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Joint Ventures in the Energy Sector: Structuring JVs for Success in Egypt

Legal Opinion

By Hugh Fraser, Managing Partner of Andrews Kurth Law Firm MENA Office and Legal Specialist in International Energy Law

The Commercial Rationale for Joint Ventures

The sheer scale of investment needed to bring Egypt’s deepwater upstream, downstream oil and gas, and power projects into operation, and the specific needs for foreign investment, casts a sharp focus on the joint venture mechanism for doing business in Egypt. The aggregate level of investment anticipated across these sectors currently exceeds $100 billion and it is hoped that the IMF funding package of $12 billion agreed in August will serve as the catalyst to kick start or accelerate much of the needed investment.

Joint ventures in the energy sector are, by definition, a compromise. The starting point for any business venture is that it should be wholly owned with full direction of strategy, investment, management, and financial rewards. They are set into play because one party cannot perform the business venture under its own steam or, if it could act independently, there are compelling commercial and/or legal reasons to combine resources and share risk. The sheer scale of investment needed is the typical driver for a joint venture in the energy sector and, in the MENA region, local ownership laws, local content procurement rules and policies, and the need for market connectivity all contribute to the lean towards the JV model.

Joint ventures are focused around the respective inputs and roles of the two or more participating parties, which typically revolve around six resources: capital, technology and intellectual property, clients and market connectivity, manpower resources, facilities and specialist equipment. The definition of who provides which of these resources and the management of the combination of the resources will be critical to the success of the venture.

They are differentiated from main contractor/sub-contractor, principal and agent/distributor, manufacturer/licensee, franchisor/franchisee and foreign beneficial owner/local nominee shareholder business relationships usually on account of their higher level of complexity, more integrated combination of resources and deeper risk/reward mechanisms where profits and losses are typically shared on a pro-rated fashion according to mutual ownership of the business. They can take the form of collaboration or co-operation arrangements on an ongoing basis, consortia for specific projects or “evergreen” joint venture companies where a separate legal entity is established.

The Key Commercial and Legal Issues in Joint Ventures

The commercial and legal issues and principles underpinning any joint ventures can be neatly segmented into ten areas:

The parties to and the objectives and scope of the venture including as to products/services and territory;

The legal structure and ownership of the joint venture, with much depending on whether a joint venture is being established and in that case whether on a 50/50 deadlock basis or a majority controlled/minority basis;

The financing of the business, budgeting, reporting, and controls; and related taxation inputs including liability for customs duties, withholding taxes, corporate taxes and personal taxes/social security;

The management and decision-making framework including key corporate governance and business ethics rules and policies; anti-corruption provisions are a major and topical risk management consideration;

The roles and inputs of the parties, as set out above, in relation to the six key resources inputs;

The financial rewards and returns to the parties: these may be channeled by way of interest on capital, royalties on intellectual property licensed in, rentals of facilities and/or equipment, fees for services for personnel provided and dividends/distributions of profits; the concept of resources being provided at “cost” or otherwise can be a key area of tension;

The allocations of risk and management of major risk concerns including warranties, indemnities, and insurance arrangements;

The protection of goodwill and the respective investments by means of exclusivity, non-competition and non-solicitation of clients and key personnel commitments and undertakings;

The governing law and dispute resolution mechanisms; and

The duration and exit arrangements.

A pre-requisite for success is that the parties have agreement and a shared understanding on how these issues are to be addressed.

The Process of Establishing
Joint Ventures

The process of establishing a successful joint venture can be considered under the following narrative:

First, there needs to be a clear and realistic market assessment for the venture and a rigorous selection and due diligence process on the prospective partner(s);

Second, Heads of Terms should be negotiated and put into effect to address the “key 10” legal and commercial areas set down above. If there is no consensus in these areas such that Heads of Terms can be agreed and signed off then the parties should not proceed to step three. It is no disgrace to admit “we could not reach consensus” and much time and investment can be lost by pretending otherwise;

Third, the Joint Venture Agreement and any ancillary contracts should be negotiated and finalized; the ancillary contracts may involve Subscription and Loan Agreements, Intellectual Property Licenses, Personnel Employment/Secondment Agreements, Services Agreements, Facilities Leases and Equipment Leases;

Fourth, the regulatory process for the establishment, registration, and licensing of the venture should be progressed including the obtaining and submission of all legalized corporate documentation and applicable investment/business plans;

Fifth, the process of vendor registrations with key clients and target clients should be initiated and completed; and

Sixth, all construction, installation, and commission steps should be implanted to bring the venture to state of operational readiness.

It therefore should be no surprise that it can take 12-24 months to have a joint venture move from conception to commencement and a realistic planning/implementation plan and critical path assessment is needed. Steps (after step 2) can and should be taken in parallel where possible, but, unfortunately, in most case, the various steps have to be taken sequentially.

Why Joint Ventures Fail or Succeed?

There is no magic formula for the failure or success of a joint venture but some of the consistent reasons why they fail can be recognized from past experience and analysis:

There was insufficient market assessment undertaken and/or the reaction of competitors was under-estimated;

The parties were ill-suited as business partners (which in many cases should have been recognized by proper due diligence) and/or one or more of the parties failed to properly perform/provide their role and inputs;

There was no consensus on the key legal and commercial arrangements (which should be avoided by the Heads of Terms/JV Agreements process if properly conducted);

There was lack of understanding of the establishment process and the timelines and costs involved, with lack of consideration given as to what interim commercial arrangements could have been instituted in parallel;

There were deficiencies in the budgeting/projections process with one or more parties under-estimating the funding requirements of the business until positive cashflow could be achieved, often resulting in cash calls being missed and defaults arising;

The management team was inexperienced, not fit for purpose or otherwise ill-chosen, and/or the decision-making processes were too bureaucratic or too loose and inconsistent with sound corporate governance and risk management;

There were failures in progressing timeously vendor registration formalities with clients;

There were deficiencies in the deadlock and dispute resolution process when commercial “crunch points” come to pass or legal problems arose relating to breach of contract by one of more parties (especially as to the protection of goodwill and investment provisions or the warranties that they were no prior or subsequent competing ventures or conflicts of interest);

There was a lack of good faith by one of the partners who sought to acquire control or total ownership of the venture by stealth and attrition; and

There was a failure to plan and implement a business-like exit arrangement in the event that the venture failed as a commercial concern or the relationship became unworkable.

The flip side of the coin has tended to be that, where these above issues are successfully addressed, the venture will have reasonable odds in favor of success.

In Conclusion

In conclusion, it can be seen the joint ventures are anticipated to play a key role in the progression of Egypt’s energy projects. There is skilled art involved in planning and implementing joint ventures if their chances of success are to be maximized. The main considerations are: the commercial rationale for the joint venture; the key legal and commercial terms; the process for the establishment of the joint venture; and the identification of the key ingredients for success and avoidance of failure. An honest, realistic and business-like approach to these areas is essential.

Hugh Fraser is Office Managing Partner of the Middle East office of the Andrews Kurth Law Firm - He specializes in energy transactions in the Middle East. Andrews Kurth collaborates with Open Chance Law Firm in relation to its Egypt energy practice.