A substantial proportion of mining and petroleum projects in Australia are owned via joint ventures, because one of their key attractions is the ability to share the risks and costs associated with funding and developing a project.
Persistent inflationary forces resulting from supply chain constraints and government stimulus packages in response to the COVID-19 pandemic, along with soaring energy prices, are putting pressure on budgets and business plans for energy and resources projects. It is no surprise then, that one of the main considerations joint venture participants face when entering a joint venture is how to deal with a situation where a joint venturer is unable to meet its funding obligations. Ideally, a well-drafted joint venture agreement will clearly set out the rights and obligations of, and remedies available to, of each joint venturer to deal with that scenario.
Without that, the status quo will prevail and there is a risk of the project becoming deadlocked and grinding to a halt. But without careful drafting, these mechanisms can often be gamed by participants.
This article considers some of the options to address a failure by a joint venturer to fund its share of expenditure. As the most common form of joint venture for a mining or petroleum project is an unincorporated joint venture, where each participant holds a direct interest in the project, this article will focus on how these options are typically reflected in unincorporated joint venture agreements (or joint operating agreements in a petroleum context). Similar but some different considerations will apply to an incorporated joint venture (where each venturer's interest is shares in the JV company).
In an unincorporated joint venture, each participant is personally liable to fund its share of joint venture costs. It is therefore crucial for appropriate mechanisms regarding remedying a failure to fund to be reflected in a joint venture agreement.
Dilution clauses
Joint venture agreements may deal with the prospect of a failure to fund by diluting the non-funding venturer's interest. Typically, there will be a prescribed formula that is applied to re-calculate the non-funding venturer's interest after that venturer has had an opportunity to rectify the non-payment.
A dilution mechanism is more appropriate in a joint venture agreement for a project which is producing and in turn generating cash flow or where the venturers have agreed that a failure to fund will not be treated as a material default.
Dilution formulas vary, but generally will either be on a:
- straight line basis, stipulating the number of percentage points decrease in the participating interest for a fixed amount not contributed; or
- exponential basis, where the defaulting venturer's interest is determined by reference to its total expenditure compared to the total expenditure of all venturers.
Where you can go wrong
If a dilution formula dilutes the defaulting joint venturer's interest at an unconscionable rate in the circumstances, a court may find such dilution clauses to be a penalty and consequently unenforceable. Similarly, to the extent that a joint venture interest has sufficient proprietary character, a court may allow a defaulting venturer to claim relief against the forfeiture of their joint venture interest where the dilution would be unconscionable in the circumstances.
In addition, a joint venture agreement may include a minimum threshold interest that each joint venturer must hold (usually 5%-10%). If a joint venturer’s interest is diluted below that minimum threshold interest, it may be deemed to have forfeited its interest, perhaps in consideration for a royalty.
Compulsory sale (buy-out) clauses
Joint venture agreements may treat non-payment by a venturer as a default that triggers the "compulsory buy-out" or "forced sale" of the defaulting venturer's interest. A compulsory buy-out or sale of a defaulting venturer's interest is a more draconian option and may be more appropriate in a joint venture agreement where the venturers have agreed to a firm commitment to expend their agreed share of funding. Without funding, the venture or project cannot proceed, so a venturer that is incapable of funding should be liable to lose its interest.
Under such a mechanism, the non-defaulting venturer(s) will have the option of purchasing the defaulting venturer's interest in the joint venture, with the consideration for the transaction to be determined in accordance with the joint venture agreement.
Typically, the amount payable for the defaulting venturer's interest will be based on the market value of the interest, as agreed between the venturers or otherwise determined by an expert. Often a joint venture agreement will specify that a discount will be applied to the value of the interest (to discourage the possibility of the defaulting venturer profiting from the arrangements).
Where you can go wrong
The greater the discount the greater the risk a court will deem the buy-out clause to be a penalty and consequently unenforceable or otherwise grant the defaulting venturer relief from the forfeiture of their joint venture interest. CRA Ltd and Kelian Ltd v New Zealand Goldfield Investments and Claremont Petroleum [1989] VR 87 provides some useful guidance on the discount rates courts may enforce in the context of a compulsory sale clause. In this instance, a default provision in a joint venture agreement which provided for the non-defaulting venturers to acquire the defaulting venturer’s joint venture interest at market price less 5% was held to be enforceable.
Forfeiture (deemed withdrawal) clauses
Another method to deal with default of a joint venturer is through forfeiture (sometimes referred to as "deemed withdrawal") clauses. Like the compulsory buy-out mechanism, this is a draconian option. Forfeiture clauses will, when triggered, result in the defaulting venturer's interest being reduced to zero and the corresponding increase in the venturer interests of the other venturer(s), without any compensation payable to the defaulting venturer.
Where you can go wrong
A defaulting venturer may be able to claim the operation of the forfeiture clause was unconscionable and apply to the court to prevent its enforcement as either a penalty or as contrary to the relief against forfeiture doctrine.
Loss or suspension of rights
A joint venture agreement may (and usually does) provide that certain rights of a non-funding venturer are suspended or lost, such as rights to production, rights to information and rights to vote. The suspension or loss of rights is not commonly a standalone mechanism. Instead, a joint venture agreement will typically provide that a non-funding venturer’s rights are suspended or lost while the process for forfeiture or compulsory buy-out (as described above) is undertaken (and can be reinstated when the breach is rectified).
Cross security
A joint venture agreement may require that the venturers each grant a security interest over their respective interests in the joint venture in favour of each other to secure the performance of their obligations under the joint venture. This is commonly referred to as a "cross charge" or “cross security".
A cross security will typically also extend to each venturer’s share of production from the joint venture.
Failure by a venturer to meet its funding obligations may result in the non-defaulting venturers making up the shortfall and the resulting debt will be secured by the cross security.
Alternatively, the manager of the joint venture may have the right to take possession of the defaulting venturer's share of production pursuant to the cross charge and apply the process from the sale of the product to the shortfall.