as to what those words meant, neither to the client, nor to the prospective third-­‐ party associate in the joint venture, and my own analysis hovered between various competing theories as to the unique nature of a joint venture.

Everyone wanted to do business and the words joint venture seemed to sum up an emotional state in legal language, but in fact, what we were talking about was a legal form still in evolution—at least as to a state-­‐of-­‐art documentation. The closest analogies were to the contractual unincorporated association; or a merger; or equity participation; or the various forms of a partnership, all similar to a joint venture, yet substantially legally different.

With time and from actual commercial ventures, I began to construct the basic elements of a joint venture, as I believed the clients foresaw their commercial objectives. Necessity forced me to examine the business aspects of the client’s purposes and from this I began to lay the theoretical foundations for the essential elements of a joint venture. As my legal counselling was taking place far from my original jurisdiction (New York) and as the clients were foreigners doing

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business in Portugal, we always referred to our collaboration as the formation of an international joint venture.

But in fact, the addition of international to a joint venture, just meant I, or better the client, was operating in a foreign (to the client) jurisdiction, and while this element necessitated a few additional precautions, the core legal theory was the same: a joint venture, whether national or international, has certain characteristics and indispensable documentation which have to do with business objectives, essentially prior, and posterior to, the joint venture and whose purpose is to ensure the continuity of a durable commercial organisation. In other words, problem-­‐prevention and problem-­‐solving over-­‐ride legal theory and even today I believe this is the correct approach.

Clients do not want conflict and the function of counsel is to avoid them at all costs.

As will be seen in our ensuing discussion, the treatment of various problems is therefore probably more important than a formal definition of a joint venture and this for a simple reason: a joint venture, whether national or international, is a wavering association of entities, whether of companies or people. Counsel must therefore encounter legal anchors to counterbalance the unstable interplay of people and their conflicts. And this instability has no mystic origin. It is the natural outcome of an association of human beings and if the law is meant to regulate as best as possible a society, a joint venture must regulate as best as possible the parties that form it.

The prudent counsel should always approach the formation of a joint venture with the same spirit an engineer assumes when overseeing the construction of a building: the first and paramount task is to ensure the house is built of sound materials and will withstand the shocks of time. Both these elements are always present in joint ventures: the clauses and the unforeseen future events, the rights of the parties and the changing of circumstances. All of this can be achieved with proper documentation.

As will be discussed in subsequent sections, one of the most essential legal documents that accompany a joint venture is the shareholders’ agreement. Of course a joint venture is possible without the drafting and use of a shareholders’ agreement but its utility is so paramount, its flexibility and adaptability to both regulate and protect the various competing rights and obligations of the future founders of the joint venture is so effective that I always explain to clients why it should be used.

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Our review must, however, begin with the elements of a joint venture.

II. The Definition of a Joint Venture We lawyers are trained to characterise legal facts into theory and therefore it is expected on a chapter about joint ventures, I should as soon as possible clarify what I mean by a joint venture.

Of course, I shall, but with a word of explanation and apology. A definition is useful and important because a joint venture raises specific questions which the practitioner must confront; and, to resolve them, the practitioner must know when a joint venture is being formed. We must know the nature of the material upon which we are being asked to mould and shape. As for the apology, it actually makes more sense to discuss all the problems entrepreneurs face when deciding to join with others in a business venture and then, when all the various solutions have been presented, conclude with a definition which coincides with how entrepreneurs behave.

Observation ought to proceed theory. But such an approach would be unnecessarily suspenseful, and therefore consistent with the method of my profession I do now offer my practical vision of a joint venture.

There is no universal, static definition of a joint venture. But the essential characteristics of a joint venture can be reflected in the following definition: The expression joint venture refers to any form of doing business by one party in a jurisdiction, either foreign or domestic, by means of a stable, permanent entity, for a term, usually indefinite, with economic independence and a lawful purpose, with another party, regulated by the state-­‐of-­‐the-­‐art documentation.

Here attention must be paid to various ideas compressed into one paragraph: the legal form has little theoretical importance, it can be any of the forms recognised by law such as a corporation, limited liability company, partnership; there has to be at least two entities, individual or corporate, otherwise we do not have a joint venture but a venture; the joint venture should be a permanent entity, otherwise we are probably dealing with an unincorporated consortium regulated by contract; the joint venture should be independent or we are normally confronting a controlled subsidiary with little rights in the minority owner; we are excluding cartels, for they are not lawful; and finally, the joint venture, more than any other form of doing business, is

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characterised by a well-­‐developed body of accompanying documents, which certainly ought to include the shareholders’ agreement.

Of course, to define a legal structure by reference to documents without listing these documents is not entirely fair to the reader. But documentation adjacent to a joint venture is voluminous, complex, varied, and attempting to cram such references into a definition is not a helpful task.

Without question, I shall dwell in the ensuring sections on the documentation in detail, for I know as a practising attorney that what both the novice and expert need are concrete examples.

Another way of describing a joint venture is to say it is not a contractual association but a venture of equity contributions by at least two entities. A joint venture is not normally two or more parties agreeing contractually on how they shall do business, it could be that of course theoretically, but in practice it is not. In the day to day life of entrepreneurs, a joint venture is associated with an equity contribution where two or more parties contribute to the capital of the venture and if the venture is lawful, stable and permanent, it is a joint venture.

A further approach to a definition of a joint venture can be extracted from European competition law where a distinction is made between concentrative and co-­‐operative joint ventures and which definition, while intended to be confined to competition law, still offers practical guidance on what other jurists conceive of as a joint venture.

In the most basic view, a concentrative joint venture involves an autonomous economic and legal entity intended to have a lasting basis involving more than one legal entity (the joint venture partners) and is not formed for the purpose of coordinating market activity. The European Commission has defined a concentrative joint venture as that organisation: ‘…performing on a lasting basis all the functions of an autonomous entity, (and) does not give rise to coordination of the competitive behaviour of the parties amongst themselves and the joint venture…’.

On the other hand, the co-­‐operative joint ventures have as their object or effect the coordination of the competitive behaviour of entities which remain independent. A co-­‐operative joint venture is subject to Articles 85 and 86 of the Treaty of Rome, which regulate anti-­‐monopoly practices, and this is definitely a classification the practitioner will wish to avoid. Otherwise, a whole body of European competition law becomes relevant and EU approvals may become necessary.

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III. What a Joint Venture is not As indicated above, in its simplest expression, a joint venture is a form of cooperation between two or more parties to achieve an economic objective which is normally the realisation of profit, through a common, commercial vehicle. Admittedly, such a definition is broad and encompassing and it is therefore also helpful to consider what a joint venture is not. There are no hard and fast rules, but, then, lawyers are accustomed to approaching hazy frontiers and the descriptive material below must be understood as being an orientation, with no hard and fast rules.

Other forms of collaboration can be found in various forms, some similar to joint ventures, others only by fanciful imagination.

A. Cooperation Agreements The use of the word co-­‐operative (read restraint of trade) utilised above is entirely different from the use of the word cooperation. This is exemplified by the Commission Notice on Cooperation Agreements (1968) and affords another example of a definition of what appears to be a joint venture but is not.

Very often companies in the same or similar industry form an association to pursue an activity of benefit to an entire industry or service sector. It is not necessary that a company be formed. An agreement—the cooperation agreement—can achieve the same objective. The agreement may be the joint procurement of information, joint market research, joint research and development, debt collecting associations, tax consultant agencies. The list is not intended to be definitive as the 1968 Notice contains a descriptive review of various typical cooperation agreements.

A summary of the sole or joint characteristics of a cooperation agreement which preclude the agreement from being considered by the Commission as a possible anti-­‐monopoly Article 85 agreement has been set forth in a Commission Notice of 1993 on the assessment of joint ventures where the agreements: …have as their sole object the procurement of non-­‐confidential information and therefore serve in the preparation of autonomous decisions of the participating enterprises,

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-­‐they have as their sole object management cooperation; -­‐they have as their sole object cooperation in fields removed from the market, -­‐they are concerned solely with technical and organisational arrangements; -­‐they concern solely arrangements between non-­‐competitors, -­‐even though they concern arrangements between competitors, they neither limit the parties’ competitive behaviour nor affect the market position of third parties.

But of course an agreement to cooperate is not the same as forming a company, an essential ingredient to a joint venture and the practitioner when drafting a cooperation agreement can focus attention on the agreement and not a wide range of rights and obligation inherent in a joint venture, such as management structure, dividend policies, voting rights, composition of board, protection of minority rights, quorums for altering the articles of incorporation, to name only a few of the many topics joint ventures obligate us to consider.

B. Joint Venture by Merger The merger of two or more companies is clearly the most complete joint venture possible. Here, one or more entities are extinguished and incorporated into the remaining, or surviving, entity.

There are different legal techniques for achieving this end, e.g., company A is merged into company B; or companies A and B form company C, and A and B are legally dissolved.

A merger implies there is an existing organisation(s) while a joint venture imparts the sense of starting a new organisation together, the parties are about to launch a new company with diverse capital contributions. Thus, the merger is not a common form of joint venture.

The end result may be the same but the road is so different practitioners would not consider they were dealing with a joint venture. In a merger, one of the salient legal prerequisites would be extensive due diligence procedures, a massive undertaking to ensure a thorough radiology of the companies involved. This precaution is not necessary for the usual joint venture.

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C. Joint Venture by Acquisition In contrast to the merger technique, a method frequently utilised to forge a joint venture is the acquisition of the ownership interests of a company. Again, the end result may be a joint venture if the purchase results in a division of equity between various parties. But, once again, extensive due diligence procedures become necessary prior to the purchase and therefore a different approach to counselling an equity purchase is necessary. An equity purchase will take us down the road of a joint venture but it is not the traditional form of a future collaboration.

For example, a joint venture by acquisition requires substantial documentation similar to a joint venture, but significant differences persist, e.g., the company Articles will probably have to be substantially altered in accordance with the new entry of a partner, the due diligence procedures are lengthy and complex, many clauses have to be drafted into the joint venture agreement pertaining to the present status of the company being purchased as well as its status on the day of purchase. Such clauses requiring business to be continued in the ordinary manner and prohibiting any sudden sale of assets or even major purchases are not normal considerations in the formation of a joint venture.

The joint venture by foundation begins on ground level zero while the equity purchase is picking up somewhere, and where that recovery point is can generate many tasks for counsel.

D. Management Contracts A related structure that may also be considered a joint venture by the parties is that of one entity managing another entity. This is quite common in the hotel, catering, and restaurant industries.

For example, an internationally known hotel chain may sign a contract with the owner of a local foreign hotel to manage the hotel for a fee. No equity interests are purchased. Under our definition this would not be a joint venture but a management contract. Indeed, the clauses typical of a management contract have little in common with the joint venture agreement. Yet, hotel owners will often state they have a joint venture with a particular international hotel group.

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E. Transfer of Technology (Normally Trade Secrets) Contract A substantial amount of international business is conducted by the celebration of contracts involving a transfer of technology. The European Commission Regulation 556/89 of 30 November 1988 describes the essential meaning of know-­‐how as being as being: ‘…a body of technical information that is secret, substantial and identified in any appropriate form’. It may relate to a manufacturing process, a product or a service. The transfer of the know-­‐how is of course dependent on the payment of royalties and many other usual conditions which have created its own body of law and literature.

If a technology contract is the sole operating document between the parties it is not normally treated as a joint venture in the literature of the law. However, such contracts do often form part of joint ventures.

F. Franchise Contracts Franchising has become a popular, widely-­‐used method for stimulating business through the projection of a trademark on a product or services and creating a standardised method of decoration and selling. A more specific designation has been distribution franchising or retail format franchising. The European Commission in its group exemption for franchising (Regulation 4087/88) has indicated many of the features which characterise franchises: -­‐use of a common name, consistent visual presentation of premises from territory to territory; -­‐technical assistance given to the franchisee in the purchasing and merchandising of the product or services; -­‐a transfer of know-­‐how.

The franchise contract has a similarity to a joint venture: mutual collaboration, concentration on the same product or service, pursuit of a common economic goal. The differences, however, are significant to warrant a separate, distinct legal classification. The parties are not part of the same legal structure. It would be rare for the franchiser to participate in the capital structure of the

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franchisee. The parties maintain their own distinct legal personalities. Clearly, a franchise contract is not a joint venture although at times a joint venture may include a franchise.

I have alluded to my own priorities as a practitioner to the importance of documentation.

Whether we are dealing with small-­‐ and medium-­‐sized companies or the global multinational, a solid foundation of documents serves to steer the parties through the future without irrevocable ruptures and we shall now see why.

III. The Indispensable Documentation to a Joint Venture

While every practitioner has her/his own preferred collection of documents, and some may be a part of others, in business practice the documentation adjacent to a joint venture is normally composed of: •

A Letter of Intent

•

A Joint Venture Agreement

•

The Shareholders’ Agreement

At times, the articles of the joint venture may be drafted prior to its incorporation so as to ensure all parties are in agreement. In the case of an equity purchase it is customary to have extensive due diligence procedures.

It is possible to construct a documentation list which exceeds a baker’s dozen, but I am cognisant that for the everyman practitioner, a joint venture can be constructed with just the documents I indicated above.

There is no authority that says these must be the documents. These are the documents that naturally flow from the way business people begin to form an association with another party.

And of course, among sophisticated parties with experienced counsel, this list of documents can either be expanded or condensed as I have already stated.

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For example, one document I often call for and which I find very helpful is an agreed budget and operating plan for three to five years. But this is a practical step intended to avoid arguments in the initial stages of the joint venture and for purists, perhaps not a necessary element, too nitty-­‐ gritty on the grounds such details are best left to the participants and their accountants.

Naturally, documentation has no sacred terminology. The same document may have multiple names. Instead of stating letter of intent it might be called heads of agreement, or an aide de memoir; or the articles of the joint venture might be denominated joint venture constitution or even pre-­‐incorporation agreement but if we understand the function of these documents, their nomenclature shall rescind into second plane in importance. I have even seen a shareholders’ agreement entitled, An Agreement for the Protection of Minority Owners, which it surely is.

No joint venture can proceed without the practitioner paying considerable attention to the structure and contents of the above documents. Any one item raises several questions that determine the likelihood of the success or failure of the joint venture and I shall now examine them in a practical fashion.

But surely, most practitioners would agree that the three fundamental documents of a joint venture are a letter of intent, a joint venture agreement and the powerful shareholders’ agreement, that indispensable document for protecting minority rights.

A. The Letter of Intent The Letter of Intent should not be a binding legal document. If counsel has an opportunity to assist in the preliminary exchange of correspondence between two or more prospective parties intending to do business together, the non-­‐binding aspect of the letter should be stressed.

If carefully prepared, the letter of intent is not a contract but a statement of purpose, a declaration as to what the parties shall eventually do. Although frequently thought of as a legal document, it is not. In this respect, the French words aide de memoir (an agenda) more accurately reflect the true purpose of the letter of intent.

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Entrepreneurs want to outline what they understand are the common objectives but invariably the letter of intent is incomplete in many respects. Unfortunately, if the letter of intent is couched in legal terms or uses contractual language, ideas formulated in a letter of intent come back to haunt counsel as, in the future, one party will argue a disputed point is already conceded in the letter of intent. And then counsel has to either say the client was ill-­‐informed (never a wise attribution to lightly make) or acted hastily, which if true, casts the client in a pitiful light; also to be avoided if the practice of law has any hopes of generating income for we practitioners.

Letters of intent should be kept broad and speak in generalities. The objective should be to studiously avoid any contractual responsibility and allow the letter of intent to serve merely as a working agenda for the parties. It is certainly helpful to set forth what are the basic elements of the joint venture.

Jurisdiction of where the joint venture shall operate, identity of the participating entities, the object of the joint venture, the foreseen capital, the contribution of each participant, number of members on the board of directors, minority rights, all these elements are basic considerations to be expressed in a letter of intent but as an agenda for future discussion or contractual formulation with the assistance of counsel.

(i) Sample Letter of Intent A typical non-­‐binding letter of intent could take the following form: The undersigned parties, the President of American Digital, Inc. and the President of Portuguese Software Services SA, concur that they have studied market and industrial reports concerning computer sales in Portugal; that they agree that the Portuguese market is receptive to products of American Digital Inc. due to its excellent technological reputation; agree that Portuguese Software Services SA has all necessary technical knowledge to augment sales of products of American Digital Inc. in Portugal; that both parties agree they shall take all the necessary steps towards implementing a joint venture by the formation of a Portuguese society by quotas, American Digital Inc. holding fifty-­‐one per cent of the capital while Portuguese Software Services SA shall hold the other forty-­‐nine per cent.

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Subject to approval by the respective board of directors of both parties as to all relevant and material legal documents, as well as ratification of the commercial bases of the joint venture, it is anticipated the joint venture company shall have a capital sufficient to be autonomous for at least a period of three (3) years. An agreement regulating the minority rights of Portuguese Software Services SA shall be an integral part of the final documentation.

Within a period of three months from the date of this letter of intent, final legal documents will be prepared by counsel and submitted to each party for approval.

This letter of intent is nothing more than a statement of goodwill as more questions are left unanswered than answered. What will be the final intended capital? What shall be the form of management? What are the minority rights alluded to? When will the company be formed?

For added emphasis, so as to relieve any corporate executive who is worried the letter of intent may be considered binding, a number of phrases exist which can be inserted so as to render the document blatantly useless as a contract or promissory contract. Such expressions are: •

subject to written approval by the respective board of directors of each party and confirmed by such board in writing to the other party

•

merely as an informal, non-­‐binding expression of corporate policy and commercial objectives, the parties confirm…

•

without legal responsibility until reviewed and approved in writing by counsel to each party

•

with a view towards establishing a joint venture in the immediate future after consultation with the board of directors of each party, and subject to their written approval

•

as a working agenda only and without any binding legal obligations

•

This letter will serve as a topical outline of our discussions concerning our projected joint venture

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Mostly any language will suffice so long as it renders the letter of intent to be true to its designation: intent and not a contract.

It is also helpful, should counsel be present, not to seek to bolster a letter of intent into a formal contract. It is rare for the parties and counsel to understand all ramifications during the early stages of negotiations and many an attorney has sighed relief when it is realised the letter of intent is not per se enforceable.

B. The Joint Venture Agreement Once the parties have indicated their mutual commercial interests in a joint venture, it becomes the task of counsel to prepare the joint venture agreement, sometimes also referred to as a pre-­‐ incorporation agreement. This latter designation is a misnomer because the recourse to a corporation may not be the legal form adopted by the parties; in fact in Europe the limited liability company is a viable alternative to the stock corporation. Nevertheless, the nomenclature is what it is from decades of practice.

The joint venture agreement and the shareholders’ agreement, soon to be discussed, are the two kingpin documents in the formation of a joint venture. It can be debated whether these two documents should be combined into one document or kept separate. As each document is so important in the formation of a joint venture, it is best they be kept separate for the theory of a joint venture normally implies the application of company law whereas the underlying theory of a shareholders’ agreement is contract law. Moreover, the joint venture agreement is the architect’s plan of the joint venture. It details all the interior structure of the corporate house to be constructed as we shall see when we discuss some of the elements.

On the other hand, the shareholders’ agreement is an agreement between the members of the house, legal neighbours if you will, and it purports to regulate various aspects of this relationship. Stone walls make good neighbours and the more the rights of the shareholders are regulated amongst themselves the more successful, or at least free from conflict, shall be the joint venture. While the two documents may contain repetitions of the same ideas, their separation is useful as it segregates the different objectives of each document. This shall become clearer in our discussion of the shareholders’ agreement.

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Two separate documents are my preferred methodology but it surely is not the only possible strategy. It may be the clients do not have a great deal of time available and they are urging counsel to draft, and quickly, the essentials for signature. Here expediency orientates the practitioner and the pressure of time may dictate the use of one document.

Returning to the joint venture agreement, this essential legal document is the Constitution, the source document for all questions concerning the formation of the joint venture. But the joint venture agreement is more than a Constitution. It also is a road map as to what may transpire. In other words, the wise draftsman will also look to the future. Supplementing theory by facts and looking at the essential and advisable details of a typical joint venture agreement will provide the practitioner with a sense of dominion and understanding.

The basic theory we shall want to guide us is the primary function of the joint venture agreement: a constitution of the elements of the joint venture; a document to survive the formation of the joint venture; and, finally, to contain within it the intended philosophies of the founding members. This latter will be extremely helpful should it be necessary to have recourse to a trier of facts in the event of a dispute.

The topics selected below are those most relevant to the formation and operation of a joint venture.

IV. A Sample Set of Joint Venture Agreement Topics The simplest way to understand a professionally drafted joint venture is to examine topics and their reasons. The actual drafting of these clauses requires only an understanding of their purpose and therefore within the skills of the practitioner. The exposition which follows is an outline for the minimum drafting requirements for a joint venture. The more complex the joint venture, the more topics needed to be added. But the topical discussion below alerts the practitioner to the myriad problems present even in the simplest of joint ventures.

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•

Identification of Parties

The identity of the parties to the agreement should be of major importance. Often one party in a jurisdiction considers a joint venture precisely because of the value of the name of the other party. Therefore, to the degree this is important, the joint venture agreement should make clear who the parties are and no others will suffice. If a major multinational has taken the time to negotiate a joint venture agreement then there is no reason why it should not be a party to the agreement with no right of assignment.

Unfortunately, sometimes a multinational will set up a separate subsidiary to participate in a joint venture it has negotiated. Before accepted, there should be given very satisfactory explanations.

•

Objectives of the Joint Venture

The objectives of the joint venture should be as broad as possible. The objective here is to prevent future competition in complementary fields and to stimulate further collaborative efforts. This is particularly relevant where the practitioner represents a minority partner whose knowledge of the jurisdiction is what the majority partner is essentially purchasing.

•

Assignment

This topic is but a corollary of the topic above. The joint venture agreement is restricted to certain parties, those parties alone, and it can not be assigned, e.g., to a subsidiary which may have no assets. This restriction should not be left to the provisions of the applicable commercial code or common law. It should be a contractual provision in the agreement.

•

Legal Form of the Joint Venture

The choice of the legal nature of the company to be utilised for the joint venture will affect many rights and obligations. For example, absolute restrictions on the transfer of shares is possible in a statutory closed corporation (defined as such in the relevant legal authority) but not in a typical share corporation.

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Consequently, the possible legal forms afforded by the jurisdiction in question must be considered and their implications understood and evaluated. From the legal form the participants chose, there will follow many important rights. Frequently minority rights are not as well protected in a share corporation as they can be in a limited liability company. This is a classic case where form conditions rights and therefore must be studiously reviewed by counsel.

•

Capital of the Company

Undercapitalised companies invariably lead to conflicts for one partner will prefer credit while the other, usually the local partner, will abhor it—and with good reason. Consequently, the wise counsellor will ensure the joint venture company has funds for some years of operation or, if this is not possible, all parties understand there will be recourse to credit. It is extremely helpful, if at all possible, to annex to the joint venture agreement an operating budget for the first few years of the future joint venture.

•

Determination of Percentage Ownership of Each Party

The determination of what percentage of capital the parties shall own is really a question of power: what rights will the various anticipated equity interests attract? Dependent on the jurisdiction, different rules apply, for example, in one jurisdiction, the articles of association can be altered by a simple majority, while in another it requires 75% of the votes. Furthermore, not all rights are determined by the same percentage of votes. Altering the articles requires one percentage while signing a major contract may only require a majority vote of the board of directors. Additionally, the amount of majority needed on any one topic may also depend on the legal form in question, e.g., a share corporation or a limited liability company.

Therefore, when counselling a client as to the amount of capital to be subscribed, never assume 51% is sufficient to control the company. It may be an illusory majority. What has to be

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thoroughly understood are the requirements of the local laws of the jurisdiction in which the joint venture is formed as concerns the particular legal form of the joint venture.

In this respect, the use of the word forming a company in a joint venture agreement is not entirely satisfactory. At this stage of drafting, counsel should have already formed in their mind what is the preferred legal form.

•

Transfer of Shares

In as much as a joint venture has its origins in the trust and confidence of the original partners, a transfer of shares or equity interests should never be permitted without detailed regulations covering such transfers. This concept is normally included under the expressions right of first preference or right of first option or right of first refusal. But many considerations must be pondered, including whether there should even be permitted any transfers and this total restriction may only be possible for a certain type of closed corporation, if permitted at all in the local jurisdiction.

•

Restriction on Transfers of Shares: Shareholders’ Agreement or Articles?

Often a great deal of time is spent in negotiations in discussing restriction on the transfer of the equity interests of a joint venture. This is perfectly natural. Many joint ventures are, in composition, medium-­‐sized companies, with few partners, and the business climate is one of familiarity and reliance on good will and knowledge of the business practices of the partners.

Future partners may not want unknown third parties suddenly entering into the capital structure.

Consequently, the international practitioner has to be familiar with the current state of art.

Prohibitions against the transfer of social interests, as such are often classified in continental law, are standard language in a joint venture agreement.

Initially it is important to know that it is not possible to restrict the free transfer of shares of the traditional share corporation. It is possible in statutory closed corporations, or limited liability partnerships, and each jurisdiction has its own definition of these words. But in general we are

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speaking of a small, closely-­‐held, restricted number of shareholders in a corporation, and here it is possible to condition the transfer of shares.

In certain companies, such as the limited liability company which, in common law jurisdictions is characterised by the initials Ltd., it is possible to restrict completely the transfer of shares or whatever form the equity interests revest. Assuming, therefore, the practitioner has determined under what conditions a transfer of shares may be restricted, there are normally two logical places for such restrictions: either the articles of the company or a shareholders’ agreement, discussed in more detail below.

Inserted into the articles of the company, there is given public notice and third party purchasers are put on notice as to the formalities to be followed. Forming part of a shareholders’ agreement confers on the parties to the agreement actions in law for breach of any of the provisions of the shareholders’ agreement. And it must be remembered the shareholders’ agreement is almost always a private agreement and not recorded anywhere, although, for example, in Brazil, a shareholders’ agreement can be registered.

It is certainly good practice for restrictions on share transfers to be put into a shareholders’ agreement when dealing with public corporations or in jurisdictions where no restrictions can be written into the articles, the shareholders’ agreement is the only alternative. But, in the majority of cases, especially in closed corporations, where restrictions on transfers are permitted, it is wise and prudent practice to put the necessary provisions into the articles for then no prospective transferee can claim he is a bona fide purchaser without knowledge of transfer restrictions.

The actual clause drafted will depend on the type of company. As an example, the articles may prohibit completely the transfer of shares, or make the transfer dependent on the consent of the company (expressed through a general assembly), or make the transfer conditional on first offering the shares to the company or other shareholders.

Practitioners will recognise immediately that this condition is known as a right of preference or a right of first refusal. The company or shareholders have a preference before others to purchase the shares or they have the right to turn down the offer and permit the transfer.

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Against this general legal background, two issues immediately arise: (1) the circumstances under which a transfer should be allowed even when the parties have accepted the philosophy of a prohibition; and (2) the procedures to be followed. It is current practice in joint ventures, even where there is a general prohibition on the transfer of shares, to allow a transfer to an affiliate or to a company controlling the shareholder or controlled by the shareholder. The theory is that many corporations have subsidiaries and the negotiating party may ultimately wish a subsidiary to be the operating partner in the joint venture, if not initially, then later.

Here caution must be exercised and details spelt out. How do we determine an affiliate? How do we determine when a company is controlled by another? In some jurisdictions, there are statutes which attempt to define such expressions, although for other reasons, such as tax benefits.

Hence, it makes more sense for the drafter of the clause to make the provisions as detailed as possible, with reference to percentages.

A typical clause might read as follows: The prohibition against transfer of shares established in this agreement shall not be applicable on transfers to companies controlled by the transferor, controlling the transferor or an affiliate of the transferor, provided the degree of control or affiliation is represented by at least a 30 per cent [or any other percentage agreed] ownership right, provided the transferor continues to be liable under the joint venture agreement as well as any complementary agreement and the transferee balance sheet demonstrates it to be a bona fide operating company with a net worth equal to _____ times the capital of the joint venture company.

Regarding appropriate language for the exercise or not of the right of preference, the important issues to focus on are how the notice shall be given; to where it shall be sent; how many days in which the right of preference must be exercised; and, most importantly, the absence of any response is conclusive as to the failure of exercise.

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•

Quorum Rights

No topic assumes such importance as quorum rights and for a simple reason: absentee ownership. Often multinationals are absentee partners. Therefore the practitioner representing a large corporation must ensure important decisions are not taken without the knowledge and the right of participation of the client.

The laws of different countries set out the rules on general quorum requirements. By this is meant two questions: (1) how many voters must be present to have a validly constituted general assembly, e.g., in a stock corporation; and (2) are a certain number of votes required for a special topic such as an augment of capital?

Knowing the answer to these two questions will ensure that the absentee owner is not confronted with serious policy decisions after the fact. However, the practitioner must be aware of what I call sleeper quorum provisions, whereby the joint venture agreement states if a quorum is not present on the first call, any number present on the second call make a valid quorum. Such provisions should never be accepted. Quorum rights are too important to be easily by-­‐passed on a second call.

•

Qualified Majority on Key Issues

A corollary of the above suggestion is the requirement of a qualified majority on selected topics.

A qualified majority means establishing a quorum requirement on certain issues that is more stringent than the general commercial code provisions. What these issues are will be dependent on the general law of the jurisdiction and the information supplied by the client although the parties can classify any item they wish within this category.

What items are specifically important to any particular joint venture depends on the details of the venture. But the client knows well what the vital issues for its successful participation are. It is good practice to sit down with the client and go through a list of major issues normal affecting a joint venture: augments of capital, dividend policies, assumption of obligations, and/or major purchases. It is not wise to rely on the general rules of the commercial code of the jurisdiction in question. In some cases, there may not even be a quorum requirement.

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•

Board of Directors or other Form of Management

The composition of the board of directors is always an important issue and it is better the battle be fought prior to the formation of the joint venture and not subsequently. If minority interests want special voting rights through a place on the board, then the joint venture agreement is the place wherein this is dictated and the rules establishing election and representation are set forth.

•

Management

Management is not necessarily sitting on the board of directors. In fact, it is possible to have a company without a board of directors, e.g., a limited liability company, but all companies have to have a manager.

No issue causes such detailed discussions as management and the more complex and the more capital involved, the more there is to talk about, ranging from the issues of general manager to heads of specific departments. Therefore, it is prudent the joint venture agreement reveal the intentions of the parties prior to incorporation.

•

Disclosure

It is impossible to foresee all problems. And if it is not possible to foresee all problems, logically it is not possible to take precautions against them. For this reason, a technique has been in use for some years whereby each party obliges itself to disclose to the other all relevant facts which could affect the joint venture. It is an excellent device and should always be used. The most effective way is to require counsel to each party to submit to the other party a letter confirming all relevant facts have been disclosed. Given the seriousness of such an opinion letter, it is not likely to be delivered without a substantial amount of confirmation by counsel.

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•

Survival of the Joint Venture Agreement

A properly drafted joint venture agreement should state that the agreement survives as a constitution between the original partners. This will have important interpretive effect in the event of future litigation. The more developed this clause, the more helpful it becomes: why the parties are forming a joint venture, what are the objectives, what is foreseen for the future. Such idea, the philosophies if you will of the founders, is too often unexpressed, but is helpful when the only solution is recourse to a tribunal.

•

Confidentiality

Very often confidentiality agreements are a separate document. For ease in discussion, I am including it as a clause in a simple joint venture agreement, where in fact it could easily be placed. Whether such an agreement is better in the joint venture agreement or as a separate document will have to do with the complexity of the confidentiality drafted and perhaps complex technological joint ventures merit a separate confidentiality agreement when a substantial amount of trade secrets are being divulged by one party to the other.

Various topics should be included in this clause. Whatever technique is utilised, the items to be covered should include: –A prohibition on all parties to utilise information obtained for whatever purpose; and –A prohibition on all parties concerning public announcements until the joint venture is formed.

•

Settlement of Dispute Mechanisms

It’s always good legal practice to ask yourself: what if the joint venture fails, and what if the parties go into litigation? The joint venture agreement should always contain mechanisms or clause(s) which will survive the creation of the joint venture, as to the steps to be taken when there is need for a dispute mechanism.

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Many alternatives exist to litigation. They can be: ––An obligation on the complaining party to advise the board of directors of the other party of the problems and to be obliged to wait for a certain period for a resolution or not; or ––An obligation by either party to use ‘their best efforts’ to resolve any claim or dispute by constituting a committee of persons close to the problem from both sides and to listen to their recommendations; or, ––Initially be compelled to go to an outside fact-­‐finding entity, perhaps an arbitration board, which can not make a binding decision but only recommendations; or ––Of course it is possible to constitute arbitration as the mechanism for resolving disputes affecting the joint venture.

The option chosen will depend on the parties and their legal experience prior to the joint venture.

•

Merger or Entire Agreement Clause

The joint venture agreement becomes the final instrument of the terms and conditions negotiated. Prior instruments, such as the letter of intent or even shorter contractual agreements are merged into the final language of the joint venture agreement and the joint venture agreement should state this obvious fact.

•

Applicable Law

While it may be possible to have a foreign law as the law of the joint venture agreement, it is not a sensible legal option and even more difficult to implement. The law of the situs of the joint venture should be the applicable law to regulate all questions of interpretation of law. This facilitates implementation of the joint venture agreement. If the parties do not want the applicable law of the jurisdiction to apply, then arbitration should be established as the dispute settling mechanism.

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•

Authorised Signatures

There is nothing more effective in effectuating a change of counsel than the failure of counsel to ensure those who sign have the authority to do so. Particularly in continental Europe, authority should never be assumed.

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Force Majeure

Of all the clauses in a joint venture none more rarely becomes necessary than the force majeure clause, meaning rendering impossible performance under the contract without any direct responsibility on the part of any party. In some American legal documents it is entitled a catastrophe clause which displays the American preference for simplified legal language which is also descriptive and graphic.

Nationalisation of a party, privatisation of a government party, destruction of an existing manufacturing plant, eruption of hostilities, these are examples of improbable events but possible. Consequently, the force majeure clause, although seldom invoked, is relevant and should be utilised.

•

Notices

The joint venture agreement should recite where notices are to be sent. Nothing is more frustrating and less understood by a client than his attorney’s inability to send the necessary notice effectively or to commence legal process with a legally binding address established beforehand.

This completes a list, which clearly not exhaustive is still a reasonable beginning for the outline of a joint venture agreement. Many joint ventures, due to their economic simplicity or low capital origins need no more documents. The next step is the formation of the joint venture company.

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However, joint ventures, can involve significant capital involvement, complex relationships between the parties, even hopes and fears as to what the future may bring, and in these circumstances there has grown into use the shareholders’ agreement. Properly drafted, the shareholders’ agreement is a powerful tool to protect the minority against the abuses of the majority but at the same time granting to the majority the security as behoves the party with the larger capital contribution.

C. The Shareholders’ Agreement Why, you might ask, do we need a shareholders’ agreement when we have a joint venture agreement and then the articles of the joint venture company? Isn’t that enough? It can be, it often is, but the theory of the shareholders’ agreement reveals its practical function.

It is intended to regulate in detail the relationships between the parties which will endure during the life of the joint venture. Moreover, the use of a separate shareholders’ agreement emphasises to all parties, counsel and shareholders, that crucial majority and minority rights need to be regulated. Their importance justifies a separate document.

Were the details transposed to the joint venture agreement, which is in theory possible, or even the articles of the joint venture company, the former would become a cumbersome blueprint on how to do business as well as defining rights and responsibilities of various parties. Additionally, from a trial viewpoint, it is usually preferable to concentrate the court’s attention on a particular legal document and not the entire business history.

As for inserting majority and minority rights into the articles of the company, such an insertion would make too many public revelations, as articles of a joint venture company are normally subject to publication.

The expected details of a shareholders’ agreement becomes apparent if we compose a simple list of typical topics. While each practitioner must mould the agreement to the specifics of the joint venture, it is common to find treated in a shareholders’ agreement the following: ––A general description of the business plans of the joint venture ––Composition of the board of directors

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––How shall voting take place on the board of directors ––What rules govern voting in the general assembly ––What is the managerial structure of the joint venture ––Restrictions or not on the transfer of shares or other social interests ––Are there any special or required dividend policies ––Are partners expected to make loans to the joint venture ––Shall any partner(s) be required to give guarantees on loans to the joint venture company ––Projected operating budget for some years may be fruitful ––If the parties have similar business, are there any restrictions on competition between partners ––What accounting methods shall the joint venture use ––Some duplication of topics between the joint venture agreement and the shareholders’ agreement is unavoidable.

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The Nature of the Shareholders’ Agreement

The legal theory of what is a shareholders’ agreement has not been free from controversy and has evolved through decades of practice. Initially, arguments were advanced of the similarities between the shareholders’ agreement and a voting agreement; or voting syndicates; and even holding companies, a hybrid of trust law; arguments were advanced as to the separation of ownership of the share from ownership of the right to vote. With such a plurality of competing ideas there was also the complexity of what theory would be more adequate in a particular jurisdiction.

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On the one hand, the shareholders’ agreement was a private agreement and on the other hand, its purpose was to regulate the life of a company, thus causing the agreement to be a crossroad between the civil law of contracts and the commercial law of societies.

For the practitioner, the most workable theory is that of a plurilateral contract, involving, obviously, the parties to the contract, and if precaution is taken to have the newly-­‐formed joint venture sign the shareholders’ agreement upon its formation, then there is a third party for whom the consequences of the agreement were intended to affect.

As noted shortly, such a theory is not without some contradictions. But the law should serve the participants, in this case, entrepreneurs, and as I have strived to make clear, the more detail that is drafted, the more theory will have to conform to the objectives of the parties.

Again, contract theory offers the most plausible interpretation of the shareholders’ agreement because this is how the entrepreneur is envisioning the document in question. Hence, form and theory ought to coincide in the objective sought.

From this idea has evolved into present usage the concept among practitioners that the shareholders’ agreement is a parasocial agreement, meaning it is founded on the law of obligations although it is incident or complementary to the objective of regulating to some degree the functioning of a society or company. It must be remembered that in many civil law countries companies are considered an agglomeration of individuals forming a society. Hence the expression: parasocial, similar to a society but not quite a society.

Visualising the shareholders’ agreement as forming part of the law of obligations also permits treating the infrequent anomalies. While most shareholders’ agreement are intended to regulate the conduct between future partners, it is foreseeable a shareholders’ agreement between a partner in a company and one who is not a partner, e.g., a borrower and a lender.

Here we have an agreement to which a third party is part and yet this third party is not nor is ever intended to be a member of the joint venture. What the third party wishes is merely to influence voting rights in the joint venture.

When disputes arise, having the joint venture as a party to the shareholders’ agreement allows for a more efficient enforcement of rights.

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Contract theory permits regulating the different viewpoints or interests in focus and at risk while at the same time avoiding complicated legal structures such as a holding company or even trust or deposit of shares in a bank with instructions for voting in a certain fashion.

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The Parties, Object, Form, and Duration of a Shareholders’ Agreement.

To what extent the future directors of a joint venture, in the name of the company, can be a party to a shareholders’ agreement is not free from polemic. This is due in large measure to the fact that the directors of a company, or its equivalent, have a fiduciary agreement to the company and not to any one group of shareholders.

Faced with this dilemma, the only solution is a well-­‐drafted and crafted shareholders’ agreement which shies away from actually conditioning the votes of a director but instead establishes policy objectives, such as retention or not of profits, augments or not of capital, alterations to articles, emission of debt, proportional voting rights, to cite some examples.

In the usual case, the shareholders’ agreement is restricted to the future partners but of course it might be a lending bank would want to be a party to ensure proper application of substantial sums which are being granted. For a third party to attempt to condition the management of the future joint venture would be abhorrent to company law but again, within contract theory, at least the third party bank would have contractual rights against the partners for future abuses.

As to the object of a shareholders’ agreement, of course it must be lawful and any shareholders’ agreement intended to restrict competition or otherwise run afoul of local laws would be immediately struck down. Equally suspect are those shareholders’ agreement whose purpose is to perpetuate a fraud on another partner who is not aware of the shareholders’ agreement.

Again, contract theory is a solid pillar for the shareholders’ agreement for within the theory of contract is to be found the most broad of all standards: good faith. Without good faith, and here the judge of facts becomes critical, there can be no shareholders’ agreement.

The form of a shareholders’ agreement should be in writing and it is hard to imagine business being conducted in any other fashion. As to the duration of a shareholders’ agreement, while there appears to be no logical reason why it could not be indefinite or without term, still, the lawyer’s aversion to eternal agreements is well founded. Better to establish an event, e.g.,

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dissolution of the joint venture, as a termination point so as not to have to argue about the validity of agreements with no term.

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The Essential Characteristics of a Shareholders’ Agreement.

For the general orientation for the practitioner, the shareholders’ agreement has certain essential characteristics which are separate from the details it regulates. The true shareholders’ agreement will: (a) be between present or future owners of the joint venture capital; (b) regulate, or attempt to regulate their conduct in relation to a company; (c) create an obligation on the part of at least one partner to exercise voting rights in a determined orientation; and (d) establish a term to the agreement.

A shareholders’ agreement as a legal instrument affects the parties to the agreement, obviously based on contract theory, but since the parties are also to become partners in a joint venture, the legal operations of the future company are also affected.

And what if the managers of the joint venture chose to ignore the shareholders’ agreement, e.g., on a dividend policy clause, by not declaring dividends? Can the partners compel the dividend short of a dismissal of the management team? In legal theory, the joint venture company is a separate legal entity from that of its partners.

Various legal theories have competed for best describing a shareholders’ agreement, including ranging from a voting trust to a voting syndicate to a pooling agreement. Such debatable theories have little interest for the client, particularly as their implementation might require the creation of an actual trust, or transferring the shares to an independent third party, all of which arise the suspicions of the client because of the inherent complexity.

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The conflict between theory and practice can best be avoided by a carefully worded clause in the joint venture agreement whereby the provisions of a shareholders’ agreement contain a sufficient stiff liquidated damages clause.

This, because in reality what happens is one partner, perhaps controlling the management, may decide not to declare dividends promised as foreseen in the shareholders’ agreement. Under these circumstances, the injured partner, rather than having to resort to a law suit against the joint venture, can simply sue on the liquidated damage clause, which if sufficiently large in quantity, is an efficient tool of persuasion.

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Making the Corporation a Party to Shareholders’ Agreement.

As the enforceability of a shareholders’ agreement may meet with the defence that a further proper party to such litigation is the joint venture, but then the latter is not a party to the agreement, so to avoid this tactical conundrum, it makes good sense to do just that. Clients detest, and rightly so, legal instruments which after achieving at least two dozen pages (and, if the provenance of the agreement is from counsel with substantial joint venture experience, it may be ten times that figure), prove unable to enforce the rights therein contemplated.

Therefore, in the early stages of a joint venture when good will is in abundance, inserting a clause in the shareholders’ agreement foreseeing the future signature of the joint venture confers considerable advantages.

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Form for a Shareholders’ Agreement

Although there are jurisdictions where a shareholders’ agreement must be recorded to be effective against third parties, and in such cases, the statutory provisions must be followed, there are no special formalities to the form of the shareholders’ agreement except since counsel is retained and paid to draft documents, this is an excellent opportunity to ensure clarity and comprehension on major issues between the partners.

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Transferee Bound by Shareholders’ Agreement

Since the shareholders’ agreement regulates critical matters which spill over into the joint venture, counsel must face the prospect of the agreement being diluted by one of the partners leaving the joint venture. True, the contractual provisions of the original parties may prevail, but oftentimes problems arise many years after the departure of one of the founding members. This problem can be resolved in close corporations where there are restrictions on the transfer of shares. In other words, the transfer shall not be permitted unless the new incoming partner agrees to the terms of the shareholders’ agreement. In large capitalised joint ventures with multiple partners, this may be not feasible or it may be even illegal as against the freedom of transfer of capital.

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A Typical Shareholders’ Agreement

Words are the tools of attorneys and form often teaches more than theory. With this in mind, I offer a short form of shareholders’ agreement which may be helpful to my colleagues, with my comments where appropriate.

––Parties Complementary to the joint venture agreement executed and dated __________, the same parties further agree:

Between:

[identity of all parties]

––The shareholders’ agreement should seek to bind the chain of corporate links.

This agreement shall be binding on all parties controlled directly or indirectly by the signatories as well as those parties controlling same.

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If a definition is needed, a clause or phrase can be added: Controlling interest (or affiliate or group) shall mean an interest in the capital of any company, or the latter participating in the capital of the party to this agreement, amounting to at least …%.

–––The initial opening paragraphs are also an excellent place to insert a broad obligation on all shareholders to ensure the company shall adhere to the shareholders’ agreement: The shareholders obligate themselves to secure that the joint venture company fully and integrally performs all obligations contained in this shareholders’ agreement and shall become a party to same upon formation.

––Reasons for agreement

It is helpful to indicate the reasons which led to the formation of the joint venture, particularly when conflicts arise and third parties are called upon to judge a dispute.

The parties have formed or intend to form a joint venture for the following reasons…

Bearing in mind applicable competition law statutes, it is also useful in such a paragraph as this to speak about the conduct of the future partners: No shareholder, or any affiliate, or any company to which the shareholder belongs as a group, shall, directly or indirectly, compete with the business of the joint venture company.

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––Board of directors

The shareholders’ agreement is often used to ensure adequate representation and voting rights is possible both at the board of director and also at the general assembly level, particularly where there are minority interests. For example, at the general assembly level a shareholders’ agreement could provide for a supra-­‐majority for a needed quorum, a percentage which would ensure the voting of the minority partner is necessary on a particular item, e.g., augmentation of capital.

The more detailed is this clause the more probable the various shareholders shall be able to protect and secure their rights. However, legal theory often conflicts with the intentions of the founding partners.

In all cases, whether at the general assembly or at the board of directors level, partners, shareholders, dependent on the nature of the company, are supposed to act, vote, influence the policies of the joint venture not for individual gains but for the welfare of the joint venture. A successful venture will of course mean a profitable participation. Therefore, why bother with a clause intended to manacle (for that is what it is) the action of either the general assembly or the board of directors which is clearly against the theory of independent management and hence illegal?

Unfortunately, the clients expect and frequently demand clauses which if of dubious efficacy nevertheless are seen by them as vital. And, it is true, that in most cases, if people agree to a certain commercial action which in the trade is a custom and not considered against the law, they will comply. Hence the multiplicity of shareholders’ agreements in joint ventures.

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I offer below a topical list which is commonly found in joint venture agreement, subject to the reservations I have already made, i.e. the list is not intended to be entirely consistent with legal theory (a heresy for a lawyer to state!) but in practice it works.

•

Composition

•

Casting vote

•

Procedures

•

Issues

•

Voting requirements

•

Composition

One of the aspects of share ownership is the right to nominate or vote towards the composition of the board of directors. There are various techniques for ensuring minority owners receive representation on the board of directors, such as cumulative voting rights. But in close corporations it is more common to resort to a shareholders’ agreement, such as: The parties agree party…shall have the right to nominate …members of the board of directors which board shall consist of…members and entity …shall nominate the rest.

To the quoted language can be added the right of one entity to designate the Chairman, on an alternate basis with other partners.

––Casting Vote

An equal number of members on a board of directors is not favoured; it invariably leads to deadlocks and then the necessity for a casting vote to break the deadlock. With an unequal number of members, the board of directors will avoid impasses and the wording of such a clause is straightforward:

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The board of directors shall be composed of … members. Corporation X shall have the right to nominate…members and Corporation Y shall have the right to nominate… members. The Chairman shall be nominated by the members of the board, with voting rights equal to but not superior to any other member. The Chairmanship shall rotate on the same basis as the composition of the board and in the absence of good cause shall be drawn on a rotation basis from the members designated by the shareholders.

––Procedures

It is a good idea to set out in detail how often the board shall meet, where, the necessity for an agenda and most importantly the notices to be given and how such notices shall be effectuated.

A frequent problem is absentee ownership. A joint venture requires a working partnership and the most effective way is to compel frequent board meetings and to prevent board meetings taking place without notice. A simple requirement that a registered letter with the selected agenda be sent to a predetermined address substantially reduces the appearance of problems in the functioning of the joint venture.

––Typical issues for a shareholders’ agreement

Many topics are of vital concern to the joint venture, such as an augment of capital, and others less so, such as personnel considerations. There is a clear division between matters of relevance to the board of directors and those of the general assembly. Each jurisdiction has its own rules and this may in turn be dependent on the form of the joint venture.

Hence, the most useful approach is to make a list of issues normally of importance to a joint venture and the local practitioner should know what organ has the proper competency as to each topic.

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First the topics: o

augmentation of capital

o

issue of any shares, special shares or other equity interests

o

capital expenditures in excess of an agreed amount

o

merger or formation of another company

o

purchase of interest in another company

o

hiring of personnel in annual amounts exceeding an agreed upon figure

o

acquisition or disposition of assets above a certain amount

o

any substantial borrowings above an agreed amount

o

execution of any substantial contract

o

alteration of company business

o

alteration of articles of incorporation

o

salary determination for board members

o

contracts with members of board members

o

guarantees of company

o

creation of liens

o

loans

o

dividend declarations

This is only a selected list and is not intended to be complete and varies with the actual circumstances of each joint venture. It would not be unusual to require a unanimous vote of all members of the board of directors for the topics on this list unless the minority partner was truly a miniscule interest. But in theory it can and of course what ever stipulations are reached on the quantity of votes needed to muster approval in the board of directors can also be applied as regards the general assembly.

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The above list could be regrouped into three categories each requiring different voting treatment. The classification could be topics requiring a unanimous vote; topics requiring a qualified majority vote (more than 50 %) and topics requiring a simple majority. The allocation of the topics to each category is then made in accordance with the facts of the joint venture.

––Voting requirements

The amount of votes needed on a particular issue shall depend on the composition of the board and the equity ownership of the various partners. It can be more than a simple majority and less then unanimous, e.g., a two third requirement. Once the topics or issues are settled the actual clause regulating the voting is straight forward: ‘Regarding the following list, no resolution shall be deemed validly passed unless it has the approval of …% of the members of the board of directors’

If preferred, the percentage may be varied according to each topic.

A clause concerning the general assembly needs only slight modification to make it clear it is the votes in the general assembly that are being regulated.

Our concern as lawyers is to what extent the voting orientation of either a representative on the board of directors or a shareholder in the general assembly can be determined prior to the issue being raised. Clearly, a restriction on the independent judgment of a director or shareholder is contrary to the interests of the society. True, but the reality of commercial practice is such restrictions, or orders if you like, are agreed upon frequently and obeyed.

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Can such tenuous rights be enforced? Perhaps not, but again the reality of joint venture legal practice is that the parties will usually not litigate the issue if it has been agreed upon beforehand.

––Management ––Nomination of managers

It is common for shareholders’ agreements to agree on a division of management functions and this is particularly true when we are dealing with a joint venture involving a multination. It is also a sound approach when there are minority interests. For example, the foreign (out of the jurisdiction) majority may wish to nominate the general manager and the local minority interest the financial director. A suggested clause might read as follows: [Shareholder] shall nominate the general manager of the company while [shareholder] shall designate the financial director.

––Finances and accounting ––Finances

An agreed budget plan for at least three years of operations is a topic to be included in the shareholders’ agreement and such a budget plan can be annexed to the shareholders’ agreement. The budget can provide for annual expenditures, borrowing necessities, product development, personnel descriptions and appropriate salaries, use of dividends, retained earnings, amortisation and depreciation schedules, to cite some of the most obvious.

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––Accounting

The standard of accounting to be adopted should be the subject of a clause, such as: The books and records of Corporation X shall be kept in accordance with accepted international standards and shall be audited annually by a firm licensed to issue audit certificates in the jurisdiction.

––Dividend policy

Partners do not always agree on the application of the results of the annual operations of their joint venture; one may want to invest, another may want to receive dividends. As already described, this conflict can be avoided with a budget plan already agreed upon between the parties. Still it is good draftsmanship to have a separate clause on dividend policy since the declaration or not of dividends often generates disputes: The partners agree that after the constitution of legal reserves, and after hearing the recommendation of the board of directors, they shall vote to have …% of dividends declared.

A variation to this clause could be the following: If the company during any fiscal year has profits as determined in accordance with international accounting procedures, the shareholders agree that there shall be declared as a dividend at least …% of the after-­‐tax profits provided there is obtained a certificate from the company’s auditors certifying such a dividend is possible without prejudice to the company.

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––Transfer of shares

It is standard practice in shareholders’ agreement to include restrictions on the transfer of shares by conditioning such transfers on notice to the other shareholders and their right to exercise a right of preference in the acquisition. There are multiple options: •

Total restriction on the transfer of shares.

•

Total freedom on the transfer of shares.

•

No transfers during a specified period so as to ensure continuity of the original partners.

•

Transfers permitted provided the entire block is sold.

•

Transfers permitted subject to the other shareholders having a right of first refusal.

•

Transfers permitted providing the transferee makes an offer to buy all or a predetermined quantity of shares of the other shareholders.

Whatever the option chosen, the clause in the shareholders’ agreement must regulate price, obliging purchase of any minority interests above a threshold amount, binding the transferee to the shareholders’ agreement and releasing the transferor from any guarantees he gave on behalf of the company.

––Complementary legal documents

Legal documents already drafted in final form should be recited here: The parties agree to alter the articles of association of __________ corporation in accordance with the amended articles annexed hereto and initialled by the parties.

Any specific contracts agreed upon should be mentioned and they can be even annexed. This often happens when one of the partners is a party to a contract with the joint venture company.

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The parties agree there shall be executed a contract of technical assistance between __________ corporation [one of the shareholders] and the corporation. Annexed hereto is the contract in final form to be approved by the board of directors and implemented no later than xx/xx/xx [date of commencement of contract].

Any loan agreements which have to be executed or agreed-­‐upon can also be annexed to the shareholders’ agreement.

––Law of the Agreement

The shareholders’ agreement should always state: This agreement shall be subject to and interpreted in accordance with the laws of xxx [where the agreement is to be implemented].

It makes sense to have the laws of the situs of the joint venture as the law of the joint venture and the shareholders’ agreement; references to foreign law only complicate the resolution of disputes.

––Resolution of litigation

No matter what method is chosen to resolve differences which may appear between the shareholders, it is obligatory to have a clause which ensures the validity of the shareholders’ agreement until a court of law determines it has ceased to exist. Otherwise, any pretext shall be sufficient for a shareholder to escape the consequences of such an agreement: Until otherwise declared by a court of last resort or there being no further possibilities of appeal, the present shareholders’ agreement shall remain in full force and effect in spite of any litigation to the contrary.

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The legal adviser will also have to decide between arbitration and a tribunal. This in turn may depend on the nature of the joint venture. The more technical the business the more likely arbitration is a preferred form of resolution.

––Validity of agreement by percentage of capital held by a party

A shareholders’ agreement is often executed with only a few participants who hold substantial interests. While these percentages of capital are maintained, the shareholders’ agreement makes sense. For example, a party holding one per cent of the capital would expect only in very unusual circumstances to receive special treatment. Accordingly, the following clause is suggested: This agreement shall only confer rights on any one party so long as that party, as defined in this or other complementary documents, holds _____ percentage of the capital of the joint venture company.

––Termination

Most parties never think about the termination of a joint venture when they are organising its formation. If the pre-­‐nuptial agreement diminishes the hue of a romantic marriage, discussions of how the joint venture shall be terminated prior to its formation is no less counter productive.

Yet, it is a fact that the joint venture, if it fails, raises more complications than an unsuccessful joint venture. For while people can leave one another de facto, the life of a company remains until extinguished: Any party to this agreement may serve a notice on the other party indicating the fair market price at which he is willing to sell or buy the other party’s share, the fair market price to be ascertained by independent auditors, without such notice constituting a waiver of any rights derived from any of the agreements to which the parties are signatories. Should the other party decline to sell or buy, then the notifying party has

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the right to petition for dissolution of the joint venture agreement, or any other appropriate action permitted under the law of the local jurisdiction, and this clause shall be deemed to be consent of the other party to such initiative.

––English/foreign language version

Extremely important is the official language version of the contract. Nothing creates more litigation, than people arguing that the words written were not the understanding of the parties.

All agreements, including the shareholders’ agreement, should be executed in the language of the country where the joint venture is operating to avoid translation issues before the local court and another copy executed in the language of the other participants. This avoids argument before an arbitration board or court as to whether the parties understood the meaning of any one particular word or phrase. The relevant clause should state: There have been executed copies of this agreement in [language of country of jurisdiction] and in the agreed translation in [indicate language]. The controlling version for purposes of interpretation and resolution of conflict shall be the [country of implementation] version.

––Amendments

In this epoch of emails and other forms of digital communications, communication is instant but not always does the recipient respond. No serious amendment to the shareholders’ agreement should ever be left to an email communication. A formal amendment is the preferred form: No amendments to this agreement shall be valid and enforceable unless in writing, whether formally by contract or other recognised written medium, by the party against whom is sought to be invoked the amendment.

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––Notices

It is draftsmanship to always include in any significant legal document where any notices are to be sent. This avoids innumerable problems and facilitates the delivery of any legal document, such as convocation for a general assembly, or notice of a default. The language required is simple enough since all we wish are agreed-­‐upon addresses: For all notices of any nature whatsoever required to be served or forwarded to any party, the following addresses shall be full and sufficient delivery:…

––Breach of the shareholders’ agreement

With the shareholders’ agreement so much in use, it is natural to inquire: and what if one party breaches the agreement? What are remedies available? The answer of course depends on the jurisdiction but there are general lines of orientation which can be offered and they are naturally classified under the designation of equitable remedies.

If the remedy sought is an affirmative one, then the proper legal form is one for specific performance or execution of the clause in question, e.g., obligation to declare dividends.

If the remedy sought is a negative solution, then the proper legal form is an injunction, perhaps against a board of directors where one party has been excluded from representation. In all cases, breach of a shareholders’ agreement also confers the right to damages as between the relevant parties.

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––The closing process

The expression closing refers to the legal formality of actually forming the company. The meaning of the word closing is not always precise. It may be defined as the chronological enactment of all conditions expressed in the joint venture agreement relating to the formation or realisation of the joint venture.

The closing is not one act but a series of events which leads to satisfaction of all contractual obligations. If there has been careful draftsmanship, the closing is a reflection of the joint venture documentation. Some of the steps occur more or less simultaneously. Each joint venture has its own individual personality. However, the general outlines are: •

All investment approvals granted when relevant

•

All government consents obtained

•

All legal formalities completed in preparation of the constitution of the company or the purchase of the equity interest.

•

Adjustments to purchase price may be necessary in an acquisition as a result of due diligence procedures revealing more accurately the details of the assets and liabilities of the target company.

•

Additionally, counsel to the seller confirms there are no known impediments to the realisation of the legal acts being undertaken.

•

All necessary contracts are signed. All necessary consents to assignments of any contracts are produced.

•

If we are dealing with an acquisition, written approval of the sale from other equity owners shall be evidenced.

•

Capital contributions or payments are made.

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•

Legal formalities are performed, such as forming the company before the Notary or transfer of shares, as well as other, posterior requirements.

•

There is normally convened a general assembly and the election of the board of directors or other management organ is completed.

VI. Sort of a postscript

The formation of a joint venture without doubt necessitates extensive drafting ability and patience. Each joint venture shall have its own special contours and legal requirements.

Nevertheless, there are recurring problems and I would like to set forth, if not in an inspirational form, at least in a well-­‐meaning fashion a list of items which should be foremost in the mind of the practitioner and can be dwelt with in either the joint venture agreement or the shareholders’ agreement. Accordingly, I indicate my own short-­‐list: •

Name of the joint venture company

•

Identity of partners

•

Capital structure

•

Choice of legal form

•

Management structure

•

Need for a shareholders’ agreement

•

Articles of association of joint venture

•

Annual budget

•

Augments of capital

•

Dividend policy

•

Composition of board of directors

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•

Voting on board of directors

•

Location of board meetings

•

Quorum requirements for board or general assembly

•

Supra-­‐majority requirements to protect minority interests

•

Specific provisions affecting minority interests

•

Transfer of shares and restrictions on same

•

Labour policies

•

Material contracts

•

Loan policies

•

Dispute resolution

•

Law of the joint venture contract

•

Termination of joint venture

•

Disposal of assets (trademark rights)

While the topics I have listed may seem to some too exhaustive, and to others, not enough, I concur with both. The joint venture can not be properly pre-­‐documented. Commercial life holds to no specific patterns and all the joint venture practitioner can do is to be aware of the wide range of problems possible and ensure, through dialogue with the client, that the joint venture objectives find support in the documentation drafted.

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LEGAL ISSUES IN CREATING AND DOCUMENTING JOINT VENTURES AND STRATEGIC ALLIANCES E. Lee Reichert & Robert M. Fogler1 I.

Introduction.

Joint ventures and strategic alliances have become increasingly commonplace as companies attempt to achieve business goals and objectives through innovative relationships.2 For example, in June 2008, international brewing giants Molson Coors Brewing Company and SABMiller finalized a joint venture which combined the U.S. and Puerto Rico operations of the two companies under the name “MillerCoors.”3 The subsequent tightening of the global debt and equity markets after 2008, along with a slowdown in merger and acquisition activity, caused in part by cyclical market influences and ongoing recessionary pressures, has fueled additional interest in these types of legal arrangements.

The terms “joint venture” and “strategic alliance” have been used to describe many types of business relationships and have had many different meanings over the years. Historically, joint ventures were prevalent in the mining industry, which led to the development of a number of joint venture legal forms.4 A 1950 law review article accurately noted that the “[s]earch for the historical development of joint ventures as a legal concept is intriguing and elusive.”5 Today, the most common definition of either a joint venture or a strategic alliance is a business venture that involves two or more entities working together to achieve mutually agreed on business objectives.6 When companies structure their business relationship as a separate legal entity, such as MillerCoors, the resulting entity generally is referred to as a joint venture.7 In contrast, a contractual arrangement or series of interrelated agreements without the creation of a separate stand-alone legal entity typically is referred to as a strategic alliance.8

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This chapter discusses the legal issues that arise in establishing joint ventures and strategic alliances, as well as the most relevant terms and provisions in the underlying governing agreements embodying such business relationships.

II.

Preliminary Issues in Evaluating a Joint Venture or Strategic Alliance.

Attorneys should advise their clients on various issues that likely will arise in connection

with a potential joint venture or strategic alliance before drafting or negotiating any operative documents. Typical legal issues include (1) antitrust concerns, (2) confidentiality, non-analysis and nondisclosure agreements, (3) preliminary nonbinding term sheets, letters of intent (“LOIs”) or memorandums of understanding (“MOUs”), (4) the form of the resulting legal structure, including if a new entity is involved, the type of entity and jurisdiction under which the entity should be organized, and (5) tax and other regulatory issues.

A.

Antitrust Concerns.

Companies that enter into joint ventures or strategic alliances often are in similar or

complementary industries and hope to achieve strategic synergies. In some cases, however, companies contemplating a joint venture or strategic alliance are either direct competitors or potential competitors, who may be looking for cost-saving measures. In circumstances involving competitors, companies and their counsel must consider carefully whether the proposed arrangement will raise antitrust concerns and ultimately pass regulatory scrutiny.9 For example, it was a certainty that antitrust clearance would be required for the MillerCoors joint venture, which involved the combination of the operations of Molson Coors Brewing Company (representing the third largest market share in the U.S. at the time) with SABMiller (representing the second largest market share in the U.S. at the time).

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countries that may have jurisdiction over the companies or the companies’ products or services.10 For example, in the U.S., both the United States Department of Justice Antitrust Division and the Federal Trade Commission (“FTC”) have responsibility for overseeing the country’s antitrust laws.

The FTC has recognized that while joint ventures may offer many pro-competitive benefits, they also may raise antitrust concerns.11 For example, the FTC has warned that joint ventures may harm consumers because such ventures could result in higher prices or reduced output and that such relationships may be illegal as an attempt by competitors to fix prices.12 To the extent that a joint venture or strategic alliance will require antitrust regulatory approval, it is important to address various issues regarding the antitrust clearance in the definitive documents (e.g., conditions to closing, HSR clearance, etc.). It also may be necessary for the parties to establish a “clean team” under which certain individuals are identified for each company to review sensitive information from the other company, but who are limited in how they may use or share the information with other employees in their own company. Finally, if the proposed joint venture or strategic alliance implicates antitrust issues, additional protection and provisions may need to be built into any confidentiality agreements between the companies.

B.

Confidentiality, Non-Analysis and Nondisclosure Agreements.

As a starting point, any company that is considering a joint venture or strategic alliance

(particularly if a competitor is involved) should ensure that it enters into an agreement that provides sufficient legal protection regarding confidentiality, non-analysis and nondisclosure issues.13

As discussed further below, entering into these agreements can help companies

maintain common law protection of their “trade secrets.”

In negotiating these preliminary agreements, businesses and their attorneys should focus on the following issues:14 17299566v1

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•

the definition of “confidential information” or “proprietary information;”

•

any carve-outs or exclusions from the definition of confidential information;

•

how to treat information or materials disclosed verbally (for example, requiring information to be identified as “confidential information” in a writing sent by the disclosing party shortly after verbal disclosure);

•

permitted use(s) of any disclosed confidential information;

•

to the extent that disclosed confidential materials include items such as chemical formulas or compositions, whether the recipient can analyze or in any way attempt to determine or reverse engineer the materials;

•

the degree of care that a party must use with regard to such disclosed confidential information;

•

parties to whom disclosure is permitted (for example, only to a clean team, or only to employees, consultants, and/or affiliates on a need-to-know basis), including potential disclosure to antitrust regulators;

•

the binding nature of the restrictions on non-signatories (such as employees, consultants and affiliates);

•

disclaimers by the parties (for example, disclaimers regarding the accuracy of disclosed information, agency and partnership disclaimers);

•

anti-waiver provisions regarding attorney-client privilege issues;

•

equitable remedies in the event of a breach;

•

the return or destruction of disclosed confidential information in the event the business relationship is not consummated; and

•

the time period for which confidentiality and/or nondisclosure restrictions continue in place.

In most joint ventures and strategic alliances, the restrictions on the companies regarding use, analysis and disclosure will be mutual because of the joint nature of the relationship.

However, the respective companies to a joint venture or strategic alliance sometimes provide an unequal amount of confidential information and materials. As a result, companies’ interests may

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differ dramatically when negotiating agreements addressing disclosure of confidential information.15 The company that will be disclosing greater amounts of information and materials will want to (1) expand the definition of confidential information, (2) limit the ways in which the recipient may use the disclosed confidential information, (3) limit the persons who have access to the disclosed confidential information, and (4) lengthen the term during which the disclosed confidential information is protected. The company receiving most of the information generally will have the opposite motivation.

Companies should agree on a jurisdiction or body of laws that will control the enforceability of such agreements as well as a venue for any disputes that may arise.

International companies and their attorneys should bear in mind that the laws of each party’s sovereign country are often vastly diverse and that such laws may affect the enforceability of any nondisclosure or confidentiality agreements entered into between the parties. It is common for companies to an international joint venture to select the use of rules promulgated by the International Chamber of Commerce or a similar organization when the parties are unwilling to be governed by the local laws of the jurisdiction of one of the companies.16 C.

Preliminary Term Sheets, LOIs and MOUs. Following the entry of confidentiality agreements, there typically is a period of due

diligence in which the companies engage in investigations of one another. During this time, parties to a possible joint venture or strategic alliance often simultaneously discuss a term sheet, LOI or MOU that sets forth the basic business terms and purpose of the proposed relationship.

It is important for attorneys to be mindful of the issues associated with drafting and executing a term sheet, LOI or MOU, so as to ensure that the document is not determined to be a binding agreement.17 This is the case even more so than in the merger and acquisition arena, 17299566v1

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given that parties are more likely under applicable law to have been deemed to have entered into a general partnership, even if that was not their intention. Companies, of course, generally seek to avoid being part of a general partnership due to the associated liability for partners.18 A term sheet, LOI or MOU typically will cover only significant terms, such as the proposed purpose of the joint venture or strategic alliance, each company’s proposed contributions to the venture, management and control issues and, to the extent applicable, termination and buyout provisions.19 Oftentimes, the term sheet, LOI or MOU will set forth the companies initial contemplated legal structure, although depending on timing considerations this still may be subject to change or refinement based on tax, antitrust or other considerations.

D.

Legal Structure.

There are many ways to structure a joint venture or strategic alliance – which can be both

a major advantage and major disadvantage for the businesses involved. As a result, companies should choose the legal structure carefully to best achieve their desired business objectives. At a high-level, the two most common structural categories are stand-alone joint venture entities or one or more of a series of contractual arrangements (which may or may not include an equity investment component). Each broad category is outlined below in greater detail.

1.

Stand-alone Joint Venture Entity.

Many businesses are structured as classic joint ventures in which each party has an equity stake in a newly created legal entity.20 There are, of course, numerous forms of entities available under various jurisdictions,21 including the states within the U.S. (e.g., corporations, general partnerships, limited partnerships, and limited liability companies (“LLCs”)).22 It is not surprising that the MillerCoors joint venture was structured as a LLC, given the increasing popularity of this form of entity in the U.S.23 Notably, in preparing its Model Joint

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Venture Agreement, the American Bar Association Joint Venture Task Force also opted for a Delaware LLC as the default entity for joint ventures.24 If a new legal entity is contemplated, determination of the type of entity will primarily depend on limited liability, tax, employee and financing considerations, as well as the likely exit or liquidity strategy.25 Many businesses that wish to create a joint venture entity in the Untied States find LLC and S-Corporation entities to be appealing as they offer insulation for owners from liability derived from the joint venture.26 Also, unlike C-Corporations, LLCs and SCorporations are not subject to double taxation (once at the corporate level and once at the shareholder level); instead, the tax burden in LLCs and S-Corporations generally “flow-through” to the owners of such entity without being taxed at the corporate level.27 A company’s desire to obtain outside financing from venture capital or private equity funds is an important, yet overlooked, consideration when parties determine the initial legal structure of their relationship. Under the rules for S-Corporations, entities such as funds (which tend to be limited partnerships) are not qualified to be S-Corporation shareholders; similarly, foreign residents are disqualified from being S-Corporation shareholders.28 Additionally, some private equity and venture capital funds avoid investing in LLCs for various other reasons.29 First, private equity and venture capital funds seek as much certainty as possible in their investments.30 Corporations, particularly those formed in Delaware, have a long history of case law which provides greater predictability with respect to director duties and shareholder rights.31 Second, these types of funds typically seek to have some measure of control through director representation on the portfolio company’s board, which while possible through LLCs, is structurally somewhat more difficult.

Third, many funds (particularly those with foreign

investors) have restrictions in their fund documents that prohibit investments in flow-through

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entities because of certain adverse U.S. income tax consequences to their limited partners. Also, institutional investors that fund venture capital projects sometimes are tax-exempt organizations which makes any potential tax benefit from flow-through losses meaningless.32 Finally, venture capital funds typically seek for ways to enhance cash flow. If the net operating losses of the company have flowed through to investors, the losses sustained by the company are no longer available to the enterprise.33 Some commentators suggest that the tax benefits that are realized by starting out as an LLC outweigh the transaction costs of later restructuring a U.S. LLC when another entity type is required.34 In any event, companies in a joint venture should weigh tax, financing and other legal considerations carefully in determining the initial form of legal entity. For example, a joint venture that can be financed by a few key individual investors may be a good candidate for initial organization as an LLC or an S-Corporation; however, a company that will likely require venture capital, private equity, institutional, or foreign investors (or which plans to go public through an initial public offering) may be better suited to commence operations as a CCorporation.35 Joint venture entities often allow companies greater flexibility and the ability to change the nature of the relationship as it evolves because the companies’ relationship primarily is based on their mutual financial interests in making the joint venture entity successful, rather than specific contractual obligations. As a result, and as opposed to contractual-based forms of strategic alliances, companies can more quickly and easily change the direction or nature of the joint venture entity in accordance with evolving business conditions and realities.

2.

Contractual Strategic Alliance Agreement(s).

Companies structure many strategic business relationships as one or a series of contractual agreements to provide certain resources, products or services to one another.36 These 17299566v1

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business arrangements work well in cases where each company’s contribution is easy to define and is unlikely to change as the relationship evolves, or where the parties want to be able to “divorce” and terminate their joint relationship without much difficulty. Common examples of contractual strategic alliances vary by industry, but include joint development, supply, distribution and licensing agreements. While contractual strategic alliances give each company control over its obligations, the operative agreements generally do not provide much flexibility if the nature of the relationship changes.

Where companies have a high degree of trust in one another, the contractual arrangements can be very informal, although the parties may be exposed to some legal risk. For example, Hewlett-Packard and Canon previously established a successful longstanding strategic relationship in their laser printer alliance, which operated for more than twenty years without any formal contract between the companies.37 3.

Contractual Agreement(s) that Include an Equity Investment Component.

Many contractual strategic alliances include an equity investment component in addition to business agreement(s), particularly in the technology industry where startups and emerging growth companies often seek to partner with larger, more-established businesses with greater access to capital.38 To the extent that a company issues equity (or warrants to acquire equity) as consideration for entering into the strategic alliance, parties and their counsel must be cognizant of any relevant state, federal and international securities laws and regulations.

In exchange for an equity investment, a strategic investor often receives (1) representation on the underlying company’s board of directors and/or a right to have an observer at board and board committee meetings, (2) an option to increase its investment in the underlying company in later financing rounds, (3) priority or distribution rights on the product, technology

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or service being developed by the underlying company, or at a minimum, “most favored nations” pricing for itself and its affiliates,39 and/or (4) a right of first refusal on any sales of the underlying company itself or its key assets, such as technology.40 With the significant decline in institutional venture capital fund investments in recent years,41 many companies have used strategic alliances with equity investment components to provide the necessary capital to operate their businesses.42 In addition, a smaller company often benefits from the credibility gained by its association with a more-established company with whom it has simultaneously expanded its business relationship.43 The principal benefits to a larger established company of making an equity investment as part of a strategic alliance include (1) access to a new product, service or technology without expending the often greater funds necessary to internally develop the product, service or technology, (2) possibly preventing competitors from acquiring a valuable product, service or technology, and (3) creating an opportunity to later acquire the entire company if the product, service or technology proves to be commercially successful.44 E.

Tax and Regulatory Issues.

Tax consequences of the proposed joint venture or strategic alliance structure often are a

determinative factor in the ultimate legal structure or form of legal entity. In addition, depending on the type of companies involved, the nature of their business operations (e.g., regulated industries such as financial services, telecommunications, or public utilities), or if parties are from different international jurisdictions, a joint venture or strategic alliance may implicate state, federal or international regulatory issues.

In certain circumstances, a company may be

prohibited from entering into a classic joint venture by the company’s commercial debt documents. Finally, from an operational standpoint, a joint venture or strategic alliance may

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have implications on a participant’s existing operations and reporting requirements, including reporting rules of applicable securities exchanges.

III.

Key Terms and Provisions in Governing Documents.

The specific provisions of any joint venture or strategic alliance necessarily will vary depending on the companies that are involved and the nature of the business relationship.45 There are a number of terms that attorneys regularly face in drafting and negotiating the operative legal documents. These generally fall into the following categories: (1) operational business terms; (2) financial provisions; (3) corporate governance clauses; and (4) deadlock, dispute resolution and exit terms. Each of these categories is discussed further below.46 A.

Operational Business Terms.

1.

Scope of Business Operations.

The governing documents typically identify the purpose, scope and limits, if any, of the proposed business operations. This may be important if antitrust or other foreign governmental review is anticipated. To the extent that the companies (or their affiliates) are providing different types of support or services, care should be taken to ensure that these are properly identified in the relevant agreements.

2.

Contribution of Assets and Assumption of Liabilities.

Joint ventures and strategic alliances often are driven by a mutual desire to obtain access to another company’s resources, technology or other assets. As a result, it is important to agree on the assets that each company will contribute to the arrangement.47 As a condition to entering into a joint venture or strategic alliance, one or both of the companies often requires the other company to make certain representations and warranties about the assets (as well as any accompanying liabilities) it will contribute to the relationship or about its capabilities.48

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In cases where one or both of the companies contribute tangible assets (including cash or accounts receivable), drafting the governing documents generally is straightforward. In other cases, one or both of the companies may contribute intellectual property or other intangible assets that are not easily quantifiable or identifiable. In such cases, the companies should establish a valuation methodology or agree upfront to the valuation for the intangible assets.49 Just as in the merger and acquisition context, to the extent a new legal entity is being created, it is important for the parties to understand the liabilities, if any, that will be assumed by the joint venture. Both parties should carefully review any representations or warranties (and the accompanying disclosure schedules) as they relate to liabilities being assumed by a joint venture entity, particularly liabilities that are not readily apparent from a balance sheet.

3.

Intellectual Property.

Companies involved in a joint venture or strategic alliance need to determine how to protect, control and allocate any intellectual property (including confidential and proprietary information) that is contributed to, or developed during the course of, the relationship.50 The definitive documents should address many of the same issues previously discussed with regard to confidentiality, non-analysis and nondisclosure agreements.51 Companies also may want to provide that all employees and consultants with access to confidential information during the course of the joint venture or strategic alliance execute a separate stand-alone confidentiality agreement. In the case of a classic joint venture, these agreements also should include a provision assigning any new intellectual property and inventions to the joint venture entity.52 By executing such agreements, the parties increase the chances that a reviewing court or arbitrator will allow confidential information to retain its trade secret status. Although there is no federal law in the U.S. that protects trade secrets, most states have enacted the Uniform Trade 17299566v1

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Secret Act (“UTSA”).53 Under the UTSA, to prevail in a trade secret lawsuit, as a general matter, a company must establish four elements: (1) the information had economic value; (2) the information was not generally known to individuals with a legitimate means to discover the information; (3) the information was misappropriated; and (4) the information was guarded in a reasonable manner under the circumstances.54 In the international context, countries have diverse laws with respect to intellectual property protection. Both the North American Free Trade Agreement (“NAFTA”) and the Trade-Related Aspects of Intellectual Property Rights Agreement (“TRIPS”) promulgated by the World Trade Organization, follow the general tenets of trade secret law under UTSA, and may be used by parties in international joint ventures and strategic alliances to protect trade secrets.55 A party seeking trade secret protection may have difficulty in convincing a court or arbitrator to recognize such protection if it fails to require parties with access to the confidential information to execute confidentiality and nondisclosure agreements.

In lieu of contributing intangible assets, a company may license its intellectual property to either the other company or to a newly formed joint venture entity. The license may be utilized on a royalty-free basis or for a negotiated fee, oftentimes subject to a most-favored nations provision. The licensing company generally places limits on how the joint venture entity or the other company uses the licensed intellectual property so as not to harm its reputation or dilute the value of the intellectual property.56 Typically, any license expires automatically upon the termination of the joint venture or strategic alliance.57 Finally, the governing documents should address how ownership of any new intellectual property that is developed in the course of the joint venture or strategic alliance is allocated. In particular, in a joint venture entity where the newly created intellectual property is the property

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of the joint venture entity, the operative documents should discuss ownership of new intellectual property once the joint venture entity subsequently is liquidated or otherwise dissolved.58 4.

Restrictions on Solicitation and Competition.

In any joint venture or strategic alliance there is an increased risk that once a company’s employees start to work closely with a joint venture partner, the employees will be recruited to join the partner’s organization. For this reason, the operative agreements (and in some cases even initial confidentiality, non-analysis and nondisclosure agreements) may contain a mutual non-solicitation provision restricting each company’s ability to recruit directly or indirectly the other company’s employees.59

These provisions need to be carefully drafted to ensure

enforceability under applicable law.

Companies that enter into a joint venture or a strategic alliance also often desire to tie up their strategic partner, either through restrictions on competition or exclusivity provisions.60 Such clauses may raise antitrust concerns or otherwise be unenforceable under applicable law.61 As an alternative to such terms, joint venture or strategic alliance agreements occasionally provide for most favored nations provisions.62 B.

Financial Provisions.

The definitive documents with respect to either a joint venture or strategic alliance will

need to address the parties’ economic agreement and possible future financing objectives.

1.

Distribution of Profits or Revenues.

Where companies structure the business venture as a joint venture entity or a strategic alliance with an equity investment component, the companies often share profits or revenues prorata based on their respective equity interest percentages. Conversely, where one company contributes more cash to the relationship, that company may receive a priority on the distribution

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of profits or revenues.63 Companies should be aware that foreign law may require a certain allocation method of profits where at least one party to the joint venture is a foreign investor.64 Where a strategic alliance is structured through one or more contractual arrangements, allocation of profits or revenues can take a variety of forms, such as a sales commission payable from one company to the other company or as a royalty or license payment.65 Tax counsel generally should be involved at the initial stages of structuring profit and revenue allocations.

2.

Subsequent Financings.

Many joint ventures or strategic alliances contemplate ongoing financing from the participants. In some cases, a company that initially contributes cash in exchange for equity will receive priority rights to purchase additional equity in the venture at a later date. These rights may take the form of a pro-rata participation right in any future debt or equity financings or as a warrant or option (which involve both securities and tax law issues).

In other cases, one or both of the companies may have an obligation to provide future financing to the venture. Sometimes these obligation(s) are conditioned on the achievement of specified milestones.66 In these cases, it is important for the operative documents to set forth objectively measurable and clear milestones. Another option is for the agreements to provide for alternative or tiered milestones, whereby if only a lower level is achieved, the obligation of the company investing funds is discounted by a pre-negotiated amount.

It is fairly common for joint venture agreements to provide for penalties in the event that one party does not provide additional financing that has been approved or is required under the operative documents. Some of these provisions, such as terms that provide for dilution of the non-contributing member, may not be enforceable under the applicable laws of certain foreign jurisdictions.

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The terms of the definitive documents also may include rights of first refusal or preemptive rights in cases where the business venture seeks additional debt or equity financing from an outside source.67 In certain circumstances, one or more of the participants may have a veto right over subsequent financings.

C.

Corporate Governance Clauses.

The legal mechanisms that companies choose to allocate corporate governance control

over a joint venture or strategic alliance generally depend on the legal structure of the business relationship.

1.

Control and Management.

Where a new legal entity or a strategic alliance with an equity investment component is involved, the definitive documents normally address the size and representation on the joint venture’s or the entity’s board of directors or similar governing body.68 To the extent that there is a formal board of directors or managers, the parties should consider whether indemnification or D&O insurance is appropriate for such individuals. Persons serving in dual capacities as a director or manager for a stand-alone joint venture entity and for an investor in the joint venture may face difficult and sometimes irreconcilable fiduciary duties, depending on the provisions of the definitive documents or applicable law. For example, there may be “corporate opportunities” that a director is required to disclose and first allow the joint venture entity to pursue.69 Sometimes the definitive documents will require approval from one or both of the companies (or their representatives) with respect to certain actions — such as changes to the services, products or technology being developed, capital contributions, the incurrence of debt, capital expenditures above a designated amount, or the sale or bankruptcy of a joint venture entity.70

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Where the strategic alliance is structured as one or more contractual agreements to provide certain services, products or other technology, with no accompanying equity investment component, the companies generally have less ability to manage or control one another’s business. In these cases, the governing documents often provide for less formal meetings and communications between the parties and/or mutual approval only for changes in the way that the joint services or products are developed, marketed, distributed or sold.71 2.

Reporting and Access to Information.

It is typical for joint ventures and strategic alliances agreements to include provisions regarding reporting and information rights for the participants. In a joint venture entity or a strategic alliance that includes an equity investment component, the reporting obligations might require that full financial statements be provided on a quarterly and/or annual basis to the investing party.72 For legal entities, access to information requirements typically are established under applicable law, although parties sometimes are permitted to vary the default provisions by contract. In situations where a strategic alliance is limited to a portion of an entity’s business, such as the distribution or licensing of a particular product, the reporting obligations similarly may be limited to an accounting of sales and marketing costs of the specific product.

3.

Other Governance Provisions.

Many joint ventures or strategic alliance agreements will set forth the process for the creation and approval of annual business or marketing plans or budgets.

In addition, the

governing documents often identify the auditors and accountants for the business relationship or the process for selecting such parties. Finally, publicity and press release provisions often are heavily negotiated in joint venture and strategic alliance agreements.

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D.

Deadlock, Dispute Resolution and Exit Terms.

According to some studies, the failure rate of joint ventures and strategic alliances may

be as high as 70 percent.73 As a result, companies likely will disagree at some point about the purpose, direction or division of the assets or liabilities involved in the business relationship.

Accordingly, attorneys preparing and negotiating the definitive agreements should carefully consider the clauses that are most likely to lead to disagreement and should attempt to address those issues as well as the legal remedies associated with default and/or deadlock. For example, the parties should consider the legal remedies that will be available if a company fails to meet its obligation(s) to provide the assets or ongoing capital necessary to operate the business venture.

1.

Remedies for Defaults.

By their nature, joint ventures and strategic alliances typically require flexibility.74 Many obligations of the parties involve ambiguous “agreements to agree” on the future direction of, or commitments to, the business relationship,75 particularly where companies from different jurisdictions are involved that have cultural and legal differences.76 It can become easy for one company to shirk its obligations to support the business venture without technically breaching any provisions of the governing documents.77 While there may be non-contractual reasons for a company to act in good faith, such as maintaining its industry reputation, attorneys should draft provisions in the operative documents to incent each company to support the business venture.78 A common solution is to bundle together commitments, so that one company’s commitment to perform a particular obligation is conditioned on the other company’s performance of a prior or contemporaneous obligation.79 An alternative is to provide reciprocal penalties such that the parties find themselves in a “mutual hostage” situation if the business relationship deteriorates.80 Even if these penalties, such as liquidated damages, are difficult to legally enforce, the threat of litigation (along with uncertainty and cost) may motivate the 17299566v1

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companies to work out their differences in good faith.81 Finally, companies sometimes establish reciprocal rewards under the governing documents to the achievement of important milestones (for example, expanding a license if specified sales milestones are achieved).82 2.

Deadlocks.

Deadlocks in a joint venture or strategic alliance typically arise when the companies’ relationship becomes strained and one or both companies stop cooperating on the business venture or when a decision expressly requires joint agreement of the two companies.83 There are a few common procedures for attempting to avoid or resolve deadlocks.

First, the parties can agree that “high-level” executives, sometimes identified by name or position in the operative documents, will attempt to resolve any deadlocked issues or other disputes that have been escalated to their attention.84 This “escalation” mechanism often is relatively quick and inexpensive, however, there is no guarantee it will actually resolve a deadlock, particularly if one of the companies has decided that it is unwilling to reach agreement, or in the event that one party simply refuses to attend the escalation meeting(s).

Second, companies can agree to mediation or arbitration with a third party.

Occasionally, this process can be confrontational, which can negatively impact an otherwise solid business relationship between the companies.85 Moreover, in many cases, mediation or arbitration is just as expensive and time consuming as litigation.

Third, in cases where the relationship is structured as a joint venture entity or where there is an equity investment component, the definitive documents can include a mechanism whereby one company can buy out the other company in order to resolve the deadlock or terminate and liquidate the joint venture.86

The mere presence of buyout mechanisms in the operative

documents, which are discussed in greater detail below, can provide certainty of resolution to

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any deadlock and as a result also often may incent the companies to work out their differences before the buyout or termination/liquidation clauses are actually invoked.

3.

Transferability.

Due to the unique nature of the business relationship that leads companies to enter into a joint venture or a strategic alliance in the first place, the operative agreements often prohibit either company from assigning its rights or interests under the agreements to an unrelated third party.87 Because joint ventures and strategic alliances are relationship driven, the assignment provisions also often include broad “change in control” language which treats any fundamental corporate change, whether through acquisition or otherwise, as an assignment which requires prior consent for the relationship to continue in place. In some cases, a change of control may trigger financial penalties or other termination rights.

To the extent that the companies do not completely prohibit transfers of equity interests in an entity, the governing documents may provide for alternatives in the case of proposed transfers of an equity interest, such as: •

rights of first offer or rights of first refusal before a party can sell its equity interest to an unrelated third party;

•

tag-along or drag-along provisions with respect to the sale of equity interests;88 and/or

•

put or call rights pursuant to which one party has the pre-negotiated right to purchase an equity interest or force a purchase of an equity interest in the joint venture.

4.

Termination and Buyouts.

Companies often do not intend for a joint venture or strategic alliance to last forever. As a result, the governing documents may contain a termination date, at which time the contractual 17299566v1

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arrangements will terminate or in the case of a classic joint venture, one party will buy out the other’s equity interest or the entity will be dissolved and liquidated.

Buyout provisions generally are difficult for companies to negotiate in advance because the companies may not be able to predict accurately when the buyout may occur or the value of the joint venture or strategic alliance at such time. To the extent the companies desire to provide for a buyout clause, it is important to accurately memorialize a valuation method based on the likely foreseeable contingencies with respect to the joint venture’s assets, brand reputation and goodwill. If ownership in the joint venture is not 50-50, minority and marketability discounts need to be addressed in the valuation methodology. Drawn-out litigation or arbitration regarding the proper valuation method could upset the operations and reputation of the joint venture in a dramatic way and become onerously expensive. Some typical solutions are to agree that the valuation will be based on profits, EBITDA (earnings before interest, taxes, depreciation and amortization), revenues at the time of the buyout or to have a third-party appraiser calculate or determine the valuation.89 As an alternative, the governing documents could contain an “auction” or “shotgun” provision as a buyout mechanism. Under these types of clauses, one company initiates the process by proposing to buy out the other at a specified valuation, and the other company must agree to sell or buy at that price (in the case of a shotgun provision) or begin an auction by proposing to buy out the other at an increased valuation (in the case of an auction provision).90 Depending on the nature of the business relationship and the companies involved, there may be regulatory issues and approvals associated with any termination of the joint venture or strategic alliance. To the extent the termination of the joint venture results in the cessation of

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business operations, the companies need to address how the operations will be wound down and how any shared assets and liabilities (including third-party debt) will be allocated or satisfied.

Companies also should consider which rights or obligations will survive the termination of the business relationship, which often include restrictive covenants, confidentiality provisions, and indemnification obligations.91 Finally, the governing documents should address the formal termination or dissolution of the joint venture or strategic alliance.

E.

Miscellaneous Provisions in Operative Agreements.

Many governing documents will contain indemnification obligations for losses caused by

a company’s actions, products or services which must be carefully reviewed. Whether or not indemnification clauses are mutual in scope may vary based on the companies and the nature of the business venture. As with most commercial agreements, attorneys drafting joint venture or strategic alliance documents should review carefully the standard boilerplate legal provisions in the context of their client’s goals and the nature of the business relationship. Finally, as discussed above, governing law and venue provisions are critical terms in the operative documents, particularly for international joint ventures.

IV.

Conclusion.

As joint ventures and strategic alliances continue to gain in popularity, attorneys will need to be conversant in the many legal issues involved in establishing and drafting the governing documents for such business relationships. To increase the possibility of success, the definitive agreements must carefully balance the flexibility required to allow the relationship to evolve while clearly specifying each company’s legal rights and obligations. It is important for attorneys to understand and be continually mindful of the desired business objectives of their clients while drafting and negotiating the relevant operative documents.

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1

E. Lee Reichert is General Counsel for Molson Coors International, where among other things, he overseas the company's international joint venture activities. Robert M. Fogler is a principal in Thousand Hills Venture Fund, L.P., a private equity fund that focuses its investments in Africa. The authors would like to recognize and express their gratitude for the invaluable assistance of Seth S. Gomm in researching and preparing this chapter, which is based in part on some of the issues discussed in an earlier article published in 2002 by the authors in The Colorado Lawyer regarding U.S. joint ventures. See generally Robert M. Fogler & E. Lee Reichert, Establishing Strategic Alliances and Joint Ventures, 31 COLO. LAW 65 (2002).

2 David T. Robinson & Toby E. Stuart, Network Effects in the Governance of Strategic Alliances, 23 J.L. ECON. & ORG. 242 (2007); Atif I. Azher, Antitrust Regulators and the Biopharmaceutical Industry: Compulsory Licensing Schemes Ignoring Gene Therapy Patients’ Needs, 25 U. PA. J. INT’L ECON. L. 383, 384 (2004); Richard J. Hoskins, Antitrust Analysis of Joint Ventures and Competitor Collaborations: A Primer for the Corporate Lawyer, 10 U. MIAMI BUS. L. REV. 119 (2002).

3 See generally Joint Venture Agreement, dated as of December 20, 2007 by and among Molson Coors Brewing Company, Coors Brewing Company, SABMiller plc, and MillerCoors, LLC, http://www.sec.gov/Archives/edgar/data/24545/000110465907090365/a07-31930_1ex10d1.htm. As a matter of disclosure, Mr. Reichert represented Molson Coors Brewing Company in connection with certain aspects of the MillerCoors joint venture.

4 See Harold S. Bloomenthal, The Evolution of the Uranium Joint Venture: Uranium Exploration and Development 8-1 ROCKY MT. MIN. L. FDN. (1976); see generally John Heronimus, Joint Ventures are Dead!: The LLC is the Form of Entity that Best Serves Your Needs, in LLCS, LLPS AND PARTNERSHIPS: ORGANIZATION AND OPERATION (Lorman 2008).

5 Henry W. Nichols, Note, Joint Ventures, 36 VA. L. REV. 425, 425 (1950).

6 Fogler & Reichert, supra note 1, at 65; see also 2 Jacob Rabkin & Mark H. Johnson, Current Legal Forms with Tax Analysis Section 2.01(1998) (noting that a joint venture involves “special combinations of two or more persons for a specific undertaking, in which a profit is jointly sought without any partnership designation as such and without intent to pursue a general or continuing business”); see generally RICHARD D. HARROCH, START-UP AND EMERGING COMPANIES § 25.01 (2d vol. 1999); Mary C. Szto, Strategic Alliances: Legal and Ethical Challenges, 16 REGENT U. L. REV. 351, 355 (2004).

7 Rachelle C. Sampson, The George A. Leet Business Law Symposium: The Role of Lawyers in Strategic Alliances, 53 CASE W. RES. L. REV. 909, 913 (2003); David E. Brown et al., Strategic Alliances: Why, How, and What to Watch For, 3 N.C. BANKING INST. 57, 71 (1999).

8 Sampson, supra note 7 at 913; see generally Harroch, supra note 6 at § 25.05. A strategic alliance can be embodied in or represented by a variety of agreements, including the following: co-marketing, distribution, affiliate, joint research, joint development, content licensing, and co-branding agreements. See generally THE JOINT VENTURE TASK FORCE OF THE NEGOTIATED ACQUISITIONS COMMITTEE OF THE BUSINESS LAW SECTION OF THE AMERICAN BAR ASSOCIATION, MODEL JOINT VENTURE AGREEMENT WITH COMMENTARY (ABA Section of Business Law 2006).

9 See generally Hoskins, supra note 2; See also Robert H. Wood, Something Radical is Afoot: Texaco, Inc. v.

Dagher and the Revolutionary Treatment of Price Fixing in the Joint Venture Context, 8 BARRY L. REV. 1, 7 (2007).

10 The Georgetown University Law Library maintains a useful website for navigating the various antitrust issues that may arise in the course of establishing a joint venture.

See http://www.ll.georgetown.edu/guides/intlAntitrustLaw.cfm.

11 Wood, supra note 9 at 7.

12 Id. 13 Szto, supra note 6 at 354.

14 See generally MODEL JOINT VENTURE AGREEMENT WITH COMMENTARY, supra note 8 at 359-379.

15 See generally Lesser, Lederer, and Steinberg, Increasing Pressures for Confidentiality Agreements that Work, MERGERS & ACQUISITIONS: THE DEALMAKERS J., March/April 1992.

16 The International Chamber of Commerce rules and regulations are available at http://www.iccwbo.org/display7/doctype6/index.html.

17 Markus May, Preparing the Pre-acquisition Documents Related to a Business Sale or Purchase, 19 DCBA BRIEF 10, 13-14 (2007); Szto, supra note 6 at 354; See generally NEGOTIATED ACQUISITIONS: HOW TO WIN A FAVORABLE POSITION FOR YOUR CLIENT IN A BUSINESS ACQUISITION WITH THE LETTER OF INTENT 31-35 (Chicago, IL: ABA, Center for Continuing Legal Education and Section of Business Law, 1997).

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18

The typical definition of a partnership is “an association of two or more persons to operate a business as coowners for a profit.” See generally MODEL JOINT VENTURE AGREEMENT WITH COMMENTARY, supra note 8.

19 Michael E. Hooton, Structuring and Negotiating International Joint Ventures, 27 CREIGHTON L. REV. 1013, 101920 (1994). For a sample joint venture term sheet and LOI, see MODEL JOINT VENTURE AGREEMENT WITH COMMENTARY, supra note 8 at 343-51; Harroch, supra note 6 at §§ 25.07, 25.08; May, supra note 17 at 13-14.

20 Brown, supra note 7 at 71; Szto, supra note 6 at 355.

21 In the international context, joint ventures often are organized as corporate type entities. Following are some examples of such commonly used entities: (i) Aktiengesellschaft or A.G. (Germany); (ii) Societe Anonyme or S.A. (France, Switzerland, Belgium); (iii) Societa Anonima or S.A. (Italy); (iv) Sociedad Anonima or S.A. (Spain, Mexico, Latin America); (v) Naamlooze Vennootschaap or N.V. (Netherlands, Netherlands Antilles); (vi) Kabushiki Kaisha or K.K. (Japan); and (vii) British PLC. ALAN GUTTERMAN, A SHORT COURSE IN INTERNATIONAL JOINT VENTURES: NEGOTIATING, FORMING AND OPERATING THE INTERNATIONAL JOINT VENTURE 59 (World Trade Press 2001).

22 Szto, supra note 6 at 355.

23 One commentator noted that “Professor Eisenberg reports that in ‘2002, there were 946,000 LLCs in the United States . . . . During the period 1996-2002, the number of LLCs increased more than 400%.’ Melvin Aron Eisenberg, Corporations and Other Business Organizations 499 (9th ed. 2005). For 2005, there were 1,456,125 limited liability companies in the United States, which amounted to a 91.5% increase over the number of LLCs in 2002. BizStats website, http:// www.bizstats.com/reports/industry-sales-firm-summary.asp (last visited Sept. 10, 2008).” Rutheford B. Campbell, Jr., The “New” Fiduciary Standards Under the Revised Uniform Limited Liability Company Act: More Bottom Bumping From NCCUSL, 61 ME. L. REV. 27, 31-32, n.21 (2009). See also Eric Reagan, Tennessee’s New Limited Liability Company Act: New Ways of Doing Business, 73 TENN. L. REV. 267, 268 (2006); Larry E. Ribstein, The Choice of Entity for Entrepreneurs 26 CAP. U. L. REV. 325, 331 (1997).

24 MODEL JOINT VENTURE AGREEMENT WITH COMMENTARY, supra note 8 at 38; 25 Id. at 7; see generally Brown, supra note 7 at 71; Szto, supra note 6 at 357; D. Gordon Smith, The Exit Structure of Strategic Alliances, 2005 U. ILL. L. REV. 303 (2005).

26 Richard A. Mann et al., Starting From Scratch: A Lawyer’s Guide to Representing a Start-up Company, 56 ARK. L. REV. 773, 800 (2004).

27 Id. at 799.

28 26 U.S.C. § 1361(b)(1) (2008).

29 Mann, supra note 26 at 803; see also J. William Callison, Venture Capital and Corporate Governance: Evolving the Limited Liability Company to Finance the Entrepreneurial Business, 26 J. CORP. L. 97, 98 (2000); Eric W. Shu, Piercing the Veil in California LLCs: Adding Surprise to the Venture Capital Equation, 45 SANTA CLARA L. REV. 1009, 1023-24 (2005); Jeff Stewart, The Nanotech University Spinout Company: Strategies for Licensing, Developing, Commercializing and Financing Nanotachnology, 2 NANOTECHNOLOGY L. & BUS. 365, 366 (2005).

30 Mann, supra note 26 at 803.

31 Id. at 805-06; Stewart, supra note 29 at 366; see generally William B. Chandler III & Anthony A. Rickey, Manufacturing Mystery: A Response to Professors Carney and Shepherd’s “The Mystery of Delaware Law’s Continuing Success”, 2009 U. ILL. L. REV. 95 (2009) (responding to criticism of the use of Delaware law for most publicly traded companies); E. Lee Reichert & John R. Chadd, Dissenters’ Rights: The Colorado Supreme Court Finally Speaks, 34 COLO. LAW 53, 62 n.58 (2005).

32 Mann, supra note 26 at 805.

33 Id. 34 Id. at 804; Ribstein, supra note 23 at 331.

35 Mann, supra note 26 at 805.

36 Greer L. Phillips & Joy Taylor, Model for Cross-Border Joint Ventures, 83 Tax Notes 115 (April 5, 1999); see also MODEL JOINT VENTURE AGREEMENT WITH COMMENTARY, supra note 8 at 5-6.

37 Szto, supra note 6 at 356.

38 Howard H. Chang et al., Some Economic Principles for Guiding Antitrust Policy Towards Joint Ventures, 1998 COLUM. BUS. L. REV. 223, 233 (1998); Szto, supra note 6 at 355.

39 Under most favored nations provisions, a company agrees to treat its business partner at least as well as any third party with respect to certain, agreed-upon provisions, which typically include pricing terms. See generally Jonathan A. Mukai, Joint Ventures and the Online Distribution of Digital Content, 20 BERKELEY TECH. L.J. 781, 806 n.144 (2005) (explaining that “Most Favored Nation clauses ‘are standard devices by which buyers try to bargain for low prices, by getting the seller to agree to treat them as favorably as any of their customers.”).

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40

Harroch, supra note 6 at § 25.05[2].

Venture Capital Investment Plummets in Q1 2009 to 12-Year Low, According to the MoneyTree Report, REUTERS, Apr. 18, 2009, http://www.reuters.com/article/pressRelease/idUS32198+18-Apr-2009+MW20090418.

42 Szto, supra note 6 at 355.

43 Brown, supra note 7 at 70; David T. Robinson & Toby E. Stuart, Financial Contracting in Biotech Strategic Alliances, 50 J.L. & ECON. 559, 592 (2007).

44 Harroch, supra note 6 at §§ 25.02, 25.05[2].

45 In the international context, drafting attorneys should be cognizant of cultural and legal practice differences in the process of drafting the governing documents. One commentator notes, “[i]n addition to foreign law considerations, a more subtle issue of cross-border alliance includes the amount of documentation American lawyers normally produce.

While this recordkeeping may merely be annoying to American businesspeople, it may be incomprehensible to those in other countries. A cultural interpreter may be necessary to explain the nature of the documentation.” Szto, supra note 6 at 360.

46 MODEL JOINT VENTURE AGREEMENT WITH COMMENTARY, supra note 8 at 359-379.

47 Zenichi Shishido, Conflicts of Interest and Fiduciary Duties in the Operation of a Joint Venture, 39 HASTINGS L.J. 63 (1987).

48 Harroch, supra note 6 at §§ 25.05[1], 25.07. When deciding which representations and warranties to require from the other company, a party should determine what facts are being relied on to enter into or invest in the joint venture or strategic alliance. As a general matter, the representations and warranties in a strategic alliance agreement typically are less extensive than those seen in the merger and acquisition context.

49 Hooton, supra note 19 at 1023.

50 For a list of some of the issues that may arise in connection with shared intellectual property, see Steven R. Salbu & Richard A. Brahm, Strategic Considerations in Designing Joint Venture Contracts, 1992 COLUM. BUS. L. REV. 253, 274-75 (1992).

51 See supra notes 13-16 and accompanying text; see generally Harroch, supra note 6 at §§ 25.05[5], 25.07.

52 Harroch, supra note 6 at § 25.07.

53 Mann, supra note 26 at 779.

54 Id. at 779-80.

55 R. Mark Halligan, Protection of U.S. Trade Secret Assets: Critical Amendments to the Economic Espionage Act of 1996, 7 J. MARSHALL REV. INTELL. PROP. L. 656, 671 (2008). There are currently 153 member nations of the World Trade Organization who would be subject to TRIPS. See http://www.wto.org/english/theWTO_e/whatis_e/tif_e/org6_e.htm. Canada, United States and Mexico are counties that are parties to NAFTA. See http://www.fas.usda.gov/info/factsheets/NAFTA.asp.

56 Brown, supra note 7 at 73-74; see also Kurt M. Saunders, The Role of Intellectual Property Rights in Negotiating and Planning a Research Joint Venture, 7 MARQ. INTELL. PROP. L. REV. 75, 76-78, 80 (2003).

57 Hooton, supra note 19 at 1029; see also Saunders, supra note 56 at 80. For a list of issues that should be addressed in such a licensing agreement, see Harroch, supra note 6 at § 25.05[6].

58 Szto, supra note 6 at 354.

59 See Harroch, supra note 6 at § 25.10.

60 Thomas A. Piraino, Jr., The Antitrust Analysis of Joint Ventures After the Supreme Court’s Dagher Decision, 57 EMORY L.J. 735, 802-03 (2008); Brown, supra note 7 at 86-87.

61 Hooton, supra note 19 at 1029-30.

62 Harroch, supra note 6 at § 25.07.

63 The priority return could be structured in the form of preferred stock or a promissory note. See generally id. at § 25.05[1].

64 See Jessica Zoe Renwald, Foreign Investment Law in the People’s Republic of China: What to Expect from Enterprise Establishment to Dispute Resolution, 16 IND. INT’L & COMP. L. REV. 453, 463-64 (2006) (discussing the allocation of profits derived by certain types of joint ventures in China that often affect foreign investors); see also Dennis Hie, Shareholder Agreements and Joint Ventures in the PRC, HONG KONG L.J. 313, 314 (2008).

65 See Brown, supra note 7 at 72-74.

66 Id. 67 Harroch, supra note 6 at § 25.05[5].

68 Salbu & Brahm, supra note 50 at 291; Brown, supra note 7 at 87; see also Pearlie Koh, Note, The Nominee Director’s Tangled Lot: Jenton Overseas Investment Pte. Ltd. v. Townsing Henry George Golden Village Multiplex Pte. Ltd. v. Phoon Chiong Kit, 2007 SING. J. LEGAL STUD. 148, (2007); Sampson, supra note 7 at 914.

41

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69

Similar conflicting fiduciary duty issues may arise for contractual strategic alliances that include an equity investment component. Szto, supra note 6 at 358-59; Stephen Fraidin & Radu Lelutiu, The George A. Leet Business Law Symposium: Strategic Alliances and Corporate Control, 53 CASE. W. RES. L. REV. 865, 874-77 (2003).

70 Salbu & Brahm, supra note 50 at 291-92; Brown, supra note 7 at 81-83.

71 See, e.g., Harroch, supra note 6 at § 25.05[4]; Brown, supra note 7 at 83-85.

72 Hooton, supra note 19 at 1026; Salbu & Brahm, supra note 50 at 293; see also Brown, supra note 7 at 89-90.

73 Piraino, supra note 60 at 740; Thomas A. Piraino, A Proposed Antitrust Approach to High Technology Competition, 44 WM. & MARY L. REV. 65, 130, 130 n.259 (2002); See generally Jeffrey B. Kaufmann, The Termination of Joint Ventures: How Does the Dance End?, 4 N.C. BANKING INST. 287 (2000).

74 Steven R. Salbu, Joint Venture Contracts as Strategic Tools, 25 IND. L. REV. 397, 399-402 (1991); see also George W. Dent, The George A. Leet Business Law Symposium: The Role of Lawyers in Strategic Alliances, 53 CASE. W. RES. L. REV. 953, 957-58 (2003).

75 Salbu, supra note 74 at 399-402.

76 See Orde F. Kittrie, More Process Than Peace: Legitimacy, Compliance, and the Oslo Accords, 101 MICH. L. REV. 1661, 1689 (2003).

77 See Salbu & Brahm, supra note 50 at 296-300.

78 Id. at 296-98, 302-03. In cases where the relationship consists of one or more contractual agreements, the parties also may want to consider including an express covenant of good faith within the operative documents. See generally E. Lee Reichert, Good Faith and Fair Dealing Developments—Part II, 27 COLO. LAW 73 (1998).

79 Salbu & Brahm, supra note 50 at 301-02.

80 Id. at 299-300.

81 Id. 82 Id. at 300-01.

83 Brown, supra note 7 at 97; Szto, supra note 6 at 357; see also Kittrie, supra note 76 at 1689 (explaining that deadlocks can even more easily occur in international joint ventures).

84 See Hooton, supra note 19 at 1028; Szto, supra note 6 at 357; Harroch, supra note 6 at § 25.05[1]. Often, the agreements provide for escalation mechanisms within each organization through a variety of levels.

85 Brown, supra note 7 at 97-98; Szto, supra note 6 at 357; Harroch, supra note 6 at § 25.05[1]; but see Jason M. Hoberman, Practical Considerations for Drafting and Utilizing Deadlock Solutions for Non-Corporate Business Entities, 2001 COLUM. BUS. L. REV. 231, 233-35 (2001).

86 Harroch, supra note 6 at § 25.05[1]; Hooton, supra note 19 at 1028.

87 Harroch, supra note 6 at § 25.07. In many cases, the operative agreements will not even permit assignment to subsidiaries or other affiliates of the contracting company, given the relationship-driven nature of the arrangement.

88 In the case of tag-along rights, “the shares of a group of shareholders (often a venture capital syndicate, together with some ancillary investors) are tied together such that if one shareholder has a buyer and wants to sell his shares, he has to notify the others and they have the right to buy his shares instead, or they can demand to “tag-along” and require that the outside buyer purchase all the shares or none.” In the case of drag-along rights, “a shareholder of the syndicate has found an interested buyer, but the buyer only wants to buy all of the shares of the syndicate, or at least some number greater than what the selling shareholder holds. If drag-along rights apply, then the selling shareholder can require all of his fellow syndicate investors, or enough to reach the number of shares that the outside buyer requires, to sell some or all of their shares.” Sean M. O’Connor, Using Stock and Stock Options to Minimize Patent Royalty Payment Risks After Medimmune v. Genentech, 3 N.Y.U. J. L. & BUS. 381, 458 (2007).

89 Brown, supra note 7 at 98; Hooton, supra note 19 at 1028-29.

90 Brown, supra note 7 at 99-100.

91 Id. at 98-99, 102; Harroch, supra note 6 at § 25.07.

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Drag along en tag along

inieiding Een aandeelhoudersovereenkomst tussen een participatiemaatschappij en andere aandeelhouders (veelal management) bevat een aantal standaard bepalingen aangaande het realiseren van een exit. Een exit houdt in de vervreemding van de participatie door de participatiemaatschappij.

Een exit kan op diverse manieren plaatsvinden.1 In dit artikel zal alleen aandacht worden besteed aan een onderhandse verkoop van de participatie aan een derde, waarbij de portfolio company een besloten vennootschap met beperkte aansprakelijkheid is en de participatiemaatschappij daarvan de meerderheidsaandeelhouder is. De exit is het moment waarop duidelijk wordt of de participatiemaatschappij een succesvolle investering heeft gedaan of niet.

Bepalingen in de aandeelhoudersovereenkomst over de voorwaarden van de exit zijn dan ook van cruciaal belang voor de participatiemaatschappij.

In een aandeelhoudersovereenkomst maken de aandeelhouders op voorhand afspraken over de wederzijdse rechten en verplichtingen van de aandeelhouders en het management. Er wordt gestreefd naar een alignment of interests. Op het moment van opstellen van de aandeelhoudersovereenkomst verkeren partijen aan de vooravond van hun huwelijk. Er wordt onderhandeld over de huwelijkse voorwaarden. Daarnaast wordt, anders dan bij de meeste huwelijken, vooraf al vastgelegd dat een scheiding zal volgen en wat daarbij de spelregels zullen zijn. Het ultieme doel is uiteindelijk om bij de exit een maximaal rendement op de investering te realiseren, waarbij alle aandeelhouders profiteren.

Nu de economische omstandigheden recentelijk zijn gewijzigd, is goed denkbaar dat er voorlopig geen uitzicht is op een succesvolle exit of dat een participatiemaatschappij

wordt gedwongen tot een exit om liquiditeitsproblemen te voorkomen. In zulke situaties wordt het belang van duidelijk geformuleerde drag along- en tag a/owg-bepalingen (nog) groter. Zo kunnen partijen van mening verschillen over de gewenstheid van een exit. Mede in het licht van de recente jurisprudentie over de uitleg van contractsbepalingen, waarbij de tendens is om een taalkundige interpretatie voorop te stellen, geldt dat een juiste formulering van drag along- en tag a/OKg-bepalingen van vitaal belang is om de gewenste exit te realiseren.2 Wat echter opvalt bij bestudering van de literatuur, waarin drag along- en tag alongrechten worden beschreven, is dat de verschillende auteurs geen identieke uitleg geven aan deze rechten en van mening verschillen over de mogelijkheid om deze rechten statutair vast te leggen. Ook in de praktijk komen allerlei variaties voor in de formulering van deze rechten. Wij realiseren ons dat de gekozen formulering in een aandeelhoudersovereenkomst niet alleen gebaseerd is op de juridische inzichten van de opstellers of partijen, maar ook afhankeUjk is van de omstandigheden van het geval, zoals de (machts)verhouding tussen partijen, wie het initiatief heeft genomen tot de investering, de herkomst van de participatiemaatschappij (Nederlands/buitenlands) en de omvang van de participatie en de investering.

Dit artikel gaat nader in op de reikwijdte van drag alongen tag a/orag-bepalingen en het spanningsveld tussen statuten en aandeelhoudersovereenkomst onder het huidige BV-recht. Tevens wordt kort aandacht besteed aan de invoering van het nieuwe BV-recht in relatie tot de hiervoor geschetste problematiek. Dit artikel sluit af met enkele conclusies en aanbevelingen.

2 1

Zie onder meer: HR19 januari 2007, NJ 2007/575, (Meyer/Pontmeyer), HR

H.L. Kaemingk/Op weg naar de exit over desinvestering van private

29 jimi 2007, NJ 2007/576, (Derksen/Homburg), Hof Amsterdam

equity', Ondernemingsrecht, 2007-5, p. 195 e.v. over de diverse exit-

1 april 2008, «JOR» 2009/1 (Van Vliet/Van Kasteren) en Rb. Amsterdam

vormen.

10 September 2008, «JOR» 2009/4 (Euroland/Gilde).

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along- en tag along-bepi Een <irag<z/o«g-bepaling (ook wel 'meesleeprecht' genoemd) houdt in dat een aandeelhouder die zijn aandelen wil verkopen, zijn medeaandeelhouder(s) kan verplichten ook de

Mede in het licht van de recente jurisprudentie over de uitleg van contractsbepalingen, geldt dat een juiste formuiering van drag along- en tag o/ong-bepalingen van vitaal belang is om de gewenste exitte realiseren. door hen gehouden aandelen te verkopen, om op die manier te bewerkstelligen dat alle aandelen kunnen worden verkocht en geleverd aan een koper. Normaliter betreft het een recht van de meerderheidsaandeelhouder, vaak de participatiemaatschappij, of- in geval van verspreid aandelenbezit - het recht van enkele investeerders gezamenlijk. De participatiemaatschappij wil haar medeaandeelhouder(s) kunnen verplichten tot een overdracht aan een door haar geselecteerde koper tegen (materieel) dezelfde voorwaarden. Een drag along-recht is een vergaand recht ('contractuele onteigening"), dat de participatiemaatschappij flexibiliteit biedt.3 De participatiemaatschappij kan namelijk op zoek gaan naar een koper voor de door haar gehouden aandelen, maar ook - in het kader van het realiseren van de hoogste verkoopprijs tegen de beste condities - naar een koper die alle aandelen in de portfolio company wil overnemen. Dit laatste is veelal de wens van de koper.4 Een tag tf/owg-bepaling (ook wel 'meeverkooprecht' genoemd) wordt veelal omschreven als een recht van de minderheidsaandeelhouder om zijn aandelen te mogen 'meeverkopen' aan een koper, die een bod doet op de aandelen van de meerderheidsaandeelhouder. De minderheidsaandeelhouder is dan wel gehouden zijn aandelen te verkopen onder voorwaarden die door de meerderheidsaandeelhouder met de koper zijn overeengekomen. Een tag along-recht moet vooral worden gezien als een verplichting voor de meerderheidsaandeelhouder, namelijk om te bewerkstelligen dat invulling wordt gegeven aan het recht van de minderheidsaandeelhouder om zijn aandelen 'mee' te verkopen.

De (ver)kooponderhandelingen die moeten leiden tot een exit worden veelal gevoerd door de participatiemaatschappij en de koper. De participatiemaatschappij heeft meestal contractueel bedongen dat zij (als meerderheidsaandeelhouder) de regie voert over de exit-onderhandelingen. Als de minderheidsaandeelhouder tevens bestuurder is van de

3

4

100

Ter nuancering kan worden opgemerkt dat een drag a/ong-recht minder zwaarwegend is voor een minderheidsaandeelhouder die opnieuw participeert ('doorrolt') in een nieuwe structuur met de koper.

H.L Kaemingk, 'Private Equity en haar plaats in het ondernemingsrecht', Ondernemingsrecht, 2005-17, p. 578.

100

portfolio company kan dit anders zijn.5 Op het moment van het (willen) inroepen van een drag along- of een tag along-recht komt de koper in beeld als belahghebbende. Echter, hij is geen partij bij de tussen de aandeelhouders vastgelegde afspraken. De koper heeft een eigen belang bij het kunnen verkrijgen van alle aandelen of alleen de aandelen van de participatiemaatschappij.6 De koper heeft de medewerking van de minderheidsaandeelhouder nodig als hij alle aandelen wil verkrijgen. Als hij daarentegen alleen het meerderheidsbelang van de participatiemaatschappij wil verwerven, wil hij juist niet geconfronteerd worden met een minderheidsaandeelhouder, die op grond van afspraken met de participatiemaatschappij een tag along-recht kan uitoefenen.

Wat gebeurt er als een participatiemaatschappij een exit kan realiseren, maar de koper niet is gei'nteresseerd in de aandelen van de minderheidsaandeelhouder(s)? De participatiemaatschappij maakt dan geen gebruik Van haar drag along-recht. Als de statuten een goedkeuringsregeling bevatten, kan de participatiemaatschappij haar aandelen verkopen aan deze koper.7 Wat is nu de positie van deze minderheidsaandeelhouder? Kan hij wel of niet meedoen aan de verkoop? De minderheidsaandeelhouder kan de koper niet verplichten zijn aandelen af te nemen, maar kan wel de participatiemaatschappij aanspreken op grond van wanprestatie onder de aandeelhoudersovereenkomst. De druk zal op de participatiemaatschappij rusten om een acceptabele oplossing te bieden voor zowel de koper als de minderheidsaandeelhouder met als risico dat zijn gewenste exit in het water valt, omdat de beoogde koper afhaakt.

Hieruit volgt dat de tag a/owg-bepaling vooral gezien moet worden als een verplichting voor de meerderheidsaandeelhouder.8

Statutaire bepaiingen versys bepaiingsn in een aandeelhoudersovereenkomst Uit het voorgaande volgt dat er bij de uitoefening van een 5

6

7

8

Hij moet dan informatie aanleveren voor het due dffigence-onderzoek en (in dit verband) garanties afgeven. Ook kan hij door de koper benaderd worden om aan te blijven als bestuurder en na de exit weer te participeren als aandeelhouder.

Zo bestaat de mogelijkheid dat een koper juist niet alle aandelen wil verwerven, bijvoorbeeld omdat hij de middelen niet heeft of niet kan verkrijgen op acceptabele voorwaarden. In het huidige economische klimaat is dat actueler dan voorheen.

Kaemingk (2005, p. 578-579) gebruikt dit voorbeeld ter illustratie van de mogelijkheid tot uitoefening van het tag a/ong-recht: de minderheidsaandeelhouder mag meedoen met de verkoop.

K. Kodde, 'De Private Equity Buy Out Transactie: structurering van de equity, aandeelhouders- en verkoopafspraken', Ondernemingsrecht200517, p. 587: "Deze meerderheidsaandeelhouder verplicht zich tegenover de minderheidsaandeelhouders om zijn aandelen alleen aan een partij te verkopen die bereid is om ook het belang van de minderheidsaandeelhouders te kopen." en JAM. ten Berg, 'Statuten versus aandeelhoudersovereenkomsten', in: Statuten zander bezwaar, Den Haag: Sdu Uitgevers 2002, p. 205 geeft een soortgelijke omschrijving en vermeldt expliciet dat het de participatiemaatschappij niet is toegestaan haar aandelen te verkopen aan een koper die niet tevens de aandelen overneemt van een minderheidsaandeelhouder, die zijn tag a/ong-recht uitoefent.

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drag along- of tag along-recht ten minste drie partijen belangen hebben. Het is onder andere om deze reden dat door diverse juristen is nagedacht over de vraag of statutaire vastlegging van dergelijke bepalingen mogelijk is, met het oog op de afdwingbaarheid en de mogelijkheid tot vennootschapsrechtelijke sanctionering van deze afspraken.9 Het opnemen van exit-regelingen in een aandeelhoudersovereenkomst biedt voor- en nadelen ten opzichte van dergelijke regelingen in de statuten. Een aandeelhoudersovereenkomst is niet openbaar en is vormvrij, maar kan slechts met instemming van alle partijen worden gewijzigd.

Daar staat tegenover dat statuten openbaar zijn, (nu nog) een verplichte blokkeringsregeling kennen en door een (gekwalificeerde) meerderheid van de aandeelhouders kunnen worden gewijzigd. In tegenstelling tot een aandeelhoudersovereenkomst zijn statuten afdwingbaar tegenover aandeelhouders die later toetreden. Een overdracht van aandelen in strijd met de aandeelhoudersovereenkomst leidt niet tot ongeldigheid van de overdracht, maar tot wanprestatie tegenover de andere aandeelhouder(s). Een statutaire regeling heeft echter goederenrechtelijke werking: een aandeelhouder kan zijn aandelen alleen conform de statutaire bepalingen overdragen.10 Het is algemeen aanvaard dat een exit-regeling in een aandeelhoudersovereenkomst de statutaire blokkeringsregeling mag aanvullen. Dwingendrechtelijke en statutaire bepalingen prevaleren echter boven in een aandeelhoudersovereenkomst vastgelegde exit-regelingen, die in geval van strijdigheid met wet of statuten nietig of vernietigbaar zijn. Er is echter wel discussie mogelijk over de vraag of een afspraak in een aandeelhoudersovereenkomst over de waardebepaling van de aandelen bij een aanbieding onder bepaalde omstandigheden of op een bepaald moment al dan niet geldig is.11 In een recent arrest overweegt het Hof VGravenhage in dit verband: "(...) dat artikel 2:195a lid 3 BW een regel van dwingend recht geeft, met dien verstande dat die regel alleen het vaststellen van statuten verbiedt

overeenkomst; daarmee hebben alle betrokken aandeelhouders wel ingestemd. Niet goed valt in tezien waarom het beginsel van de contractsvrijheid bier zou moeten terugtreden.'"2

Drag along- en tag aiong-bepaiingen als statutaire regeiing?

De literatuur is verdeeld over de vraag of drag along-hepalingen in de statuten kunnen worden opgenomen.13 Bij het opnemen van een aanbiedingsverplichting in de statu-

De minderheidsaandeelhouder kan de koper niet verplichten zijn aandelen af te nemen, maar kan wel de participatiemaatschappij aanspreken op grond van wanprestatie onder de aandeelhoudersovereenkomst. ten moet rekening worden gehouden met de vereisten van art. 2:195 lid 8 BW (de overdracht van de aandelen mag niet onmogelijk of uiterst bezwaarlijk worden gemaakt) en art. 2:195 lid 1 BW (de omstandigheden die aanleiding geven tot de aanbiedingsverplichting moeten objectief bepaalbaar zijn en voldoende nauwkeurig omschreven zijn).

Tevens geldt het bepaalde in art. 2:195a lid 3 BW (degene die wordt gedwongen zijn aandelen aan te bieden, kan een deskundigenwaardering verlangen). Wij zijn van mening dat een drag along-recht niet als een statutaire bepaling kan worden opgenomen. Hoewel de overdracht van de aandelen door een statutaire drag a/owg-bepaling niet onmogelijk of uiterst bezwaarlijk wordt gemaakt - doorgaans wenst een koper alle aandelen te kunnen kopen en de omstandigheden die leiden tot de aanbiedingsplicht voldoende nauwkeurig in de statuten kunnen worden omschreven, lijkt het ons niet mogelijk om aan demand van objectieve criteria het door de participatiemaatschappij

die inhouden dat een aandeelhouder bij gedwongen uitkoop voor zijn aandelen een prijs van minder dan de werkelijke waarde ontvangt. Over

12

Hof's-Gravenhage 7 augustus 2008, «JOR» 2008/262 (Ramsley/Fduw).

overeenkomsten diezo'n regeling bevatten is in artikel 2:195a BW nieK

13

Kodde (p. 586) is van mening dat een drag a/ong-bepaling niet als

bepaald. Hierbij dient te worden bedacht dat statuten kunnen worden gevjijzigd ook wanneer niet alle aandeelhouders daarmee hebben ingestemd en dat zander de regel van artikel 2:195a lid 3 BW een aandeel-

statutaire aanbiedingsplicht kan worden opgenomen. Kodde stelt daartoe dat het ontstaan van de aanbiedingsplicht alleen afhankelijk is van de wil van meerderheidsaandeelhouder en daarom niet objectief bepaalbaar is. Ook stelt Kodde dat - behoudens de overeenstemming

houder derhalve tegen zijn wil gedwongen zou kunnen worden om zijn

tussen de meerderheidsaandeelhouder en de koper over de verkoop van

aandelen aan te bieden en over te dragen tegen een prijs die lager is dan

a!le aandelen - de verdere voorwaarden van de koop op voorhand niet

de werkelijke waarde. Dit probleem speelt niet bij een (aandeelhouders)

bekend zijn en daardoor niet nauwkeurig kunnen worden omschreven.

Kaemingk (2005, p. 578) acht het opnemen van een statutaire drag along (nog) niet mogelijk. Portengen meent dat art. 2:195a lid 3 BW hieraan in

9

10

11

Een manier om de problematiek te adresseren kan ook zijn om in aanvul-

de weg staat (H J. Portengen, 'Naar contractsvrijheid voor de BV en haar

ling op de drag a/ong-bepalingen een contractuele call-optie overeen te

statutaire inrichting (?!)', in: Preadvies van de vereeniging 'Handelsrecht', De

komen en in aanvulling op de tog o/ong-bepaling een contractuele put

vereenvoudigde BV, Deventer: Kluwer 2006, p. 95). Op basis van hetzelfde

optie, ter versterking van de wederzijdse belangen en waarbij de positie

artikel acht Ten Berg (p. 205) het opnemen van een drag o/ong-bepaling

van de koper geen rechtstreekse relatie heeft tot die van de aandeelhou-

in de statuten wel mogelijk: de statuten kunnen bepalen dat indien de

ders zoals vastgelegd in de aandeelhoudersovereenkomst.

meerderheidsaandeelhouder een bod heeft ontvangen van een koper

Zie voor een nadere beschrijving van deze problematiek de MvT bij Wet

op alle aandelen, de minderheidsaandeelhouder verplicht is deze te

vereenvoudiging en flexibilisering BV-recht, Kamerstukken II31 058, nr. 2,

verkopen aan de meerderheidsaandeelhouder tegen de door de koper

p. 19-21.

geboden prijs. Deze verkoopt vervolgens alle aandelen door aan de

C.A. Schwarz, 'De BV zonder wettelijk verplichte blokkering', in: Onderne-

koper. Dit is overigens niet de gebruikelijke route (Kaemingk, 2005,

mingsrecht, 2004-1, p. 32-33.

p. 578, voetnoot 32).

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gewenste moment van de exit in de statuten vast te leggen.

Het ontstaan van dat moment staat immers doorgaans alleen ter discretie van de participatiemaatschappij.14 In het licht van de hierboven geciteerde uitspraak van het Hof 's-Gravenhage lijkt de (nog bestaande) mogelijkheid van een (minderheids)aandeelhouder een deskundigenwaardering te verzoeken niet langer een struikelblok te vormen.

Uit het voorgaande volgt dat een drag a/owg-bepaling alleen contractueel kan worden vastgelegd.

De literatuur is ook verdeeld over de mogelijkheid tot opname van tag a/owg-bepalingen in de statuten.1' Wij menen dat een tag along-recht wel statutair kan worden vastgelegd als een extra-verplichting die rust op de meerderheidsaan-

De vooriopige conciusie moet zijn dat de in de praktijk gebruikelijke drag a/ong-bepalingen ook onder het nseuwe BV-recht niet in de statuten kunnen worden opgenomen. deelhouder. Overigens lijkt het niet realistisch om van een participatiemaatschappij te verwachten dat deze instemt met een statutaire tag a/owg-bepaling indien een statutaire drag a/owg-bepaling niet mogelijk zou zijn.

In dit verband moet wel belang worden toegekend aan de toepasselijke blokkeringsregeling. Is dat een aanbiedingsregeling, dan is het opnemen van drag along en tag alongbepalingen in de statuten in ieder geval niet mogelijk. Bij de aanbiedingsregeling dienen de aandelen immers te worden aangeboden aan de medeaandeelhouder(s) en niet aan een derde. Voor de goedkeuringsregeling geldt dat goedkeuring voor de overdracht van de aandelen,moet worden verkregen van een daartoe aangewezen orgaan van de vennootschap. Doorgaans is dit de algemene vergadering van aandeelhouders waarin met gewone meerderheid van stemmen wordt besloten, zodat dit slechts een formaliteit is.

Wetsvoorstei vereenvoudiging en flexibilisering SV-recht16 Een uitgebreide beschrijving van de voor dit artikel relevante voorgestelde wijzigingen uit het wetsvoorstel valt buiten het bereik van deze bijdrage.17 Duidelijk is dat de praktijk gebaat zou zijn bij een ondubbelzinnige mogelijkheid tot opname van drag along- en tag a/orag-bepalingen in de statuten onder het nieuwe BV-recht. Dit past ook in de doelstelling van de wetgever.18 De vraag ligt voor of het wetsvoorstel daadwerkelijk deze mogelijkheid biedt. Onder de nieuwe regelgeving wordt het mogelijk verplichtingen van verbintenisrechtelijke aard tussen aandeelhouders onderling als extra verplichting in de statuten op te nemen.19 Vereist daarvoor is een nauwkeurige omschrijving in de statuten, zodanig dat de verplichting voldoende bepaalbaar is. Daarnaast biedt het wetsvoorstel de mogelijkheid om statutair vast te leggen dat onder omstandigheden aanbieding en overdracht van aandelen verplicht is.20 Statutaire bepalingen mogen echter (nog steeds) niet de overdracht van aandelen onmogelijk of uiterst bezwaarlijk maken.2' Het wetsvoorstel en de memorie van toelichting gaven derhalve aanleiding tot een positieve beantwoording van deze vraag.22 Echter, in 16

Voorstel van wet vereenvoudiging en flexibilisering BV-recht, Kamerstukkenll, 31 058, nr. 2.

17

Zie voor literatuur in dit verband onder meer: B. Bier/Kapitaalbescherming nieuwe stijP, TOP, 2007-6;T. van Duuren,'Joint ventures in het nieuwe bv-recht', TOP, 2007-6; J.A. Me Cahery en E.P.M. Vermeulen/ls de nieuwe bv voldoende aantrekkelijk in internationaal verband?', TOP, 2007-6; H J. Portengen en I.C.P. Greenland, 'Minderheidsbescherming in het nieuwe bv-recht', TOP, 2007-6; H J. Portengen, 'Naar contractsvrijheid voor de BV en haar statutaire inrichting (?!)', in: Preadvies van de vereeniging 'Handelsrecht', De vereenvoudigde BV, Deventer: Kluwer 2006; H.M.A Albicher, en JJ.M. van Mierlo/Tweede tranche ambtelijk voorontwerp nieuw BV-recht: inventarisatie naar aanleiding van de consultatieronde', in TijdschriftvoorOndernemmgsbestuur, 2006-2; LTimmerman e.a, 'Advies over het wetsvoorstel inzake de veS»envoudiging en flexibilisering van het bv-recht', in: Ondernemingsrecht, 2007-1; PJ. Dortmond, 'Flexibel aandeelhouderschap', in: Ondern'emingsrecht, 2007-9; en A.H.G.

14

Wilod Versprille, 'Het opleggen van verbintenissen aan aandeelhouders

Overigens is het maar de vraag of een in de statuten uitgeschreven drag

bij de Flex-BV, in: JBN 2008/55.

a/ong-bepaling in het belang is van de participatiemaatschappij. Het risico bestaat dat door het vastleggen van de objectief bepaalbare crite15

18

Nota naar aanleiding van het verslag, 24 november 2008, Kamerstukken

ria de in de praktijk gewenste flexibiliteit wordt opgegeven.

II, 31 058, nr. 6, p. 20: "Statutaire regelingen hebben als voordeel dat zij

Kodde (p. 587) stelt dat een tog a/ong-recht van een minderheidsaan-

zijn ingebed in de vennootschapsrechtelijke structuur. In het wetsvoor-

deelhouder als een extra verplichting (art. 2:192 BW) op de meerder-

stel is er daarom naar gestreefd om de opname van regelingen in de

heidsaandeelhouder rust, waarvoor enkel geldt dat deze verplichting

statuten zoveel mogelijk te bevorderen, zonder Overigens de ruimte voor het sluiten van aandeelhoudersovereenkomsten te beperken."

nauwkeurig moet worden beschreven en de eis van objectieve bepaalbaarheid niet van toepassing is. Aan het nauwkeurigheidsvereiste

19

Art. 2:192 lid 1 onder a BW (nieuw).

kan volgens Kodde worden voldaan, nu het om een concreet geval gaat

20

Art. 2:192 lid 1 onder c BW (nieuw).

waarin de meerderheidsaandeelhouder besluit zijn aandelen te verko-

21

Art. 2:195 lid 5 BW (nieuw).

pen aan een derde. Ook ondervindt een statutaire fag a/ong-bepaling

22

Portengen signaleerde al dat de eerder in het wetsvoorstel opgenomen

geen hinder van de beperkingen van de wet, nu deze de overdracht

verplichte statutaire prijsbepaling door onafhankelijke deskundigen in

niet onmogelijk en uiterst bezwaarlijk maakt: in de meeste gevallen zijn

de weg stond aan de mogelijkheid tot het opnemen van drag along- en

alle aandelen juist makkelijker te verkopen, dan slechts een deel van de

fag a/ong-bepalingen in de statuten. Het huidige wetsvoorstel voorziet

aandelen. Ook Portengen (p. 96.) acht een statutaire tag along mogelijk.

echter in de mogelijkheid tot het opnemen van een afwijkende prijsbe-

Kaemingk (2005, p. 578) en Ten Berg (p. 205-206) zijn een andere mening

palingsregeling in de statuten (art. 2:192 lid 3 BW). Die laatste horde lijkt

toegedaan. Een statutaire tog a/ong-bepaling kan volgens Ten Berg ertoe

daarmee genomen (in: H J. Portengen, 'Naar contractsvrijheid voor de

102

leiden dat de meerderheidsaandeelhouder zijn aandelen niet kan over-

BV en haar statutaire inrichting (?!)', in: Preadvies van de vereeniging 'Han-

dragen als de minderheidsaandeelhouder geen gebruik wil maken van

delsrecht', De vereenvoudigde BV, Deventer: Kluwer 2006, p. 95). Daarbij

zijn tog a/ong-recht en de koper slechts geTnteresseerd is in de koop van

komt nog dat het wetsvoorstel - als waarborg ter bescherming van de

alle aandelen in de vennootschap, waardoor de overdracht onmogelijk

minderheidsaandeelhouder(s) - voorziet in unanimiteitsvereisten ten

of uiterst bezwaarlijk wordt.

aanzien van het opnemen van extra verplichtingen (art. 2:192 lid 1 BW)

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SOU UITGEVERS HUMMER 3, MEI 2009 TUDSCHRIFTVOORDEONDERNEMINGSRECHTPRAKTIJK

DRAG ALONG EN TAG ALONG

de Nota naar aanleiding van het verslag heeft de minster gesteld dat een statutaire drag a/owg-bepaling kan worden beschouwd als variant van een verplichting tot aanbieding en overdracht van aandelen, die op grond van het nieuwe art. 2:192 BW in de statuten kan worden opgenomen als deze redelijk is.23 Daarnaast moeten de gevallen waarin deze verplichting geldt objectief bepaalbaar zijn. Bij wijze van voorbeeld wordt door de Minister opgemerkt dat een statutaire drag a/owg-regeling die inhoudt dat: "een vennootschapsorgaan, of een of meer aandeelhouders, in het concrete geval de voorwaarden kunnen bepalen voor het ontstaan van de verplichting tot aanbieding en overdracht van aandelen aan een derde" niet voldoet aan de vereisten van redelijkheid en objectieve bepaalbaarheid.24 De voorlopige conclusie moet zijn - gelet op het standpunt van de minister - dat de in de praktijk gebruikelijke drag along-bepalingen ook onder het nieuwe BV-recht niet in de statuten kunnen worden opgtjnomen. Het standpunt van de minister lijkt echter op gespannen voet te staan met de hierboven geciteerde uitspraak van het Hof 's-Gravenhage.

Tag a/owg-bepalingen daarentegen kunnen onder het nieuwe wetsvoorstel wel als verplichting tussen aandeelhouders statutair worden vastgelegd. Hierbij geldt echter weer dat het onaannemelijk is dat een participatiemaatschappij een dergelijke statutaire verplichting op zich zal willen nemen zonder dat daar een drag along-recht tegenover staat.

Conclusies en aanbewelingen Een drag along-recht is een recht van een participatiemaatschappij en een verplichting voor de minderheidsaandeelhouder(s). Het is geen verplichting tegenover de koper. Als deze alle aandelen wil verwerven, moet hij dit overeenkomen met de participatiemaatschappij en niet vertrouwen op afspraken in de aandeelhoudersovereenkomst. Als de participatiemaatschappij het drag along-recht niet uitoefent, verkrijgt de koper niet alle aandelen. Een tag along-recht is een recht van de minderheids-

en verplichtingen tot aanbieding en overdracht van aandelen (art. 2:195 lid 4 BW) in de statuten, omdat dergelijke verplichtingen niet tegen de wil van de aandeelhouder kunnen worden opgelegd (art. 2:192 lid 1 en 3 BW, laatste volzinnen).

23

Nota naar aanleiding van het verslag, 24 november 2008, Kamerstukken H,31 058, nr. 6, p. 13.

24

De NVP heeft op dit standpunt gereageerd en aangegeven dat het standpunt van de msinister - een verzwaring van de eerder vermelde vereisten - een ongerechtvaardigde uitzondering impliceert: alleen 'onaanvaardbaarheid'op grond van de redelijkheid en billijkheid van art. 6:248 lid 2 BW beperkt immers de contractsvrijheid en voor het vennootschaprecht geldt op grond van art. 2:8 BW een zelfde eis. Objectieve

aandeelhouder en een verplichting voor de meerderheidsaandeelhouder. Het is geen verplichting tegenover de koper.

De participatiemaatschappij moet invulling geven aan het tag along-recht en kan slechts een (ver)koop overeenkomen met een koper die het tag along-recht respecteert. In het kader van de realisatie van een exit door een participatiemaatschappij kan een tag along-recht een zwaarwegende verplichting zijn. Anders dan het drag along-recht, beperkt een tag along-recht de mogelijkheden tot een succesvolle exit. Het risico bestaat dat een exit niet kan worden gerea-

in het kader van de reaiisatie van een exit door een participatiemaatschappij kan een tagalongrecht een zwaarwegende verplichting zijn. liseerd als de gevonden koper niet gei'nteresseerd is in meer aandelen dan het pakket dat hij van de participatiemaatschappij wil overnemen. Het wetsvoorstel vereenvoudiging en flexibilisering BV-recht biedt meer ruimte voor het vastleggen van statutaire exit-bepalingen, maar is onvoldoende om volledig tegemoet te komen aan de wensen van de (private equity-)praktijk.

Het verdient aanbeveling voor partijen om zorgvuldigheid te betrachten bij de formulering van exit-bepalingen in de aandeelhoudersovereenkomst. In de onderhandelingen over de aandeelhoudersovereenkomst zal het streven van de participatiemaatschappij gericht zijn op zoveel mogelijk ruimte en flexibiliteit ten aanzien van het realiseren van een exit. De minderheidsaandeelhouder zal echter op zoek zijn naar bescherming van zijn positie. Dit kan hij bereiken door bijvoorbeeld voorwaarden te stellen aan het realiseren van een exit en het kunnen inroepen van een drag alongrecht door de participatiemaatschappij. Deze bescherming kan gelegen zijn in bepalingen over de besluitvorming tot een exit, een minimumperiode waarbinnen geen exit mag plaatsvinden (tenzij een vooraf gedefinieerd (hsog) rendement wordt behaald bij een verkoop binnen die periode), de mogelijkheid tot het inroepen van een drag along-recht beperken tot de situatie dat meerdere aandeelhouders willen verkopen en een te realiseren minimumopbrengst of minimumrendement op hun aandelen (IRR). Bij het formuleren van de exit-bepalingen moeten partijen zich realiseren dat het bepalingen betreffen over de toekomstige scheiding, terwijl de andere bepalingen in de aandeelhoudersovereenkomst de voorwaarden van het samenzijn regelen.

Over de auteurs Mr. Harm Uittien en mr. Steffen A. Alleman zijn beiden als advocaat verbonden aan Van Doorne N.V. te Amsterdam.25

bepaalbaarheid zou daarom geen vereiste moeten zijn voor het opnemen van een statutaire verplichting tot aanbieding en overdracht van aandelen. Bovendien is het door de Minister genoemde voorbeeld geen 'onredelijke' regeling (Reactie NVP op het wetsvoorstel vereenvoudiging en flexibilisering BV-recht (Kamerstukken II, 31 058), 8 januari 2009).

TIJDSCHRIEtVOORDEONDERNEMINGSRECHTPRAKtIJK H U M M E R ; MEI 2009

25

Wij danken S.P. Kamerbeek voor zijn ondersteuning bij de totstandkoming van deze bijdrage.

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SOU U I T G E V E R S

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3 Clements Inn London WC2A 2AZ T 020-7025 2950 F 020-7025 2951 bvca@bvca.co.uk www.bvca.co.uk

A Guide to Venture Capital Term Sheets

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Index Page

I

Introduction

2

II

What is a Term Sheet?

4

III

The investment process

6

IV

What terms may be included in a Term Sheet?

8

1.

Type of share

8

2.

Valuation and milestones

8

3.

Dividend rights

9

4.

Liquidation preference and deemed liquidation

10

5.

Redemption

12

6.

Conversion rights

12

7.

Automatic conversion of share class/series

12

8.

Anti-dilution (or price protection)

13

9.

Founder shares

14

10.

Pre-emption rights on new share issues

15

11.

Right of first refusal, co-sale and tag along rights

15

12.

Drag along or bring along

16

13.

Representations and warranties

16

14.

Voting rights

17

15.

Protective provisions and consent rights (class rights)

17

16.

Board of Directors/Board Observer

18

17.

Information rights

19

18.

Exit

19

19.

Registration rights

20

20.

Confidentiality, Intellectual Property Assignment and Management Non-compete Agreements

20

21.

Employee share option plan

21

22.

Transaction and monitoring fees

21

23.

Confidentiality

21

24.

Exclusivity

21

25.

Enforceability

22

26.

Conditions precedent

22

V

Venture capital glossary of terms

23

VI

Example of a Term Sheet for a Series A round

35

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I

Introduction

The BVCA - The British Private Equity and Venture Capital Association is the industry body for the UK private equity and venture capital industry. Our membership represents the overwhelming number of UK-based private equity and venture capital firms and their advisers. The BVCA has many years of experience representing the UK industry, which on the world stage is second only in size to the United States, to government, the European Commission and Parliament, the media, regulatory and other statutory bodies at home, across Europe and around the world. We promote the industry to entrepreneurs and investors, as well as provide services and best practice standards to our members.

The venture capital investment process is now a well-established means of raising funds for early stage companies, usually those involved in seeking to exploit new developments in technology or life sciences. A privately funded company might have a number of funding rounds. The first round is often to raise a small amount of money (seed capital), the investors often being friends and family or a specialist early stage venture capital investor. For rounds without a venture capital investor there may or may not be formal investment documents.

There is a big difference in the nature of venture capital investment depending on the stage of investment and it is important to try to match the skills of an investor with those required for a particular business. A first round of investment from venture capitalists is usually called a Series A round, with subsequent rounds progressing through the alphabet. This Guide reviews those terms that may be included in a Term Sheet for a Series A or for subsequent investment rounds, although not every term discussed will be necessarily appropriate for every investment. Sometimes investments are made by way of debt, but the majority of investments are made by way of a purchase of shares. This Guide deals only with the latter.

The aim of this Guide is to provide those who are not familiar with the venture capital investment process with an outline of how investments can be structured, the terms and terminology typically used in a Term Sheet, and the broader investment process. It is hoped that this familiarity will assist those who are trying to raise venture capital by helping them to understand the commercial implications of the terms being offered. This in turn will hopefully expedite the negotiation of Term Sheets and completion of the investment process.

After the section outlining the purpose of a Term Sheet, there is a section describing the investment process with some worked examples of how the share structure alters in certain circumstances. There is next a glossary of terms most often used in venture capital transactions. Where each term is used for the first time in this Guide it is in italics. Finally, there is an example of a Term Sheet for a Series A round.

This has been included to show how the various terms described in this Guide might be set out in a Term Sheet.

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The selection of terms addressed in this Guide will not be appropriate for every venture capital investment, but should cover most of the terms typically used in the UK today and point out a few of the major differences with the practices in Continental European jurisdictions.

To complement this guide there are now available on the BVCA website (www.bvca.co.uk) standard documents for venture capital investment, namely a subscription and shareholders' agreement and articles of association, together with explanatory notes.

It should be noted that private equity is the generally accepted term used to describe the industry as a whole, encompassing both management buy-out and buy-in activity and venture capital which relates exclusively to the seed through to expansion stages of investment. This Guide is relevant primarily to only the venture capital stages of investment and so this will be the term used.

The BVCA and I would like to thank the Venture Committee working group for the time and effort made in preparing this Guide. This was co-chaired by John Heard (Abingworth Management Ltd) and Simon Walker (Taylor Wessing) and also included Frédéric Court (Advent Venture Partners), Rob James (DFJEspirit Capital Partners LLP), Roy Merritt (OrCapital), and Jeppe Zink (Amadeus Capital Partners).

Jo Taylor Chairman, BVCA Venture Committee October 2007

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II What is a Term Sheet?

A Term Sheet is a document which outlines the key financial and other terms of a proposed investment.

Investors use a Term Sheet as a basis for drafting the investment documents. With the exception of certain clauses – commonly those dealing with confidentiality, exclusivity and sometimes costs – provisions of a Term Sheet are not usually intended to be legally binding. In addition to being subject to negotiation of the legal documentation, a Term Sheet will usually contain certain conditions which need to be met before the investment is completed and these are known as conditions precedent (see paragraph 26, Section IV).

If a company seeks to raise venture capital in the UK the principal documents needed for an investment round are generally a Subscription Agreement, a Shareholders' or Investors' Rights Agreement (frequently these are combined into a single Subscription and Shareholders' Agreement or Investment Agreement) and Articles of Association. The provisions of a Term Sheet will be included in these documents.

The Subscription Agreement will usually contain details of the investment round, including number and class of shares subscribed for, payment terms and representations and warranties (see paragraph 13, Section IV) about the condition of the company. These representations and warranties will be qualified by a disclosure letter and supporting documents that specifically set out any issues that the founders believe the investors should know prior to the completion of the investment.

A Shareholders' or Investors' Rights Agreement will usually contain investor protections, including consent rights (see paragraph 15, Section IV), rights to board representation and non-compete restrictions. The provisions in this Agreement will hopefully be used as the basis for corresponding provisions on subsequent funding rounds. The Articles of Association will include the rights attaching to the various share classes, the procedures for the issue and transfer of shares and the holding of shareholder and board meetings.

Some of the protective provisions in the Shareholders' Agreement may instead be contained (or indeed) repeated in the Articles of Association. The decision to include terms in one or both of these documents may be jurisdiction-specific, based primarily on company law restrictions (e.g. some Continental European jurisdictions limit the rights that can be attached to clauses in the Articles of Association), enforceability concerns (the investor protections can be difficult to enforce in some Continental European jurisdictions) and confidentiality concerns (Articles of Association typically must be filed as a public document with a relevant company registry while the other investment documents can often be kept confidential).

A venture capital investment round is usually led by one venture capital firm. That firm will put together a syndicate either before or after the Term Sheet is agreed and then co-ordinate the syndicate until the round is completed. The syndicate will usually comprise some or all of the existing investors and some new ones, one of whom will typically lead the round.

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There are two main sources of institutional venture capital funding for Series A investment and beyond: venture capital funds, including venture capital trusts (VCTs) and corporate strategic investors.

Once agreed by all parties, lawyers use the Term Sheet as a basis for drafting the investment documents.

The more detailed the Term Sheet, hopefully the fewer the issues which will need to be agreed during the drafting process. The process can be complex and working with lawyers who are familiar with venture capital transactions is recommended in order to minimise both timeframe and costs.

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III The investment process In order to help explain some of the concepts that will be contained in this Guide this section follows a company through several stages of its life cycle from establishment to its Series A funding round.

This example should not be taken as representing a standard process or representing typical valuations or percentage ownerships. At each stage each case will be different and will need to be handled on an individual basis.

‘NewCo’ is a company spun out from an academic institution to exploit intellectual property developed by the scientist (the founder) whilst working as an employee of that institution. The academic institution has agreed to transfer (assign) its ownership rights in the intellectual property rights (IPR) to NewCo in return for a 50% shareholding in the business. It has also agreed that the founder who has carried out the research that led to the creation of the IPR should own the other 50% through a holding of founder shares (see paragraph 9, Section IV). The capital structure of NewCo is as set out in Box 1.

Box 1. Capital structure for NewCo following establishment of the company and assignment of intellectual property

Start-up Number of ordinary shares

Cash or cash equivalent invested at £1 per share

Founder

50

£50

Institution

50

£50

Undiluted share capital

100

The investment by the founder is satisfied by a cash payment and the investment by the academic institution is satisfied by the transfer of IPR to NewCo. However, individuals who are acquiring shares in NewCo and are also going to be employees should take tax advice before the shares are acquired because of recently introduced regulations in the UK. With the help of the academic institution and the founder's network of contacts, NewCo then successfully attracts the investment of a venture capital company (seed investor) that specialises in investing in very early stage companies.

On the basis of the world-class reputation of the scientist, the strength of the IPR and the potential market for the products arising from the technology, the seed investor and NewCo agree that the premoney valuation (see paragraph 2, Section IV) for its business is £200,000. From discussions between the seed investor and NewCo it is also agreed that the company needs to raise £200,000 to enable it to carry out some key experiments to establish the proof of principle for the technology and therefore enable it to raise its next funding round. The seed investor also requires that an option pool (see paragraph 21, Section IV) be established that could be used to help attract new staff to join NewCo.

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With these parameters agreed the capital structure of NewCo following the investment by the seed investor is as set out in Box 2.

Box 2. Capital structure following seed round Seed round Cash or cash equivalent invested

Number of 'A' shares issued at this round

Undiluted total ordinary shares and 'A' shares

Options

Fully diluted equity

Value of shares

Founder(s)

£50

0

50

0

50

£100,000

Institution

£50

0

50

0

50

£100,000

£200,000

100

100

0

100

£200,000

20

20

20

220

Seed investment Option pool Total

£200,100

100

200

£400,000

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IV What terms may be included in a Term Sheet?

1.

Type of share A venture capital investor will normally only subscribe to a preferred class of shares. These are shares to which certain rights attach, that are not shared by ordinary shares held by the founders and others. Venture capital investors require these additional rights because in most cases they are investing much larger sums than the founders (whose investment usually takes the form of good ideas, time and a small amount of seed money) and at a much higher valuation. The venture capital investors will also have less control over the company’s day-to-day operations than the founders, who typically remain closely involved in management.

If a preferred share class already exists at the time of an investment round, the new round of investors will typically create a new series of preferred shares to distinguish the rights (voting, financial, etc.) that attach to their preferred series from those that attach to all prior series of shares. Distinguishing the rights enjoyed by different series is common practice because the investments made at the time of the creation of each series are usually based on different company valuations and circumstances and, consequently, have different risk profiles.

In some Continental European jurisdictions, there are restrictions on the types of different shares classes permissible. This can be compensated for to an extent by creating special rights for certain shareholders in the investment documentation.

2.

Valuation and milestones The venture capital investors will agree with the company on a valuation for the company prior to the new investment round (the pre-money valuation). The pre-money valuation is used to determine the price per share to be paid by investors on the completion of the new investment round (the purchase price). The purchase price is calculated by dividing the pre-money valuation by the fully diluted number of shares of the company immediately prior to the time of completion.

In the example in Section III the pre-money valuation agreed is £200,000 and immediately prior to completion there are 100 ordinary shares. The value of those shares and therefore the purchase price of the incoming investor is £200,000/100 which equals £2,000 per share.

Fully diluted usually includes shares that have been issued by the company, shares allocated to the employee option pool (see paragraph 21 below) and any other shares which the company could be required to issue through options, warrants, convertible debt or other commitments.

The pre-money valuation should be distinguished from the post-money valuation, which refers to the valuation of the company immediately following (and which includes the investment proceeds from) the new round. Therefore, following completion of the example in Section III, NewCo has an undiluted post-money valuation of £400,000 represented by £200,000 pre-money valuation and £200,000 of investment. If the option pool is included in the calculation the fully diluted post-money valuation is £440,000 i.e. £2,000 x (200 shares + 20 options).

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Quite often, venture capital investors will not wish to make all of their investment on completion.

Instead they will invest in tranches, subject to various technical and/or commercial targets (milestones) being met. These milestones will be set out in the Subscription Agreement. Failure to meet a milestone does not automatically mean that the investors will not provide the additional money, but it may mean that they will seek to negotiate different terms for these amounts.

Sometimes a mechanism, a ratchet is used to adjust the respective shareholdings of the investors and the founders depending on either the company's performance or the level of returns on an exit (exit ratchet). This technique is principally used to find a bridge between widely differing views of a company's value, or to provide additional incentives/rewards to the founders for delivering excellent returns to the investors. Ratchets can be complicated in operation and need to be very carefully thought through due to tax issues and in order to avoid conflicts of interest between the founders, the company and its other shareholders at a later date 3.

Dividend rights Venture capital investors often invest in early stage companies that are in an intense growth phase. The objective is to grow the business and its value and to realise a return on investment (ROI), typically targeting a multiple of the amounts invested – on exit. In most cases such companies should be reinvesting all profits (without which a dividend cannot be paid) to continue growing the company, rather than paying dividends to shareholders. Sometimes there is a prohibition on the payment of any dividend, which may be for a limited period of time.

Even if the payment of a dividend is permitted, a common way of ensuring that a company is not obliged to pay dividends while it is growing is to provide the investors with a share class that has a preferential, cumulative dividend, usually fixed at a percentage of the purchase price paid for each preferred share. The company will also be prevented from paying any dividend to other shareholders until the dividend is paid to the holders of the preferred shares. Since that dividend cumulates usually until an exit (see paragraph 18 below), it effectively prevents any other dividend being paid until then. In addition, investors will often have an overriding right to veto the payment of any dividend.

If a dividend is cumulative, it means that for each period that the dividend accrues (e.g. quarterly or annually) any amounts not paid are cumulated until the company has the necessary cash.

At that time the cumulated accrued amounts must be paid to the investors’ share class in their entirety, before any dividends can be paid to other share classes. If the preferred shares are converted into ordinary shares, the investors will usually expect all accumulated dividends to be paid or capitalised into ordinary shares on such conversion.

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IV What terms may be included in a Term Sheet? continued In addition to a dividend preference, venture capital investors typically require that the preferred shares be entitled to participate in any distributions on the ordinary shares, or in other words, to enjoy a pro rata share of any dividends paid to the ordinary shares on top of any dividend preference paid only to the preferred shares. Allowing preferred participation ensures that a company cannot declare a small preferential dividend to the preferred holders followed by a much larger dividend to the ordinary shareholders.

In some jurisdictions, escalating dividend provisions can be used to encourage the company to work towards an exit and to help its investors recover some of their investment if the company fails. These require the company, if it has not achieved a successful exit (see paragraph 18 below) within a certain period of time, to declare and pay cumulative dividends to preferred shareholders at rates that increase each year.

4.

Liquidation preference and deemed liquidation The liquidation preference is a right which can be required by venture capital investors in recognition of the risk they bear on their capital contribution. While there are many variations, the liquidation preference typically provides that, in the event the company is liquidated or subject to a deemed liquidation (see below), the preferred shareholders will receive a certain amount of the proceeds before any other shareholders. This preference amount may be equal to the amount of the preferred shareholders’ investment, or a multiple of it.

The remaining proceeds are often then shared amongst the preferred and ordinary shareholders.

There are numerous ways in which this may be effected, but the most common are: ●

the remaining proceeds are shared pro rata, according to their percentage shareholding, among the preferred and ordinary shareholders (in which case the preferred shares are considered fully participating, i.e. after receiving the preference amount, the preferred shareholders participate fully with the ordinary shareholders in sharing the remaining proceeds);

●

after payment of the liquidation preference amount, the ordinary shareholders may catch up by receiving an amount equal to the amount paid by them or credited as paid by them for their shares, thereafter the proceeds being shared out on a pro rata basis between all shareholders (in which case the preferred shares are considered simple participating).

The size and structure of the liquidation preference will be negotiated to reflect the risk inherent in each investment round: the higher the risk, the higher the required return. Many factors (including the valuation of the company) will be considered in this calculation.

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Venture capital investors usually require that the liquidation preference applies not only in connection with a liquidation or winding up of the company, but also in the case of a deemed liquidation, a term usually defined to include a merger, acquisition, change of control or consolidation of the company, or a sale of all or most of its assets, but sometimes also includes an initial public offering (IPO) or a qualified exit (see paragraph 18 below).

The example below shows what would happen if there were liquidity events at the value of £200,000 or £1,000,000 in each of the following scenarios (all of which assume a fully participating liquidation preference based upon the issued share capital following the seed round described in Box 2 of Section III): ●

Where there is no liquidation preference attached to the 'A' shares

●

1 x liquidation preference

●

2 x liquidation preference.

Liquidated preference

Percentage shareholding

Investor

50%

£200,000 liquidity event cash return

£1,000,000 liquidity event cash return

None

£100,000

1x

£200,000

£200,000 (preference) £400,000 (share in £800,000 balance)

2x

£200,000

£400,000 (preference) £300,000 (share in £600,000 balance)

University

£500,000

25%

None

£50,000

£250,000

1x

0

£200,000

2x

0

£150,000

None

£50,000

£250,000

1x

0

£200,000

2x

0

£150,000

Founder

25%

In this example, in the event the company is only sold for £200,000 the investor will only get his money back if he has negotiated a liquidation preference so that the first £200,000 from such an event goes to the investor. In the event of a sale at £1,000,000 the calculation works so that in the event of 1x preference the first £200,000 goes to the investor and then the remaining £800,000 is shared pro rata in accordance with the shareholding, in this case 50:25:25.

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IV What terms may be included in a Term Sheet? continued 5.

Redemption The right of redemption is the right to demand under certain conditions that the company buys back its own shares from its investors at a fixed price. This right may be included to require a company to buy back its shares if there has not been an exit within a pre-determined period.

Failure to redeem shares when requested might result in the investors gaining improved rights, such as enhanced voting rights.

A right of redemption is not appropriate for every investment and is not allowed or is limited (e.g. to a certain percentage of the issued and outstanding shares) in some jurisdictions in Continental Europe. In those parts of Europe where it is allowed, subject to certain restrictions, redemption can be used to ensure that the venture capital investors recover some of their investment if a company has not been able to achieve a successful exit (see paragraph 18 below) within a certain period of time. However, in the UK and certain other jurisdictions, there are legal requirements that must be satisfied before a company can redeem any of its shares.

A right of redemption can also be used by an investor where it needs to strongly discourage a company from breaching certain obligations, by providing a way for the investor to dispose quickly of its shareholding. In jurisdictions where redemption is not possible under local company law, an alternative is to negotiate a conditional right for the investors to put (sell) their shares to the founders at a fixed price.

6.

Conversion rights Where venture capital investors hold a preferred class of shares and it is permitted to convert these to ordinary shares, they generally require the right to convert them at any time, at an initial conversion ratio of 1:1. Conversion is normally delayed until exit so that investors are able to avoid losing the rights attached to the preferred class of shares.

This conversion ratio will be adjusted to take account of any reorganisation of a company's capital structure. In some jurisdictions, this conversion ratio can be adjusted to provide for a form of anti-dilution protection (see paragraph 8 below). If a dilutive event has occurred and this ratio has been increased, the investor may choose or may be compelled to convert its preferred shares into ordinary shares immediately prior to a liquidity event (such as a trade sale or an IPO).

7.

Automatic conversion of share class/series In most cases, investors will be required to convert all of their shares into ordinary shares prior to a company listing its shares on a publicly traded exchange. Venture capital investors often require an automatic conversion mechanism for all share classes, effective immediately prior to an IPO. Investors will only want this conversion mechanism to work where an IPO is likely to provide

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a sufficient opportunity for them to dispose of their shares (liquidity) after the expiry of any lock up periods. Accordingly the investors usually define certain criteria in advance that must be met for an IPO to trigger automatic conversion (usually referred to as a Qualified IPO), e.g. only offerings on certain exchanges, by recognised national underwriters, at a valuation exceeding a certain threshold and raising at least a minimum amount of gross proceeds. Otherwise, preferred shareholders would risk having their shares converted and losing all of their preferential rights even if the company lists its shares at a low value on a minor exchange.

8.

Anti-dilution (or price protection) Venture capital investors often require anti-dilution protection rights to protect the value of their stake in the company, if new shares are issued at a valuation which is lower than that at which they originally invested (a down round). This protection usually functions by applying a mathematical formula to calculate a number of new shares which the investors will receive, for no or minimal cost, to offset the dilutive effect of the issue of cheaper shares.

There are several variations of the formula, each providing different degrees of protection. These include full ratchet protection, which will maintain investors' full percentage ownership at the same level or at the same value in down rounds. Other versions of the formula provide some compensation for the dilution, but allow the ownership percentage to fall; the most common of these is weighted average. The level of protection required by an investor depends on several factors, including the valuation of the company at the time of the investment and the perceived exposure to further financing requirements.

While the basic concept remains the same, there are several different mechanisms used in Continental European jurisdictions to create this protection. In the UK, the mechanism of adjusting the conversion ratio of preferred shares to ordinary shares to adjust for dilutions can be used, although other methods, including the issue of shares for a nominal sum or bonus shares, are also used. The latter might involve the granting of options (or warrants as they are sometimes referred to), which are only exercisable if the anti-dilution provision is triggered.

In the example set out in Box 2 of Section III, if the project did not proceed as well as expected and when the time came to raise another round from new investors it emerged that these potential new investors were only prepared to invest at a pre-money valuation (for them) of £200,000, this would imply that they would only pay £1,000 per share (£200,000/200). However the existing investors paid £2,000 per share and therefore, under full anti-dilution provisions, their shareholding would be adjusted in order to issue them with new shares, the effect of which would be to bring the price they paid for the 'A' shares to £1,000 per share.

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IV What terms may be included in a Term Sheet? continued The result of the full anti-dilution provisions is that the existing investors would have to be issued with a further 100 shares to bring their shareholding to 200 for which they paid a total of £200,000 which equals £1,000 per share. In terms of the overall shareholding this brings the ownership of the business between the founders, academic institution and investors to 50 shares: 50 shares: 200 shares or 16.6%:16.6%:66.6% (a change from 50 shares: 50 shares: 100 shares or 25%:25%:50%).

9.

Founder shares Founders and senior management are usually central to the decision of venture capital investors to put money into a company. Having decided to put money behind a management team they have confidence in, investors are usually keen to ensure that they remain in place to deliver their business plan. Therefore, it is often the case that founders and key managers (and sometimes all shareholders/employees who leave the company within a certain period of time are required to offer to sell their shares back to the company or to other shareholders. The price paid for the shares may depend upon circumstances of departure – it may be at market value if the founder/ manager is deemed to be a good leaver, or it might be considerably less in the case of a bad leaver. A bad leaver may be someone who has breached his contract of employment, or it may also be someone who resigns from the company within a particular period. The Board often retains the right to determine whether to implement the bad leaver provisions.

In addition or as an alternative to good leaver/bad leaver provisions, investors may require that shares held by founders who are employees or consultants be subject to a vesting schedule in order to incentivise the founders not to leave employment with the company in the short term. The effect of this is that anyone holding such shares must be employed or engaged as a consultant by the company for a certain period of time if that person is to obtain unrestricted ownership of all of their shares. Within that period shares may vest on a straight-line basis or on whatever basis is negotiated. Sometimes founders have different vesting schedules in recognition of their different levels of contribution to the company.

In NewCo it was decided that the founder's 50 shares would vest on a straight-line basis over 4 years, with the first year's allocation vesting on the completion of the venture capital investment.

Number of shares

0 months – 12 months

12 months – 24 months

24 months – 36 months

36 months – 48 months

Annual vesting %

12.5

12.5

12.5

12.5

Cumulative vesting %

12.5

25

37.5

50

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If a founder leaves within the requisite period, he will keep only that proportion of his shares that are deemed to be vested. In this example, if the founder left between 12-24 months, 25 shares or 50% of the shareholding would have vested. The remaining shares that are unvested lose their value, either by being bought back by the company for a nominal amount or converted into deferred shares which have no rights attaching to them. It may be decided that on certain events such as death or incapacity or where a founder's employment may terminate through no fault of their own, the vesting schedule is accelerated either partially or fully. The Board may retain the right to determine such issues at the time, in the light of circumstances.

10.

Pre-emption rights on new share issues If the company makes any future share offering, a venture capital investor will require the right to maintain at least its percentage stake in the company by participating in the new offering up to the amount of its pro rata holding, under the same terms and conditions as other participating investors. This pre-emption right is automatically provided for by law in the UK and most Continental European jurisdictions, although it can be waived.

If the new offering is based on a company valuation lower than that used for an investor’s prior investment, that investor may also receive shares under its anti-dilution rights (see paragraph 8 above). Certain issues will usually be exempted from the pre-emption rights, including the issue of anti-dilution shares and the issue of shares on the exercise of share options.

11.

Right of first refusal, co-sale and tag along rights These are contractual terms between shareholders which are usually included in the Articles of Association. If one shareholder wishes to dispose of shares that are subject to a right of first refusal (ROFR), it must first offer them to those other shareholders who have the benefit of the ROFR. There are usually certain exceptions to the ROFR, such as the right of individuals to transfer shares to close relatives and trusts and investors to transfer shares freely to third parties, each other or within an investor's group. The requirement to go through a ROFR process may add several weeks to the timescale for selling shares.

If a shareholder wishes to dispose of shares that are the subject of a co-sale or tag along right, the other shareholders who benefit from the right can insist that the potential purchaser agrees to purchase an equivalent percentage of their shares, at the same price and under the same terms and conditions. This may have the effect of making the shares more difficult to sell.

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IV What terms may be included in a Term Sheet? continued A venture capital investor’s decision to invest in a company is often based largely on the strength of the technical and management experience of the founders and management. It does not want these individuals to dispose of their shares in the company while it remains an investor.

Consequently, investors frequently require a ROFR as well as co-sale/tag along rights on any sale of shares by a founder or key managers. Indeed they may sometimes require a prohibition on founders and key managers selling shares for a stated period.

Sometimes in the UK the investor class will create a ROFR on each other's shares. Some investors are strongly against this because it can make their shares more difficult to sell (less liquid) and potentially less valuable since a prospective buyer will often be reluctant to make an offer for shares that can be pre-empted by someone else.

12.

Drag along or bring along A drag along provision (sometimes called bring along) creates an obligation on all shareholders of the company to sell their shares to a potential purchaser if a certain percentage of the shareholders (or of a specific class of shareholders) vote to sell to that purchaser. Often in early rounds drag along rights can only be enforced with the consent of those holding at least a majority of the shares held by investors. These rights can be useful in the context of a sale where potential purchasers will want to acquire 100% of the shares of the company in order to avoid having responsibilities to minority shareholders after the acquisition. Many jurisdictions provide for such a process, usually when a third party has acquired at least 90% of the shares (sometimes referred to as a squeeze out), but the legal process is usually subject to possible court review.

Venture capital investors may require that certain exceptions are included in drag along provisions for situations when they cannot be obligated to sell their shares. Among these are drag along sales where the investors will not receive cash or marketable securities in return for their shares or will be required to provide to the purchaser representations and warranties concerning the company (or indemnify those given by the company or the founders) or covenants (such as non-compete and non-solicitation of employees).

13.

Representations and warranties Venture capital investors expect appropriate representations and warranties to be provided by key founders and management and, in jurisdictions where it is allowed, the company. The primary purpose of the representations and warranties is to provide the investors with a complete and accurate understanding of the current condition of the company and its past history so that the investors can evaluate the risks of investing in the company prior to subscribing for its shares.

The representations and warranties will typically cover areas such as the legal existence of the

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company (including all share capital details), the company’s financial statements, the business plan, assets (in particular intellectual property rights), liabilities, material contracts, employees and litigation.

It is very rare that a company is in a perfect state! The warrantors have the opportunity to set out issues which ought to be brought to the attention of the new investors via the disclosure letter or schedule of exceptions. This is usually provided by the warrantors and discloses detailed information concerning any exceptions to or carve-outs from the representations and warranties (e.g. specific company assets, contracts, shareholders, employees, etc.). If a matter is referred to in the disclosure letter the investors are deemed to have notice of it and will not be able to claim for breach of warranty in respect of that matter.

Investors expect those providing representations and warranties about the company to back them up with a contractual obligation to reimburse them in the event that the representations and warranties are inaccurate or if there are exceptions to them that have not been fully disclosed.

There are usually limits to the exposure of the warrantors, which are a matter for negotiation when documentation is being drawn up, and vary according to the severity of the breach, the size of the investment and the financial resources of the warrantors.

14.

Voting rights Venture capital investors will have certain consent and voting rights that attach to their class of shares (see paragraph 15 below). Preferred shares may have equivalent voting rights to ordinary shares in a general meeting, though it is also possible that they may carry more than one vote per share under certain circumstances in jurisdictions where it is allowed.

Where an appropriate event has occurred that triggers a change in the conversion ratio, the number of votes that the investors' shares will carry for any subsequent general shareholder vote will often be automatically adjusted to reflect the change in the conversion ratio at the time of the vote.

15.

Protective provisions and consent rights (class rights) The venture capital investors in an investment round normally require that certain actions cannot be taken by the company without the consent of the holders of a majority (or other specific percentage) of their class or series of shares (investor majority). Sometimes these consent rights are split between consent of an investor majority, consent of the investor director(s) or consent of the Board. Typically what requires investor majority consent and what requires investor director consent would relate to major changes in the company such as those set out in the paragraph below whereas operational matters that need more urgent consideration by the Board would

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IV What terms may be included in a Term Sheet? continued be left for board consent. Alternatively, each of the largest investors may have specific consent rights. The purpose of these rights is to protect the investors from the company taking actions which may adversely affect the value of their investment.

The types of actions covered include (among many others): changes to share classes and share rights, changes to the company’s capital structure, issuance of new shares, mergers and acquisitions, the sale of major assets, winding up or liquidating the company, declaring dividends, incurring debts above a certain amount, appointing key members of the management team and materially changing the company’s business plan. These shareholder rights are particularly important for investors who do not appoint a director to the Board of Directors (see paragraph 16 below).

Note that in some Continental European jurisdictions, local company law requires that some of the actions covered by these consent rights remain the unfettered right of the Board of Directors to decide. In such cases, the Articles of Association of the company will usually require that the level of majority needed for a board decision concerning these actions include the agreement of an appropriate number of the directors appointed by the investors.

Alongside these consent rights, there are usually various undertakings or covenants given by the company or sometimes the founders to do certain acts. Typically these include taking steps to protect intellectual property, applying investment monies in accordance with the business plan and maintaining appropriate insurance. Other types of covenants are described in the sections below headed Information Rights (see paragraph 17 below) and Confidentiality, Intellectual Property Assignment and Management Non-compete Agreements (see paragraph 20 below).

16.

Board of Directors/Board Observer Venture capital investors require that the company has an appropriate Board of Directors (note: in some Continental European jurisdictions, e.g. Germany, a two-tiered board is required: a Management Board and a Supervisory Board and in other Continental European jurisdictions where two-tiered board systems are optional, e.g. France, some investors prefer one board).

In accordance with what is regarded as UK corporate governance best practice, investors usually prefer the Board to have a majority of non-executive directors (i.e. directors who are not employees of the company). Although a majority of non-executives may be impractical for small companies, it is usual for such companies to have at least one or two non-executives. One or more of the non-executive directors will be appointed by the investors under rights granted to them in the investment documentation. Some investors will never appoint a director, because of potential conflicts of interest and liability issues and will instead require the right to appoint a Board Observer, who can attend all board meetings, but who will not participate in any board decisions. The Board of Directors tends to meet once a month in general, in particular for early stage companies with active investors on the Board.

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In many cases, investors will require that the Board has a Remuneration or Compensation Committee to decide on compensation for company executives, including share option grants (see paragraph 21 below), as well as an Audit Committee to oversee financial reporting. These committees will be made up entirely or of a majority of non-executive directors and will include the directors appointed by the investors. Each of these committees should have its own mandate set out in writing.

By law, like all directors, the investor directors' responsibilities are to act in the interest of the company rather than as a representative of the funds that they manage. Often venture capitalists separate the investment decisions for the funds invested in the companies from the investor director's decisions in order to avoid conflicts of interests for the investor director. This is typically done by having another investment executive representing the funds' interests when dealing with the company with respect to the Investor consent matters.

17.

Information rights In order for venture capital investors to monitor the condition of their investment, it is essential that the company provides them with certain regular updates concerning its financial condition and budgets, as well as a general right to visit the company and examine its books and records.

This sometimes includes direct access to the company's auditors and bankers. These contractually defined obligations typically include timely transmittal of audited annual financial statements, annual budgets, and unaudited monthly and quarterly financial statements. However it should be noted that in some Continental European jurisdictions, a company is required to treat all shareholders equally, so that any information provided to one shareholder will have to be provided to all shareholders.

18.

Exit Venture capital investors want to see a path from their investment in the company leading to an exit, most often in the form of a disposal of its shares following an IPO or by participating in a sale. Sometimes the threshold for a liquidity event (see paragraph 4 above) or conversion (see paragraph 6 above) will be a qualified exit. If used, it will mean that a liquidity event will only occur and conversion of preferred shares will only be compulsory if an IPO falls within the definition of a qualified exit. A qualified exit is usually defined as a sale or IPO on a recognised investment exchange which in either case is of a certain value to ensure the investors get a minimum return on their investment.

Consequently, investors usually require undertakings from the company and other shareholders that they will endeavour to achieve an appropriate share listing or trade sale within a limited

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IV What terms may be included in a Term Sheet? continued period of time (typically five to seven years depending on the stage of investment and the maturity of the company). If such an exit is not achieved, investors often build in structures which will allow them to withdraw some or all of the amount of their investment (see paragraphs 3 and 5 above).

19.

Registration rights Registration rights are a US securities law concept that is alien to many European companies and investors. Such rights are needed because securities can only be offered for public sale in the US (with certain exceptions) if they have first been registered with the Securities and Exchange Commission (SEC). The registration process involves the company whose shares are to be offered providing significant amounts of information about its operations and financial condition, which can be time consuming and costly.

Unlike in European jurisdictions, where all of a company’s shares usually become tradable upon a public listing, a company registering shares to be traded in the US is not required to register all of its outstanding shares. Any shares that are left unregistered can only be traded under very restricted circumstances, which can greatly diminish their value. Consequently, investors in the US or in companies which may consider pursuing a listing in the US, usually require the company to enter into a Registration Rights Agreement. Among other things, this gives the investors rights to demand registration of their shares (demand rights) and to have their shares registered along with any other shares of the company being registered (piggy-back rights) and allocates costs and potential liabilities associated with the registration process.

20.

Confidentiality, Intellectual Property Assignment and Management Non-compete Agreements It is good practice for any company to have certain types of agreements in place with its employees. For technology start-ups, this generally includes Confidentiality Agreements (to protect against loss of company trade secrets, know-how, customer lists, and other potentially sensitive information), Intellectual Property Assignment Agreements (to ensure that intellectual property developed by academic institutions or by employees before they were employed by the company will belong to the company) and Employment Contracts or Consultancy Agreements (which will include provisions to ensure that all intellectual property developed by a company's employees belongs to the company). Where the company is a spin-out from an academic institution, the founders will frequently be consultants of the company and continue to be employees of the academic institution, at least until the company is more established.

Investors also seek to have key founders and managers enter into Non-compete Agreements with the company. In most cases, the investment in the company is based largely on the value of the technology and management experience of the management team and founders. If they

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were to leave the company to create or work for a competitor, this could significantly affect the company’s value. Investors normally require that these agreements be included in the Investment Agreement as well as in the Employment/Consultancy Agreements with the founders and senior managers, to enable them to have a right of direct action against the founders and managers if the restrictions are breached.

21.

Employee share option plan An employee share option plan (ESOP) is a plan that reserves and allocates a percentage of the shares of the company for share option grants to current and future employees of the company (and certain other individuals) at the discretion of a management committee. The intention is to provide an incentive for the employees by allowing them to share in the financial rewards resulting from the success of the company. Investors typically want 10%-20% of the share capital of the company to be reserved in an ESOP creating an option pool. The company will then be able to issue the shares under the plan without requiring further approval from the investors. Founders and other management with significant shareholdings may be excluded from participating in the ESOP.

22.

Transaction and monitoring fees Venture capital investors are usually paid a fee by the company to cover internal and external costs incurred in connection with the investment process. Some investors may require an annual monitoring fee to compensate for the level of their involvement with the investee company, in addition to the usual compensation for travel and out-of-pocket expenses with relation to the investment management.

23.

Confidentiality All exchanges of confidential information between potential venture capital investors and the company need to be subject to a Confidentiality Agreement. This agreement should be executed as soon as discussions with the company about a potential investment begin. If this has not been done then a confidentiality restriction should be included in the Term Sheet.

24.

Exclusivity Once a Term Sheet is signed, venture capital investors will undertake various types of due diligence on the company (any or all of technical, commercial, legal and financial). They will usually provide the company with a list of areas which they would like to cover and information which they would like to receive. The process can take several weeks or even months and the investors may also use third party advisors to assist them in the process (e.g. lawyers,

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IV What terms may be included in a Term Sheet? continued accountants and consultants). This will involve expense and the investors will not want to discover that while they are incurring this expense the company accepts investment from other investors. To protect themselves, some investors will ask for an exclusivity period during which the company is prohibited from seeking investment from any third parties. A breach of this obligation will result in the company and founders incurring a financial penalty.

25.

Enforceability With the exception of clauses dealing with confidentiality, transaction fees and exclusivity, the provisions of a signed Term Sheet will not be intended to be legally binding. It should, however, be noted that in some Continental European jurisdictions there is an obligation to act in good faith when deciding not to proceed with an investment either at all or on the terms set out in the Term Sheet. If so, it might not be possible for the investors or the company to walk away from or unilaterally seek to change the Term Sheet without a justifiable reason.

26.

Conditions precedent A full list of conditions to be satisfied before investment will be included in the Term Sheet. A venture capital investment will usually be conditional on not only the negotiation of definitive legal documents, but the satisfactory completion of due diligence and approval by the Investment Committee of each of the venture capital investors.

Satisfactory completion of due diligence can include conclusion of commercial, scientific and intellectual property due diligence, a review of current trading and forecasts, a review of existing and proposed management service contracts, a review of the company's financial history and current financial position, either a full legal review or one targeted on specific areas and, if it is not already in place, obtaining key man insurance and satisfactory references and checks on key employees.

It is also common for investors to require the founders and senior management to sign up to Employment or Consultancy Agreements in a form approved by the investors. In the case of investment from VCTs it will also be a condition that before they invest the appropriate tax clearance has been obtained from the HM Revenue & Customs.

22

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V Venture capital glossary of terms Angels High net worth individuals who provide seed money to very early stage companies, usually investing their own money rather than that of institutional or other investors.

Anti-dilution provisions Provisions which protect the holder's investment from dilution as the result of later issues of shares at a lower price than the investor paid by adjusting the option price or conversion ratio or issuing new shares (see paragraph 8, Section IV above).

As converted basis The determination of preferred shares rights, such as vesting and participation in a dividend, on the basis that those shares have been converted into ordinary shares, taking account of whatever adjustments might be necessary.

Audit Committee A committee of the Board of Directors consisting of a majority of independent (non-executive) directors, responsible for selecting and overseeing the work of outside auditors and other audit activities. The definition of an independent director may vary from one market to another (see paragraph 16, Section IV above).

Bridge loan, bridge finance or bridge round A loan or equity investment to provide financing for a relatively short time period until the issuer can complete a longer term financing such as a public offering or new investment round.

Burn rate The rate at which a company is consuming cash each month.

Capitalise Converting a debt owed to a company into equity (see paragraph 3, Section IV above).

Capitalisation table (cap table) A spreadsheet listing all shareholders and holders of options and any other securities, along with the number of shares, options and convertible securities held (see Box 1 and Box 2 in Section III above).

Carried interest The portion of any profits realised by a venture capital fund to which the fund managers are entitled, in addition to any returns generated by capital invested by the fund managers. Carried interest payments are customary in the venture capital industry. Also known as the carry.

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V Venture capital glossary of terms continued Completion or closing In the context of a venture capital investment round, the release of investment funds to the company and the issuance of shares to the investors following execution of the investment documents and verification that all necessary conditions have been fulfilled.

Co-investment See Syndication.

Conversion The act of exchanging one form of security for another security of the same company, e.g. preferred shares for ordinary shares, debt securities for equity (see paragraph 6, Section IV above).

Conversion ratio The ratio indicating the number of underlying securities that can be acquired upon exchange of a convertible security, e.g. the number of ordinary shares into which preferred shares are convertible (see paragraph 6, Section IV above).

Convertible debt A debt obligation of a company which is convertible into shares.

Convertible preferred shares Preferred shares convertible into ordinary shares.

Co-sale or Tag along rights A mechanism to ensure that if one investor or founder has an opportunity to sell shares the other shareholders are also given that opportunity on a proportional basis. (see paragraph 11, Section IV above).

Covenants Undertakings given to the investors by the company and sometimes the founders to do or not do certain acts (see paragraph 15, Section IV above).

Cumulative dividends A dividend which accumulates if not paid in the period when due and must be paid in full before other dividends are paid on the company's ordinary shares (see paragraph 3, Section IV above).

Cumulative preferred shares A form of preferred shares which provides that if one or more dividends is omitted, those dividends accumulate and must be paid in full before other dividends may be paid on the company's ordinary shares (see paragraph 3, Section IV above).

Debt/equity ratio A measure of a company's leverage, calculated by dividing long-term debt by ordinary shareholders' equity.

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Debt financing Financing by selling notes or other debt instruments.

Deed of adherence An agreement that purchasers of shares (new or existing) may be required to sign to ensure they are bound by the terms of an Investment Agreement.

Deemed liquidation or liquidity event Term used to describe trigger events for a liquidation preference. Usually defined to cover, among other things, a merger, acquisition, change of control or consolidation of the company, or a sale of all or most of its assets (see paragraph 4, Section IV above).

Default Failure to discharge a contractual obligation, e.g. to pay interest or principal on a debt when due.

Demand registration rights (US) The contractual right of a security holder to require an issuer to file a registration statement to register the holder's securities so that the holder may sell them in the public market without restriction (see paragraph 19, Section IV above).

Dilution The process by which an investor's percentage holding of shares in a company is reduced by the issuance of new securities (see paragraph 8, Section IV above).

Directors & officers insurance Directors and officers (D&O) insurance is professional liability coverage for legal expenses and liability to shareholders, creditors or others caused by actions or omissions by a director or officer of a company.

Disclosure letter A letter given by the founders, and maybe other key members of the management team, and the company to the investors setting out exceptions to the representations and warranties.

Discounted cash flow (DCF) An investment appraisal technique which takes into account both the time value of money and also the total profitability of a project over a project's life.

Divestment The disposal of a business or business segment.

Dividends When a company makes a profit, it can pay part of these profits to its shareholders in the form of cash, additional shares or other assets. Such payments are known as dividends (see paragraph 3, Section IV above).

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V Venture capital glossary of terms continued Down round A round of venture capital financing in which the valuation of the company is less than the previous round (see paragraph 8, Section IV above).

Drag along/bring along A mechanism ensuring that if a specified percentage of shareholders agree to sell their shares, they can compel the others to sell ensuring that a prospective purchaser can acquire 100% of a company (see paragraph 12, Section IV above).

Due diligence The process of researching a business and its management prior to deciding whether to proceed with an investment in a company (see paragraph 26, Section IV above).

Early stage capital Finance for companies to initiate commercial manufacturing and sales, following receipt of seed capital.

Earnings Profits after expenses.

EBIT/EBITDA Earnings before interest and taxes/earnings before interest, taxes, depreciation and amortisation: financial measurements often used in valuing a company.

Employee share option plan (ESOP) A scheme to enable employees to acquire shares in the companies in which they work (see paragraph 21, Section IV above).

Equity Ownership interest in a company represented by shares.

Exclusivity Agreement Often negotiated by a syndicate of investors, an agreed period of exclusivity during which the company and/or its existing shareholders cannot negotiate with others for investment into the company.

Exercise price The price at which an option or warrant can be exercised.

Exit mechanism Term used to describe the method by which a venture capitalist will eventually sell out of an investment (see paragraph 18, Section IV above).

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Exit strategy Potential scenarios for liquidating an investment while achieving the maximum possible return. For venture capital-backed companies, typical exit strategies include Initial Public Offerings (IPOs) and acquisitions by or mergers with larger companies (see paragraph 18, Section IV above).

Flotation To obtain a listing or IPO on a stock exchange (see paragraph 18, Section IV above).

Follow-on investment round An additional investment by existing and/or new investors, which may be provided for in documentation relating to the initial investment.

Founder shares Shares issued to the founders of a company, usually at a low price in comparison to that paid by investors (see paragraph 9, Section IV above). See also Sweat equity.

Full ratchet Anti-dilution provisions that apply the lowest sale price for any ordinary shares (or equivalents) sold by the company after the issuing of an option or convertible share as being the adjusted option price or conversion price for those options or shares (see paragraph 8, Section IV above).

Fully diluted share capital The issued share capital of a company if all options and other rights to subscribe for shares are exercised.

Fully participating Term sometimes used to describe a liquidation preference which entitles beneficiaries to receive a priority initial fixed payment and share pro rata with other share classes in any remaining proceeds (see paragraph 4, Section IV above).

Generally accepted accounting principles (GAAP) Rules and procedures generally accepted within the accounting profession.

Good leaver/bad leaver A criteria applied to a shareholder employee who is ceasing to be employed to determine whether his shares should be subject to a compulsory sale, and if so, at what price (see paragraph 9, Section IV above).

Independent or outside director A non-executive member of the Board of Directors who is not an employee of a company nor affiliated with a controlling stockholder of a company. The definition of independent may be further defined in different countries or markets (see paragraph 16, Section IV above).

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V Venture capital glossary of terms continued Information rights The contractual right to obtain information about a company, attend board meetings, etc. typically received by venture capitalists investing in privately held companies (see paragraph 17, Section IV above).

Initial public offering (IPO) The sale of shares to the public by a company for the first time. Prior to an IPO, companies that sell shares to investors are considered privately held. This is the first time that a company has tried to raise funds on a public market such as a stock exchange. Terms used to describe this are flotation, float, going public, listing when a company obtains a quotation on a stock market (see paragraph 18, Section IV above).

Institutional investor An organisation whose primary purpose is to invest assets owned by the organisation or entrusted to them by others. Typical institutional investors are banks, pension funds, insurance companies, mutual funds and university endowments.

Intangibles The non-physical assets of a company that have a value, e.g. intellectual property rights including trademarks and patents.

Intellectual property (IP) Legal term used to describe the patents, licences, copyrights, trademarks and designs owned by a company (see Section III above).

Internal rate of return (IRR) An accounting term for the rate of return on an asset. It is defined as the interest rate that equates the present value of future returns to the initial investment. It is greatly affected by the timing of the exit.

Investment Agreement This is a summary of the main terms of the investment into the company. Typically it will describe the amounts and types of shares to be issued and the specific rights of the investors such as veto rights and information rights (see Investment Agreements in Section II above).

Key man insurance Insurance obtained by the Company on the lives of key employees, usually the chief executive officer and the person or persons ultimately responsible for continuing to develop the technology (see paragraph 26, Section IV above).

Lead investor In a substantial investment, the whole risk is often shared among a syndicate. Normally, one investor will take the lead in negotiating the terms of the investment and managing due diligence (see Syndication below).

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Licence Agreement An agreement under which certain commercial and/or intellectual property rights may be used by the licensee, for example the institution may licence intellectual property rights to the investee company.

Liquidation or winding up The sale of all of a company's assets, for distribution to creditors and shareholders in order of priority.

This may be as a result of the insolvency of the company or by agreement amongst shareholders (see paragraph 4, Section IV above).

Liquidation preference A negotiated term of a round of venture capital financing that calls for certain investors to have all or most of their entire investment repaid if the company is liquidated. Often also triggered by a deemed liquidation (see paragraph 4, Section IV above).

Liquidity Converting an asset (such as shares) to cash (see paragraph 18, Section IV above).

Listing When a company's shares are traded on a stock market it is said to be listed (see paragraph 18, Section IV above).

Lock-up A provision in the Underwriting Agreement between an investment bank and existing shareholders that prohibits corporate insiders and private equity investors from selling for a certain period of time following a public offering (usually 180 days after an IPO).

Milestone A contractual target that must be met by the company. Often used by investors as a condition for releasing further amounts of financing (see paragraph 2, Section IV above).

Net present value (NPV) The current value of future cash flows discounted back to today's date using a stated discount rate.

NewCo Word often used to describe a newly formed investee company (see Section III above).

New money Investment funds coming from an investor who is not a current shareholder of the company.

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V Venture capital glossary of terms continued Non-executive director Part-time directors who share all the legal responsibilities of their executive colleagues on the Board of a company. The general view is that they can operate as an independent director able to take a longterm view of a company and protect the interests of shareholders. An investor will often appoint a nonexecutive to a board as one way of monitoring its investment (see paragraph 16, Section IV above).

Non-qualified IPO An IPO which is not a qualified IPO. Options The right, but not the obligation, to buy or sell a security at a set price (or range of prices) in a given period.

Ordinary shares These are equity shares that are entitled to all income and capital after the rights of all other classes of capital and creditors have been satisfied.

Outside director See Independent or outside director.

Par The nominal cash amount assigned to a security by the issuer. For an equity security, par is usually a very small amount that no longer bears any relationship to its market price.

Pari passu Equally, rateably, without preference. Generally used to describe securities which are to be treated as being of equal priority or preference.

Participating preferred shares Preferred shares which entitle the holder not only to its stated dividend and liquidation preference, but also allows the holder to participate in dividends and liquidating distributions declared on ordinary shares.

Patent The right to exclude others from making, using, importing or selling an invention or a process for a specific period of time.

Pay to play A provision which requires investors to participate in subsequent rounds or forfeit certain rights such as anti-dilution.

Piggy-back registration rights (US) Contractual rights granted to security holders giving them the right to have their holdings included in a registration statement if and when the issuer files a registration statement (see paragraph 19, Section IV above).

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Post-money valuation The value of a privately held company immediately after the most recent round of financing. This value is calculated by multiplying the company's total (fully diluted) number of shares by the share price of the latest financing (see paragraph 2, Section IV above).

Pre-emption right The right of an investor to participate in a financing to the extent necessary to ensure that, if exercised, its percentage ownership of the company's securities will remain the same after the financing as it was before. Sometimes also used as a term for a right of first refusal on shares of other investors (see paragraph 10, Section IV above).

Preferred ordinary shares (UK) These may be known as A ordinary shares, cumulative convertible participating preferred ordinary shares or cumulative preferred ordinary shares. These are equity shares with preferred rights. Typically they will rank ahead of the ordinary shares for income and capital. Once the preferred ordinary share capital has been repaid, the two classes may then rank pari passu in sharing any surplus capital. Their income rights may be defined; they may be entitled to a fixed dividend (a percentage linked to the subscription price, e.g. 8% fixed) and/or they may have a right to a defined share of the company profits – known as a participating dividend (e.g. 5% of profits before tax).

Pre-money valuation The value of a privately held company prior to the most recent round of financing (see paragraph 2, Section IV above).

Put option A contract whereby the holder of the option has the right to sell to the grantor shares at a specific price (strike price) at some time in the future.

Qualified IPO An IPO which gives the company a market capitalisation of at least a certain amount (often a multiple of the valuation at the time of an investment) and is accompanied by a fully underwritten fund raising of a certain amount (see paragraph 7, Section IV above).

Recapitalisation The reorganisation of a company's capital structure by the infusion of new cash and/or the replacement of current shareholders by new ones. Recapitalisation can be an alternative exit strategy for venture capitalists.

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V Venture capital glossary of terms continued Ratchets A structure whereby the eventual equity allocations between the groups of shareholders depend on either the future performance of the company or the rate of return achieved by the venture capital firm.

This allows management shareholders to increase their stake if the company performs particularly well (see paragraph 2, Section IV above).

Redeemable shares Shares which the company can be made to repurchase or which the company has the right to repurchase at a predetermined value (see paragraph 5, Section IV above).

Registration rights (US) The contractual right of a shareholder to participate in the registration of the issuer's stock for resale in the public market (see paragraph 19, Section IV above).

Remuneration Committee or Compensation Committee A committee of the Board of Directors responsible for reviewing and setting the remuneration of certain executive officers of the company. The Remuneration Committee may also be responsible for the allocation of share options to employees. A Remuneration Committee is typically comprised of a majority of independent directors of the company (see paragraph 16, Section IV above).

Representations and warranties Terms in an Investment or Subscription Agreement whereby usually the founders and key managers and (subject to local company law) the company give undertakings in respect of the past and present operating condition of a company. Examples include operating in a legal fashion, no bad debts, ownership of assets.

Breach of warranty gives the investors the right to claim damages and, if it is sufficiently fundamental, may enable the investors to terminate the contract (see paragraph 13, Section IV above).

Restrictive covenants/non-competes Undertakings given by founders/key management in the Investment Agreement and contracts of employment or Consultancy Agreements which restrict their ability to undertake activities which might compete with the company both during their employment/consultancy and post termination of employment in order to protect the business and the value of the company (see paragraph 20, Section IV above).

Right of first refusal (ROFR) A contractual right, frequently granted to venture capitalists, to purchase shares held by other shareholders before such shares may be sold to a third party (see paragraph 11, Section IV above).

ROI Return on investment (see paragraph 3, Section IV above).

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Secured debt/loan Loan, where the lender, in the event of a failure to meet either an interest or principal payment, gains title to specific assets.

Seed capital Capital provided to allow a business concept to be developed, perhaps involving the production of a business plan, prototypes and additional research, prior to bringing a product to market and commercial large-scale manufacturing (see Section I above).

Series A round of venture capital financing. Each sequential round is distinguished by a letter: A, B, C, etc. (see paragraph 1, Section IV above).

Shareholders' Agreement/Investor Rights Agreement Many of the rights between shareholders in a company are set out in its Articles of Association. This is a public document that is filed at Companies House. In many cases shareholders will want to create rights and obligations between them that they would prefer to keep confidential. In such cases, rather than put those rights and obligations into a public document they will enter into private contractual arrangements, in a document such as a Shareholders' Agreement. If the agreement also includes terms relating to the subscription for shares it will often be referred to as the Investment Agreement (see Section II above).

Share option An agreement providing for the purchase or sale of shares within a stipulated time and for a certain price (see paragraph 21, Section IV above).

Subscription Agreement A Subscription Agreement sets out the terms upon which an investor will subscribe for shares in a company. If the agreement also includes terms relating to shareholders' rights it may also be described as an Investment Agreement (see Section II above).

Sweat equity Equity (shares in a company) which is given to the founder of the company in recognition of the effort (sweat) which he has expended in getting the company started up (see Section III and paragraph 9 in Section IV above).

Syndication An arrangement whereby a group of investors come together to invest in an investment proposition which they would not be prepared to consider individually whether because of risk or amount of funding required. There is however usually a lead investor (see Section II above).

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V Venture capital glossary of terms continued Trade sale Sale of a company to another company. As a form of exit, it is an alternative to flotation and more common (see paragraph 18, Section IV above).

Trade secret Information, such as a formula, pattern, device, or process, that is not known to the public and which gives the person possessing the information a competitive advantage. May sometimes include customer lists, marketing and/or business plans, and details of suppliers and customers.

Tranching Investment made in stages; each stage being dependent on achievement of targets or milestones (see paragraph 2, Section IV above).

Transfer restrictions Restriction of the sale of shares by founders, management or investors for a predefined period of time or until certain conditions have been fulfilled (see paragraph 11, Section IV above).

Use of proceeds The purpose to which the company intends to use the funds raised from new investors. The investment documentation often stipulates that the funds must be used for this purpose.

Vesting Where an employee or consultant has been granted rights to receive options or has been issued shares which are subject to his completing a specific length of service or achieving certain milestones, the options or shares will have vested when the period or milestone has been satisfied. Once vested the employee or consultant is entitled to exercise those options to obtain shares or to receive full rights to the shares (see paragraph 9, Section IV above).

Warrant Another word for an option to purchase a security. The term is generally used for options provided by the company to outside investors (as distinct from officers, employees, etc.).

Weighted average Anti-dilution provisions that apply a weighted average formula to adjust the option price or conversion ratio of an early-round investor, based on the sale price and number of equivalent shares sold by the company after the issuing of the option or convertible security (see paragraph 8, Section IV above).

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VI Example of a Term Sheet for a Series A round Strictly private and confidential Not to be disclosed or distributed to third parties

Draft ●

Indicative Term Sheet [For use on Series A round]

We are pleased to present our proposal for an investment in• (the “Company”).

1.

Investment

1.1

You have told us that the proposed business plan calls for an equity injection of £•. Of this amount, funds managed by us (the “Funds”) will provide £• alongside investment by other venture capital funds or financial institutions (together the “Investors”). We will act as lead equity investor.

1.2

The investment will be at a fully diluted pre-money valuation of £•, including employee share options (both granted or committed) equal to •% of the fully diluted equity. The investment will represent a •% shareholding for the Investors on a fully diluted basis, following an expansion of the share option pool as detailed in paragraph 2.4. The current capitalisation of the Company is set out in Part I of Appendix 1 and the capitalisation of the Company after this proposed funding is set out in Part 2 of Appendix 1. (See paragraph 2, Section IV above.)

1.3

The investment will be made in the form of convertible participating [redeemable] preferred shares (“Preferred Shares”) at a price of £• per Preferred Share (the “Original Issue Price”) the terms of which are set out in Appendix 2.

1.4

[The investment will be made in full at completion.]/ [The investment will be staged with •% being invested at completion (the "First Tranche") and •% being invested subsequently (the "Second Tranche"). [The Investors will have the right, but not the obligation, to subscribe for the Second Tranche at the same price per share as the First Tranche at any time.] [Provided that the performance milestones referred to in paragraph 2.6 have been met, the board of directors of the Company (the "Board") will have the right to call the Second Tranche within • months of the performance milestones being satisfied.] (See paragraph 2, Section IV above.)

1.5

The proceeds from the investment must be used for the Company's working capital requirements [in particular •].

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VI Example of a Term Sheet for a Series A round continued 2.

Conditions of investment

2.1

The investment is conditional on negotiation of definitive legal documents, satisfactory completion of due diligence and approval by our Investment Committee. (See paragraph 26, Section IV above.)

2.2

Satisfactory completion of due diligence will include: (a)

Conclusion of our commercial due diligence [including •]

(b)

References from customers and partners

(c)

Market and technology review by an independent third party

(d)

Management references

(e)

Review of current trading and forecasts for the next • – • months

(f)

Review of existing and/or proposed management service contracts

(g)

Review of the Company’s financial history and current financial situation by our advisors including, a review of the last set of audited accounts and the latest set of monthly management accounts prior to completion of our investment

(h)

Full legal review of the Company by our lawyers, focusing particularly on ownership of all necessary intellectual property and benefit of all key commercial contracts

(i) 2.3

[VCT tax clearance from HM Revenue & Customs]

The Company must secure institutional co-investment of at least £• on identical terms from other venture capital funds or similar organisations acceptable to us. We will not underwrite the total funding sought nor guarantee the securing of co-investors.

2.4

The expansion of the share option pool prior to the investment to represent •% of the equity [pre-funding]/[post-funding] on a fully diluted basis. These extra share options will be reserved for new employees and will have an exercise price equal to the Original Issue Price (see paragraph 1.3) [or may be exercised at a discount to that price subject to consent from the relevant tax authority and the Investor Director (see paragraph 4.3)]. Following grant, these options will vest quarterly over a • year period, [subject to a minimum employment of • year].

(See paragraph 21, Section IV above.)

2.5

The investment must comply with the money laundering regulations and rules of the Financial Services Authority.

2.6

[Appendix 7 sets out the performance milestones which must be satisfied within the periods stated before Subsequent Tranches can be called.] (See paragraph 2, Section IV above.)

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3.

Good leaver/bad leaver provisions Ordinary Shares in the Company (the "Ordinary Shares") held by [INSERT NAMES OF FOUNDERS] (the "Founders") [and [INSERT NAMES OF RELEVANT EMPLOYEES]] will be subject to [vesting rights] [and good leaver/bad leaver provisions] as summarised in Appendix 3.] (See paragraph 9, Section IV above.)

4.

Terms of investment

4.1

The Company and the [INSERT NAMES OF RELEVANT MANAGERS] (the "Managers") will provide the Investors with customary representations and warranties examples of which are set out in Appendix 4 and the Managers will provide the Investors with customary non-competition, non-solicitation and confidentiality undertakings. (See paragraph 13, Section IV above.)

4.2

The Board will have a maximum of • directors. [For so long as the Investors hold •% of the issued share capital of the Company on an as converted basis] the Investors will have the right to appoint [one] director (the "Investor Director"). The composition of the Board on completion will be •.

There will be a minimum of • board meetings each year. (See paragraph 16, Section IV above.)

4.3

The Investors' or the Investor Director's consent will be required for certain key decisions, examples of which are set out in Appendix 5. (See paragraph 16, Section IV above.)

4.4

The Managers and the Company will undertake certain matters to the Investors, examples of which are set out in Appendix 8.

4.5

[The Investors will also have at all times the right to designate a non-voting observer to the Board.] (See paragraph 16, Section IV above.)

4.6

[The Company will form a Remuneration Committee [and an Audit Committee] upon completion and the Investor Director will be the chairman [of both].] (See paragraph 16, Section IV above.)

4.7

The Company will have an obligation to supply normal financial and operational information about the Company to the Investors. (See paragraph 17, Section IV above.)

4.8

he Investors and the existing shareholders will have rights to acquire and sell shares as outlined in Appendix 6. (See paragraphs 10, 11 and 12, Section IV above.)

4.9

[In the event of an initial public offering of the Company's shares on a US stock exchange the Investors shall be entitled to full registration rights customary in transactions of this type (including • demand rights and unlimited piggy-back rights), with the expenses paid by the Company ] (See paragraph 19, Section IV above.)

4.10 The key members of the management team will be required to sign service agreements which include customary provisions for non-disclosure, non-competition, non-solicitation,

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VI Example of a Term Sheet for a Series A round continued confidentiality, assignment of intellectual property rights, and termination. (See paragraph 20, Section IV above.)

4.11 [Within [ • ] months of completion,] [Before completion,] the Company must obtain key man insurance, naming the Company as beneficiary on the lives of • and • for an amount of £• and director and officer liability insurance, both in a form acceptable to the Investors.

4.12 The Company will agree to pay to the Investors an annual, index-linked monitoring fee of £• per annum plus VAT, charged quarterly in advance, plus reasonable out of pocket expenses in respect of each Investor Director. (See paragraph 22, Section IV above.)

4.13 [The Company and the Investors will bear their own costs in relation to the investment save that the Company will contribute an aggregate of £• to the investment appraisal and legal costs of the Investor.] [In addition, on completion, the Company will pay to us a transaction fee of £• plus VAT]. (See paragraph 22, Section IV above.)

5.

Confidentiality

5.1

This Term Sheet is written on the basis that its contents and existence are confidential and will not (except with the agreement in writing of the Investors and the Company or in order to comply with any statutory or stock exchange or other regulatory requirements) be revealed by the Investors, the Company or the Founders to any third party or be the subject of any announcement. (See paragraph 23, Section IV above.)

5.2

The Investors and the Founders agree that they will enter into a non-disclosure agreement before the Investors begin their due diligence investigations.

6.

Applicable law This letter is governed by English law and on acceptance the parties submit to the non-exclusive jurisdiction of the courts of England and Wales.

7.

Expiry date The Founders and the Company are requested to confirm their acceptance of the terms of our proposal within 14 days of the date of this letter, failing which our proposal will lapse.

8.

Exclusivity In consideration of the Investors expending time and professional and other fees (the “Costs)” in progressing this offer the Founders and the Company agree and undertake that they will not directly or indirectly until the earlier of the expiry of • days from the date of acceptance of the terms of this proposal or the date that the Investors notify the Company of their intention not to proceed with this proposal (the “Period”) solicit, directly or indirectly, further offers for the

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purchase and/or subscription of shares in the Company (or any part thereof) or any material part of the business, assets or undertakings of the Company or enter into or continue to seek negotiations with any party other than the Investors in connection with such matters. (See paragraph 24, Section IV above.)

The Founders and the Company agree and undertake to inform the Investors immediately of the identity of any third party who contacts the Founders or the Company with a view to the sale of any interest in the shares of the Company or any part of the business of the Company.

[By accepting this offer the Founders and the Company confirm that if: (a)

they withdraw from negotiations with the Investors during the Period; or

(b)

if they breach the exclusivity provisions in paragraph 8[; or

(c)

if the Investors decide not to proceed with this offer due to a materially adverse fact or circumstance [which exists today but] of which the Investors become aware during this Period,]

then the Company and the Founders undertake to pay to the Investors: (i)

the sum of £• (such sum being a genuine pre-estimate of the loss to the Investors in the event that this offer does not proceed); and

(ii)

to the extent not recovered under paragraph (i) above the Costs incurred by the Investors in relation to this proposal;

provided that under no circumstances shall the Company and the Founders be obliged to pay the Investors more than £• under this paragraph 8].

Each of the undertakings referred to in this paragraph 8 shall be read and construed independently so that if any undertaking is held to be invalid or unenforceable for any reason the remaining undertakings shall continue to apply.

9.

No intention to create legal relations Except for the provisions of each of paragraphs 5 to 10, which are intended to create legally binding obligations between the parties, this Term Sheet sets out indicative terms on which we would be prepared to make an investment in the Company and will not give rise to any contract between us. (See paragraph 25, Section IV above.)

10.

Exclusion of representations and warranties By accepting this proposal you acknowledge that you have not relied on any representation or warranty on our part or entered into any other agreement with us in connection with the provision of funding by the Investors.

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VI Example of a Term Sheet for a Series A round continued To confirm your acceptance of the terms of this proposal please sign and date the duplicate copy of this Term Sheet and return it to us.

[On copy]

To: [INSERT NAME OF INVESTOR] We hereby acknowledge and accept the terms of the above Term Sheet. We confirm that we grant you a • day period of exclusivity from the date of acceptance and that in the event that we subsequently withdraw from the transaction, in accordance with paragraph 8 of the Term Sheet, we will reimburse to you on demand a sum equal to all the external professional costs and expenses incurred by you up to the date of our withdrawal subject to the maximum amount specified in paragraph 8. (See paragraph 25, Section IV above.)

..........…………………………………………............…………

Signed by [ for and on behalf of [

] ] Limited

date ………..........………………………

..........…………………………………………............…………

date ………..........………………………

[Founder]

..........…………………………………………............…………

date ………..........………………………

[Founder]

..........…………………………………………............…………

date ………..........………………………

[Founder]

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Appendix 1 Capitalisation table

Part 1 [current capitalisation]

Part 2 [post funding capitalisation]

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VI Example of a Term Sheet for a Series A round continued Appendix 2 Rights attaching to Preferred Shares 1.

The price per Preferred Share will be £•. (See paragraph 2, Section IV above.)

2.

The Preferred Shares will vote with Ordinary Shares on an as converted basis as a single class on all matters, other than those referred to in Appendix 5. (See paragraphs 14 and 15, Section IV above.)

3.

The Preferred Shares will have a preferential cumulative coupon of •% per annum [starting on • 200 • ] (the "Preference Dividend") to be paid [on an exit, IPO or conversion of the Preferred Shares]/[in [four] equal instalments on •, •, and • in each year]/[on • in every year], on a liquidation [or on redemption of the Preferred Shares]. Any other dividends or distributions will be payable to all shareholders on a pro rata basis (in the case of the holders of Preferred Shares, determined on an as converted basis). (See paragraph 3, Section IV above.)

4.

Upon liquidation of the Company, the Preferred Shareholders will receive in preference to all other shareholders an amount in respect of each Preferred Share equal to [• times] the Original Issue Price (the "Liquidation Preference"), plus all accrued but unpaid dividends. [The holders of Ordinary Shares will also be entitled to recover an amount per Ordinary Share equal to the amount paid up on those Ordinary Shares.] To the extent that the Company has assets remaining after the distribution of that amount, the Preferred Shareholders will participate with the holders of Ordinary Shares pro rata to the number of shares held on an as converted basis. (See paragraph 4, Section IV above.)

5.

Sale of all or substantially all of the assets of the Company or a sale of shares involving a change in control (each, a "Corporate Transaction") will be treated in the same way as a liquidation and the proceeds of sale will be distributed as set out in paragraph 3. (See paragraph 4, Section IV above.)

6.

An IPO [that is not a Qualified IPO] will be treated in the same way as a liquidation. [The Company will issue to each holder of Preferred Shares that number (if any) of Ordinary Shares so that the proportion which the Ordinary Shares held by that shareholder bears to the fully diluted share capital following completion of all such issues and the conversion of the Preferred Shares will be equal to the proportion which the proceeds that that shareholder would have been entitled to receive on a sale on that date would bear to the valuation of the Company at that date.]/[The Company shall issue to each holder of Preferred Shares by way of capitalisation of reserves such number of Ordinary Shares as shall have an aggregate value (at the offer price for Ordinary Shares issued in the IPO) equal to the aggregate subscription price for the Preferred Shares held.] (See paragraph 4, Section IV above.)

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7.

The Preferred Shares may be converted into an equivalent number of Ordinary Shares by their holders at any time.

8.

The Preferred Shares will be converted automatically into an equivalent number of Ordinary Shares upon the completion of a firmly underwritten initial public offering ("IPO") of Ordinary Shares: (i) at a net offering price per share of at least [• times] the Original Issue Price (after adjusting for any recapitalisation events) and (ii) resulting in net aggregate proceeds to the Company of not less than £• (the "Qualified IPO") (See paragraph 7, Section IV above).

9.

On conversion of the Preferred Shares on an IPO all accrued but unpaid dividends on the Preferred Shares must be paid save to the extent that the Company does not have sufficient profits available for distribution to pay the Preference Dividend, in which case the Company will allot to each holder of Preferred Shares by way of capitalisation of reserves such number of Ordinary Shares as shall have an aggregate value equal to the unpaid dividend. Any capitalisation will be at the price of the Ordinary Shares at IPO. (See paragraph 3, Section IV above.)

10.

The Preferred Shares will have a [full ratchet]/[broad-based weighted-average]/ [narrow-based weighted-average] anti-dilution protection in the case of any new issue of shares at a price below the Original Issue Price (after adjusting for any recapitalisation events) other than share issues which are not subject to pre-emption rights. This anti-dilution protection will operate by the issue of Ordinary Shares at par through a capitalisation of share premium account. (See paragraph 8, Section IV above.)

11.

[If the Company makes a subsequent issue of shares in which the Investors are entitled to participate and an Investor elects not to do so (i.e. does not wish to pay to play) for at least •% of its allocation that Investor will lose its anti-dilution right in respect of any Preferred Shares it holds.]

12.

[If no [Qualified] IPO or Corporate Transaction has occurred within • years from completion, each of the Preferred Shares will be redeemable at the option of [the holder]/[the Investor Majority] for an amount in cash equal to the [Original Issue Price][the Liquidation Preference], plus all accrued but unpaid dividends.] (See paragraph 5, Section IV above.)

13.

[An Investor Majority will have the right exercisable at any time to require the Company to redeem all [or some only] of the Preferred Shares in issue if: (a)

the Preference Dividend is not paid when due;

(b)

the Company fails to redeem any Preferred Shares when due;

(c)

a resolution to wind the Company up, to reduce the Company's share capital or to vary the rights of the Preferred Shares is proposed.]

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VI Example of a Term Sheet for a Series A round continued Appendix 3 Rights attaching to Ordinary Shares held by the Founders [and employees] 1.

* Subject to paragraph 3 below, the Ordinary Shares held by the Founders will vest equally on a [quarterly/monthly] basis over a • year period. (See paragraph 9, Section IV above.)

2.

* If a Founder ceases to be an employee of the Company those Ordinary Shares which have not vested will convert into deferred shares in the Company (the "Deferred Shares"). The Deferred Shares will have no right to receive a dividend, minimal rights to capital and will be non-voting.

The Company will have the right to purchase back the Deferred Shares for an aggregate purchase price of £• at any time.

3.

* [If there is a Corporate Transaction at a time when any of the Ordinary Shares held by the Founders remain un-vested, the consideration may be structured in such a way that it defers realisation of the value attached to the un-vested shares until such time as they would have been vested.]

4.

* [If a Founder ceases to be an employee of the Company as a result of death, permanent incapacity or wrongful dismissal, all of his Ordinary Shares will become vested shares.] * Only to be used where Founders are to hold vested shares.

5.

[In the event of an employee shareholder [(other than a Founder)] ceasing to be an employee of the Company within a period of [•] years starting on the date of commencement of his employment with the Company, all of his shares [(other than those held following the exercise of share options)] must be offered for sale: (a)

where the relevant employee shareholder is a Bad Leaver, at the lower of market value and the nominal value of the shares; and

(b)

where the relevant employee shareholder is a Good Leaver, at the market value of the shares.]

The shares must be offered for sale in the following priority: (a)

to new employee(s) nominated by the Investors;

(b)

to any existing employee(s);

(c)

to participants in or trustees of the Company's employee share option scheme;

(d)

to any other person approved by the Investor Directors and the Board;

(e)

to the Company.

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6.

[Unless otherwise determined by the Board,] "Good Leaver" means any employee shareholder [(other than a Founder)] who ceases to be employed [after • years from the start of his employment or] as a result of death or permanent incapacity, summary dismissal when the dismissal is found to have been wrongful or constructive, or whose contract of employment is terminated in circumstances where he is not in breach of his contract. "Bad Leaver" means any employee shareholder [(other than a Founder)] who is not a Good Leaver.

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VI Example of a Term Sheet for a Series A round continued Appendix 4 Proposed warranties The Investors will require the following items to be warranted by the Founders and the Company: ●

Status of the Company

●

Latest available audited accounts

●

Management accounts covering the period from latest audited accounts to completion of the proposed investment

●

Position since audited accounts date

●

Business plan

●

Ownership of assets and HP liabilities

●

Employment contracts

●

Intellectual property

●

No outstanding liabilities to executives

●

Pension plan

●

No litigation pending or threatened

●

No breaches of existing or recent contracts

●

Register of members correct/no other share issues committed

●

Insurance policies up to date

●

Loans/guarantees

●

Taxation

●

Property leasehold – terms/rights/obligations.

The above items are not comprehensive and are only intended to provide a guide to the warranties that are likely to be included in the Investment Agreement. In particular, additional items may require warranting following due diligence. The objective of these and other warranties will be to ensure that Founders and the Company have provided the Investors with accurate information on matters upon which the Investors have based their investment decision.

(See paragraph 13, Section IV above.)

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Appendix 5 Proposed covenants 1.

Investor consents The prior written approval of the Investors [holding • % of the Preferred Shares] will be required to:

2.

●

Change the share capital

●

Amend Memorandum and Articles of Association

●

Pay any dividends

●

Acquire any new business, shares or other securities

●

Permit a sale or IPO of the Company

●

Wind up the Company

●

Enter into any guarantee or indemnity in respect of the obligation of a third party

●

Grant any superior registration rights to those granted to the Investors

●

Adopt a budget

●

Sell or deal with assets other than in ordinary course of business

Board consent The prior written approval of [both] [the majority] of the Investor Directors will be required to: ●

Incur development or capital expenditure outside the annual budget

●

Dispose of any asset of a capital nature having a book or market value greater than £[•]

●

Make any change of trade/business [(including adherence to VCT "qualifying"' trade definition)]

●

Create or close any subsidiaries/joint ventures/consortiums/partnerships/branches

●

Any act or thing other than in ordinary course of business

●

Any change of auditor/accounting reference date/accounting policies/bank

●

Change the annual budget

●

Agree any borrowings, loans, advances or credit outside the annual budget

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VI Example of a Term Sheet for a Series A round continued ●

Any appointment of an employee or consultant or variation of terms where emoluments exceed £• or more than 3 months notice required

●

Appoint or remove directors to/from the board of the Company or any subsidiary companies

●

Create charges

●

Conduct any material litigation

●

Implement any variation to the Company's pension arrangements

●

Acquire real estate and other real estate-related matters

●

Enter into any arrangement with any director or shareholder of the Company or any subsidiary companies

●

Enter into any transaction otherwise than on arm's length terms

●

Amend any material supply or distribution agreement

●

Enter into any material long term contract

Materiality and other financial limits for the above to be discussed. The above items are not comprehensive and are only intended to provide a guide to the consent items that are likely to be included in the Subscription and Shareholders Agreement.

(See paragraph 15, Section IV above.)

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Appendix 6 Conditions of issue and transfer of shares 1.

[Investors will have a right of first refusal on any new issue of shares of any class.] [Investors will have the right to participate with the holders of Ordinary Shares in any new issue of shares of any class pro rata to their holding of shares (determined on an as converted basis).] (See paragraph 10, Section IV above.)

2.

Investors will have a right of first refusal to acquire any Preferred Shares which are proposed to be transferred or sold with any Preferred Shares not taken up in such offer being offered to the holders of Ordinary Shares. Holders of Ordinary Shares will have a right of first refusal to acquire any Ordinary Shares which are proposed to be transferred or sold with any Ordinary Shares not taken up in such offer being offered to the holders of Preferred Shares. (See paragraph 11, Section IV above.)

3.

[No Ordinary Shares can be sold without the Investor's prior consent] [No Ordinary Shares held

by Founders can be sold until they have vested]. (See paragraph 11, Section IV above.)

4.

[All Shareholders will have co-sale rights such that if any Founder [or employee] has an opportunity to sell [any of his shares] [shares exceeding •% of the issued share capital], the other shareholders must be given the opportunity to sell a pro rata proportion of the number of shares being sold by the Founder [or employee] on the same terms and at the same price. (See paragraph 11, Section IV above.)

5.

All Shareholders will have rights such that if any shareholder has an opportunity to sell any or all of its shares, the effect of which would result in a change of control of the Company, the other shareholders must be given the opportunity to sell all of their shares on the same terms and at the same price. (See paragraph 11, Section IV above.)

6.

If holders of at least •% of the Preferred Shares [and Ordinary Shares] agree to sell their shares, there will be drag along rights so that all remaining shareholders and option holders will be required to sell on the same terms, provided that the dragged shareholders will not be required to provide to the purchaser any representations or warranties except as to title or to agree to any other terms. (See paragraph 12, Section IV above.)

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VI Example of a Term Sheet for a Series A round continued Appendix 7 Performance milestones (See paragraph 2, Section IV above.)

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Appendix 8 Undertakings 1.

The Company shall maintain in effect for the benefit of the Company the keyman policies for [•].

2.

The Company shall take out insurances satisfactory to the Investors.

3.

The Company shall take all such reasonable action as may be required of it by the Investors to protect its assets.

4.

All new business opportunities relevant to the Company shall only be taken up through the Company or a wholly owned subsidiary.

5.

New employees engaged by the Company shall not bring with them intellectual property belonging to third parties.

6.

The Company shall convene and hold at short notice an extraordinary general meeting of the Company when requested by the Investors.

7.

The Company shall enter into an election under section 431(1) of ITEPA jointly with each of the relevant Managers.

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Original cover concept and guidelines by IUVO www.iuvodesign.com

157

term sheets COVER.indd 2

Designed and produced by Jeffrey Pellin Consultancy www.pellin.co.uk

9/10/07 13:30:38

3 Clements Inn London WC2A 2AZ T 020-7025 2950 F 020-7025 2951 bvca@bvca.co.uk www.bvca.co.uk

A Guide to Venture Capital Term Sheets

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California MCLE - Equity Joint Venture Contract - BMW Brilliance Aut…Holding BV and Shenyang JinBei Automotive Industry Holdings Co. Ltd.

CHINA

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EQUITY JOINT VENTURE CONTRACT EXECUTION COPY Equity Joint Venture Contract for the Establishment of BMW BRILLIANCE AUTOMOTIVE LTD. by and between BMW Holding BV Laan van Vredenoord 5 2289 DA Rijswijk ZH Netherlands and Shenyang JinBei Automotive Industry Holdings Company Limited 6th Floor, Building B, No. 1 Shiji Road Hunnan Industrial Zone, High-Tech District Shenyang, Liaoning Province People’s Republic of China

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EQUITY JOINT VENTURE CONTRACT Table of Contents

EQUITY JOINT VENTURE CONTRACT Preliminary Statement Article 1 Definitions Article 2 Parties Article 3 Establishment and Legal Form of JV Company Article 4 Purpose and Scope of Business of JV Company Article 5 Total Investment and Registered Capital Article 6 Transfer of Interest in the Registered Capital of the JV Company Article 7 Board of Directors Article 8 Deadlock Article 9 Management Organization Article 10 Assistance by the Parties Article 11 Existing Equipment, Existing Building and Production Site Article 12 Technology Transfer Article 13 Quality Standards Article 14 Purchase of Materials and Services / Local Content Article 15 Sale of JV Products Article 16 Trademarks Article 17 Non-Competition Article 18 Labor Management Article 19 Trade Union Article 20 Finances, Taxes, Audit and Distribution of Profits Article 21 Bank Accounts and Foreign Exchange Article 22 Joint Venture Term Article 23 Termination Article 24 Consequences of Termination Article 25 Insurance Article 26 Confidentiality Article 27 Force Majeure Article 28 Applicable Law Article 29 Dispute Resolution Article 30 Miscellaneous Annex 1 Business Plan and Budget Annex 2 Benchmarks, ROS Percentage

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EQUITY JOINT VENTURE CONTRACT EQUITY JOINT VENTURE CONTRACT

THIS EQUITY JOINT VENTURE CONTRACT (hereinafter the “Contract”) is entered into in Beijing on this 27th day of March 2003, in accordance with the Law of the People’s Republic of China on Sino-Foreign Equity Joint Ventures (the “Joint Venture Law”), the implementing regulations issued thereunder (the “Joint Venture Regulations”), and other applicable laws and regulations of the People’s Republic of China, by and between Shenyang JinBei Automotive Industry Holdings Company Limited (“BRILLIANCE”) and BMW Holding BV (“BMW”).

Preliminary Statement The Parties hereby agree to jointly establish a Sino-foreign equity joint venture company (the “JV Company”) in the province of Liaoning, People’s Republic of China on the basis of the principles of equality and mutual benefit in accordance with the terms and conditions set forth below and with applicable laws and regulations.

Article 1

Definitions

Unless the terms or the context of this Contract otherwise provide, the following terms in this Contract shall have the meanings set forth below: 1.1

“Affiliate” of a Party shall mean, any company or other entity or natural person other than the JV Company that, through ownership or voting stock or otherwise, Controls or is Controlled by, or under common Control with, such Party. Within the PRC, the “company” as used in this Article 1.1 shall include any kind of business entity with legal person status under PRC Laws.

Notwithstanding the foregoing, Brilliance Automotive Group Holdings Co., Ltd., Brilliance China Automotive Holdings Ltd., Shenyang Brilliance JinBei Automotive Co., Ltd., Shenyang Aerospace Mitsubishi Motors Engine Manufacturing Co., Ltd., China Aerospace Brilliance Automotive Co., Ltd., JinBei General Motors Automotive Co., Ltd., Shenyang Xin JinBei Investment and Development Co., Ltd., and Shenyang JinBei Auto Industry Co., Ltd. shall be considered Affiliates of BRILLIANCE for the purposes of this Contract.

1.2

“Articles of Association” shall mean the Articles of Association of the JV Company as executed by the Parties in Beijing of even date and amended thereby from time to time.

1.3

“Assets” shall mean collectively the Existing Buildings and the Existing Equipment, which are owned by JinBei and which will be sold by JinBei to the JV Company pursuant to the Building Purchase Agreement and the Equipment Purchase Agreement.

1.4

“BMW AG” shall mean Bayerische Motoren Werke Aktiengesellschaft, the ultimate parent company of the BMW group of companies that directly owns one hundred percent (100%) of the shares of BMW.

1.5

“BMW Cars” shall mean any passenger cars that bear BMW trademarks.

1.6

“BMW Group” shall mean BMW AG and its Affiliates.

1.7

“BMW Holding BV” shall mean the Party to the Contract which is a wholly owned Affiliate of BMW AG. 1

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1.8

“Board” or “Board of Directors” shall mean the Board of Directors of the JV Company.

1.9

“Brilliance Group” shall mean Brilliance China Automotive Holdings Ltd. and its Affiliates.

1.10

“Building Purchase Agreement” shall mean the agreement under which JinBei shall sell the Existing Buildings to the JV Company.

1.11

“Business License” shall mean the business license to be issued to the JV Company by the PRC State Administration for Industry and Commerce.

1.12

“Business Plan(s)” shall mean the business plan(s) of the JV Company that are determined in accordance with Article 4.4.2 of this Contract.

1.13

“Business Registration Authority” shall mean the PRC State Administration for Industry and Commerce or its successor or local office in charge of company registration.

1.14

“Change of Law” shall mean any event or circumstance, as further discussed in Article 3.5, where the PRC local or national government or any other local or national public body or authority in the PRC that has the power to make decisions or rules binding upon the JV Company, undertakes any of the following: adopts any new law, regulation, decree or rule, amends or repeals any provision of any existing law, regulation, decree or rule, or adopts any different interpretation or method of implementation of any law, regulation, decree or rule.

1.15

“China” or the “PRC” shall, for purposes of this Contract, mean the People’s Republic of China, exclusive of the province of Taiwan and the Special Administrative Regions of Hong Kong and Macau.

1.16

“Contract Execution Date” shall mean the date that both Parties have duly executed this Contract.

1.17

“Control(s)” or “is Controlled by” or any reference to “Control” in this Contract shall mean the direct or indirect possession, by a company or other entity or natural person, of the power to direct or cause the direction of the management and policies of a Party, of Brilliance Group or of BMW Group by means including, but not limited to, ownership of fifty percent (50%) or more of the voting stock or registered capital, or the power to appoint or elect a majority of the directors, or the power to appoint the general manager or the principal person in charge of a business entity.

1.18

“Conversion Rate” shall mean the median of the official selling and buying EUR-RMB exchange rate published by the People’s Bank of China on the date on which the Parties shall make their respective contributions to the registered capital of the JV Company in accordance with Article 5.4.

1.19

“Directors” shall mean the persons appointed by the Parties to serve as members of the Board of Directors.

1.20

“Effective Date” shall mean the effective date of this Contract, which shall be the date on which the Contract and the Articles of Association are approved by the Examination and Approval Authority.

1.21

“Equipment Purchase Agreement” shall mean the agreement under which JinBei shall sell the Existing Equipment to the JV Company.

2

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1.22

“Establishment Date” shall mean the date described in Article 3.4 of this Contract.

1.23

“Euro” or “EUR” shall mean the lawful currency of the member States of the European Currency Union.

1.24

“Event of Force Majeure” shall mean any unforeseeable or unavoidable event or circumstance beyond the control of a Party occurring after the execution of this Contract including, without limitation, fire, storm, typhoon, flood, earthquake, explosion, war and serious strikes or work stoppages, which prevents the performance, in whole or in part, of this Contract or any of its obligations by any Party or by the JV Company.

1.25

“Examination and Approval Authority” shall mean the appropriate government department with authority to approve this Contract and the Articles of Association under applicable laws and regulations.

1.26

“Existing Buildings” shall mean the existing factory buildings, structures and fixtures located on the Site that shall be sold to the JV Company under the Building Purchase Agreement.

1.27

“Existing Equipment” shall mean the existing equipment located on the Site that shall be sold to the JV Company under the Equipment Purchase Agreement.

1.28

“JinBei” shall mean Shenyang Brilliance JinBei Automotive Co., Ltd., which is a company established and existing under the laws of the PRC.

1.29

“Joint Venture Term” shall mean the duration of the JV Company as provided for in Article 22 of this Contract.

1.30

“JV Products” shall mean those BMW Cars listed as follows (which list may be modified by the Parties from time to time upon mutual consent) and all parts and components that are used for production of such passenger cars by the JV Company.

Car line E46 E90 E46 E90 E46 E90 E60 E60 E60 E60 E60 E60

Body variance

Model

Engine code

Engine capacity

Cyl.

Gearbox

Designation

4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine 4 door limousine

318i 318i 320i 320i 325i 325i 520i 520i 525i 525i 530i 530i

N42B20 N46B20 M54B22 N52B22 M54B25 N52B25 M54B22 N52B22 M54B25 N52B25 M54B30 N52B30

2,0 L. 2,0 L. 2,2 L. 2,2 L. 2,5 L. 2,5 L. 2,2 L. 2,2 L. 2,5 L. 2,5 L. 3,0 L. 3,0 L.

4 4 6 6 6 6 6 6 6 6 6 6

Automatic Automatic Automatic Automatic Automatic Automatic Automatic Automatic Automatic Automatic Automatic Automatic

318i limousine 318i limousine 320i limousine 320i limousine 325i limousine 325i limousine 520i limousine 520i limousine 525i limousine 525i limousine 530i limousine 530i limousine

3

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1.31

“Land Use Rights Lease Contract” shall mean the contract under which the JV Company will lease the land use rights to the Site from the relevant government authority in Shenyang.

1.32

“M1 Products” shall mean the JinBei passenger cars bearing the Zhonghua brand and its succeeding models hereto.

1.33

“Other Contracts” shall mean the Building Purchase Agreement, Equipment Purchase Agreement, Plant Lease Agreement I, Plant Lease Agreement II, Services Agreement I, Services Agreement II, and the Parts and Components Supply Agreement, Land Use Rights Lease Contract. Unless otherwise specified, “Other Contracts” denotes all of these agreements. The Other Contracts shall not violate any mandatory provisions of applicable PRC Laws.

1.34

“Parties” shall mean BRILLIANCE and BMW, collectively; and, “Party” shall mean each of BRILLIANCE or BMW, individually.

1.35

“Parts and Components Supply Agreement” shall mean the contract under which BMW AG supplies parts and components to the JV Company necessary for production of the JV Products.

1.36

“Plant Lease Agreement I” shall mean the agreement to be entered into by the JV Company and JinBei in accordance with applicable PRC Laws under which the JV Company will lease certain plant/office premises on the Site to JinBei.

1.37

“Plant Lease Agreement II” shall mean the agreement to be entered into by the JV Company and JinBei in accordance with applicable PRC Laws under which JinBei will lease certain plant/office premises to the JV Company.

1.38

“PRC Holding Company” shall mean an investment company established by BMW or its Affiliate in China in accordance with applicable PRC Laws.

1.39

“PRC Laws” shall mean all laws, regulations, decrees or other acts of a legally binding nature that are in force from time to time in the PRC including any amendment or substitution thereof.

1.40

“Premium Market Cars” shall mean those passenger cars of the brands in the “premium” market segments of passenger cars, a non-exhaustive list of which is set forth as follows: Acura Alfa Romeo Audi Bentley Cadillac Chrysler Ford GM/Buick/Opel Honda Infiniti Jaguar Lancia Land Rover Lexus

all models all models all models all models Catera, Cien, CTS, Escalade, Evoq, Sigma SUV, XLR Jeep Gran Cherokee, 300M Mondeo Omega,Vectra, Signum, GS (Regal) Legend, NSX, S2000, Accord, Civic (City), All SUV’ s all models all models Kappa, Thesis, Zeta all models all models 4

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EQUITY JOINT VENTURE CONTRACT MercedesBenz MG Rover Mitsubishi Nissan Peugeot Porsche Renault Rover Saab Toyota Toyota Volvo VW

all models ZT, ZT-T Galant, Pajero, Pajero Pinin Cima, Skyline 607, 407 all models Vel Satis, Avantime, Laguna, Megane 75 all models Aristo, Celsior, Crown, Century, Camry, Corolla, RAV 4, Landcruiser 100, Harrier all models Phaeton, Passat, Bora, Golf, all new SUVs

1.41

“Renminbi” or “RMB” shall mean the lawful currency of the PRC.

1.42

“Return on Sales” or “ROS” shall mean a percentage equal to net pre-tax income for a fiscal year divided by net sales for the same period.

1.43

“Services Agreement I” shall mean the agreement to be entered into by the JV Company and JinBei in accordance with applicable PRC Laws under which the JV Company will provide certain services and facilities to JinBei.

1.44

“Services Agreement II” shall mean the agreement to be entered into by the JV Company and JinBei in accordance with applicable PRC Laws under which JinBei will provide certain services and facilities to the JV Company.

1.45

“Shenyang JinBei Automotive Industry Holdings Company Limited” shall mean the Party to the Contract which is ninety percent (90%) owned by Shenyang Xin JinBei Investment and Development Company Limited and ten percent (10%) owned by Shenyang JinBei Auto Industry Company Limited.

1.46

“Site” shall mean that piece of land which is situated at Shanzuizi Road, Dadong District, Shenyang City, Liaoning Province, PRC, the location, layout, and boundaries of which are shown and detailed in the Building Purchase Agreement. The Site has been used by JinBei before the establishment of the JV Company and will be leased to the JV Company, under the Land Use Rights Lease Contract .

1.47

“Technology License Agreement” shall mean the Technology License Agreement between BMW AG and the JV Company, pursuant to which BMW AG will license to the JV Company the right to use certain technology and operational know-how in connection with the production, sale and service of the JV Products.

1.48

“Trademark License Agreement” shall mean the Trademark License Agreement between the JV Company and BMW AG, which is (Bao Ma in Chinese script)” in the registrator in the PRC of the trademark “BMW” in English and “BAO MA (pin yin) and Chinese, pursuant to which BMW AG will license to the JV Company the right to use the trademark “BMW” in English and “BAO (Bao Ma in Chinese script)” in Chinese in connection with the sale of the JV Products.

MA (pin yin) and

1.49

“Transfer Price” shall mean the price for the transfer of the equity interest as defined in Article 24.1.2.

5

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1.50

“United States Dollars” or “US Dollars” or “USD” shall mean the lawful currency of the United States of America.

1.51

“WTO” shall mean the World Trade Organization.

Unless otherwise stated, all references to numbered Articles and Annexes are to Articles and Annexes of this Contract.

Article 2 2.1

Parties

Parties The Parties to this Contract are: BRILLIANCE:

Shenyang JinBei Automotive Industry Holdings Company Limited, a company established and existing under the laws of the PRC.

Place of Registration:

Shenyang, Liaoning Province, PRC

Legal Address:

6th Floor, Building B, No. 1 Shiji Road Hunnan Industrial Zone, High-Tech District Shenyang, Liaoning Province People’s Republic of China

Legal Representative:

Name: Position: Nationality:

Registered Number:

2101321101009(2-2)

BMW:

Hong Xing Chairman Chinese

BMW Holding BV, a company established and existing under the laws of the Netherlands

Place of Registration:

S’-Gravenhage, Netherlands

Legal Address:

Laan van Vredenoord 5 2289 DA Rijswijk ZH Netherlands

Legal Representatives:

Name:

Arjen van Jong Dr. Wolfgang Stofer,

Position:

Directors

Nationality:

Dutch, German

Registered Number:

108 701

If a Party changes its legal representative, it shall promptly notify the other Party of such change and the name, position, and nationality of its new legal representative.

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EQUITY JOINT VENTURE CONTRACT

Representations and Warranties 2.2.1

Each Party hereby represents and warrants to the other Party that as of the date hereof and as of the Effective Date: (i)

it is a legal person, duly organized, validly existing and in good standing under the laws of the place of its establishment or incorporation; its ownership and Control has not changed in any way since the 23rd day of March, 2003. A duly certified copy of the Articles of Association as registered with the Business Registration Authority has been presented to the other Party on or before the date of the execution of this Contract;

(ii)

its legal representative is duly and fully authorized and empowered to sign, execute and give effect, on its behalf, to this Contract, the Articles of Association, and any agreements and documents referred to in this Contract and to which it is a party;

(iii)

its execution, delivery and performance of this Contract, the Articles of Association and any other agreements and documents contemplated hereunder will not violate any of its constitution documents, any other agreement or obligation of such Party, any judgment or arbitral award binding such Party, or any currently effective law, regulation or decree of the jurisdiction in which it is organized or incorporated, that may be applicable to any aspect of the transactions contemplated hereunder;

(iv)

it has all requisite power, authority and approval required to enter into this Contract and upon the Effective Date will have all requisite power, authority and approval to duly perform each of its obligations hereunder;

(v)

upon the Effective Date, the provisions of this Contract shall constitute its legal and binding obligations;

(vi)

it has disclosed, in writing, all material information in its possession relating to the cooperation between the Parties set out under this Contract, as well as the establishment and operation of the JV Company which might have a material adverse effect on its ability to fully perform its obligations hereunder, or which if disclosed to the other Party, could have a material effect on the other Party’s willingness to enter into this Contract, and none of the information provided by it to the other Party contains any material statements which are false or misleading; and

(vii)

no lawsuit, arbitration, other legal or administrative proceeding, or governmental investigation is pending, or to the best of its knowledge, threatened, against it that would affect in any way its ability to enter into or perform this Contract;

2.2.2

Brilliance represents and warrants that it is not Controlled directly or indirectly by any company, corporation or entity which directly or indirectly produces, distributes or sells, inside or outside China, passenger cars under any trademarks or brandnames other than “JinBei” and “Zhonghua”.

2.2.3

BMW represents and warrants that it is not Controlled directly or indirectly by any company, corporation or entity which directly or indirectly produces, distributes or sells, inside or outside the Federal Republic of Germany, 7

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EQUITY JOINT VENTURE CONTRACT passenger cars under any trademarks or brandnames other than “BMW”, “MINI” and “Rolls-Royce”.

2.2.4

Article 3 3.1

Each Party shall indemnify the other Party against all direct losses, expenses and liabilities arising from a breach of any of the foregoing representations and warranties. For the avoidance of doubt, for the indemnification provided in this clause, each Party shall not be responsible for the other Party’s indirect, special, punitive or consequential losses, damages, costs or expenses including loss of profit, loss of use, loss of contracts, and loss of production.

Establishment and Legal Form of JV Company

Establishment of Company The Parties hereby agree to establish the JV Company promptly after the Effective Date in accordance with the Joint Venture Law, the Joint Venture Regulations, and other applicable PRC Laws. The JV Company shall be an enterprise legal person under the laws of the PRC subject to the protection and jurisdiction of PRC Laws. All of the activities of the JV Company shall comply with applicable PRC Laws.

3.2

Limited Liability Company 3.2.1

3.3

The JV Company shall be a limited liability company under the laws of the PRC. For each of the Parties, the profits, losses, risks, liabilities and any other obligations whatsoever of the JV Company shall be limited and in proportion to the subscribed amount of its respective contribution to the registered capital of the JV Company. No Party shall have any liability to the JV Company or to any third party in connection with the activities of the JV Company, either jointly or severally, other than the requirement to make such contribution, unless otherwise agreed to in writing by the Parties.

3.2.2

Except as otherwise provided in this Contract, once a Party has paid in full its contribution to the registered capital of the JV Company, it shall not be required to provide further funds to or on behalf of the JV Company by way of capital contribution, loan, advance, guarantee or otherwise.

3.2.3

Unless otherwise agreed in writing by a Party, creditors of the JV Company and other claimants against the JV Company shall have recourse only to the assets of the JV Company and shall not seek compensation, damages or other remedies from a Party.

3.2.4

In no event shall any Party be responsible for any losses, risks, liabilities or obligations whatsoever resulting from any act of the other Party.

Name and Address of Company ” in The name of the JV Company shall be “ ” in English and “ BMW BRILLIANCE Automotive Ltd. Chinese. The legal address of the JV Company shall be Shanzuizi Road, Dadong District, Shenyang City, Liaoning Province, PRC. 3.3.1

The JV Company shall use the BMW name and logo as long as BMW maintains at least a fifty percent (50 %) interest in the registered capital of the JV Company, unless otherwise agreed by BMW. At the expiry or termination of this Contract, the JV Company immediately shall change its name by 8

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EQUITY JOINT VENTURE CONTRACT removing therefrom the word “BMW” as well as stop using the BMW name and logo without replacing them with any similar word, expression, or symbol, as provided for in more detail in the Trademark License Agreement.

3.3.2

3.4

Should BMW, against its own volition, partly or wholly lose its equity participation in the JV Company or should BMW as a result of any legal, judicial, official or other measure no longer be able to use any of its material rights as provided for under this Contract or should the powers of BMW’s representatives in the Board or BMW’s right to nominate people to be the members of the Management of the JV Company as provided for under this Contract or under the PRC Laws be diluted, the JV Company immediately shall, unless otherwise approved by BMW, change its name as well as stop using the BMW name and logo without replacing them with any similar word, expression, or symbol, as provided for in more detail in the Trademark License Agreement. BRILLIANCE undertakes not to continue or take over the JV Company’s business using the BMW name or logo or any similar word, expression, or symbol.

Date of Establishment The date of the establishment of the JV Company shall be the date on which the JV Company is issued its Business License.

3.5

Change of Law 3.5.1

If, after the date of the execution of this Contract, a Change of Law occurs and it will, upon application by the JV Company and the Party concerned and upon approval by the relevant government authorities, result in treatment to the JV Company or to any Party substantially more favorable than the terms of this Contract (without resulting in less favorable treatment to the other Party), then the JV Company and the Party concerned shall promptly apply to receive the benefits of such more favorable treatment and the other Party shall use all reasonable efforts to facilitate such application.

3.5.2

If, after the date of the execution of this Contract, a Change of Law occurs and it directly or indirectly causes material adverse consequences to the JV Company or to any Party’s benefits under this Contract, then upon written notice thereof from the JV Company (acting through its Board) to the Parties or by the affected Party to the other Party, the Parties shall promptly consult with each other and determine whether:

3.5.3

(i)

to continue to implement this Contract in accordance with the original provisions thereof; or

(ii)

to effectuate necessary adjustments in order to preserve each Party’s benefits under this Contract on a basis no less favorable than the benefit it would otherwise receive had such a Change of Law not occurred.

Article 3.5.2 shall not apply to any Change of Law that takes effect after the date of the execution of this Contract if, before that date, such Change of Law has been announced by the relevant PRC authorities as a measure necessary to implement the PRC’s accession to the WTO and the Parties were aware of or could reasonably have been aware of that Change of Law and its consequences.

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Branches The JV Company may establish branch offices and subsidiaries anywhere inside and outside of the PRC, subject to compliance with PRC Laws and upon the approval of both the Board of Directors and if required the Examination and Approval Authority. Subject to receipt of all required approvals and licenses the JV Company shall establish a distribution and sales branch in Beijing in which its distribution, sales and marketing activities will be located.

Article 4 4.1

Purpose and Scope of Business of JV Company

Purpose The purpose of the JV Company is to use efficient and advanced technology and management, production and distribution techniques to manufacture and sell the JV Products, to secure the quality, the value and competitiveness of such products, and to obtain satisfactory economic benefits for the Parties.

4.2

Business Scope 4.2.1

The business scope of the JV Company shall be to produce BMW passenger cars, engines, parts and components, and accessories therefore; to sell the products produced by itself; and to provide after-sales services (including spare parts) in connection with its products.

4.2.2

The JV Company also will conduct all business activities necessary for or ancillary to the activities listed in Article 4.2.1 including, but not limited to, industrial, engineering, commercial, financial, marketing, financial services, and training activities.

At the discretion of the Board of Directors and subject to compliance with PRC Laws and the obtaining of approval from the Examination and Approval Authority, additional products might be manufactured, marketed, sold and serviced by the JV Company.

4.3

Production Scale The annual production scale of the JV Company is estimated to be 30,000 passenger cars when the JV Company is operating at full scale.

4.4

Initial Business Case / Business Plan / Budget 4.4.1

The Parties have prepared on a best estimate basis an initial business case which reflects their common understanding of the estimated profitability of the JV Company (the “Initial Business Case”). The Initial Business Case sets out the financial plan of the JV Company for the years 2003 – 2010.

4.4.2

The Board of Directors shall annually approve a long-range plan for the JV Company (the “Business Plan”) covering a six-year period starting with the following calendar year. The creation of Business Plans is a rolling process with each Business Plan replacing the Business Plan that was approved for the preceding year. The format of the Business Plans are stated in Annex 1 hereto.

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4.5

EQUITY JOINT VENTURE CONTRACT

4.4.3

The Board of Directors shall annually approve a budget for the JV Company for the following calendar year (the “Budget”). The Budget shall set forth the detailed financial planning of the JV Company. The format of the Budget are stated in Annex 1 hereto. The Budget shall be prepared together and in compliance with the Business Plan and shall be in compliance with the cost positions of the Business Plan that are applicable for the same calendar year.

4.4.4

The Board shall approve the Business Plans and the Budgets prepared and submitted by the Management; provided that the Management prepares the Business Plans and Budgets in accordance with the requirements of Articles 4.4 and 4.5 of this Contract and any internal rules and guidelines adopted by the Board.

Benchmarks / ROS 4.5.1

Based on the Initial Business Case the Parties have agreed to calculate certain percentage figures that shall apply to the following cost positions of the JV Company: (i) cost of production, (ii) cost of wholesale and (iii) cost of retail. The percentage figures indicate the percentages of the respective cost positions of the adjusted turnover of the JV Company as provided in the Business Plan approved in the current year. The single cost items covered by these cost positions are defined in Annex 2.

4.5.2

In order to provide guidance to the Management of the JV Company, the Parties have agreed on certain target percentage figures for each of the cost positions mentioned in Article 4.5.1 (the “Benchmarks”). . The Initial Business Case also provides a percentage for the Return on Sales of the JV Company on an annual basis. The Benchmarks and the percentage for the Return on Sales will be set forth in a separate agreement to be entered into between the Parties.

4.5.3

Unless the Board of Directors has revised the Benchmarks in accordance with Article 7.2.1(b)(viii), the Business Plan and the Budget shall be prepared by the Management in compliance with the Benchmarks and the ROS for the applicable calendar year.

4.5.4

When implementing the Budget during a calendar year, the General Manager is, subject to internal rules and guidelines adopted by the Board of Directors, authorized to deviate from each of the Benchmarks and/or the ROS provided that such deviation shall at all times satisfy both of the following conditions:

Article 5 5.1

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(i)

in case of a deviation from a Benchmark, the deviation shall be within fifteen percent (15%) greater or fifteen percent (15%) less of the relevant Benchmark; and

(ii)

in case of a deviation from the ROS, the deviation shall be within five percent (5%) greater or five percent (5%) less of the ROS. Total Investment and Registered Capital

Total Amount of Investment The total amount of investment of the JV Company shall be four hundred fifty million Euro (€450,000,000).

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Registered Capital The registered capital of the JV Company shall be one hundred fifty million Euro (€150,000,000).

5.3

5.4

5.5

Contribution to Registered Capital 5.3.1

BRILLIANCE’s contribution to the registered capital of the JV Company shall be seventy-five million Euro (€75,000,000), and shall represent fifty percent (50%) of the total registered capital of the JV Company. BRILLIANCE’s registered capital contribution shall be made in cash in RMB in an amount equivalent to seventy-five million Euro (€75,000,000) converted at the Conversion Rate on the date on which the capital contribution is due pursuant to the terms of Article 5.4 below.

5.3.2

BMW’s contribution to the registered capital of the JV Company shall be seventy-five million Euro (€75,000,000), which shall represent fifty percent (50%) of the total registered capital of the JV Company. BMW’s registered capital contribution shall be made in cash in Euro. The amount shall be translated into RMB at the Conversion Rate for recording purposes.

Contribution Schedule 5.4.1

Both Parties shall make their contributions to the registered capital of the JV Company within ninety (90) calendar days of the issuance of the Business License of the JV Company.

5.4.2

Notwithstanding the provisions of Article 5.4.1, a Party shall not be obligated to make its contribution if it is clear that the other Party will not be able to make its capital contribution as provided in Article 5.4.1.

5.4.3

In the event that any Party fails to make its capital contribution, in whole or in part, in accordance with the terms of this Article 5, such Party shall pay simple interest to the JV Company on the unpaid amount from the date due until the date the contribution is made at the rate for short-term (6 months) commercial loans offered by the Shenyang branch of Bank of China in Renminbi on the due date plus two percent (2%), if the contribution is to be made in Renminbi, and at the LIBOR for Euro rate, fixed on the due date at 11:00 am (GMT) for commercial short term loans of three months plus two percent (2 %), if the contribution is to be made in Euro. If any Party does not make its capital contribution in full within ninety (90) days of the due date, the other Party shall have the right to terminate this Contract, and/or claim damages from the breaching Party.

Investment Certificates 5.5.1

The JV Company shall retain, at its expense, an accountant, certified and registered in China and acceptable to the Parties, who promptly shall verify the capital contributions by the Parties and issue a capital verification report to the JV Company. Any capital contribution in the form of cash shall be deemed to have been made on the date on which the relevant amount of cash has been deposited into a bank account in the name of the JV Company.

5.5.2

Within thirty (30) days from receipt of the capital verification report, the JV Company shall issue investment certificates to each Party evidencing the contributions by each Party on the basis of such report. The certificates shall 12

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EQUITY JOINT VENTURE CONTRACT be signed by the Chairman and the Vice-Chairman of the Board and sealed with the JV Company’s seal. Each investment certificate shall indicate the following: the name of the JV Company; the Establishment Date; the names of the Parties; amount of the capital contribution and the date on which such contribution was made; the certificate’s date of issue. A copy of the investment certificate shall be submitted to the Examination and Approval Authority for the record. The General Manager shall maintain a file of all capital verification reports and copies of all investment certificates that have been issued to the Parties.

5.6

Financing 5.6.1

The balance between the total amount of investment and registered capital of the JV Company, pursuant to approval by the Board and in accordance with the business needs of the JV Company, may be raised by the JV Company through loans from domestic and/or foreign banks or other financial institutions or, if permitted by law, through loans from the Parties or their Affiliates. Such loans provided by the Parties or their Affiliates shall be referred to as “Shareholder Loans”.

5.6.2

The JV Company shall be responsible for obtaining any loans or other financing that may be required by it to finance its operations and capital expenditures. If and to the extent the JV Company is unable to raise funds through loans from domestic and/or foreign banks or other financial institutions at rates that the Board determines to be competitive, each Party shall on a pro rata basis in accordance with its share of the registered capital of the JV Company, itself or through its Affiliates, provide Shareholder Loans to the JV Company which shall not exceed the maximum amount of loans as provided for in the Business Plan applicable for the respective time period. In the event the financing needs of the JV Company as proposed by the Board shall exceed the maximum amount of loans as provided for in the Business Plan applicable for the respective time period, both Parties shall seriously consider whether to provide any additional Shareholder Loans in excess of such maximum amount of loans.

If BRILLIANCE or its Affiliates registered in the PRC are not permitted under PRC Laws to provide Shareholders Loans, then BRILLIANCE shall be obliged to cause its Affiliates registered outside of the PRC to provide Shareholder Loans or guarantees to the JV Company. If BRILLIANCE fails to do so, then BMW shall not have the obligation to provide Shareholder Loans. If BMW or its Affiliates are not permitted under the Dutch laws and regulations to provide Shareholders Loans, then BMW shall be obliged to cause its Affiliates to provide Shareholder Loans or guarantees to the JV Company. If BMW fails to do so, then BRILLIANCE shall not have the obligation to provide Shareholder Loans.

5.6.3

If agreed between the Parties, the Parties may at their discretion provide for other forms of financial assistance to the JV Company. Unless otherwise agreed to by the Parties, any method of financial assistance by either of the Parties as provided for under this Article 5.6.3 shall be made only to the extent that the other Party provides an equal amount of financial assistance on a pro rata basis in accordance with its shareholding in the JV Company. If a Party has provided the JV Company with other forms of financial assistance under this Article, the Party’s obligation to provide for Shareholder Loans as provided for under Article 5.6.2 shall be reduced accordingly.

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Increase of Registered Capital 5.7.1

Any increase in the registered capital of the JV Company shall be approved by a unanimous vote of all of the Directors of the Board and, if required by PRC Laws, submitted to the Examination and Approval Authority for approval. Upon receipt of such approval, the JV Company shall register the increase in the registered capital with the Business Registration Authority pursuant to PRC Laws.

5.7.2

Unless otherwise agreed to by the Parties and approved by the Board, the Parties shall make any increase in the registered capital in the same proportions as their originally-subscribed contributions to the registered capital. The Parties may agree, in writing, to adjust their registered capital proportions, subject to PRC Laws and any required approval of the Examination and Approval Authority.

5.7.3

If further registered capital is required for the business of the JV Company the Parties will give serious consideration to any information and proposals provided in this regard.

Article 6

Transfer of Interest in the Registered Capital of the JV Company

6.1

Except as otherwise provided in this Contract, neither Party shall, without the prior written consent of the other Party assign, pledge or otherwise encumber any of its interest in the registered capital of the JV Company.

6.2

Notwithstanding Article 6.1 above, either Party (the “Assigning Party”) shall be entitled to transfer or assign all of its interest in the registered capital of the JV Company to one of its wholly-owned Affiliates, provided that the following occur (and that such provisions shall apply to any further transfer from an Affiliate to another Affiliate): 6.2.1

the Assigning Party shall give to the other Party (the “Non-assigning Party”) not less than one month’s prior written notice of its intention to effect such transfer;

6.2.2

the transferee or assignee (collectively, the “Assignee”) shall execute with the “Non-assigning Party”, a revised version of this Contract and of the Articles of Association, which documents shall, unless otherwise agreed between the Nonassigning Party and the Assignee, be the same as the versions prior to the transfer or assignment, except that the Assignee shall be substituted for the Assigning Party as a Party to those documents;

6.2.3

the Assigning Party, by its execution of this Contract, unconditionally and irrevocably guarantees as a separate liability to the Non-Assigning Party that the Assignee will perform all of its obligations under this Contract;

6.2.4

the Assigning Party shall procure that a legally binding contract is executed with the Assignee that, at the option of the Assigning Party, permits the re-transfer to the Assigning Party of all such shares and/or, as the case may be, any such loan capital, debentures or other securities previously so transferred, and that the Assigning Party shall exercise that option prior to any such permitted Assignee ceasing to be a wholly-owned Affiliate of the Assigning Party; 14

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6.2.5

all its interest shall be transferred, as a whole, by the Assigning Party to the Affiliate in order to avoid further partitioning of the equity interest;

6.2.6

the Affiliate is a duly incorporated, validly existing entity that is acceptable to the Non-Assigning Party.

6.3

Notwithstanding Article 6.1 above, BMW shall be entitled to transfer or assign all or some of its interest in the registered capital of the JV Company to a PRC holding company to be established as an Affiliate of BMW Group under PRC Laws and subject to all necessary licenses and approvals, provided that all conditions provided for under Article 6.2.1, 6.2.2, 6.2.3, 6.2.4 and 6.2.6 above are met.

6.4

Each Party hereby agrees that it shall consent and shall cause the Director(s) appointed by it to consent to any proposed assignment of registered capital by any Party pursuant to Article 6.2 or Article 6.3.

6.5

In addition to the conditions set out in Article 6.1 above, any transfer, pledge or encumbrance of interest in the registered capital of the JV Company shall be subject to the unanimous approval of the Board of Directors, which approval shall not be unreasonably withheld or delayed.

6.6

All equity transfers shall be submitted to the Examination and Approval Authority for approval. Upon receipt of the approval, the JV Company shall register the change in equity with the Business Registration Authority.

6.7

Each Party or its Affiliates shall remain the legal owner of all of its or its Affiliates’ Shareholder Loans to the JV Company, and the legal owner of all debentures and other securities issued or provided by the JV Company to such a Party. Neither Party shall be entitled to dispose of, transfer or assign to any third party its Shareholder Loans which it has provided to the JV Company, or the debentures or other securities which the JV Company has issued or provided to the Party, except in conjunction with a transfer of the Party’s interest in the registered capital of the JV Company, as permitted by this Contract, or except with the prior written consent of the super majority of the Board of Directors.

Article 7 7.1

Board of Directors

Formation of the Board 7.1.1

The date of establishment of the Board of Directors shall be deemed to be the Establishment Date.

7.1.2

The Board of Directors initially shall be composed of thirteen (13) Directors of which six (6) shall be appointed by BRILLIANCE, six (6) shall be appointed by BMW, and one (1) Director shall be an independent Director first nominated

by BMW and then mutually appointed by the Parties. The Parties agree that three (3) years after the Establishment Date the Board shall be reduced to a total of seven (7) Directors, of which three (3) Directors shall be appointed by BRILLIANCE, three (3) shall be appointed by BMW, and one (1) Director shall be an independent Director first nominated by BMW and then mutually appointed by the Parties. The independent Director shall be independent of BMW to the extent that the Director is not employed by BMW. If the ratio of the Parties’ contributions to the registered capital changes, the proportionate number of Directors shall change accordingly in accordance with applicable legal procedures.

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7.2

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7.1.3

The Chairman of the Board shall be appointed by BRILLIANCE and the Vice-Chairman by BMW. The Directors, Chairman and Vice-Chairman each shall have a term of office of three (3) years, and each shall be eligible for consecutive terms of office upon reappointment by the original appointing Party.

7.1.4

Any vacancy created in the Board of Directors shall be immediately filled by the Party who originally appointed the absent Director. Any Party at any time may remove any Director appointed by such Party and appoint in lieu thereof any other person to serve the remainder of the removed Director’s term. Each Party shall notify the other Party, in writing, each time it appoints or replaces a Director. Except as provided in Article 7.1.2, neither Party shall be entitled to nominate any Director to the Board who is not in a relationship of employment with it or with its Affiliates.

7.1.5

The Chairman shall be the legal representative of the JV Company but the Chairman may not unilaterally take any action binding the JV Company without authorization of the Board. The Chairman shall exercise the functions in accordance with the provisions set forth in the Contract, the Articles of Association and the resolutions of the Board.

Whenever the Chairman of the Board cannot exercise his/her functions for any reason, he/she shall authorize the Vice Chairman of the Board or, in the event the Vice-Chairman is not available, another Director, to represent the Chairman until the Chairman resumes his/her right or functions, or until a successor is appointed.

7.1.6

Each Party shall cause the Directors appointed by it to act at all times lawfully and in good faith with respect to all matters relating to the business of the JV Company and this Contract and to any other contracts and agreements concluded pursuant to this Contract. A Party immediately shall discharge a Director it has appointed to Board, upon discovery by that Party that such Director has: violated this Contract, the Articles of Association or Articles 57 or 58 of the PRC Company Law or any other relevant PRC Laws; acted in bad faith or with gross negligence to the detriment of the JV Company; committed a crime; participated in corruption; or committed any other act that would be sufficient for removal of a director under PRC Laws.

7.1.7

The JV Company shall indemnify each Director against all claims and liabilities incurred by reason of him/her being a director of the JV Company, provided that the Director’s acts or omissions giving rise to such claims or liabilities do not constitute intentional misconduct or gross negligence or a violation of criminal laws.

Powers of Board 7.2.1

The Board of Directors shall be the highest authority of the JV Company and shall have the power to make decisions on all major and important matters of the JV Company, including, without limitation, the matters as follows: (a)

unanimity decisions (i)

amendment of the Articles of Association;

(ii)

increase, decrease, transfer, assignment or pledge of the JV Company’s registered capital and the adjustment of the 16

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EQUITY JOINT VENTURE CONTRACT proportions of each Party’s contribution to the registered capital;

(b)

(iii)

merger of the JV Company with any other economic organization, or split or division of the JV Company;

(iv)

suspension of the JV Company’s operation, and/or termination, dissolution or liquidation of the JV Company;

(v)

distribution and payment of the JV Company’s profits;

super-majority decisions (vi)

approval of the Business Plan and the Budget of the JV Company (hereinafter together referred to as the “Planning Documents”) as provided for in Articles 4.4 and 4.5, such approval to include the sales volume and the sales price (price to dealer) of the JV Products as part of the Planning Documents;

(vii)

approval of retail prices (price to customer) or recommended retail prices of the JV Products as provided in Article 15.1;

(viii)

revisions of the Benchmarks as provided for in Articles 4.5.3;

(ix)

establishment of or investment in any company by the JV Company; sale, transfer, assignment or disposal by the JV Company of any equity interest in another company; establishment of a branch by the JV Company in the PRC or outside of the PRC;

(x)

purchase, sale, transfer, assignment, or disposal by the JV Company of any of its fixed assets or real property with a value exceeding two hundred fifty thousand Euro (€250,000), or the Renminbi equivalent thereof unless such activity was separately approved in the Planning Documents;

(xi)

without limitation on the authority of the General Manager under Article 4.5.4, any connected transaction between the JV Company and one Party (or any Affiliate of one Party), in which the amount of that connected transaction or the aggregate amount of that similar type of connected transaction (e.g. procurement of kits, procurement of technical services, procurement of IT-services etc.) within one calendar year exceeds one million Euro (€1,000,000) unless such transaction was separately approved in the Planning Documents; for connected transactions which are undertaken by the General Manager pursuant to Article 4.5.4, the JV Company shall not agree on any terms and conditions less favorable to it than those for connected transactions of a similar type that were approved as part of the Planning Documents (e.g. purchase of kits from BMW AG) governed by the Trademark License Agreement, Technology License Agreement, or the Other Contracts as applicable.

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(c)

7.2.2

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(xii)

without limitation on the authority of the General Manager under Article 4.5.4, the approval of any credit lines, structured financing, or issuance of public and private debentures by the JV Company in an aggregate amount exceeding three million Euro (€3,000,000), unless such transaction was separately approved in the Planning Documents;

(xiii)

approval of any guarantee to be made by the JV Company or of any mortgage, pledge, or creation of any security interest in any material assets of the JV Company, that is both outside of the JV Company’s ordinary course of business and not included in the Planning Documents;

(xiv)

approval of the accounting policy or any change thereof;

(xv)

the final accounts and audited financial statements;

(xvi)

the compensation of the General Manager and other Senior Corporate Officers;

(xvii)

the selection of the JV Company’s principal financial services provider – if any – for the granting of loans and/or credits to end customers of the JV Products;

(xviii)

any other matters requiring super-majority approval by the Board of Directors as expressly provided for in this Contract, the Articles of Association, or as determined by the Parties from time to time.

simple majority decision (xix)

without prejudice to the provisions of Articles 9.1.1 and 9.2.4, approval of any major change in management organization;

(xx)

approval of any fundamental management rules and guidelines of the JV Company;

(xxi)

approval of labor and personnel policies;

(xxii)

employment of an independent auditor;

(xxiii)

annual insurance plan of the JV Company;

(xxiv)

exercise of the JV Company’s options to require JinBei to buy back the Assets under the Equipment Purchase Agreement and the Building Purchase Agreement;

(xxv)

any other matters requiring simple majority approval, by the Board as expressly provided for in this Contract, the Articles of Association, or as determined by the Board from time to time.

Resolutions involving items in Article 7.2.1 shall be adopted by the following numbers of votes of all Directors present in person, by telephone or by proxy at duly convened Board meeting: 18

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7.2.3

7.3

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(a)

unanimous affirmative vote: items listed under Article 7.2.1 (a)

(b)

super-majority vote (i.e., at least three-fourths (3/4) of the Directors): items listed under Article 7.2.1 (b)

(c)

simple majority vote: items listed under Article 7.2.1 (c)

Unless otherwise specified in this Contract, all other matters to be decided by the Board of Directors shall be resolved by a simple majority vote of the Directors present in person, by telephone or by proxy at a duly convened meeting of the Board.

Meetings 7.3.1

The first Board meeting shall be held within fifteen (15) days from the Establishment Date.

7.3.2

The Board shall meet at least once a year. Board meetings shall be held at the legal address of the JV Company, unless otherwise determined by the Board of Directors.

7.3.3

Two-thirds of all of the Directors present in person or by proxy shall constitute a quorum for any Board meeting.

7.3.4

If, at any properly convened meeting, no quorum is present, then the Board shall reconvene at the same time and place within ten (10) days following that convened meeting, as agreed between the Chairman and the Vice-Chairman or, if no agreement is reached, fourteen (14) days after that convened meeting. At such reconvened meeting, any Director absent from such reconvened meeting without having appointed a proxy shall be deemed to have abstained from voting and further shall be deemed present for purposes of quorum and for calculating the number of Directors attending the meeting. At such reconvened meeting only the affirmative vote of each and every Director of the Board present in person or by proxy shall be taken into account for calculating the majority required by Article 7.2.2.

7.3.5

The Chairman shall preside over the Board meeting. The Chairman and the Vice-Chairman together shall set the agenda of Board meetings and shall be responsible for convening such meetings and for the keeping of the minutes of the meetings. Each Director and the General Manager may request to add to the agenda any items relating to the operation and activities of the JV Company that such Director or the General Manager deems necessary to be discussed at such meeting and shall notify the Chairman and the Vice-Chairman of such request in writing at least fourteen (14) days prior to the date of the meeting. In order to facilitate the smooth conduct of the Board’s business, the Chairman together with the Vice Chairman may appoint a secretary for the purpose of any Board meeting.

7.3.6

The Chairman together with the Vice-Chairman shall call an interim meeting of the Board under a request thereof from no fewer than one-third of the Directors specifying the matters to be discussed, and shall notify all Directors in writing about the agenda and the subject(s) of the meeting.

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7.3.7

Except in urgent cases, in which a matter must be decided within a shorter period in the interest of the JV Company the Chairman in coordination with the Vice-Chairman shall send written notice in both English and Chinese to all Directors at least fourteen (14) days prior to any regular, or ten (10) days prior to any interim meeting to be held, stating the agenda, time and place of the meeting. Such notice may, however, be waived by the unanimous consent of all Directors prior, after or at the meeting in person, by telephone or by proxy. Such notice periods shall not apply for any reconvened meeting as stated in Article 7.3.4 above.

7.3.8

Each Party has the obligation to ensure that the Directors it appoints are present at the Board meeting in person or by proxy. Should a Director be unable to attend a Board meeting for any reason, she/he must appoint a proxy, in writing, by mail, facsimile or hand-delivery, to be present and to vote at the meeting on his/her behalf. A proxy may represent one or more Directors and shall have the same rights and powers as the Director who appointed him/her.

7.3.9

Board resolutions, if so agreed by all Directors, also may be passed through a written circular vote via mail or facsimile exchange. Such written resolutions shall be filed with the minutes of the Board and shall have the same force and effect as a vote taken by the Directors physically present at a meeting.

7.3.10

Board meetings may be held by telephone or other electronic audio or video means such that everyone can hear each other at all times and participation by a Director or his/her proxy in a meeting by such means shall constitute presence of such Director or his proxy in person at a meeting.

7.3.11

Directors shall serve as Directors without remuneration, unless otherwise approved by the Board. All reasonable costs, including round-trip airplane tickets and reasonable accommodation incurred by any Director or his/her proxy for attending a Board meeting and for performance of duties assigned by the Board, shall be borne by the JV Company.

Remuneration and other expenses of each Director unrelated to the JV Company’s business shall not be borne by the JV Company. If a Director also assumes a position as a manager or staff employee in the JV Company, he/she shall be compensated by the JV Company according to that position.

7.3.12

The General Manager is entitled to attend the meetings of the Board of Directors, even if he or she is not a Director. The General Manager, however, does not have the right to vote at the Board of Directors’ meetings unless she/he also is a Director.

Minutes Unless a secretary is appointed, the minutes of meeting shall be prepared by the Chairman together with the Vice-Chairman.

This duty shall include taking minutes of the meeting, and delivering the minutes and other documents relating to the meeting to the Directors. Minutes of Board meetings shall be signed by the Chairman and Vice-Chairman, unless otherwise required under applicable PRC Laws. Copies of the minutes of Board meetings shall be sent to each Party, shall be kept in English and Chinese, and shall be placed on file at the JV Company’s head office.

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Urgency If, in the reasonable opinion of the General Manager, a decision which would fall under the responsibility of the Board must be taken urgently in order to save the JV Company or the JV Company’s interest from loss or damages before a Board Meeting can be convened or a written resolution by the Board can be obtained, the General Manager, upon securing at least the prior consent of one Director appointed by BRILLIANCE and one Director appointed by BMW, may make the respective decision and submit the decision to the next meeting in which the retroactive authorization of the Board shall be sought. However, the General Manager immediately shall inform the Chairman and the Vice-Chairman, in writing, about the situation of urgency and the decision which is taken.

Article 8

Deadlock

8.1

If for whatever reason the Board is unable to arrive at a decision on any matter, where the lack of the decision would materially and adversely affect the business operation of the JV Company and would cause serious harm to either of the Parties’ material interests under this Contract, then, within thirty (30) days after the matter is first raised at a meeting of the Board, either Party shall be entitled to serve a notice (a “Conciliation Notice”) on the other Party requiring the Parties to attempt to promptly resolve the matter.

8.2

The Party who issues a Conciliation Notice shall describe in the Conciliation Notice the matter to be discussed, its position in respect of that matter, and its evidence and arguments in support of its position. The other Party shall within thirty (30) days of the service on it of a Conciliation Notice give a written response to the Party who issued the Conciliation Notice of its position and evidence and arguments in support thereof.

8.3

Upon receipt of the written response representatives of each of the Parties shall meet with each other in person and discuss their respective positions in respect of the matter described in the Conciliation Notice. Within thirty (30) days from the receipt of the written response a meeting of the Board shall be scheduled in which the Board shall finally decide on the matter described in the Conciliation Notice. If, for whatever reason, the Board in its meeting is unable to arrive at a decision on this matter to the mutual satisfaction of each of the Parties, an event of deadlock shall be deemed to exist and either Party shall be entitled to terminate this Contract under Article 23.1.1(xiii). Each Party may refer the matter constituting the deadlock, or the termination by a Party based on the deadlock, to arbitration in accordance with the provisions of Article 29.

Article 9 9.1

Management Organization

The Board of Directors shall establish a management organization (hereinafter referred to as “Management”), which shall be responsible for and in charge of the day-to-day operation and management of the JV Company. The Management shall be made up of one General Manager, one or more Deputy General Manager(s) and other senior corporate officers as determined by the Board of Directors from time to time (collectively, the “Senior Corporate Officers”). For the avoidance of doubt, Senior Corporate Officers do not include department managers.

9.1.1

The General Manager, the Deputy General Manager Sales and the Deputy General Manager Manufacturing shall be nominated by BMW and appointed by the Board. The Deputy General Manager Finance with the function of chief 21

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EQUITY JOINT VENTURE CONTRACT financial officer shall be nominated by BRILLIANCE and appointed by the Board. The Deputy General Manager Human Resources shall be nominated by both BMW and BRILLIANCE and appointed by the Board. Other Senior Corporate Officers, if any, shall be appointed by the Board of Directors. The remuneration and benefits of the Senior Corporate Officers shall be approved by the Board. The Senior Corporate Officers shall be individuals with excellent professional qualifications or substantial experience in their respective fields and shall have very good oral and working capability in the English language.

9.2

9.1.2

The term of office for the Senior Corporate Officers shall be three (3) years, which term may be renewed.

9.1.3

If any of the Senior Corporate Officers shall resign, retire, become incapacitated, or be removed from office by the Board of Directors, the Board shall appoint a replacement based on the proposal of the initially-nominating Party as determined in Article 9.1.1 above.

9.1.4

The Board of Directors may remove any Senior Corporate Officer at any time, subject to any employment or service contract between the JV Company and that Senior Corporate Officer.

Responsibilities and Powers of Senior Corporate Officers 9.2.1

The Board of Directors shall have the power to determine, qualify and change in any way the power, responsibility and authority of the Senior Corporate Officers. The Senior Corporate Officers shall implement the decisions of the Board of Directors without any condition.

9.2.2

Subject to any qualifications and limitations as may be set by the Board from time to time, the General Manager shall be responsible for the daily management and operation of the JV Company. Within the scope expressly authorized by the Board, the General Manager shall have the authority to represent the JV Company in external matters, execute contracts or agreements, and to bind the JV Company in all matters other than those for which prior approval by the Board is required pursuant to this Contract, the Articles of Association or any resolutions of the Board.

9.2.3

The Deputy General Managers shall, under the leadership of the General Manager, assist the General Manager in the daily management and operation of the JV Company. All Deputy General Managers must report to the General Manager on all important accounts and the daily operations of the JV Company as requested by the General Manager. The General Manager, however, shall consult with the respective Deputy General Manager in charge of the matter before making a key management decision.

9.2.4

The Deputy General Manager Finance shall be responsible for the financial matters of the JV Company, such matters shall include the treasury, accounting, and financial controlling operations of the JV Company. This responsibility may not be altered pursuant to a decision of the Board to change the management organization as provided under Article 7.2.1(c) (xix). The Deputy General Manager Finance and the General Manager shall jointly report to the Board on the financial matters of the JV Company on a quarterly basis. If, after thorough discussions between the Deputy General Manager Finance and the General Manager, there remains disagreement on the contents of the financial matters, each of them shall be entitled to separately present their case to the Board.

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9.2.5

The JV Company may establish various departments as proposed by the General Manager and approved by the Board. The General Manager may from time to time propose the creation or cancellation of any departments within the organizational structure of the JV Company to the Board of Directors. Any change of the organizational structure of the JV Company, however, shall be implemented only after review and approval of the Board of Directors.

9.2.6

The General Manager shall, in consultation with the Deputy General Managers and in particular with the Deputy General Manager Finance, prepare for Board approval the Business Plan and Budget for each year as provided for in Articles 4.4 and 4.5. Unless the Board decides otherwise, the General Manager shall submit each year’s Business Plan and Budget to the Board for timely approval prior to the commencement of the fiscal year.

9.2.7

In addition to any other matters as specified herein, the General Manager shall bi-annually report to the Board of Directors, or more frequently as the Board may decide or as the General Manager deems appropriate, such matters as follows and as the Board may decide from time to time:

9.2.8

9.3

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(i)

performance of the JV Company’s business operations;

(ii)

financial conditions and results of the JV Company (unless contained in the joint reports of the Deputy General Manager Finance);

(iii)

major dealings and transactions with any domestic and foreign companies or other economic organizations;

(iv)

existing problems which are material in nature and measures proposed or carried out for the solution thereof;

(v)

other important matters materially affecting the business and/or financial status of the JV Company; and

(vi)

the budget and final accounts of the JV Company (yearly).

The JV Company shall indemnify the Senior Corporate Officers against all claims and liabilities incurred by reason of them undertaking their duties to the JV Company, provided that the acts or omissions of these officers giving rise to such claims or liabilities do not constitute intentional misconduct or gross negligence or a violation of criminal laws.

Non-competition 9.3.1

No Senior Corporate Officer shall in any way serve for, or act for the benefit or interest of, any other person, company, unit, entity or organization or participate in any activity conducted by such person, company, entity, unit or organization which may, directly or indirectly, conflict or compete with the interest or business of the JV Company.

9.3.2

All other management personnel of the JV Company shall be forbidden from concurrently serving for or working at any other company, unit, entity or organization whatsoever, unless such service or work is authorized by the General Manager and approved or ratified by the Board. Any personnel in violation of this prohibition shall be subject to immediate dismissal by the 23

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9.4

Dismissal Any Senior Corporate Officer who misuses or abuses his/her position for personal ends, engages in graft or bribery in connection with the JV Company’s business, acts in violation of any Board decisions or PRC Laws, acts in any way in competition with the JV Company, is seriously negligent in his/her duties, or fails to perform any assigned tasks without due cause shall be dismissed by the Board of Directors without any compensation. Upon such dismissal, the Board shall immediately appoint a replacement. Any other management personnel who engage in such improper activities shall be immediately dismissed by the General Manager after consultation with the Senior Corporate Officer in charge of labor matters.

9.5

Signatures 9.5.1

In accordance with any further guidelines established by the Board of Directors, the signatures of the General Manager and of the Deputy General Manager Finance shall be required for all of the JV Company’s expense reports and major financial transactions, including the opening and closing of bank accounts, the undertaking of wire transfers, and the issuance of checks for payment. However, the General Manager and/or the Deputy General Manager Finance may, by signing a letter of authorization, authorize any Deputy General Manager or other officer of the JV Company to sign on his/her behalf.

9.5.2

Notwithstanding the above the signature policy, the JV Company shall require each document of a binding nature to carry at least two authorized signatures. Unless otherwise decided by the Board, the person in charge of the respective matter or his/her superior (if signature authority is granted) shall appear as co-signatory to the General Manager or to the General Manager’s delegate.

9.6

Working Language 9.6.1

Subject to the laws of the PRC, the working language (oral and written) of the Senior Corporate Officers and the department managers of the JV Company shall be English. Within the sales organization of the JV Company, the employees at the level below the department managers must be able to use English as working language. The General Manager, at any time, can grant exceptions to this policy.

9.6.2

All the important documents of the JV Company shall be made available in English and this requirement shall be stated in the employment contracts between the JV Company and the Senior Corporate Officers and the department managers.

However, in no event, shall important documents of the JV Company be deemed invalid solely because they are not in English.

Article 10 10.1

Assistance by the Parties

Assistance by BRILLIANCE As reasonably required in writing by the JV Company, BRILLIANCE shall during the Joint Venture Term do the following: 24

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10.1.1

assist the JV Company to apply for loans from local financial institutions, where necessary;

10.1.2

assist the JV Company in the localization of the JV Products;

10.1.3

assist the JV Company to procure administrative, fiscal and other services in relation to the JV Company’s activities;

10.1.4

assist the JV Company to obtain all necessary approvals, registrations, permits and licenses from the relevant PRC authorities for the establishment and operation of the business of the JV Company;

10.1.5

assist the JV Company to apply for the most preferential tax and customs duties reductions and exemptions and other investment incentives available under PRC Laws applicable to the JV Company;

10.1.6

assist the JV Company to liaise with the relevant authorities to effectively procure the Site, water supply, power supply, transportation, telecommunications, and such other utilities as required for the JV Company’s operations; assist the JV Company to enter into the Land Use Right Lease Contract with the relevant government authority at the terms and conditions acceptable to both Parties;

10.1.7

assist the JV Company to arrange for the transportation of imported equipment between ports in the PRC and the Site at reasonable cost;

10.1.8

assist the expatriate employees of the JV Company to obtain all necessary entry visas and work permits and help them to arrange for lodging, medical care and travel formalities in China;

10.1.9

assist the JV Company to open Renminbi and foreign exchange bank accounts;

10.1.10

assist the JV Company to carry out all import and customs declaration formalities for the equipment and office appliances imported by the JV Company;

10.1.11

assist the JV Company to recruit qualified Chinese personnel in accordance with the JV Company’s needs and criteria;

10.1.12

assist the JV Company to apply for any approvals necessary for the JV Company to obtain foreign exchange, and to remit to BMW or its Affiliates dividends, royalties and other amounts owed by the JV Company to BMW or its Affiliates; and

10.1.13

handle other matters set forth in this Contract and as the JV Company might entrust to BRILLIANCE from time to time.

10.2

Assistance by BMW: As reasonably required, BMW shall during the Joint Venture Term do the following:

10.2.1

assist the JV Company to select and purchase inside and outside of the PRC, at competitive prices, materials, machinery and equipment needed by the JV Company and to ship such items to designated Chinese ports; 25

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10.2.2

assist the JV Company to train its PRC staff and workers;

10.2.3

dispatch qualified and experienced expatriate employees to the JV Company, as needed, and assist in the recruitment of other managerial, technical and operational personnel of the JV Company;

10.2.4

assist the JV Company in research and development of LC Parts and components; ensure the availability of the JV Products for the JV Company, in line with BMW AG mainstream products;

10.2.5

assist the JV Company to export JV Products; provided the JV Products manufactured by the JV Company meet BMW Quality Standards as defined in Article 13.1 and if it is economically viable for both BMW AG and the JV Company to export the JV Products;

10.2.6

assist the JV Company to localize parts and components, if necessary and commercially viable;

10.2.7

assist the JV Company to apply for loans from local financial institutions, where necessary; and

10.2.8

handle other matters as set forth in this Contract and as the JV Company might entrust to BMW AG from time to time.

10.3

Any assistance to be rendered by a Party under Articles 10.1 and 10.2 above shall be to a reasonable extent only and shall neither release the JV Company from its own responsibilities nor the other Party from its general responsibility to assist the JV Company if this is reasonably required. If a Party will incur substantial costs in providing any assistance to the JV Company under Articles 10.1 or 10.2, the Party shall be required to do so only if the JV Company by a decision of its Board of Directors has agreed to reimburse the Party for such costs.

Article 11

Existing Equipment, Existing Building and Production Site

11.1

BRILLIANCE shall cause JinBei to transfer possession of the Assets to the JV Company within ten (10) days from the date that each shall make its respective contribution to the registered capital of the JV Company in accordance with Article 5.4.

BRILLIANCE shall cause JinBei to take all actions necessary to carry out registration and all other procedures that may be required by applicable PRC Laws or the relevant PRC government authorities in respect of the transfer of the ownership of the Existing Buildings to the JV Company pursuant to the Building Purchase Agreement and in respect of the transfer of ownership of the Existing Equipment to the JV Company pursuant to the Equipment Purchase Agreement.

11.2

The JV Company shall enter into the Land Use Rights Lease Contract with the relevant government authority in Shenyang for the lease of the land use lease rights for the Site. The term of the land use rights for the Site acquired by the JV Company under the Land Use Rights Lease Contract shall be at least fifteen (15) years commencing on the date on which the relevant government authority issues the State-owned Land Use Certificate for the Site in the name of the JV Company.

11.3

BRILLIANCE shall ensure that JinBei be responsible for the payment of all outgoings, taxes and fees in connection with the Site and the Existing Buildings incurred prior to the date of the transfer of the Assets to the JV Company. Except for the following tax 26

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11.4 11.4.1

(i)

a deed tax and stamp duty imposed on the JV Company; and

(ii)

a registration handling charge and other miscellaneous fees.

BRILLIANCE’s Representations and Warranties BRILLIANCE hereby represents and warrants to BMW with respect to the Site and Existing Buildings that prior to the date on which the transfer of the Site and the Existing Buildings to the JV Company becomes effective: (i)

JinBei has obtained a land use certificate for the Site;

(ii)

JinBei is the sole owner of the Existing Buildings on the Site and has obtained a Building Ownership Certificate for the Existing Buildings;

(iii)

JinBei is entitled under PRC Laws to sell to the JV Company the ownership of the Existing Buildings to the JV Company;

(iv)

the Site and the Existing Buildings may be used by the JV Company during the entire Joint Venture Term for the full scope of business as specified in Article 4.2;

(v)

the present design, construction and operation of the Existing Buildings on the Site are in full compliance with PRC Laws and the requirements of the relevant government authorities including but not limited to land administration, environmental, construction, work safety and fire prevention rules and standards;

(vi)

JinBei has obtained all permits and other authorizations which are required for the Site or the Existing Buildings thereon under the Law of the People’s Republic of China on Environmental Protection and other PRC Laws relating to pollution or protection of the environment;

(vii)

the Site and Existing Buildings thereon are in full compliance with all material terms and conditions of the permits and authorizations referred to in item (vi) above;

(viii)

JinBei’s use of and operation of its business at the Site and the Existing Buildings thereon have not caused any actual or potential environmental pollution that could have a substantial adverse effect on the normal operation of the JV Company.

(ix)

the Existing Buildings are free of any material defects. None of the land use rights over the Site or ownership rights of the Existing Buildings is subject to (i) any contract of sale, transfer or leasing, (ii) restriction on sale, lease, or transfer, or (iii) any mortgage, lien, charge or any encumbrances of any kind;

(x)

there exists no claim by any government or administrative department, military unit, organization, company, or any other entity in any form, or any individual, that such party has the right to use, occupy, control the 27

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(xi)

it is unaware of any current or anticipated civil, criminal or administrative action or proceeding with respect to the Site or the Existing Buildings; and

(xii)

the Site, the Existing Buildings and the installations therein leased or sold to the JV Company will permit an annual production capacity of 30,000 vehicles as provided for in the Building Purchase Agreement and the Equipment Purchase Agreement. If the JV Company require further production capacity, the production of JV Products by the JV Company at the Site shall have priority over the production of any other products by Brilliance or any other parties, provided that reasonable adjustments to the relevant terms of the Plant Lease Agreement have been made.

11.5

BRILLIANCE hereby represents and warrants to BMW with respect to the Existing Equipment that: (i)

JinBei has good and marketable title to the Existing Equipment;

(ii)

JinBei is entitled under applicable PRC Laws to transfer the Existing Equipment to the JV Company and none of the Existing Equipment is subject to (i) any contract of sale, (ii) restriction of transfer, or (iii) any mortgage, pledge, lien, charge or any encumbrances of any kind of character; and

(iii)

on the date that the Assets are transferred by JinBei to the JV Company, the Existing Equipment are in good condition, fit for its intended purpose and in a state of good repair and maintenance, reasonable wear and tear excepted.

11.6

If any of the representations and warranties of BRILLIANCE made in Article 11.4 or Article 11.5 are at any time found to be untrue, misleading or incorrect, BRILLIANCE shall take all actions necessary to cure such default at its costs and expenses as soon as practical and shall indemnify the JV Company for all losses, damages and claims, including without limitation any related interest, penalties and reasonable attorney’s fees, in connection with such default. If BRILLIANCE fails to cure such default within thirty (30) days after becoming aware of the default or fails to indemnify the JV Company as provided in the preceding sentence, BRILLIANCE and BMW shall promptly consult with each other in good faith and use their best endeavors to find a solution acceptable to both Parties. This duty however shall not oblige BMW to accept any financial disadvantages. If the Parties fail to agree upon such a solution within thirty (30) days from the commencement of the aforementioned consultation, BMW may terminate this Contract by providing written notice to BRILLIANCE without liability on its part and without prejudice to any other rights it may have under applicable PRC Laws.

11.7

The Parties agree that the JV Company, pursuant to the terms of the Plant Lease Agreement I, will lease a part of the Site and certain portions of the Existing Buildings to JinBei. 28

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Article 12

Technology Transfer

12.1

The Parties agree that simultaneously with the execution of this Contract, BMW and Brilliance on behalf of the JV Company, and BMW AG shall sign a Technology License Agreement under which BMW AG will license the JV Company the right to use certain technology, management and operational know-how, which may be required by the JV Company for the production, sales and marketing, and service of the JV Products. The JV Company shall pay BMW AG certain licensing fees and royalties as provided in the Technology License Agreement. The term of the Technology License Agreement is fifteen (15) years. At the first meeting of the Board, the Board shall ratify the Technology License Agreement.

12.2

Pursuant to the terms of the Technology License Agreement, BMW AG shall make available to the JV Company a complete, correct, current version of the Technical Documentation as defined in the Technology License Agreement for each of the JV Products which the JV Company may produce in the PRC. BMW AG shall provide the JV Company with technical assistance for the start up of the production of the JV Products, procurement of necessary tooling and equipment and training of the JV Company’s Chinese employees. The purpose of the technical assistance and training is to assist the JV Company to produce qualified JV Products.

12.3

Except as otherwise provided in the Technology License Agreement, the JV Company and the JV Company’s authorized third party suppliers shall manufacture the JV Products in strict conformity with the Technical Documentation and the BMW Quality Standards, both as defined in the Technology License Agreement. If and only if the JV Company has applied to BMW AG for approval and has obtained BMW AG’s prior written authorization, the JV Company and the JV Company’s authorized third party suppliers may effect changes, modifications, improvements or substitutions of the JV Products to meet special requirements of the JV Company or special conditions in the market of the PRC.

12.4

The Parties agree that the technology and know-how licensed by BMW AG to the JV Company under the Technology License Agreement is provided only for the use of the JV Company and its local parts and components suppliers as authorized by BMW AG. Subject to the foregoing, BRILLIANCE hereby undertakes to BMW that BRILLIANCE shall not use, and shall ensure that its Affiliates shall not use, such technology and know-how in any way at any time during the Joint Venture Term and after the expiration or early termination of this Contract, unless otherwise agreed by BMW AG in writing.

12.5

As part of the technology transfer and quality management, BMW AG shall make available to the JV Company the relevant BMW IT systems and software covering production, logistics, finance, sales, warranty and parts processes. The JV Company shall install and apply such BMW systems and software at its own cost. The IT system will be customized by BMW AG for the JV Company’s needs and local requirements. The terms and conditions for the implementation and the use of the IT systems will be provided for in the software license agreement to be entered into by BMW AG and the JV Company.

Article 13 13.1

Quality Standards

The Parties recognize that the technology under which the JV Products are manufactured by the JV Company is highly advanced and requires meeting very high standards in order to produce premium class products. Therefore the JV Products, the manufacturing processes of the JV Company and the quality management of the 29

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EQUITY JOINT VENTURE CONTRACT JV Company’s business operations shall fully comply with the quality requirements as determined by BMW AG from time to time on a worldwide basis (herein referred to as the “BMW Quality Standards”) and with applicable PRC Laws.

13.2

The JV Company will ensure that its policies and practices relating to the quality and safety of the JV Products and to environmental protection shall meet the standards set by BMW AG, and applicable PRC Laws, whichever are higher.

13.3

When taking measures to meet the BMW Quality Standards, the JV Company shall at all times ensure that it complies with PRC Laws.

Article 14

Purchase of Materials and Services / Local Content

14.1

The JV Company shall be entitled to purchase and obtain, either in China or from the international markets, the raw materials, tools, machinery and equipment, parts and components, office appliances and services necessary for the operations of the JV Company. All raw materials, machinery and equipment, parts and components shall meet the BMW Quality Standards and requirements of PRC Laws.

14.2

The JV Company may incorporate localized parts and components into the JV Products, provided that such localized parts and components have been tested and accepted pursuant to a separate agreement to be entered into by BMW AG and the JV Company, and provided that such localized parts and components are commercially acceptable to the JV Company in such terms as price, warranty, and delivery schedules.

14.3

The JV Company shall establish procedures for and carry out the testing of localized parts and components pursuant to the agreement referred to in Article 14.2.

14.4

BMW AG shall support the JV Company in the localization process of parts as provided for in the agreement referred to in Article 14.2.

Article 15

Sale of JV Products

15.1

The JV Products shall be sold by the JV Company in the PRC. The retail prices (prices to customers) or the recommended retail prices of the JV Products shall be proposed by the Management of the JV Company to the Board of Directors in accordance with the policies and guidelines promulgated by BMW AG from time to time and in consideration of the market conditions in the PRC. The Board has the discretion to vary retail prices or recommended retail prices by no more than five percent (5%) greater or five percent (5%) less than the proposed retail prices or recommended retail prices submitted by Management.

15.2

Upon the decision of the Board of Directors, and subject to the approval of the Examination and Approval Authority if required, the JV Company may set up branch offices for marketing, sale and services within China.

15.3

Sales, marketing, and service of the JV Products in the PRC shall be handled by the JV Company through its authorized dealer network based on standard dealer contracts. If the Board deems it appropriate to sell the JV Products outside of the PRC, the JV Products may be sold in foreign markets provided that all export sales shall be performed on a priority basis by BMW AG and its worldwide distribution network. BMW AG will oversee all aspects of the export sales including, but not limited to, price quotations and other commercial terms.

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15.4

Notwithstanding the JV Company’s own responsibilities for the activities referred to hereinafter, the business operations, promotion and marketing (including market analysis, price and product planning, sales forecasting and reporting), sales, aftersales, distribution, and dealer management activities undertaken by the JV Company shall comply with the relevant procedures, schedules and quality requirements as are determined by BMW AG from time to time on a worldwide basis and shall comply with the applicable PRC Laws.

15.5

Without restricting the JV Company from conducting its own marketing and promotional activities, the JV Company shall cooperate with BMW AG in marketing and promotional activities that relate to the BMW brand in China. Upon the invitation of BMW AG, selected sales personnel of the JV Company shall participate in sales, marketing and/or PR conferences or events.

Article 16

Trademarks

16.1

Provided that the JV Products manufactured by the JV Company meet the BMW Quality Standards, the JV Products shall bear the appropriate trademarks, as determined by BMW, that are owned by BMW AG and duly licensed to the JV Company under the Trademark License Agreement.

16.2

The JV Company shall use such trademarks strictly in accordance with the Trademark License Agreement, which the JV Company, as licensee, shall file or cause to be filed with PRC trademark administration authorities. All licensed trademarks shall at all times remain the sole property of BMW AG. Neither the JV Company nor BRILLIANCE shall at any time claim any right, title or interest to such trademarks except for the limited use rights granted to the JV Company pursuant to the Trademark License Agreement.

16.3

For maintaining and protecting the value and the strength of the BMW trademark and for a uniform appearance of the BMW trademark worldwide the JV Company will fully comply with the BMW trademark policies and specific instructions for the use of the trademark, as provided in the Trademark License Agreement.

Article 17 17.1

Non-Competition

BRILLIANCE undertakes, and for its Affiliates it guarantees as a separate liability, that during the Joint Venture Term, neither it nor any of its Affiliates shall itself or through entering into any joint venture or similar arrangement or through cooperation with an intermediary, unless with the express prior written consent of BMW: (i)

produce, distribute or service Premium Market Cars in the PRC; or

(ii)

market its own brands in competition with the JV Products or participate in any activity or otherwise act in any way in competition with any business of the JV Company in the PRC.

For the avoidance of doubt, the Parties confirm that the provisions of Article 17.1(i) shall be applicable regardless of whether the Premium Market Cars are produced, distributed or serviced under their original brands or different brands in China. The breach of any obligation under this Article 17 by BRILLIANCE or any of its Affiliates or their successors or assigns shall be referred to as a “BRILLIANCE Competition Event.”

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EQUITY JOINT VENTURE CONTRACT The production, distribution or the provision of services for BRILLIANCE’s M-1 Products shall not constitute a BRILLIANCE Competition Event, unless

(i)

the design or appearance of a M-1 Product is similar to the design or appearance of a JV Product; or

(ii)

a M-1 Product is marketed in comparison to or with reference to a JV Product;

(iii)

a M-1 Product is marketed in reference to the Parties’ cooperation under this Contract except in line with a communication strategy mutually agreed between the Parties on this subject matter.

Notwithstanding the above, BRILLIANCE shall be entitled to make improvements and upgrades to M-1 Products, provided that such improved or upgraded M-1 Products shall not compete with the JV Products.

17.3

BMW undertakes, and for its Affiliates it guarantees as a separate liability, that during the Joint Venture Term, neither it nor any of its Affiliates shall itself or through entering into any joint venture or similar arrangement or through cooperation with an intermediary, unless with the express prior written consent of BRILLIANCE, produce in the PRC the JV Products.

17.4

BMW undertakes, and for its Affiliates it guarantees as a separate liability, that commencing from the JV Company’s first full year of production and during any calendar year of the Joint Venture Term, neither it nor any of its Affiliates shall, unless with the express prior written consent of BRILLIANCE, import to and distribute within the PRC the JV Products produced outside the PRC to the extent this exceeds five percent (5%) of the volume produced by the JV Company in that calendar year.

This restriction shall not apply and BMW or its Affiliates shall be allowed to import into and distribute within the PRC the JV Products produced outside of the PRC if and to the extent that the production capacity of the JV Company is unable to satisfy the market demand for the JV Products. The production capacity shall be determined either by the maximum production capacity of the JV Company plant (being 30.000 units) or such lower volume if the maximum production capacity can not be achieved for any reason other than those within the reasonable control of BMW or any of its Affiliates and market demand for the JV Products shall be the forecasted sales volume for the JV Company as determined by the Board of Directors for that year as part of the Planning Documents as referred to in Article 7.2.1 (b) (vi). However if it is anticipated that the production capacity of the JV Company will not meet market demand, the JV Company shall take all reasonable and available measures to optimise the production capacity of the plant as per the decision of the Board of Directors.

If the satisfaction of market demand requires further investment into the JV Company and if such investment is economically viable, both Parties on a pro rata basis shall provide such finance to the JV Company (either by way of equity capital, loans, or provision of financial securities) as provided for in and subject to Articles 5.6 and 5.7 of this Contract.

17.5

The launch of any JV Product within the PRC which is scheduled to be introduced after the Establishment Date shall firstly be conducted by the JV Company, provided that the JV Company is able to manufacture these JV Products with all necessary assistance and efforts to be contributed from BMW and BMW AG. 32

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17.6

BMW undertakes, and for its Affiliates it guarantees as a separate liability, that during the Joint Venture Term, neither it nor any of its Affiliates shall, unless with the express prior written consent of BRILLIANCE, enter into any joint venture or similar arrangement with a third party for the production and distribution of BMW Cars other than the JV Products in China, unless it has offered, in writing, the option to BRILLIANCE to enter into such an arrangement at terms and conditions materially equal to those offered and negotiated by BMW with such third party, and BRILLIANCE has not, by written notice to BMW, exercised this option within six (6) weeks of receipt of the offer from BMW. In case the terms and conditions offered to the third party change in any material or substantial aspect, BMW shall offer such changed terms and conditions in writing to BRILLIANCE, which shall then have another three (3) weeks to exercise the option to enter into an agreement with BMW on such changed terms and conditions.

17.7

For the avoidance of doubt, the Parties agree and acknowledge that BMW, subject to PRC Laws, may establish a wholly-foreign owned enterprise in China to produce and/or sell BMW vehicles other than the JV Products.

17.8

The breach of any obligation under this Article 17 by BMW or any of its Affiliates or their successors or assigns shall be referred to as a “BMW Competition Event.”

Article 18 18.1

Labor Management

Governing Principle The JV Company shall be entitled to the full enterprise autonomy granted to foreign invested enterprises and shall have complete authority over the hiring and dismissal of its employees. The recruitment, employment, discipline, dismissal and resignation of the employees of the JV Company and their wages, salaries, insurance, welfare benefits and other matters shall be handled in accordance with the PRC Labor Law and other relevant PRC Laws.

18.2

Employees of the Parties Either Party may recommend any of its existing employees (whether blue collar or white collar) to work for the JV Company. If the JV Company upon its own discretion decides to employ any of these employees, they shall terminate their employment relationship with the relevant Party prior to or at the time when they enter into employment contracts with the JV Company (except for any agreement for reemployment or agreement for payment of additional compensation or fringe benefits etc.).

Thereupon they shall be deemed to be employed by the JV Company from the labor market independently. The JV Company shall not assume any obligations of any kind in respect of such employees that are related to or arose during the period before their respective dates of hire by the JV Company. Such obligations shall be assumed by the relevant Party, which shall reimburse the JV Company for any such costs incurred by the JV Company. The JV Company shall be responsible for any obligations of any kind in respect of its employees which are related to or arise after their respective dates of hire by the JV Company.

18.3

Labor Contract The JV Company may conclude individual employment contracts with staff and workers directly or collectively with the trade union of the JV Company on behalf of the staff and workers. The JV Company shall file such contracts with the local labor department for the record.

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EQUITY JOINT VENTURE CONTRACT Labor Plan The labor plan, including the number of employees of the JV Company, the salaries and benefits of employees and the job descriptions, shall be prepared by the General Manager in consultation with the Senior Corporate Officer in charge of labor matters and shall be subject to approval by the Board. The employees of the JV Company shall be required to strictly observe the rules and regulations of the JV Company. The JV Company shall recruit and employ only such number of employees as is necessary for its operations. Board approval shall be required if the JV Company increases or decreases the total number of its employees due to such factors as expansion or reduction of business or increased or decreased efficiency.

18.5

18.6

Labor and Personnel Policies (a)

The JV Company’s policies regarding employment matters such as employment, dismissal, resignation, wages, insurance, welfare benefits, reward and discipline of its staff and workers shall be decided by the Board and shall be implemented by the General Manager. The labor contracts between the JV Company and the employees or the trade union on behalf of the employees shall be formulated in accordance with the JV Company’s policies and the applicable PRC Laws.

(b)

The initial labor and personnel policies of the JV Company shall be prepared by the General Manager for approval by the Board. These policies shall be consistent with applicable PRC Laws.

(c)

The General Manager shall implement hiring policies whereby all PRC employees of the JV Company shall be selected on the basis of examination, merits and qualifications. In this regard, upon the receipt of necessary approvals, the JV Company may hire qualified personnel from anywhere within China and, if necessary, from foreign countries.

(d)

The General Manager and the Deputy General Manager Human Resources shall consult with each other with respect to the recruitment, employment, dismissal and remuneration of key personnel of the JV Company including, but without limitation, department managers.

(e)

The JV Company shall sign non-competition and confidentiality agreements with its employees in accordance with the relevant terms and conditions in this Contract.

Training The Parties recognize that the JV Company will conduct significant training of management personnel and other employees.

18.7

Power of General Manager Subject to any limitations the Board may set and to the provisions of the labor contract between an employee and the JV Company, the General Manager shall have the power, according to the degree of seriousness of the case, to give warnings, record demerits, deduct wages, dismiss or otherwise remove any staff member or worker appointed by him/her who has violated the terms of his/her labor contract, the rules, regulations or labor discipline of the JV Company or applicable PRC Laws.

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EQUITY JOINT VENTURE CONTRACT Non-solicitation Each Party undertakes to the other Party, and for its Affiliates it guarantees as a separate liability, that for the duration of this Contract and for one year after the expiration thereof, neither it nor its Affiliates shall, directly or indirectly, solicit or entice away any director, manager or other employee and worker nor shall it or its Affiliates cause any of those personnel to resign or otherwise leave the JV Company, unless prior agreement between the Parties has been reached.

Article 19

Trade Union

The staff and workers of the JV Company may establish a trade union in accordance with the Joint Venture Law and the Trade Union Law of the PRC. Activities of the trade union shall be conducted after normal working hours, shall not interfere with the normal operations of the JV Company, and shall conform to the relevant regulations. If a trade union is established by the staff and workers of the JV Company, the JV Company shall pay two percent (2%) of the total amount of wages received by its employees into the JV Company’s trade union fund, and such payment shall be an expense of the JV Company.

Article 20 20.1

20.2

Finances, Taxes, Audit and Distribution of Profits

Taxes 20.1.1

The JV Company shall pay taxes, duties and other levies (collectively “Taxes”) in accordance with relevant PRC Laws.

If Taxes are imposed on the Parties in connection with the activities of the JV Company, the JV Company shall provide administrative assistance to the Parties to meet their obligations (e.g. preparation of returns, reports, and payments).

20.1.2

The JV Company is obliged to deduct or withhold from any payment to the Parties any Tax (e.g., withholding tax on income, business tax), then the JV Company shall withhold or deduct such amount and pay it, on behalf of Parties, to the relevant PRC government authorities. The JV Company shall endeavor to minimize such deductions or withholdings as permitted by PRC Laws and relevant double taxation treaties, and shall, if required, complete all application procedures. Further, the JV Company shall provide the Parties with all original certificates, documentation, and other information that is necessary to enable the Parties to utilize or to claim any tax credits or benefits that relate to such payments made by the JV Company on behalf of the Parties.

20.1.3

The JV Company shall apply for every kind of preferential tax and customs treatment (including subsidies) available to it under PRC Laws. Furthermore, upon request of the Parties, the JV Company shall assist the Parties to apply for all preferential tax treatment available to them and their Affiliates, which are expressly provided under PRC Laws and relevant to payments made by the JV Company.

Finances 20.2.1

The fiscal year of the JV Company shall start on January 1 of each calendar year and end on December 31 of the same year. The first fiscal year of the JV Company shall commence on the Establishment Date and end on December 35

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EQUITY JOINT VENTURE CONTRACT 31 of the same year. The last fiscal year of the JV Company shall start on January 1 of the year of termination or expiration and end on the date of termination or expiration of the Joint Venture Term.

20.3

20.2.2

The JV Company shall adopt an accounting system consistent with applicable PRC Laws. All accounting records, books and statements of the JV Company shall be prepared and kept both in Chinese and English. The JV Company shall use Renminbi as the base bookkeeping currency for its financial statements.

20.2.3

The JV Company shall as a policy require that contracts and other important documents (e.g. invoices) from third parties be in both Chinese and English. In the event that any third party does not provide both the Chinese and the English versions as required by the preceding sentence, all relevant details of the document shall be translated by the JV Company into Chinese or English, as the case may be, unless, in the case of invoices, the transaction amount is below RMB 10,000 or as otherwise provided for in the JV Company guidelines.

20.2.4

The annual, quarterly and if applicable other reports shall be prepared and jointly signed by both the General Manager and the Deputy General Manager Finance and shall be prepared and kept in both Chinese and English. The Deputy General Manager Finance shall be responsible for formulating the accounting and administrative measures regarding the JV Company’s financial affairs, which shall be submitted via the General Manager to the Board for approval.

20.2.5

The accounting system of the JV Company shall at the cost of BMW AG be supplemented with the BMW AG accounting system based on International Accounting Standards (IAS) and by the “BMW Controlling Management Information System.” Upon request and at the cost of BMW AG the JV Company shall for such periods relevant to BMW AG prepare separate accounts in full compliance with the BMW AG accounting system.

20.2.6

The JV Company shall adopt the procedures and the time targets applied by BMW AG for Long Range Planning, the Annual Business Plan, forecasting and reporting.

Audit Within three (3) months following the end of each fiscal year, the JV Company shall engage an accounting/auditing firm registered in China as its auditor to examine and verify the accounts and books of the JV Company. The accounting/auditing firm shall be a joint venture accounting firm registered in China in which any of the following is one of the joint venture partners, unless decided otherwise by the Board: Price WaterhouseCoopers, KPMG, Ernst & Young, or Deloitte & Touche.

The annual audit report issued by such firm shall be submitted to the Board. Either Party shall also have the right, but not the duty, to appoint, at its own costs, another accounting/auditing firm registered in China or abroad to audit the accounts and books of the JV Company. That audit shall be carried out during the normal business hours of the JV Company and shall not unreasonably interrupt the conduct of the JV Company’s business. The JV Company shall make available and accessible all of its accounting books and records to such auditor.

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EQUITY JOINT VENTURE CONTRACT Each Party shall at its own cost be allowed for its internal purposes at any time upon reasonable prior notice to conduct a fullyfledged audit of the JV Company’s financial affairs and business operations. Each Party shall have full access to the JV Company’s documents and the JV Company shall upon reasonable request make available the relevant key personnel for discussion.

20.4

Allocation to Three Funds After the offset of cumulative losses (if any) and the payment of income tax and other applicable taxes by the JV Company each year, the Board shall determine the amount from the after-tax net profits to be allocated into the JV Company’s reserve fund, enterprise expansion fund, and the employee bonus and welfare fund to be set up in accordance with PRC Laws. The total annual allocation to the funds mentioned above shall not exceed ten percent (10%) of the after-tax net profit of the respective year unless otherwise decided by the Board in light of the business and financial conditions of the JV Company or unless required otherwise by PRC Laws.

20.5

Distribution of Profits 20.5.1

After paying taxes in accordance with the relevant PRC Laws and making allocations to the reserve funds, expansion funds, bonuses and welfare funds for staff workers, the JV Company’s remaining profits either shall be distributed between the Parties according to the Parties’ ratio of contribution to the JV Company’s registered capital or shall be retained or reinvested as decided by the Board of Directors.

20.5.2

If the JV Company carries any loss from any previous year, the profits of the current year shall first be used to cover such loss. No profits shall be distributed or re-invested unless and until all deficits from any previous years are fully made up. Any distributable profits retained by the JV Company and carried over from any previous years that are not re-invested may be distributed together with the distributable profits of the current year.

Article 21 21.1

Bank Accounts and Foreign Exchange

Accounts The JV Company shall open separate Renminbi accounts and foreign exchange accounts with banks or financial institutions in China. The JV Company may also open foreign exchange accounts with foreign financial institutions outside of China, as designated by the Board of Directors and upon approval by the State Administration of Foreign Exchange or its competent local bureau, if required.

21.2

Foreign Exchange 21.2.1

The JV Company shall handle its foreign exchange matters in accordance with applicable PRC Laws. It shall apply for and maintain a Foreign Exchange Registration Certificate.

21.2.2

In order to balance its foreign exchange needs, the JV Company may, subject to approval by the Board, adopt any measure and engage in any activity permitted under PRC Law.

21.2.3

The JV Company shall pay its foreign exchange according to the following order of priorities, unless otherwise determined by the Board of Directors: 37

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21.3

EQUITY JOINT VENTURE CONTRACT (i)

compensation to the JV Company’s expatriate staff;

(ii)

purchase of materials, equipment and services that the JV Company imports from abroad;

(iii)

administrative expenses that the JV Company incurs which require foreign exchange payment;

(iv)

loan principal and interest, and related obligations requiring foreign exchange payment;

(v)

profit and dividends to BMW; and

(vi)

payment to BMW of proceeds from liquidation of assets pursuant to the provisions of Article 24.3.

BMW’s Priority in Foreign Exchange 21.3.1

Subject to PRC Laws, BMW is entitled to receive its dividends in foreign exchange in accordance with Article 21.2.3. To this end the JV Company shall use its best efforts to convert BMW’s dividends from RMB into foreign currency as instructed by BMW. BMW shall reimburse the JV Company for duly-documented third party costs caused by the conversion.

21.3.2

Subject to PRC Laws, for the time period and to the extent that the foreign exchange cannot be transmitted to BMW’s nominated account the JV Company shall deposit BMW’s dividends or other payments due to it in a separate interestbearing bank account. Any interest accrued on BMW’s dividends whether on a foreign currency or RMB denominated bank account shall belong to and be paid to BMW.

Article 22 22.1

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Joint Venture Term

Joint Venture Term The duration of the JV Company shall commence on the Establishment Date and continue for a period of fifteen (15) years thereafter, unless earlier terminated or further extended as provided herein.

22.2

Extension The term of the JV Company may be extended upon mutual consent of the Parties. The Parties shall commence negotiations on whether and for how long to extend the Joint Venture Term no less than one (1) year prior to the expiration of the Joint Venture Term (or any extension thereof). A written application for the extension of duration as agreed to by both Parties, shall be filed with the Examination and Approval Authority six (6) months prior to the expiration date of the Joint Venture Term (or any extension thereof).

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Article 23 23.1

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Termination

Events of Termination 23.1.1

Subject to the approval of the Examination and Approval Authority, either Party shall have the right to terminate this Contract prior to the expiration of the Joint Venture Term by written notice to the other Party, if any of the following events occur: (i)

the other Party materially breaches this Contract or the Articles of Association, and such breach is not cured within thirty (30) days of written notice to the breaching Party;

(ii)

the JV Company, after a start-up period of three (3) years from the Establishment Date, has sustained permanent heavy losses exceeding twenty-five percent (25%) of the total registered capital of the JV Company per annum for two (2) consecutive years, or if three (3) years after the Establishment Date the cumulative amount of losses has exceeded fifty percent (50%) of the total registered capital of the JV Company, whichever occurs first;

(iii)

the other Party assigns, pledges, or otherwise encumbers any of its interest in the registered capital of the JV Company in violation of this Contract or applicable PRC Laws;

(iv)

a Change of Law (exclusive of situations as provided in Article 3.5.3 hereof) has directly or indirectly caused or is clearly foreseeable to cause material adverse consequences to the JV Company or to any Party’s benefits under this Contract and the Parties are unable to agree upon necessary adjustments (as provided for in Article 3.5.2) within three (3) months after the Change of Law has occurred;

(v)

unforeseen circumstances arise where it is likely that the JV Company, will suffer an overall loss during the entire Joint Venture Term;

(vi)

the other Party and/or its Affiliate(s) materially breaches or it willfully causes the JV Company to materially breach any of the Trademark License Agreement, Technology License Agreement, the Parts and Components Supply Agreement or the agreement referred to in Article 14.2 and such breach is not cured within thirty (30) days after receipt of written notice to that causing Party;

(vii)

total or partial performance of this Contract is prevented by an Event of Force Majeure for more than one hundred twenty (120) days, and such prevention materially and adversely affects the operation of the JV Company, and the Parties are unable to find an equitable solution;

(viii)

both Parties decide to terminate their joint venture cooperation;

(ix)

the JV Company or the other Party becomes insolvent for a consecutive period of three (3) months, or it becomes bankrupt, or it dissolves;

(x)

the Technology License Agreement or the Trademark License Agreement terminates or expires; 39

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EQUITY JOINT VENTURE CONTRACT (xi)

the Business License is cancelled;

(xii)

the Business License is amended, or a license, permit, or authorization which is required by the JV Company is withdrawn, cancelled, or amended in whole or in part, and such amendment, withdrawal or cancellation has directly or indirectly caused or is clearly foreseeable to cause material adverse consequences to the JV Company or to any Party’s benefits under this Contract. If the amendment, withdrawal, or cancellation is due to the fault of a Party, such Party shall not have the right to terminate this Contract under this clause;

(xiii)

an event of deadlock exists in accordance with Article 8;

(xiv)

if a Party loses its powers to appoint one or more of its representatives on the Board or loses its powers to nominate one or more of its representatives in the Management as provided for in this Contract.

(xv)

there arises any other reason for termination expressly provided for in this Contract or applicable PRC Laws.

Notwithstanding the above, if a Party’s material breach of this Contract, the Articles of Association, the Technology License Agreement, the Trademark License Agreement, the Parts and Components Supply Agreement or the agreement referred to in Article 14.2 cannot reasonably be cured within thirty (30) days, but the breaching Party commences to cure the breach within the thirty-day period and diligently continues to cure the breach, the non-breaching Party shall not have the right to terminate this Contract for the period of time during which the breaching Party is diligently taking actions to cure the breach.

23.1.2

In addition to the provisions of Article 23.1.1, BRILLIANCE shall have the right to terminate this Contract prior to the expiration of the Joint Venture Term, by written notice to BMW, if any of the following events occur: (i)

BMW undergoes a change in Control or twenty-five percent (25%) of its equity capital is directly or indirectly acquired, or it has been directly or indirectly merged with or into another entity, unless BMW has obtained the prior written consent of BRILLIANCE for such change in Control, acquisition, or merger; or if the representation and warranty set out in Article 2.2.3 was incorrect or became incorrect after the Effective Date.

(ii)

a BMW Competition Event occurs and it is not cured within thirty (30) days of written notice from BRILLIANCE.

23.1.3

BMW shall have the right to terminate this Contract prior to the expiration of the Joint Venture Term by written notice to BRILLIANCE if any of the following events occur: (i)

BRILLIANCE is in breach of the production capacity guarantee as provided for in Article 11.4.1(xii) of this Contract and such a breach causes a material adverse effect on the operation or the financial results of the JV Company; 40

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EQUITY JOINT VENTURE CONTRACT (ii)

BRILLIANCE undergoes a change in Control or twenty-five percent (25%) of its equity capital is directly or indirectly acquired, or it has been directly or indirectly merged with or into another entity, unless BRILLIANCE has obtained the prior written consent of BMW for such change in Control, acquisition or merger; or if the representation and warranty set out in Article 2.2.2 was incorrect or became incorrect after the Effective Date.

(iii)

a BRILLIANCE Competition Event occurs and it is not cured within thirty (30) days of written notice from BMW; or

(iv)

the Parties fail to reach an agreement pursuant to Article 11.6.

Termination Notice If a Party chooses to terminate this Contract pursuant to Article 23.1, it shall send a written notice of termination to the other Party and the Parties shall endeavor, through negotiation and agreement, to resolve the problem. Should the Party receiving the notice of termination dispute or challenge the termination of this Contract, such Party shall have the right to submit the dispute for arbitration, in accordance with the provisions of Article 29, for determination of the issue of whether termination of this Contract is valid.

23.3

Liabilities for Breach of Contract Notwithstanding termination of this Contract, any Party that breaches this Contract shall be liable to compensate all losses, both actual and foreseeable at the time of the execution of this Contract, suffered by the other Party as the result of the breach, including loss of profits.

Article 24 24.1

Consequences of Termination

Buyout 24.1.1

Buyout Option

(i)

If, within sixty (60) days of receipt of the notice of termination served pursuant to Article 23, the Parties have not agreed in writing to continue this Contract, then the Parties shall agree to discuss one Party’s purchase of all of the other Party’s interest in the registered capital of the JV Company (“Buyout”). If, within sixty (60) days of receipt of the notice of termination, the Parties reach an agreement on a Buyout, then the Parties will proceed in accordance with the terms of that agreement.

(ii)

If, within sixty (60) days of receipt of the notice of termination, the Parties have not agreed, in writing, to a Buyout, then, BMW shall have the option to purchase BRILLIANCE’s interest in the registered capital of the JV Company at a price as determined pursuant to Article 24.1.2 below, multiplied by the percentage of BRILLIANCE’s share of the registered capital at the time of the Buyout. BMW shall have ninety (90) days to exercise its option, starting from the date of receipt of the notice of termination. If BMW exercises this option, BRILLIANCE shall not take any actions that might adversely affect BMW’s ability to continue the operation of the JV Company as a going concern.

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(iii)

If BMW fails to exercise its option within ninety (90) days of receipt of the notice of termination or it notifies BRILLIANCE in writing that it will not exercise the option, BRILLIANCE shall have the option to purchase BMW’s interest in the registered capital of the JV Company at a price as determined pursuant to Article 24.1.2 below, multiplied by the percentage of BMW’s share of the registered capital at the time of Buyout. Such option shall be exercised by BRILLIANCE, in writing, not later than within thirty (30) days from the date the option becomes available to BRILLIANCE.

(iv)

The ratio between BRILLIANCE’s shareholding in and BMW’s shareholding in the registered capital of the JV Company following the Buyout under this Article 24.1.1 shall be in compliance with applicable PRC Laws.

24.1.2

Transfer Price

(i)

If the termination of this Contract is caused by a breach of this Contract, the Technology License Agreement, the Trademark License Agreement, the Parts and Components Supply Agreement, the agreement referred to in Article 14.2 or the Articles of Association (a “Breach of Contract”) by BMW and BMW exercises its Buyout Option under Article 24.1.1, the Transfer Price shall be the higher of the following two figures: a)

the Net Asset Value of the JV Company at the date when BMW exercises the Buyout Option multiplied by the percentage of BRILLIANCE’s share of the registered capital of the JV Company which is to be purchased by BMW; or

b)

the result of the formula:

where: En

the amount of registered capital held in the JV Company by BRILLIANCE in calendar year n at the beginning of business year n

n

indicates each single business year between the Establishment Date until the date when BMW exercises its Buy Out Option (starts with 1)

m

indicates the business year when BMW exercises its Buy Out Option

X

Agreed rate of Return for BRILLIANCE to be twenty percent (20%) p.a. (first and last year pro rata temporis if necessary);

Dn

Absolute amount of dividends paid to BRILLIANCE in Business year n

S

BRILLIANCE’s share of the JV Company that is purchased by BMW. S is initially defined as 1.0, which represents BRILLIANCE’s fifty percent (50%) share of the JV Company.

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the amount of registered capital held in the JV Company by BRILLIANCE on the date when BMW exercises its Buyout Option

(ii)

If the termination of this Contract is caused by a Breach of Contract by BRILLIANCE and BRILLIANCE exercises its Buyout Option under Article 24.1.1, the Transfer Price shall be determined in the same manner as the determination of the Transfer Price according to Article 24.1.2(i).

(iii)

If the termination of this Contract is caused by a Breach of Contract by BRILLIANCE and BMW exercises its Buyout Option under Article 24.1.1, the Transfer Price shall be equal to the total value of the assets of the JV Company minus the total liabilities of the JV Company (the “Net Asset Value”) multiplied by the percentage of BRILLIANCE’s share of the registered capital.

(iv)

If the termination of this Contract is caused by a Breach of Contract by BMW and BRILLIANCE exercises its Buyout Option under Article 24.1.1, the Transfer Price shall be equal to the Net Asset Value of the JV Company multiplied by the percentage of BMW’s share of the registered capital.

(v)

In no event shall the receipt of the Transfer Price by a Party prejudice any rights that Party may have to claim damages under this Contract, the Trademark License Agreement, the Technology License Agreement, the Other Contracts, or PRC Laws.

(vi)

If the termination of this Contract is not caused by a Breach of Contract, the Parties shall mutually agree on a Transfer Price, which shall not be greater than the price as calculated under Article 24.1.2(i).

24.1.3

Calculation Proceedings

(i)

The Parties agree that the Net Asset Value of the JV Company referred to in Article 24.1.2 (iii) and Article 24.1.2 (iv) shall be determined on the basis of the financial statements audited by the JV Company’s auditor in accordance with applicable PRC accounting system.

(ii)

If the Parties fail to agree on the Transfer Price as determined in Article 24.1.2 (ii) above within thirty (30) days from the exercise of a Buyout Option, the Parties shall, unless otherwise agreed, jointly conduct a valuation for the purpose of determining the Transfer Price. For such valuation, each Party shall nominate an independent and competent appraiser within thirty (30) days after the exercise of the Buyout Option. Within thirty (30) days of the date of their nomination, the appraisers shall make their determination of the Transfer Price in a written report setting forth detailed reasons for such determination.

If the two (2) appraisers cannot agree on a valuation and their respective values differ by no more than ten percent (10%) of the higher one, the average of the two (2) valuations shall be adopted. If the two (2) valuations differ by more than ten percent (10%) of the higher one, then the Parties shall proceed to liquidate the JV Company pursuant to Article 24.2 of this Contract.

24.1.4

Under no circumstances, including, but not limited to a disagreement over the existence over the validity of the grounds for termination of this Contract, shall a Party object to or hinder the procedure to determine the Transfer Price as provided in this Article 24.1.3. In the event that the validity of the grounds for termination of the Contract has been successfully challenged by the non43

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EQUITY JOINT VENTURE CONTRACT terminating Party, the terminating Party shall fully compensate the non-terminating Party and the JV Company for all costs and reasonable expenses incurred by them for the determination of the Transfer Price.

24.2

24.1.5

After the Parties have agreed to a Buyout or a Party has exercised its buyout option, the Parties shall enter into an agreement for transfer of interest in the registered capital of the JV Company. The selling Party shall assist in securing all necessary government approvals. In the event that BMW is the selling Party, all payments to BMW shall be made in foreign exchange. The Parties shall complete the buyout transaction within six (6) months following the Parties agreement on a Buyout or the exercise of the Buyout Option by BMW or BRILLIANCE, as the case may be.

24.1.6

The termination of this Contract and the transfer of interest in the JV Company’s registered capital as a result of any buyout transaction shall be subject to the approval of the Examination and Approval Authority pursuant to PRC Laws.

24.1.7

The Parties agree that in the event of a Buyout pursuant to this Contract, the purchasing Party shall have the right to set off from the Transfer Price any outstanding amount owed or payable by the selling Party to the purchasing Party and/or withhold for and on behalf of the JV Company from such Transfer Price any outstanding amount owed or payable by the selling Party to the JV Company at the time and to deliver such withheld amount to the JV Company.

Liquidation 24.1.1

In the event that: (a) the Parties fail to resolve their dispute through the methods provided in Article 23.2; or (b) one Party is not to buy out the other Party’s interest in the registered capital of the JV Company as provided in Article 24.1.1, then each Party shall agree and shall cause its appointed Directors to approve the termination of this Contract and the liquidation of the JV Company.

The Board of Directors shall convene a meeting no later than fifteen (15) days following notice of either of the circumstances discussed in subparagraph (a) or (b) of this Article, and shall adopt a unanimous resolution to terminate this Contract, liquidate the JV Company, formulate liquidation procedures and establish a liquidation committee. The JV Company then shall submit an application to the Examination and Approval Authority for the termination of this Contract and the liquidation of the JV Company.

24.2.2

If an event under subparagraph (a) or (b) of Article 24.2.1 occurs, and any Party fails to cause its Directors to vote in favor of the termination of this Contract and the liquidation of the JV Company, such failure shall constitute material breach of this Contract.

Moreover, if no resolution is passed by the Board within ten (10) days of the scheduled date for the Board meeting, any Party shall be entitled to unilaterally apply to the Examination and Approval Authority to terminate this Contract and to liquidate the JV Company in accordance with the relevant provisions of the Measures on the Liquidation of Foreign-Invested Enterprises or the then-applicable PRC Laws on the liquidation of foreign-invested enterprises.

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24.2.3

The JV Company, upon commencement of its liquidation, immediately shall cease and discontinue its operation, as well as the manufacture and sale of the JV Products. In addition the JV Company immediately shall cease the use of, all copies of Proprietary Information and Technical Information and other materials provided by BMW or BRILLIANCE in written form. Any and all property, including all copies of Proprietary Information and Technical Information, owned and/or created by BMW or BRILLIANCE which has been loaned, licensed or otherwise provided to the JV Company shall be returned to whichever of BMW or BRILLIANCE provided such property.

For purposes of this Article 24.2.3, “Technical Information” shall mean all technical and other specifically productrelated information which BMW or BRILLIANCE or their respective Affiliates have disclosed to the JV Company regarding the JV Products and their development, manufacture and use, including but not limited to operating procedures, quality assurance procedures, formulas, standards, specifications and all other information needed to engage in the manufacturing, processing, and marketing of the JV Products.

For purpose of this Article 24.2.3, “Proprietary Information” shall mean all proprietary information other than Technical Information that is disclosed by BMW or BRILLIANCE or their respective Affiliates to the JV Company, and relates to the manufacture, marketing and sale of JV Products, including but not limited to financial data, customer lists, marketing strategies, and distribution mechanisms.

24.3

Liquidation Proceedings 24.3.1

The liquidation of the JV Company shall be handled in accordance with the applicable PRC Laws. The liquidation committee shall be composed of three (3) persons. One (1) shall be appointed by BRILLIANCE from the Directors it has appointed to the Board, one (1) shall be appointed by BMW from the Directors it has appointed to the Board, and the third shall be a person agreed upon by the first two (2) nominees and shall be an accountant or a lawyer registered in China. In case any Director so appointed cannot serve, a replacement shall be appointed within ten (10) days (from the date of the initial appointment) by the Party that originally appointed the Director who cannot serve.

24.3.2

If the first two (2) members fail to agree as to the third member within fifteen (15) days of their appointment, the third member shall be appointed by the President of the Law Society of Hong Kong and shall be a reputable lawyer. As soon as all three (3) liquidation committee members are appointed, the Board of Directors shall submit a list of their names to the Examination and Approval Authority for examination and verification.

24.3.3

The Board of Directors shall within fifteen (15) days of receipt of the report of the liquidation committee, approve the liquidation plan of the liquidation committee. After the Board of Directors approves the liquidation plan, the liquidation plan promptly shall be filed with the Examination and Approval Authority.

24.3.4

The liquidation committee shall use its best efforts both to obtain the highest possible prices for the assets of the JV Company and to maximize foreign exchange proceeds. Unless otherwise agreed, in writing, the Parties hereby 45

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EQUITY JOINT VENTURE CONTRACT agree that the JV Company’s assets will be sold to the Party, at that time, offers the higher price for them.

24.3.5

The liquidation expenses, including remuneration to committee members and to the lawyers and accountants retained by the liquidation committee, shall be paid out of the JV Company’s assets in priority to the claims of other creditors.

24.3.6

After the settlement of all outstanding debts and taxes, the remaining proceeds of liquidation, if any, shall be paid over to the Parties in proportion to their respective paid-in contributions to the registered capital of the JV Company at the time of liquidation. BMW shall have priority to receive all of its share of the proceeds in foreign exchange.

24.3.7

Upon completion of the liquidation of the JV Company, the liquidation committee shall submit a liquidation proceedings wind-up report to the Board of Directors for approval and submission to the Examination and Approval Authority for the record. In addition, the committee shall carry out the necessary procedures to cancel the JV Company’s tax registration, cancel its Approval Certificate and business registration and return its Approval Certificate and Business License, and de-register with the customs authorities.

Article 25

Insurance

25.1

The JV Company shall, at all times during its operation, procure and maintain full and adequate insurance coverage in a manner prudent and advisable for such enterprises.

25.2

The relevant insurance policies may be obtained from any insurance company authorized to provide such policies in the PRC. The types of insurance and the value, duration and denomination of the currency of the premiums and insurance proceeds shall be determined by the Board of Directors based on the practices of BMW AG and its Affiliates in other countries and/or on the actual circumstances in the PRC.

Article 26

Confidentiality

26.1

Each of the Parties acknowledges and agrees that the discharge of its obligations under this Contract will involve the disclosure of confidential information (“Confidential Information”).

26.2

Each of the Parties, its Affiliates, and the JV Company shall at all times use its best efforts to use Confidential Information only for the purposes specified in this Contract, and shall not disclose any Confidential Information to any third parties without the prior written consent of the other Party. No entity other than the JV Company shall be permitted to use, practice or exploit any Confidential Information provided by any Party or by any Party’s Affiliates in any manner, without the prior written consent of both Parties. Each of the Parties, its Affiliates, and the JV Company shall not be entitled to make or permit or authorize the making of any press release or other public statement or disclosure concerning this Contract or any of the transactions contemplated in it without the prior written consent of the other Party.

26.3

If a Party and/or the JV Company receives Confidential Information, then the receiver shall cause its personnel with access thereto, to execute a confidentiality agreement with respect to the Confidential Information, in a form and substance satisfactory to the providing Party. The receiving Party, its Affiliates, and the JV Company shall 46

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EQUITY JOINT VENTURE CONTRACT make Confidential Information available only to those of their personnel whose duties necessitate access to or familiarity with such Confidential Information.

26.4

The confidentiality obligations of the Parties set forth in this Article 26 shall be maintained during the term of this Contract and for an additional period of three (3) years after either the expiration of the Joint Venture Term or termination of this Contract.

26.5

The Party that provides the Confidential Information shall have the power to determine what data, technologies, documents and information constitute Confidential Information subject to this Article 26.

26.6

Notwithstanding the provisions of this Article 26, either Party may disclose Confidential Information:

26.7

(i)

to its legal and financial advisers requiring the information for the purposes of this Contract; and

(ii)

to the extent required by law or by a stock exchange.

The provisions of this Article 26 do not apply to Confidential Information that: (i)

can be shown to be known by the receiving party, by written records made prior to disclosure by the disclosing party;

(ii)

is or becomes public knowledge other than through the receiving party’s breach of this Contract; or

(iii)

was obtained by the receiving party from a third party having no obligation of confidentiality with respect to such information.

Article 27

Force Majeure

27.1

If any Party is prevented from performing any of its obligations under this Contract due to an Event of Force Majeure, the time for performance of the obligations under this Contract that were prevented from performance by such Event of Force Majeure shall be extended by a period equal to the period of delay caused by such Event of Force Majeure, subject to Article 23.1 hereof; all other obligations under this Contract and the time for performance thereof shall remain unaffected.

27.2

The prevented Party shall within ten (10) business days of the occurrence of such Event of Force Majeure notify the other Party of the occurrence of any Event of Force Majeure by cable, telex, facsimile or courier. Within fifteen (15) days of the occurrence of such Event of Force Majeure, the prevented Party shall provide the other Party a detailed description of the Event of Force Majeure and, if the event takes place in the PRC, a valid certificate notarized by a local notary or issued by a proper governmental agency in the place where the Event of Force Majeure occurred, confirming the occurrence of such Event of Force Majeure. The prevented Party shall give clear answers in writing to any questions the other Party might have regarding the Event of Force Majeure and the prevented Party’s hindered performance of its obligations under this Contract. The prevented Party shall use reasonable endeavors to mitigate and circumvent the Event of Force Majeure.

27.3

Should the delay caused by any Event of Force Majeure continue for more than ninety (90) consecutive days from the date of such notice, the other Party may 47

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EQUITY JOINT VENTURE CONTRACT choose to either continue to perform its obligations under this Contract or terminate this Contract in accordance with Article 23 hereof.

Article 28

Applicable Law

This Contract shall be governed by the officially promulgated laws of the PRC. In the event there is no published law in the PRC governing a particular aspect of this Contract, reference shall be made to general international practices. BRILLIANCE shall use its best efforts to inform and continue to update the JV Company, BMW of all PRC Laws pertaining to this Contract and to the Annexes hereto.

Article 29 29.1

Dispute Resolution

Amicable Settlement Subject to the Parties’ right to terminate this Contract as provided for in Article 23, in the event that a dispute arises out of or in connection with this Contract between the Parties, the Parties shall endeavor, in good faith, to reach an amicable settlement of the dispute through friendly negotiations.

29.2

Arbitration 29.2.1

If no mutually acceptable settlement of the dispute is reached within the sixty (60) days following the date of the commencement of the settlement negotiation, or if any Party refuses to engage in any settlement negotiation, any Party may submit the dispute for arbitration to the Arbitration Institute of the Stockholm Chamber of Commerce (“Stockholm Arbitration Institute”) in Stockholm, Sweden. Any periods for discussion or agreement between the Parties as mentioned under other provisions of this Contract shall be calculated against the 60-day period.

29.2.2

Any arbitration of disputes arising out of or in connection with this Contract shall be conducted at Stockholm in accordance with the arbitration rules of the Stockholm Arbitration Institute in effect at the time of arbitration.

Arbitration shall be conducted as follows: (i)

the arbitrators may refer to both the English and Chinese versions of this Contract;

(ii)

all proceedings in any such arbitration shall be conducted in English, and a daily transcript in English of such proceedings shall be prepared; and

(iii)

there shall be three (3) arbitrators, all of whom shall be fluent in English. The Parties shall each select one (1) arbitrator. The third arbitrator shall be appointed by the president of the Stockholm Arbitration Institute and shall serve as chairman of the panel.

The award of the arbitrators shall be final and binding upon the Parties. The Parties hereby agree to honor such award.

Any competent court may enforce such award. All arbitration costs, including costs for the enforcement of any arbitration award, shall be borne by the losing Party.

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29.2.3 Article 30

The Parties agree that during the arbitration proceedings, they shall continue to observe and perform their respective obligations under this Contract, except for those arising from the provisions subject to or involved in arbitration.

Miscellaneous

30.1

This Contract, including its Annexes, is written in the English and Chinese languages, each in fifteen (15) originals: three (3) in each language for each Party, four (4) in each language for the JV Company, and five (5) in each language for the Examination and Approval Authority. Both the Chinese language and the English language versions shall be equally authentic.

30.2

This Contract , including its Annexes, constitutes the entire agreement between BRILLIANCE and BMW with respect to the subject matter of this Contract and supersedes all prior discussions, notes, memoranda, negotiations, understandings and documents and agreements between them thereon. All agreements, contracts and other documents executed by the Parties on the subject matter before the execution of this Contract shall become null and void automatically when this Contract enters into effect.

30.3

This Contract and its Annexes may be amended only by written agreement executed by the duly authorized representatives of each Party. Such amendments shall become effective upon the approval of the Examination and Approval Authority pursuant to PRC Laws.

30.4

The rights and obligations of the Parties established by and under this Contract shall continue to exist throughout the Joint Venture Term (and any extension thereof) and shall not be prejudiced by the establishment of the JV Company, the adoption of the Articles of Association, or the execution of any of the Annexes hereto. In the event of any conflict or inconsistency between this Contract and the Articles of Association or any of the Annexes hereto, this Contract shall prevail and the conflicting provisions shall be amended accordingly. Articles 26, 28 and 29 of this Contract shall survive its termination.

30.5

All notices given by one Party to the other Party or by the JV Company to any Party shall be made in English by personal delivery, facsimile or registered airmail letter to the address indicated below or to such other address notified in lieu thereof and all notices given by any Party to the JV Company shall be sent to legal address of the JV Company.

BRILLIANCE: Address: Attention: Telephone: Facsimile:

Shenyang JinBei Automotive Industry Holdings Company, Ltd. 6th Floor, Building B, No. 1 Shiji Road, Hunnan Industrial Zone, High-Tech District Company Secretary 0086-24-88201183 0086-24-88201330

BMW: Address: Attention: Telephone: Facsimile:

Bayerische Motoren Werke Aktiengesellschaft Petuelring 130, 80788 Munich, Germany General Counsel 0049-89-38225410 0049-89-38226470

Unless otherwise specifically provided, the date of receipt of a notice or communication hereunder shall be deemed to be whichever of the following shall first 49

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EQUITY JOINT VENTURE CONTRACT occur: the date of receipt, if delivered personally; ten (10) days after its postmark, in the case of a registered airmail letter; and, one (1) working day after dispatch, in the case of a facsimile. Any Party may change its address for the purpose hereunder by written notice to the other Parties.

30.6

Failure or delay on the part of any Party to exercise any right or privilege under this Contract shall not operate as a waiver nor shall any partial exercise of any right or privilege preclude any further exercise thereof. Any waiver by a Party at any time of a breach of any term or provision of this Contract shall not be construed as a waiver by such Party of any subsequent breach of that term or provision, of its rights under such term or provision, or of any of its other rights under this Contract.

30.7

If any one or more of the provisions contained in this Contract or any document executed in connection herewith shall be invalid, illegal or unenforceable in any respect under any applicable law, then: (i) the validity, legality and enforceability of the remaining provisions contained herein or therein shall not in any way be affected or impaired and shall remain in full force and effect; and (ii) the invalid, illegal or unenforceable provision shall be replaced by the Parties immediately with a term or provision that is valid, legal and enforceable and that comes closest to expressing the intention of such invalid, illegal or unenforceable term or provision.

30.8

The Annexes hereto shall become and be considered as, when duly executed in accordance with this Contract, an integral part of this Contract.

30.9

The headings contained in this Contract are for reference only and shall not be deemed to be a part of this Contract or to affect the meaning or interpretation hereof.

30.10

This Contract shall become effective on the Effective Date.

IN WITNESS WHEREOF, the Parties hereto have caused this Contract to be executed as of the date first above written by their duly authorized representatives.

Shenyang JinBei Automotive Industry Holdings Company Limited: /s/ Mr. Wu Xiao An Name: Mr. Wu Xiao An Title: Authorized Representative Nationality: Chinese BMW Holding BV: /s/ Helmut Panke Name: Dr. Helmut Panke Title: Authorized Representative Nationality: German 50

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EQUITY JOINT VENTURE CONTRACT Annex 1: Structure of Business Plan and Budget

The JV business plan and budget consists of the following elements (A-H): A.

General Financial Planning Premises

1.

Exchange rate

2.

Interest rate

3.

Taxes (income, business tax, real-estate tax)

4.

Definition of JV cost center responsibilities

B.

Wholesale Planning:

1.

Volume and model mix plan

2.

Wholesale and retail price plan

3.

Headcount plan

4.

Investment plan

5.

Sales allowances

6.

Goodwill

7.

Direct freight expenses finished cars

8.

Marketing costs

9.

Fixed overheads (depreciation, office rent, insurance)

10.

Other overheads (travel & entertainment, IT, fax/phone, repair/maintenance etc.)

11.

Budget per cost center (only required for budget first year)

C.

Manufacturing & Supply Logistic Planning:

1.

Production plan (SOPs, volume, ramp up curve, shift model)

2.

Material requirement – quantity and prices (CKD Kits, LC parts, other direct materials, consumables)

3.

Freight and packaging – quantity and prices

4.

Headcount plan (direct and indirect labour)

5.

Investment plan

6.

Variable production cost (labour, direct materials)

7.

Fixed overheads (depreciation, rent, insurance, fixed cost contribution)

8.

Other overheads (Consumables, utilities, maintenance, IT, cleaning etc.)

9.

Launch support

10.

Budget per cost center (only required for budget first year)

D.

Model Costing (Input information from A, B and C):

1.

CIF imported CKD Kits

2.

Import duty

3.

Customs clearance and logistic expenses

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4.

Cost of local content parts and components

5.

Royalty

6.

Variable assembly cost

7.

Consumption tax

8.

Total cost of sales

9.

Price to dealer

10.

Retail Price

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EQUITY JOINT VENTURE CONTRACT

E.

Profit & Loss/Operating Statement:

1.

Revenue cars

2.

Revenue parts

3.

Cost of sales

4.

Gross profit 1

5.

Direct wholesale cost

6.

Gross profit 2

7.

Personnel cost

8.

Marketing cost

9.

Fixed overheads

10.

Other overheads

11.

Royalty & launch support

12.

Interest

13.

Profit before taxes

14.

Taxes

15.

Profit after taxes

F.

Balance Sheet:

1.

Bank/cash requirement

2.

Accounts receivables (payment terms vs. dealers)

3.

Inventories (kits in transit, parts in transit, kits & LC inventory, kits in progress, local cars inventory, parts inventory)

4.

Fixed assets

5.

Accounts payable (payment terms vs. suppliers)

6.

Loans

7.

Provisions and reserve funds

8.

Equity

9.

Dividend distribution

G.

Liquidity and Cash Flow Plan

1.

Monthly cash flow and liquidity plan for current year

2.

Cash flow statement over LRP period

H.

Benchmarks/ROS

1.

Return on sales

2.

Benchmark cost of wholesale and cost of retail

3.

Benchmark cost of production 52

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EQUITY JOINT VENTURE CONTRACT Annex 2: Benchmarks and ROS

Business Plan Planning Titles Gross Sales Cars and Definition Cost of Definition Return on Sales Parts Wholesale Definition Cost of Retail Definition Cost of Production (ROS) - Sales Allowances (% age figure) (% age figure) (Cost per unit figure) (% age figure) Net Sales Sum of Sum of Sum of Personnel Costs Fixed Personnel Costs - CIF Wholesale Dealer Margin and Bonus Production Profit/Loss before taxes JV - Import Duty, Customs + Variable Personnel Costs Clearance + Marketing Costs + Sales Allowances Production Divided by + Fixed Overheads + Calculated interest from + Variable Overhead Costs - Transport to factory Wholesale paym, terms Production Net Sales + Other Overheads - Bank Guarantee Wholesale + Fixed Overheads Production - Variable Assembly + Other Overheads Production Costs - Local Content divided by divided by divided by Adjusted Net Retail Sum of produced units of all Revenue - Royalty Adjusted Net Sales (ANRR) models (ANS) - Consumption tax Gross Profit I ANS= ANRR= - Direct costs Net Sales Net Retail Revenue cars (transport to dealer, cars/parts only good will for cars and parts) Gross Profit II - Import Duty - Import Duty cars only cars/parts - Personnel Cost - Consumption tax - Consumption Tax cars Wholesale cars and parts only - Marketing Costs - Fixed Overhead Wholesale - Other Overheads Wholesale - Personnel Costs Production - Fixed Overheads Production - Other Overheads Production - BMW Launch Support plus Royalty - Interest Profit/Loss before taxes JV - Taxes Profit/Loss after taxes JV Out of JV P&L Scope: Dealer Margin/Bonus Net Retail Revenue 53 Source: OneCLE Business Contracts.

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PLC Resource 9-100-2819. Full name: Joint venture shareholders' agreement. Drafting note at 3-1075700

DATED ------------

JOINT VENTURE SHAREHOLDERS' AGREEMENT

between

[PARTY1]

and

[PARTY 2]

215

CONTENTS CLAUSE 1.

Interpretation .......................................................................................................................1

2.

The business of the JVC .....................................................................................................4

3.

[Period to Completion .........................................................................................................4

4.

Completion ..........................................................................................................................5

5.

Conditions............................................................................................................................6

6.

Directors and management .................................................................................................9

7.

Finance for the JVC ......................................................................................................... 11

8.

Restrictions on the parties................................................................................................ 12

9.

The business plan ............................................................................................................. 13

10.

Accounting........................................................................................................................ 14

11.

Dividend policy ................................................................................................................ 15

12.

Tax matters ....................................................................................................................... 15

13.

Deadlock ........................................................................................................................... 17

14.

Resolution of deadlock..................................................................................................... 18

15.

Transfer of shares ............................................................................................................. 19

16.

Obligatory transfer event ................................................................................................. 20

17.

Transfer following obligatory transfer event.................................................................. 21

18.

Expert ................................................................................................................................ 23

19.

Termination and liquidation ............................................................................................ 24

20.

Completion of the sale and purchase of shares in the JVC............................................ 25

21.

Status of agreement .......................................................................................................... 27

22.

Confidentiality .................................................................................................................. 27

23.

Warranty ........................................................................................................................... 29

24.

Whole agreement.............................................................................................................. 29

25.

Assignments...................................................................................................................... 30

26.

Variation and waiver ........................................................................................................ 30

27.

Costs.................................................................................................................................. 30

28.

No partnership .................................................................................................................. 31

29.

Good faith ......................................................................................................................... 31

30.

Third party rights.............................................................................................................. 31

31.

Notice ................................................................................................................................ 31

32.

Interest on late payment ................................................................................................... 32

33.

Language........................................................................................................................... 33

34.

Severance .......................................................................................................................... 33

35.

Further assurance.............................................................................................................. 33

36.

Counterparts...................................................................................................................... 33

37.

Agreement survives completion ...................................................................................... 33

38.

Governing law and jurisdiction ....................................................................................... 34

SCHEDULE SCHEDULE

MATTERS RESERVED FOR SHAREHOLDER APPROVAL............................................ 35

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THIS AGREEMENT is dated [DATE]

PARTIES (1)

[FULL COMPANY NAME] incorporated and registered in England and Wales with company number [NUMBER] whose registered office is at [REGISTERED OFFICE ADDRESS] (X).

(2)

[FULL COMPANY NAME] incorporated and registered in England and Wales with company number [NUMBER] whose registered office is at [REGISTERED OFFICE ADDRESS] (Y).

BACKGROUND (A)

X and Y each hold one share in a newly formed company incorporated in England and Wales with company number [NUMBER] and whose registered office is at [REGISTERED OFFICE ADDRESS] (JVC).

(B)

The JVC shall carry on business in accordance with the terms and conditions of this agreement.

(C)

X and Y shall exercise their rights in relation to the JVC in accordance with the terms and conditions of this agreement.

AGREED TERMS 1.

INTERPRETATION

1.1

The definitions and rules of interpretation in this clause apply in this agreement.

Articles: the articles of association of the JVC as amended from time to time in accordance with this agreement.

Business: has the meaning given in clause 2.

Business Day: a day (other than a Saturday or Sunday) when banks in the City of London are open for business.

Business Plan: has the meaning given in clause 9.

Completion: the completion of the formation of the JVC in accordance with clause 4.

Completion Date: has the meaning given in clause 4.2.

Conditions: the conditions set out in clause 5.

Confidential Information: has the meaning given in clause 22.

Continuing Shareholder: has the meaning given in clause 15.5.

Control: in relation to a body corporate, means the power of a person to secure that the affairs of the body corporate are conducted in accordance with the wishes of that person: 1 217

(a)

by means of the holding of shares, or the possession of voting power, in or in relation to that or any other body corporate; or

(b)

by virtue of any powers conferred by the articles of association, or any other document, regulating that or any other body corporate,

and a Change of Control occurs if a person who controls any body corporate ceases to do so or if another person acquires control of it.

Deadlock Notice: has the meaning given in clause 13.3.

Deadlock Resolution Notice: has the meaning given in clause 14.

Encumbrance: includes any mortgage, charge (fixed or floating), pledge, lien, hypothecation, guarantee, trust, right of set-off or other third party right or interest (legal or equitable) including any assignment by way of security, reservation of title or other security interest of any kind, howsoever created or arising, or any other agreement or arrangement (including a sale and repurchase agreement) having similar effect.

Expert: a person appointed in accordance with clause 18 to resolve a matter under this agreement.

Fair Value: means the value of any shares determined in accordance with clause 17.

Financial Year: in relation to the JVC, means a financial accounting period of 12 months ending on the date given in clause 4.3(i) but, in the first year in which the JVC is formed, means the period starting with the day the JVC is formed and ending on the date given in clause 4.3(i).

Group: in relation to a company (wherever incorporated), that company, any company of which it is a Subsidiary (its holding company) and any other Subsidiaries of any such holding company; and each company in a Group is a member of the Group.

Unless the context otherwise requires, the application of the definition of Group to any company at any time shall apply to the company as it is at that time.

JVC: the company incorporated and registered in England and Wales under registered number [NUMBER].

Obligatory Transfer Event: in relation to a party, any event specified in clause 16 that happens to that party.

Reserved Matters: the matters listed in the the Schedule.

Shareholders: the holders of shares in the JVC. Subsidiary: in relation to a company wherever incorporated (a holding company) means a "subsidiary" as defined in section 736 of the Companies Act 1985 and any other company which is a subsidiary (as so defined) of a company which is itself a subsidiary of such holding company.

Unless the context otherwise requires, the application of the definition of Subsidiary to any company at any time shall apply to the company as it is at that time.

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Taxes Act 1988: the Income and Corporation Taxes Act 1988.

Transfer Notice: has the meaning given in clause 15.5.

X Agreement: the agreement relating to the transfer of the X Business to the JVC executed on [DATE], a copy of which is attached to this agreement for identification.

X Business: the business to be transferred to the JVC [by X] at Completion under the terms of the X Agreement.

X Director: any director appointed to the JVC by X. X Share: an ordinary share of £[1] in the capital of the JVC designated as an X Share.

Y Agreement: the agreement relating to the transfer of the Y Business to the JVC executed on [DATE], a copy of which is attached to this agreement for identification.

Y Business: the business to be transferred to the JVC [by Y] at Completion under the terms of the Y Agreement.

Y Director: any director appointed to the JVC by Y. Y Share: an ordinary share of £[1] in the capital of the JVC designated as a Y Share.

1.2

Clause, schedule and paragraph headings do not affect the interpretation of this agreement.

1.3

A reference to a clause or a schedule is a reference to a clause of, or schedule to, this agreement. A reference to a paragraph is to a paragraph of the relevant schedule.

1.4

A person includes a natural person, a corporate or unincorporated body (whether or not having a separate legal personality).

1.5

Words in the singular include the plural and in the plural include the singular.

1.6

A reference to one gender includes a reference to the other gender.

1.7

[All warranties, representations, agreements and obligations expressed to be given or entered into by more than one person are given or entered into jointly and severally by the persons concerned.]

1.8

A reference to a particular statute, statutory provision or subordinate legislation is a reference to it as it is in force [from time to time OR at the date of this agreement] taking account of any amendment or re-enactment and includes any statute, statutory provision or subordinate legislation which it amends or re-enacts and subordinate legislation for the time being in force made under it [provided that, as between the parties, no such amendment or re-enactment shall apply for the purposes of this

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agreement to the extent that it would impose any new or extended obligation, liability or restriction on, or otherwise adversely affect the rights of, any party].

1.9

A reference to writing or written includes faxes but not e-mail.

1.10

Documents in agreed form are documents in the form agreed by the parties to this agreement and initialled by them or on their behalf for identification.

1.11

A reference in this agreement to a document is a reference to the document whether in paper or electronic form.

1.12

A reference in this agreement to other documents referred to in this agreement is a reference to the following documents [SPECIFY ANY RELEVANT DOCUMENTS REFERRED TO].

1.13

Where the words include(s), including or in particular are used in this agreement, they are deemed to have the words "without limitation" following them.

1.14

Any obligation in this agreement on a person not to do something includes an obligation not to agree or allow that thing to be done.

1.15

Where the context permits, other and otherwise are illustrative and shall not limit the sense of the words preceding them.

1.16

[References to times of day are, unless the context requires otherwise, to [London] time and references to a day are to a period of 24 hours running from midnight on the previous day.]

2.

THE BUSINESS OF THE JVC

2.1

The business of the JVC is [BUSINESS OF THE JVC].

2.2

Each party shall use its reasonable endeavours to promote and develop the business of the JVC to the best advantage of the JVC.

3.

[PERIOD TO COMPLETION

3.1

The parties shall procure that prior to Completion and except as required by clause 4, the JVC shall not carry on any trade or business or be engaged in any activities of any sort nor have any assets or liabilities.

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3.2

Each of X and Y undertake to the other that until Completion, the X Business and the Y Business respectively shall be maintained and conducted in the usual course of business without any interruption or alteration in the nature, scope or manner of the business and so as to maintain the same as a going concern.]

4.

COMPLETION

4.1

Completion shall take place at [TIME] on the Completion Date at:

4.2

4.3

4.4

(a)

the offices of [NAME OF PARTY]; or

(b)

any other place agreed in writing by X and Y.

Completion Date means [DATE] but if the Conditions have not been satisfied or waived in accordance with clause 5 (conditions) on or before that date means: (a)

the second Business Day after they are all satisfied or waived; or

(b)

any other date agreed in writing by X and Y.

At Completion the parties shall procure that such meetings of the JVC and the board of directors are held as may be necessary to: (a)

increase the authorised share capital of the JVC to £[AMOUNT], [divided into [NUMBER] X shares of £[1] each and [NUMBER] Y shares of £[1] each] and re-designate the share held in the JVC by X as an X Share and the share held in it by Y as a Y Share;

(b)

adopt the memorandum of association and Articles of the JVC in the agreed form;

(c)

change the JVC's name to [NAME];

(d)

appoint [NAME(s)] as X director[s] and [NAME(s)] as Y director[s] and [NAME] as chairman. [NAME] shall be Managing Director and [NAME] shall be Finance Director;

(e)

appoint [NAME] as the secretary of the JVC;

(f)

resolve that the registered office of the JVC shall be at [ADDRESS];

(g)

appoint [NAME] as the auditors of the JVC;

(h)

appoint [NAME] as the [principal] bankers to the JVC; and

(i)

resolve that the JVC's financial year shall end on [DATE] in each year.

At Completion: (a)

the parties shall procure that the JVC shall issue credited as fully paid [NUMBER] X Shares to X and enter X in the register of members of the JVC as the holder of such X Shares and issue a share certificate to X in respect of all such shares; and 5 221

(b)

4.5

in consideration for the issue of X Shares, X shall transfer or procure the transfer of the X Business to the JVC in accordance with the terms of the X Agreement [and pay [AMOUNT] by [AGREED METHOD OF PAYMENT] to the JVC].

At Completion: (a)

the parties shall procure that the JVC shall issue credited as fully paid [NUMBER] Y Shares to Y and enter Y in the register of members of the JVC as the holder of such Y Shares and issue a share certificate to Y in respect of all such shares; and

(b)

in consideration for the issue of Y Shares, Y shall transfer or procure the transfer of the Y Business to the JVC in accordance with the terms of the Y Agreement [and pay [AMOUNT] by [AGREED METHOD OF PAYMENT] to the JVC].

4.6

At Completion the Shareholders shall adopt the Business Plan that has been prepared for the Financial Year in which the JVC is formed and which is in agreed form.

4.7

The JVC shall not carry on any business, and shall have no assets or liabilities, before Completion except as necessary to comply with this clause.

4.8

At Completion the parties shall procure that the following agreements are executed in agreed form: (a)

[DETAILS OF, FOR EXAMPLE, SERVICES AGREEMENTS WITH DIRECTORS, DISTRIBUTORSHIP AGREEMENTS OR IP LICENCES].

4.9

The parties waive or agree to procure the waiver of any rights or restrictions which may exist in the Articles or otherwise which might prevent the allotment and issue of the X Shares and Y Shares pursuant to clause 4.4 and clause 4.5.

5.

CONDITIONS

5.1

Completion is conditional on the satisfaction or waiver of the following Conditions: (a)

Where both parties are satisfied (whether or not as a result of receiving confirmation to this effect from the European Commission) that the JVC does not constitute a concentration having a Community dimension within the meaning of Council Regulation (EC) No 139/2004 on the control of concentrations between undertakings, as amended [or any subsequent legislation] then: (i)

both parties are satisfied (whether or not as a result of receiving confirmation from the Office of Fair Trading) that the JVC does not

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constitute a relevant merger situation within the meaning of part 3 of the Enterprise Act 2002;

(b)

(ii)

both parties have received confirmation in terms satisfactory to them that the JVC shall not be referred to the Competition Commission for further investigation in accordance with part 3 of the Enterprise Act 2002;

(iii)

[both parties have received confirmation in terms satisfactory to them that the JVC shall not be referred to the Competition Commission for further investigation on the condition that one or both of the parties gives specified undertakings to the Office of Fair Trading in accordance with part 3 of the Enterprise Act 2002 and the terms of those undertakings are in all respects satisfactory to the relevant party or parties required to give the undertakings; ]

(iv)

[following a reference, the Competition Commission finding that the JVC is not expected to result in a substantial lessening of competition within any market or markets in the UK for goods or services; or]

(v)

[following a reference, the Competition Commission finding that the JVC may be expected to result in a substantial lessening of competition within a market or markets in the UK for goods or services but that the acceptance of specified undertakings by one or both of the parties would have the effect of remedying, mitigating or preventing that lessening of competition and the terms of such undertakings are in all respects acceptable to the relevant party or parties required to give the undertakings;]

Where the JVC does constitute a concentration with a Community dimension within the meaning of Council Regulation 139/2004/EC, as amended [or any subsequent legislation] then: (i)

the parties have received confirmation from the European Commission in terms satisfactory to them that despite the JVC constituting such a concentration, the Commission has decided not to oppose the concentration and declared it to be compatible with the Common Market; and/or

(ii)

[the parties, having been told by the European Commission that the JVC has been referred to the government, regulatory body or competition authority of any EU member state, have received confirmation in terms satisfactory to them from that government, regulatory body or competition authority, that the JVC has been approved in accordance with the relevant national legislation of that EU member state;]

(iii)

[the parties have received confirmation from the European Commission in terms satisfactory to them that, despite opening

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proceedings in relation to the JVC, the Commission has declared it to be compatible with the Common Market; or] (iv)

(c)

[the parties have received confirmation from the European Commission that the JVC shall be declared to be compatible with the Common Market, whether before or after initiating proceedings, on the condition that one or both of the parties gives certain specified undertakings to the European Commission and the terms of those undertakings are in all respects satisfactory to the relevant party or parties required to give the undertakings.]

[The parties have received confirmation in terms satisfactory to them that the JVC has been approved and no objections have been raised by: (i)

[LIST ANY OTHER RELEVANT NATIONAL COMPETITION AUTHORITIES AND NATIONAL MERGER CONTROL RULES IN ANY OTHER COUNTRIES WHERE THE JVC IS TO BE NOTIFIED FOR CLEARANCE;].]

(d)

[All other necessary regulatory and governmental consents having been obtained.]

(e)

[Both parties having passed [RESOLUTIONS REQUIRED] at general meetings approving this agreement.]

(f)

[Any other third party consents having been obtained.]

(g)

[No person having threatened or commenced any proceedings to prohibit or otherwise challenge the transaction.]

(h)

[No legislation or regulation being proposed or passed that would prohibit or materially restrict the implementation of the agreement or the participation in the JVC of either party.]

(i)

[The X Agreement becoming unconditional (save in relation to any condition making completion of that agreement conditional upon completion of this agreement) and not being terminated in accordance with its terms.]

(j)

[The Y Agreement becoming unconditional (save in relation to any condition making completion of that agreement conditional upon completion of this agreement) and not being terminated in accordance with its terms.]

(k)

[There not having occurred any material adverse change in the business, operations, assets, position (financial, trading or otherwise), profits [or prospects] of the X Business, taken as a whole, or any event or circumstance that may result in such material adverse change.]

(l)

[There not having occurred any material adverse change in the business, operations, assets, position (financial, trading or otherwise), profits [or prospects] of the Y Business, taken as a whole, or any event or circumstance that may result in such material adverse change.]

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(m) 5.2

[ANY OTHER SPECIFIC CONDITIONS?]

X and Y shall use all reasonable endeavours to procure that the Conditions are satisfied as soon as practicable and in any event no later than 6.00 pm: (a)

on [DATE ON WHICH PARTIES EXPECT ALL CONDITIONS TO BE SATISFIED]; or

(b)

where a later date has been agreed in writing by X and Y, on that date.

5.3

A Condition may only be waived by both parties in writing.

5.4

If at any time either party becomes aware of a fact or circumstance that might prevent a Condition being satisfied, it shall immediately inform the other party.

5.5

If the Conditions have not been satisfied or waived by 6.00 pm on [BACK STOP DATE] this agreement shall cease to have effect immediately after that time on that date except for: (a)

clause 1 (interpretation);

(b)

this clause (conditions);

(c)

clause 22 (confidentiality);

(d)

clause 24 (whole agreement);

(e)

clause 26 (variation and waiver);

(f)

clause 27 (costs);

(g)

clause 31 (notice);

(h)

clause 33 (language);

(i)

clause 34 (severance);

(j)

clause 38 (governing law and jurisdiction);

(k)

any rights or liabilities that have accrued under this agreement; and

(l)

[INCLUDE OTHER RELEVANT PROVISIONS].

6.

DIRECTORS AND MANAGEMENT

6.1

The board of directors of the JVC has responsibility for the supervision and management of the JVC and its business but shall obtain the approval of the holders of the X Shares and the Y Shares before taking any decision in relation to any of the Reserved Matters.

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6.2

There shall be a minimum number of [TWO] directors [and no more than [NUMBER] directors] on the board made up of an equal number of X Directors and Y Directors.

6.3

The post of chairman shall be held in alternate years by an X Director or by a Y Director. The chairman shall not have a casting vote. If the chairman for the time being is unable to attend any meeting of the board of directors the party who appointed him shall be entitled to appoint another Director appointed by it to act as chairman at the meeting.

6.4

A party may nominate a director, and remove a director whom it nominated, by giving notice to the JVC and the other party. The appointment or removal takes effect on the date on which the notice is received by the JVC or, if a later date is given in the notice, on that date. [Each party will consult with the other prior to any appointment or removal of a director.]

6.5

The party removing a director shall indemnify and keep indemnified the JVC against any claim connected with the director's removal from office.

6.6

The parties intend there to be a meeting of directors at least [once a month] to be held at [SPECIFY LOCATION OF MEETINGS].

6.7

A director may, and at the request of a director the secretary shall, call a meeting of directors.

6.8

The parties shall ensure that at least seven days' notice of a meeting of directors is given to all directors entitled to receive notice accompanied by: (a)

an agenda specifying in reasonable detail the matters to be raised at the meeting; and

(b)

copies of any papers to be discussed at the meeting.

6.9

A shorter period of notice of a meeting of directors may be given if at least one X Director and one Y Director agree in writing.

6.10

Matters not on the agenda, or business conducted in relation to those matters, may not be raised at a meeting of directors unless all the directors agree in writing.

6.11

The quorum at any meeting of directors (including adjourned meetings) is one X Director (or his alternate) and one Y Director (or his alternate).

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6.12

No business shall be conducted at any meeting of directors unless a quorum is present at the beginning of the meeting and at the time when there is to be voting on any business.

6.13

If a quorum is not present within 30 minutes after the time specified for a directors' meeting in the notice of the meeting then it shall be adjourned for [NUMBER] Business Days at the same time and place.

6.14

A meeting of directors shall be adjourned to another time or date at the request of all the X Directors or all the Y Directors present at the meeting. No business may be conducted at a meeting after such a request has been made. No more than one such adjournment may be made in respect of a meeting.

6.15

Meetings of directors shall make decisions by passing resolutions. A resolution is passed if: (a)

more votes are cast for it than against it; and

(b)

at least one X Director and one Y Director have voted in favour of it.

6.16

Except as provided by clause 6.18, at a meeting of directors, each director has one vote.

6.17

An X Director or a Y Director absent from a meeting may appoint any person (except an existing director representing the other class of shares) to act as his alternate at the meeting. For the purposes of the meeting the alternate director: (a)

shall be the X Director or Y Director by whom he is appointed and may vote in place of the X Director or Y Director; and

(b)

where the person appointed as an alternate is already a director of the JVC in his own right, shall also be a director (and may vote) in his own right.

6.18

If the Shareholders are not represented at any meeting of the board of directors by an equal number of X Directors and Y Directors (whether present in person or by alternate), then one of the directors so nominated by the Shareholder which is represented by fewer directors shall be entitled at that meeting to such additional vote or votes as shall result in the directors so present representing each Shareholder having in aggregate an equal number of votes.

7.

FINANCE FOR THE JVC

7.1

The parties envisage that the JVC shall be self-financed from the cash flow of the X Business and Y Business [and [ANY CASH CONTRIBUTION MADE BY EITHER PARTY]].

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7.2

[If it needs any additional initial finance, the JVC shall seek a loan from its principal bankers.]

7.3

There is no obligation on the parties to provide any further finance to the JVC but, if they do so, the parties shall each provide the same amount on the same terms unless they agree otherwise in writing.

7.4

If the parties agree to increase the share capital of the JVC, half of the shares issued shall be X Shares, and issued to X, and half shall be Y Shares and issued to Y unless they agree otherwise in writing.

8.

RESTRICTIONS ON THE PARTIES

8.1

Neither party nor any of its Subsidiaries shall [(unless otherwise agreed in writing by the other party and the JVC)], in [TERRITORY] during the times specified below, carry on or be employed, engaged or interested in any business which would be in competition with any part of the Business of the JVC [or any of its Subsidiaries] (as described in clause 2.1), including any developments in the Business after the date of this agreement. The times during which the restrictions apply are:

8.2

8.3

(a)

[any time when the party in question is a shareholder in the JVC; and]

(b)

[for a period of [two] years after the party in question ceases to be a shareholder in the JVC.]

Neither party nor any of its Subsidiaries shall, in the same area of business in which the JVC operates and during the times specified below, deal with or seek the custom of any person that is a client or customer of the JVC [or any of its Subsidiaries] [or was a client or customer at any time during the period of 12 months immediately preceding the party in question ceasing to be a shareholder in the JVC]. The times during which the restrictions apply are: (a)

[any time when the party in question is a shareholder in the JVC; and]

(b)

[for a period of [two] years after the party in question ceases to be a shareholder in the JVC.]

Neither party nor any of its Subsidiaries shall, during the times specified below, offer employment to, enter into a contract for the services of, or attempt to solicit or seek to entice away from the JVC [or any of its Subsidiaries] any individual who is at the time of the offer, or attempt, a director, officer or employee [holding an executive or managerial position] with the JVC [or any of its Subsidiaries] or procure or facilitate the making of any such offer or attempt by any other person. The times during which the restrictions apply are: (a)

any time when the party in question is a shareholder in the JVC; and

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(b)

8.4

for a period of [two] years after the party in question ceases to be a shareholder of the JVC.

[Neither party nor any of its Subsidiaries shall, during the times specified below, solicit or entice away from the JVC any supplier to the JVC who supplies goods AND/OR services to the JVC or who has supplied goods AND/OR services to the JVC at any time during the period of 12 months immediately preceding the party in question ceasing to be a shareholder in the JVC if that solicitation or enticement causes or would cause such supplier to cease supplying, or materially reduce its supply of, those goods AND/OR services to the JVC. The times during which the restrictions apply are: (a)

any time when the party in question is a shareholder in the JVC; and

(b)

for a period of [two] years after the party in question ceases to be a shareholder of the JVC.]

8.5

The undertakings in this clause are given by each party to the other [and to the JVC [and its Subsidiaries]] and apply to actions carried out by each party (or any of its Subsidiaries) in any capacity and whether directly or indirectly, on the party's (or Subsidiary's) own behalf, on behalf of any other person or jointly with any other person.

8.6

Nothing in this clause prevents a party or any of its Subsidiaries: (a)

from holding for investment purposes only any units of any authorised unit trust; or

(b)

from holding for investment purposes only not more than [PERCENTAGE]% of any class of shares or securities of any company traded on any [RELEVANT STOCK EXCHANGES].

8.7

Each of the covenants in this clause is considered fair and reasonable by the parties. If any such restriction shall be found to be unenforceable but would be valid if any part of it were deleted or the period or area of application reduced, the restriction shall apply with such modifications as may be necessary to make it valid and effective.

8.8

Each party shall procure that its Subsidiaries comply with the terms of this clause.

9.

THE BUSINESS PLAN

9.1

The Business Plan is an annual business plan for the JVC prepared by the JVC and it shall include in relation to the Financial Year to which it relates: (a)

a cashflow statement giving: (i)

an estimate of the working capital requirements; and

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(ii)

an indication of the amount (if any) that it is considered prudent to retain, for the purpose of meeting those requirements, out of those profits of the previous Financial Year that are available for distribution to shareholders;

(b)

a monthly projected profit and loss account;

(c)

an operating budget (including capital expenditure requirements) and balance sheet forecast;

(d)

a management report giving business objectives for the year; and

(e)

a financial report which shall include an analysis of the estimated results of the JVC for the previous Financial Year compared with the Business Plan for that year, identifying variations in sales revenues, costs and other material items.

9.2

The Business Plan for the Financial Year in which the JVC is formed shall be in agreed form and adopted by the Shareholders at Completion.

9.3

The Business Plan for every other Financial Year shall be: (a)

prepared by the board of directors of the JVC within 45 days of the end of the preceding Financial Year (the first day being the first day of the Financial Year to which the plan relates); and

(b)

adopted and approved by the Shareholders [by agreement in writing or at [a/the annual] general meeting of Shareholders] as soon as possible after it has been prepared.

10.

ACCOUNTING

10.1

The JVC shall at all times maintain accurate and complete accounting and other financial records including all corporation tax computations and related documents and correspondence with HM Revenue & Customs in accordance with the requirements of all applicable laws and generally accepted accounting principles applicable in the United Kingdom.

10.2

Each party and its authorised representatives shall be allowed access at all reasonable times to examine the books and records of the JVC.

10.3

The JVC shall supply each party with the financial information necessary to keep the party informed about how effectively the Business of the JVC is performing and in particular shall supply each party with: (a)

a copy of each year's Business Plan for approval in accordance with clause 9.3;

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(b)

a copy of the audited accounts of the JVC prepared in accordance with the laws applicable in and the accounting standards, principles and practices generally accepted in the United Kingdom, within [NUMBER] months of the end of the year to which the audited accounts relate; and

(c)

monthly management accounts of the JVC to be supplied within [NUMBER] days of the end of the month to which they relate (the first day being the first day of the following month) and the accounts shall include a profit and loss account, a balance sheet and a cashflow statement.

10.4

[Each party shall be entitled to require the JVC, and the JVC shall as soon as possible comply with such a request, to provide any documents, information and correspondence necessary (at the cost of the party making the request) to enable the relevant party to comply with filing, elections, returns or any other requirements of HM Revenue & Customs or of any other revenue or tax authority.]

11.

DIVIDEND POLICY

11.1

[Subject to the requirements of the Companies Act 1985, and unless the parties agree otherwise in relation to any particular Financial Year, the JVC shall distribute by way of dividend at least [PERCENTAGE]% of the profit of the JVC in relation to each Financial Year but after making all necessary, reasonable and prudent provisions and reserves for taxation, [for the repayment of borrowings by the JVC (if any), minority interests and extraordinary items] as shown in the audited accounts for that year.]

OR [The JVC shall not declare, pay or make any dividend or other distribution until all loans made to the JVC by the Shareholders have been repaid in full.]

11.2

A distribution under this clause in relation to any Financial Year shall be made within six months of the day to which the audited accounts for that year are made up.

12.

TAX MATTERS

12.1

[Unless the Shareholders otherwise expressly agree in writing, the Shareholders shall procure that all of the JVC's trading losses and all other amounts eligible for relief for taxation shall be carried by the JVC and not surrendered (wholly or partly) to the Shareholders.]

OR [Unless the Shareholders otherwise expressly agree in writing, each Shareholder shall co-operate to ensure so far as possible that all of the JVC's trading losses and other 15 231

amounts eligible for relief from corporation tax under Chapter IV, Part X of the Taxes Act 1988 (consortium claims for group relief) shall be surrendered or made available to the Shareholders (or any other company which is a member of its Group, where such company is entitled to receive the same pursuant to section 402(3) of the Taxes Act 1988) in proportion to the Shareholder's respective interests in the X and Y Shares. For this purpose, the following provisions shall apply:

12.2

(a)

each Shareholder shall give and procure that the JVC gives its consent, and each Shareholder shall take and procure that the JVC takes, such other action as may reasonably be required to ensure that such surrenders are effectively made within any relevant time limits;

(b)

each Shareholder shall procure that, in respect of each surrender, the relevant claimant company within its Group makes a payment in respect of the amount surrendered (as referred to in section 402(6) of the Taxes Act 1988) within [nine months] of the end of the claim period (within the meaning of section 403A of the Taxes Act 1988);

(c)

the amount of any payment referred to in clause 12.1(b) shall be equal to the sum obtained by multiplying the amount so surrendered by a percentage equal to the effective percentage rate of corporation tax applicable in the United Kingdom to companies generally (excluding, for the avoidance of doubt, the small companies rate as defined in section 13 of the Taxes Act 1988) in respect of income profits for the claimant company's claim period (as defined above); and

(d)

any such payment made pursuant to clause 12.1(b) shall be subject to return if and to the extent that it is determined that relevant losses or other amounts surrendered are not available for surrender or there is an insufficiency of profits of the claimant company and any such payment shall be adjusted to the extent that it is subsequently found to have been incorrectly calculated.]

[Unless the Shareholders otherwise expressly agree in writing, each Shareholder shall be entitled to surrender in proportion to their respective interests in the X and Y Shares (and to procure that any other company which is a member of its Group, where such company is entitled to surrender the same pursuant to section 402(3) of the Taxes Act 1988, surrenders) to the JVC, trading losses and other amounts eligible for relief from corporation tax under Chapter IV, Part X, of the Taxes Act 1988 up to the maximum extent permitted by law. For this purpose the following provisions shall apply: (a)

each Shareholder shall give and procure that the relevant surrendering company within its Group (if the surrendering company is not a Shareholder) gives all consents and each Shareholder shall take and procure that the relevant surrendering company within its Group (if the surrendering company is not a Shareholder) takes such other action as may reasonably be required to ensure that such surrenders are effectively made within any relevant time limits;

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(b)

in respect of any such surrender, each Shareholder shall procure that the JVC shall make a payment to the relevant surrendering company as respects the amount surrendered (as referred to in section 402(6) of the Taxes Act) within [nine months] of the end of the claim period (within the meaning of section 403A of the Taxes Act);

(c)

the amount of payment referred to in clause 12.2(b) shall be equal to the extra amount of tax which would have been payable by the claimant company in the absence of such surrender; and

(d)

any such payment made pursuant to clause 12.2(b) shall be subject to return if, and to the extent, that it is determined that relevant losses or other amounts surrendered are not available for surrender or there is an insufficiency of profits of the claimant company and any such payment shall be adjusted to the extent that it is subsequently found to have been incorrectly calculated.]

13.

DEADLOCK

13.1

There is a deadlock if a resolution is proposed at a properly convened meeting of Shareholders of the JVC or of the board of directors of the JVC and one of the following applies: (a)

there is no quorum at the meeting and at the meeting when it is reconvened following an adjournment;

(b)

where it is a meeting of directors, of the directors present, all X Directors or all Y Directors vote against or abstain from voting on the resolution (unless one of their number proposed the resolution); or

(c)

where it is a meeting of Shareholders, all the Shareholders of the X Shares or all the Shareholders of the Y Shares vote against or abstain from voting on the resolution (unless one of their number proposed the resolution).

13.2

There is no deadlock if a meeting, or adjournment, is inquorate because the person who proposed the resolution does not attend.

13.3

Either party may within 28 days of the meeting at which the deadlock arises (the first day being the day after the meeting) serve notice on the other party (Deadlock Notice):

13.4

(a)

stating that in its opinion a deadlock has occurred; and

(b)

identifying the matter giving rise to the deadlock.

The parties undertake that after service of the Deadlock Notice they shall: (a)

immediately refer the matter giving rise to the deadlock to the chairman of the parent company of each party's Group for resolution; and 17 233

(b)

use all reasonable endeavours in good faith to resolve the dispute.

13.5

If a deadlock occurs before the first anniversary of this agreement and cannot be resolved in accordance with this clause 13 within [14] days from the date the deadlock matter is referred to the chairman under clause 13.4, either party may transfer its shares in accordance with clause 15 at a price determined by an Expert to be Fair Value for the shares in accordance with clause 17.4 to clause 17.7 (save that for the purposes of clause 17.7(c) the date of sale shall be the date the deadlock occurred).

14.

RESOLUTION OF DEADLOCK

14.1

A Deadlock Resolution Notice is a notice served by one party on the other in which the server offers, at the price for each share specified in the notice (in cash and not on deferred terms), either to sell all its shares in the JVC to the recipient of the notice or to buy all the recipient's shares in the JVC.

14.2

A Deadlock Resolution Notice: (a)

may not be revoked; and

(b)

may not be served before [the first anniversary of the date of this agreement].

14.3

If the parties are unable to resolve a deadlock within [14] days from the date the deadlock matter is referred to the chairmen under clause 13.4, then either party may within 28 days of the expiry of the 14 day period (the first day is the day after the day of expiry) serve a Deadlock Resolution Notice on the other.

14.4

The recipient of a Deadlock Resolution Notice may choose to do either of the following, at the price for each share specified in the Deadlock Resolution Notice, by serving a counter-notice within 28 days of receiving the Deadlock Resolution Notice (the first day is the day after the day of receipt):

14.5

(a)

buy all the shares in the JVC of the server of the Deadlock Resolution Notice; or

(b)

sell all its shares in the JVC to the server of the Deadlock Resolution Notice.

If no counter-notice is served within the period of 28 days available, the recipient of the Deadlock Resolution Notice is deemed to have accepted the offer in the Deadlock Resolution Notice at the expiry of that period.

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14.6

The service of a counter-notice, or deemed acceptance of the Deadlock Resolution Notice, shall bind the parties to buy and sell the shares (as the case may be) on the terms set out in clause 20.

14.7

If both parties serve a Deadlock Resolution Notice under clause 14.3, [only the first Deadlock Resolution Notice to be served OR the Deadlock Resolution Notice containing the highest price per share] shall be effective.

14.8

If at the end of the 28 day period specified in clause 14.3 neither party has served a Deadlock Resolution Notice, either party may elect by written notice served on the other party for the JVC to be wound up in accordance with clause 19.

14.9

References in this clause to shares held by a party in the JVC are to all the shares in the JVC held by that party and not to some only of those shares.

15.

TRANSFER OF SHARES

15.1

No party shall transfer, grant any security interest over, or otherwise dispose of or give any person any rights in or over any share or interest in any share in the JVC unless it is permitted or required under this agreement and carried out in accordance with the terms of this agreement. [If a party transfers (or purports to transfer) any shares other than in accordance with this clause, it shall be deemed to have served a Transfer Notice.]

15.2

A party may do anything prohibited by this clause if the other party has consented to it in writing.

15.3

A party may transfer all of its shares in the JVC to a member of its Group without following the steps in this clause if at the time of the transfer and in relation to all the shares being transferred, the transferring party: (a)

procures that the transferee enters into a shareholders' agreement with the remaining party to this agreement on the same terms as apply to the transferring party in relation to those shares immediately before the transfer; and

(b)

guarantees all the obligations and any liabilities of the transferee under that agreement.

15.4

A party may transfer all of its shares in the JVC to any person for cash and not on deferred terms if the party follows the steps in this clause.

15.5

The party wishing to transfer its shares (Seller) shall give an irrevocable notice (Transfer Notice) to the other party (Continuing Shareholder) of the details of the proposed transfer including: 19 235

(a)

if it wishes to sell its shares to a third party, the name of the proposed transferee; and

(b)

the price (in cash) at which it wishes to transfer its shares.

15.6

If the Continuing Shareholder gives notice to the Seller within [28] days of receiving the Transfer Notice (the first day being the day after it receives the Transfer Notice) that it wishes to buy all the Seller's shares in the JVC, the Continuing Shareholder shall have the right to do so at the price specified in the Transfer Notice.

15.7

The Continuing Shareholder is bound to buy all the Seller's shares when it gives notice to the Seller under clause 15.6 that it wishes to do so. The sale and purchase of shares shall take place on the terms set out in clause 20.

15.8

If at the expiry of the period specified in clause 15.6, the Continuing Shareholder has not notified the Seller that it wants to buy the shares, the Seller may transfer all its shares in the JVC to the buyer identified in the Transfer Notice at a price not less than the price specified in that notice provided that it does so within [NUMBER] months of the expiry of the period specified in clause 15.6.

15.9

Each party undertakes (in respect of the shares that it holds) to give, and to use its reasonable efforts to procure that shareholders in its Group give, the approvals required for the transfer of shares under this clause.

15.10

The Seller shall procure that, in relation to the shares being sold in the JVC, any buyer of the shares who is not already a Shareholder and therefore a party to this agreement, shall enter into a shareholders' agreement on completion of the sale of such shares with the Continuing Shareholder on the same terms as apply to the Seller in relation to those shares before completion.

15.11

References in this clause to shares held by a party in the JVC are to all the shares in the JVC held by that party or any member of its Group and not to some only of those shares.

16.

OBLIGATORY TRANSFER EVENT If anything mentioned in this clause happens to a party it is an Obligatory Transfer Event in respect of that party and the provisions of clause 17 apply: (a)

the liquidation (voluntary or otherwise) of the party [or any other company in the party's Group], other than a genuine solvent reconstruction or amalgamation in which the new company assumes (and is capable of assuming) all the obligations of the party [or other company in the party's Group];

(b)

a Change of Control of the party; 20 236

(c)

an order is made by a court of competent jurisdiction, or a resolution is passed for the administration of a party, or documents are filed with the court for the appointment of an administrator, or notice of intention to appoint an administrator is given by the party, or its directors or by a qualifying floating charge holder (as defined in paragraph 14 of Schedule B1 to the Insolvency Act 1986);

(d)

any step is taken by any person other than a member of the other party's Group (and is not withdrawn or discharged within 90 days) to appoint a receiver, administrative receiver or manager in respect of the whole or a substantial part of the assets or undertaking of the party [or any other company in the party's Group];

(e)

the party [or any other company in the party's Group] being unable to pay its debts as they fall due for the purposes of section 123 of the Insolvency Act 1986;

(f)

the party [or any other company in the party's Group] entering into a composition or arrangement with its creditors;

(g)

any chargor enforcing any charge created over any shares held by the party in the JVC;

(h)

if a process has been instituted that could lead to the party being dissolved and its assets being distributed among the party's creditors, shareholders or other contributors;

(i)

the party ceasing to carry on its business or substantially all of its business; or

(j)

the party commits a material or persistent breach of this agreement which if capable of remedy has not been so remedied within [20] Business Days of the other party requiring such remedy.

17.

TRANSFER FOLLOWING OBLIGATORY TRANSFER EVENT

17.1

Where an Obligatory Transfer Event happens to a party it shall give notice of it to the other party as soon as possible and, if it does not, it is deemed to have given notice of the Obligatory Transfer Event on the date on which the other party becomes aware of such Obligatory Transfer Event.

17.2

The party receiving notice of an Obligatory Transfer Event (in this clause the Buyer) has the right, within [NUMBER] days of receiving the notice (the first day is the day after it received the notice), to offer to buy all the shares of the other party (in this clause the Seller) in the JVC at a price for cash specified by the Buyer and not on deferred terms (Offer).

17.3

The Seller has a period of [NUMBER] days (Share Pricing Period) of receiving the Offer (the first day is the day after the day of the Offer) within which to: 21 237

(a)

accept the price offered for the shares by the Buyer; or

(b)

request that a Fair Value for the shares is determined by the Expert,

and the Seller is deemed to have accepted the Offer at the price stated by the Buyer in its Offer notice under clause 17.2 if it does not expressly accept or request a Fair Value determination by the end of the Share Pricing Period.

17.4

The price for the shares shall be: (a)

(b)

the price offered by the Buyer if, at the expiry of the Share Pricing Period, the Seller has: (i)

accepted that price; or

(ii)

neither accepted that price nor requested the determination of a Fair Value by the Expert; or

the Fair Value determined by the Expert if the Seller requests such a determination before the expiry of the Share Pricing Period.

17.5

Where the price is referred to the Expert, to exercise his right to buy the Buyer shall give notice to the Seller within [NUMBER] days of receiving notification of the Fair Value determined by the Expert (the first day being the day after the Buyer receives the Fair Value notification).

17.6

Acceptance or deemed acceptance under clause 17.3 or the service of a notice to buy under clause 17.5 shall bind the parties to buy and sell the shares, as the case may be, in accordance with clause 20.

17.7

In this clause the Fair Value of the shares to be sold in the JVC shall be the value that the Expert certifies to be the fair market value in his opinion based on the following assumptions: (a)

the value of the shares in question is that proportion of the fair market value of the entire issued share capital of the JVC that the Seller's shares bear to the then total issued share capital of the JVC (with no premium or discount for the size of the Seller's shareholding or for the rights or restrictions applying to the shares under this agreement or the Articles);

(b)

the sale is between a willing buyer and a willing seller on the open market;

(c)

the sale is taking place on the date that the Obligatory Transfer Event occurred;

(d)

if the JVC is then carrying on its Business as a going concern, on the assumption that it shall continue to do so;

(e)

the shares are sold free of all Encumbrances; and

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(f)

[to take account of any other factors that the Expert reasonably believes should be taken into account.]

17.8

If any problem arises in applying any of the assumptions set out in clause 17.7, the Expert shall resolve the problem in whatever manner he shall, in his absolute discretion, think fit.

18.

EXPERT

18.1

An Expert is a person appointed in accordance with this clause to resolve a matter under this agreement.

18.2

The parties shall endeavour to agree on the appointment of an independent Expert.

18.3

If the parties are unable to agree on an Expert within seven days of either party serving details of a suggested expert on the other, either party shall then be entitled to request the then President of the Institute of Chartered Accountants in England and Wales to appoint an Expert who is an accountant of repute with experience in the valuation of private companies limited by shares.

18.4

The Expert is required to prepare a written decision and give notice (including a copy) of the decision to the parties within a maximum of three months of the matter being referred to the Expert.

18.5

If the Expert dies or becomes unwilling or incapable of acting, or does not deliver the decision within the time required by this clause then: (a)

either party may apply to the then President of the Institute of Chartered Accountants in England and Wales to discharge the Expert and to appoint a replacement Expert with the required expertise.

(b)

this clause applies in relation to the new Expert as if he were the first Expert appointed.

18.6

All matters under this clause shall be conducted, and the Expert's decision shall be written, in the English language.

18.7

The parties are entitled to make submissions to the Expert [including oral submissions] and shall provide (or procure that others including the JVC provide) the Expert with such assistance and documents as the Expert reasonably requires for the purpose of reaching a decision, subject to the Expert agreeing to give such confidentiality undertakings as the parties may reasonably require.

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18.8

To the extent not provided for by this clause, the Expert may in his reasonable discretion determine such other procedures to assist with the conduct of the determination as he considers just or appropriate[, including (to the extent he considers necessary,) instructing professional advisers to assist him in reaching his determination].

18.9

Each party shall with reasonable promptness supply (and procure that others including the JVC supply) each other with all information and give each other access to all documentation and personnel as the other party reasonably requires to make a submission under this clause.

18.10

The Expert shall act as an expert and not as an arbitrator. The Expert's written decision on the matters referred to him shall be final and binding on the parties in the absence of manifest error or fraud.

18.11

Each party shall bear its own costs in relation to the reference to the Expert. The Expert's fees and any costs properly incurred by him in arriving at his determination (including any fees and costs of any advisers appointed by the Expert) shall be borne by the parties [equally or in such other proportions as the Expert shall direct].

19.

TERMINATION AND LIQUIDATION

19.1

Except for the provisions which this clause states shall continue in full force after termination, this agreement shall terminate:

19.2

(a)

when one party ceases to hold any shares in the JVC;

(b)

when a resolution is passed by shareholders or creditors, or an order made by a court or other competent body or person instituting a process that shall lead to the JVC being wound up and its assets being distributed among the JVC's creditors, shareholders or other contributors; or

(c)

[INCLUDE ANY OTHER EVENTS THAT SHOULD LEAD TO TERMINATION].

The following provisions of this agreement remain in full force after termination: (a)

clause 1 (interpretation);

(b)

clause 8 (restrictions on the parties);

(c)

clause 12 (tax matters);

(d)

this clause;

(e)

clause 22 (confidentiality);

(f)

clause 24 (whole agreement);

(g)

clause 26 (variation and waiver); 24 240

(h)

clause 27 (costs);

(i)

clause 31 (notice);

(j)

clause 33 (language);

(k)

clause 34 (severance);

(l)

clause 38 (governing law and jurisdiction); and

(m)

[INCLUDE ANY OTHER RELEVANT PROVISIONS].

19.3

Termination of this agreement shall not affect any rights or liabilities that the parties have accrued under it.

19.4

[If this agreement terminates (other than by reason of a transfer of shares pursuant to clause 15.3) each party shall, if requested by the other, procure that the name of the JVC is changed to avoid confusion with the name of the party making the request.]

19.5

Where the JVC is to be wound up and its assets distributed, the parties shall agree a suitable basis for dealing with the interests and assets of the JVC and shall endeavour to ensure that: (a)

all existing contracts of the JVC are performed to the extent that there are sufficient resources;

(b)

the JVC shall not enter into any new contractual obligations;

(c)

the JVC is dissolved and its assets are distributed as soon as practical;

(d)

any assets transferred to the JVC pursuant to the X Agreement shall be returned to X or as X directs and any assets transferred to the JVC pursuant to the Y Agreement shall be returned to Y or as Y directs; and

(e)

any other [proprietary information or intellectual property rights] belonging to or originating from a party shall be returned to it by the other party or the JVC and all such [proprietary information or intellectual property rights] shall be erased from the computer systems (to the extent possible) of the JVC and the party who is returning it.

19.6

Where any party is required by any law, regulation or governmental or regulatory authority to retain any [proprietary] information (or copies of such information) of the other party or the JVC, it shall notify the other party in writing of such retention giving details of the information that it has been required to retain.

20.

COMPLETION OF THE SALE AND PURCHASE OF SHARES IN THE JVC

20.1

This clause applies only to transfers between the parties pursuant to clause 14 (resolution of deadlock), clause 15 (transfer of shares) and clause 17 (transfer following obligatory transfer event).

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20.2

20.3

The sale of shares under this agreement shall be completed at the offices of [NAME OF PARTY] on the [NUMBER] Business Day: (a)

after the deemed acceptance of a Deadlock Resolution Notice under clause 14.5 or receipt of a counter-notice to a Deadlock Resolution Notice under clause 14.4; or

(b)

after the Continuing Shareholder (having received a Transfer Notice) gives notice to the Seller that it wishes to buy all the Seller's shares under clause 15.6; or

(c)

after acceptance or deemed acceptance of an offer to buy under clause 17.3 or after service of a notice to buy under clause 17.5.

At completion the party selling the shares shall: (a)

transfer the shares free from all Encumbrances by way of a duly completed share transfer form transferring the legal and beneficial ownership in the shares to the buyer together with the relevant share certificate and such other documents as the buyer may reasonably require to show good title to the shares or enable it to be registered as the holder of the shares;

(b)

deliver the resignations of any directors appointed by the selling party to take effect at completion and acknowledging that they have no claims against the JVC;

(c)

warrant that it has no right to require the JVC to issue any share capital or other securities and that no Encumbrance affects any unissued shares or other securities of the JVC;

(d)

warrant that no commitment has been given to create an Encumbrance affecting the shares being sold (or any unissued shares or other securities of the JVC) and that no person has claimed any rights in respect thereof; and

(e)

undertake to do all it can, at its own cost, to give the buyer the full legal and beneficial title to the shares.

20.4

At completion the buying party shall pay the purchase price by [AGREED METHOD OF PAYMENT] to the selling party [or its lawyers (who have been irrevocably authorised by the selling party to receive it)].

20.5

At or before completion the JVC shall repay any loans made by the selling party to the JVC (together with any interest accrued thereon) and the parties shall use their best endeavours to procure that the selling party is released from any guarantees, security arrangements [and other obligations] that it has given in respect of the JVC and its business.

20.6

The parties shall procure the registration (subject to due stamping by the buyer) of the transfer of shares in the JVC pursuant to this clause and each of them consents to such transfer and registration pursuant to this agreement and the Articles.

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20.7

The shares shall be sold with all rights that attach, or may in the future attach, to them (including the right to receive all dividends and distributions declared, made or paid on or after the events referred to in clause 20.2(a), clause 20.2(b), and clause 20.2(c)).

20.8

The party buying the shares is not obliged to complete the purchase of any of the shares being sold unless the purchase of all the shares being sold is completed simultaneously.

20.9

[If the party selling the shares fails to complete the transfer of shares as required under this clause, the JVC: (a)

is irrevocably authorised to appoint any person to transfer the shares on the selling party's behalf and to do anything else that the party buying the shares may reasonably require to complete the sale; and

(b)

may receive the purchase price in trust for the party selling the shares, giving a receipt that shall discharge the party buying the shares.]

21.

STATUS OF AGREEMENT

21.1

Each party shall, to the extent that it is able to do so, exercise all its voting rights and other powers in relation to the JVC to procure that the provisions of this agreement are properly and promptly observed and given full force and effect according to the spirit and intention of the agreement.

21.2

If any provision in the memorandum or Articles of the JVC conflicts with any provision of this agreement, this agreement shall prevail.

21.3

The parties shall, when necessary, exercise their powers of voting and any other rights and powers they have to amend, waive or suspend a conflicting provision in the memorandum or Articles to the extent necessary to permit the JVC and its business to be administered as provided in this agreement.

22.

CONFIDENTIALITY

22.1

In this clause Confidential Information means any information: (a)

which either party may have or acquire (whether before or after the date of this agreement) in relation to the customers, [suppliers,] business, assets or affairs of the JVC (including, without limitation, any information provided pursuant to clause 10);

(b)

which either party or any member of its Group may have or acquire (whether before or after the date of this agreement) in relation to the customers, [suppliers,] business, assets or affairs of the other party or any member of the other party's Group, as a consequence of the negotiations 27 243

relating to this agreement or any other agreement or document referred to in this agreement or the performance of the agreement or any other agreement or document referred to in this agreement; or (c)

which relates to the contents of this agreement (or any agreement or arrangement entered into pursuant to this agreement),

but excludes the information in clause 22.2.

22.2

22.3

Information is not Confidential Information if: (a)

it is or becomes public knowledge other than as a direct or indirect result of the information being disclosed in breach of this agreement;

(b)

either party can establish to the reasonable satisfaction of the other party that it found out the information from a source not connected with the other party or its Group and that the source is not under any obligation of confidence in respect of the information;

(c)

either party can establish to the reasonable satisfaction of the other party that the information was known to the first party before the date of this agreement and that it was not under any obligation of confidence in respect of the information; or

(d)

the parties agree in writing that it is not confidential.

Each party shall at all times use all reasonable endeavours to keep confidential (and to ensure that its employees, agents, Subsidiaries and the employees and agents of such Subsidiaries, and the JVC (in respect of information specified in clause 22.1(b) and clause 22.1(c)) shall keep confidential) any Confidential Information and shall not use or disclose any such Confidential Information except: (a)

to another member of the X Group or Y Group, as the case may be, or to a party's professional advisers where such disclosure is for a purpose related to the operation of this agreement;

(b)

with the written consent of such of the JVC or the party or any member of its Group that the information relates to;

(c)

as may be required by law or by the rules of any recognised stock exchange, or governmental or other regulatory body, when the party concerned shall, if practicable, supply a copy of the required disclosure to the other before it is disclosed and incorporate any amendments or additions reasonably required by the other and which would not thereby prevent the disclosing party from complying with its legal obligations;

(d)

to any tax authority to the extent reasonably required for the purposes of the tax affairs of the party concerned or any member of its Group; or

(e)

if the information comes within the public domain (otherwise than as a result of the breach of this clause 22.3).

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22.4

22.5

Each party shall inform (and shall use all reasonable endeavours to procure that any Subsidiary and the JVC shall inform) any officer, employee or agent or any professional adviser advising it in relation to the matters referred to in this agreement, or to whom it provides Confidential Information, that such information is confidential and shall require them: (a)

to keep it confidential; and

(b)

not to disclose it to any third party (other than those persons to whom it has already been disclosed in accordance with the terms of this agreement).

Upon termination of this agreement, either party may demand from the other and the JVC the return of any documents containing Confidential Information in relation to the first party by notice in writing whereupon the other party shall (and shall use all reasonable endeavours to ensure that its Subsidiaries, and its officers and employees and those of its Subsidiaries and the JVC shall): (a)

return such documents; and

(b)

destroy any copies of such documents and any other document or other record reproducing, containing or made from or with reference to the Confidential Information,

save, in each case, for any submission to or filings with governmental, tax or regulatory authorities. Such return or destruction shall take place as soon as practicable after the receipt of any such notice.

22.6

The obligations of each of the parties in this clause 22 shall continue without limit in time and notwithstanding termination of this agreement for any cause.

22.7

On the signing of this agreement the parties shall issue a joint announcement about the formation of the JVC in the agreed form.

23.

WARRANTY Each party warrants and represents to the other that, at the date of this agreement, the JVC has not carried on any business, has no assets or liabilities, has no employees and is not a party to any contracts except as necessary to comply with clause 4.

24.

WHOLE AGREEMENT

24.1

This agreement, and any documents referred to in it [or executed contemporaneously with it], constitute the whole agreement between the parties and supersede any previous arrangement, understanding or agreement between them relating to the subject matter they cover.

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24.2

Each party acknowledges that in entering into this agreement, and any documents referred to in it [or executed contemporaneously with it], it does not rely on, and shall have no remedy in respect of, any statement, representation, assurance or warranty of any person other than as expressly set out in this agreement or those documents.

24.3

Nothing in this clause 24 operates to limit or exclude any liability for fraud.

25.

ASSIGNMENTS

25.1

No person may assign, or grant any Encumbrance over [or sub-contract,] or deal in any way with, any of its rights under this agreement or any document referred to in it without the prior written consent of all the parties [(such consent not to be unreasonably conditioned, withheld or delayed)].

25.2

Each person that has rights under this agreement is acting on its own behalf.

26.

VARIATION AND WAIVER

26.1

A variation of this agreement shall be in writing and signed by or on behalf of all parties.

26.2

A waiver of any right under this agreement is only effective if it is in writing and it applies only to the person to which the waiver is addressed and the circumstances for which it is given.

26.3

A person that waives a right in relation to one person, or takes or fails to take any action against that person, does not affect its rights against any other person.

26.4

No failure to exercise or delay in exercising any right or remedy provided under this agreement or by law constitutes a waiver of such right or remedy or shall prevent any future exercise in whole or in part thereof.

26.5

No single or partial exercise of any right or remedy under this agreement shall preclude or restrict the further exercise of any such right or remedy.

26.6

Unless specifically provided otherwise, rights and remedies arising under this agreement are cumulative and do not exclude rights and remedies provided by law.

27.

COSTS Unless otherwise provided, all costs in connection with the negotiation, preparation, execution and performance of this agreement, shall be borne by the party that incurred the costs.

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28.

NO PARTNERSHIP The parties to this agreement are not in partnership with each other and there is no relationship of principal and agent between them.

29.

GOOD FAITH

29.1

All transactions entered into between either party [or any of its Subsidiaries] and the JVC shall be conducted in good faith and on the basis set out or referred to in this agreement or, if not provided for in this agreement, as may be agreed by the parties and, in the absence of such agreement, on an arm's length basis.

29.2

Each party shall at all times act in good faith towards the other and shall use all reasonable endeavours to ensure that this agreement is observed.

29.3

Each party shall do all things necessary and desirable to give effect to the spirit and intention of this agreement.

30.

THIRD PARTY RIGHTS

30.1

This agreement and the documents referred to in it are made for the benefit of the parties to them and their successors and permitted assigns, and are not intended to benefit, or be enforceable by, anyone else.

30.2

The right of the parties to terminate, rescind or agree any amendment, variation, waiver or settlement under this agreement is not subject to the consent of any person that is not a party to the agreement.

31.

NOTICE

31.1

A notice given under this agreement: (a)

shall be in writing in the English language (or be accompanied by a properly prepared translation into English);

(b)

shall be sent for the attention of the person, and to the address, or fax number, given in this clause 31 (or such other address, fax number or person as the relevant party may notify to the other party, such notice to take effect five days from the notice being received); and

(c)

shall be: (i)

delivered personally; or

(ii)

delivered by commercial courier; or

(iii)

sent by fax; or

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31.2

(iv)

sent by pre-paid first-class post or recorded delivery; or

(v)

(if the notice is to be served by post outside the country from which it is sent) sent by airmail.

The addresses for service of notice are: (a)

[FIRST PARTY] Address: For the attention of: Fax number:

(b)

[SECOND PARTY] Address: For the attention of: Fax number:

31.3

A notice is deemed to have been received: (a)

if delivered personally, at the time of delivery; or (i)

if delivered by commercial courier, at the time of signature of the courier's receipt; or

(b)

if sent by fax, at the time of transmission; or

(c)

if sent by pre-paid first class post or recorded delivery, 48 hours from the date of posting; or

(d)

if sent by airmail, five days from the date of posting; or

(e)

if deemed receipt under the previous paragraphs of this sub-clause is not within business hours (meaning 9.00 am to 5.30 pm Monday to Friday on a day that is not a public holiday in the place of receipt), when business next starts in the place of deemed receipt.

31.4

To prove service it is sufficient to prove that the notice was transmitted by fax to the fax number of the party or, in the case of post, that the envelope containing the notice was properly addressed and posted.

32.

INTEREST ON LATE PAYMENT

32.1

Where a sum is required to be paid under this agreement but is not paid before or on the date the parties agreed, the person due to pay the sum shall also pay an amount equal to interest on that sum at the rate set out in clause 32.2 for the period beginning 32 248

with the date on which the payment was due and ending with the date the sum is paid (and the period shall continue after as well as before judgment).

32.2

The rate of interest shall be [PERCENTAGE]% per annum above the base lending rate from time to time of [NAME OF BANK]. Interest shall accrue on a daily basis and be compounded quarterly.

32.3

This clause 32 is without prejudice to any claim for interest under the Late Payment of Commercial Debts (Interest) Act 1998.

33.

LANGUAGE If this agreement is translated into any language other than English, the English language text shall prevail.

34.

SEVERANCE

34.1

If any provision of this agreement (or part of a provision) is found by any court or administrative body of competent jurisdiction to be invalid, unenforceable or illegal, the other provisions shall remain in force.

34.2

If any invalid, unenforceable or illegal provision would be valid, enforceable or legal if some part of it were deleted or modified, the provision shall apply with whatever modification is necessary to give effect to the commercial intention of the parties.

35.

FURTHER ASSURANCE Without prejudice to clause 4, each party shall promptly execute and deliver all such documents, and do all such things, as the other party may from time to time reasonably require for the purpose of giving full effect to the provisions of this agreement.

36.

COUNTERPARTS This agreement may be executed in any number of counterparts, each of which is an original and which together have the same effect as if each party had signed the same document.

37.

AGREEMENT SURVIVES COMPLETION This agreement (other than obligations that have already been fully performed) remains in full force after Completion.

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38.

GOVERNING LAW AND JURISDICTION

38.1

This agreement and any disputes or claims arising out of or in connection with its subject matter are governed by and construed in accordance with the law of England.

38.2

The parties irrevocably agree that the courts of England have exclusive jurisdiction to settle any dispute or claim that arises out of or in connection with this agreement.

This agreement has been entered into on the date stated at the beginning of it.

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Schedule

Matters reserved for shareholder approval

1.

Permitting the registration of any person as a member of the JVC other than X and Y in relation to their initial investment and any of their transferees in accordance with the terms of this agreement.

2.

Altering the name of the JVC.

3.

Altering the memorandum or Articles of the JVC.

4.

Adopting or amending the Business Plan in respect of each financial year.

5.

Changing the nature of the JVC's Business or the commencement of any new busines by the JVC which is not ancillary or incidental to the Business.

6.

Making any acquisition or disposal by the JVC of any material asset(s) [otherwise than in the ordinary course of business].

7.

Creating or granting any Encumbrance over the whole or any part of the Business, undertaking or assets of the JVC or over any shares in the JVC or agreeing to do so.

8.

[OTHER RESERVED MATTERS.]

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Signed by [NAME OF DIRECTOR] for and on behalf of [NAME OF X]

.......................................

Director

Signed by [NAME OF DIRECTOR] for and on behalf of [NAME OF Y]

.......................................

Director

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